Would you be prepared to survive and overcome a crisis if it struck your business? Many well-run small businesses simply lack the resources required to continue operating and must sell or close their doors at some point. Business interruption insurance, also known as business income insurance, is there to help you get through the hard patches, putting you back on your feet and trading as usual. In this article, we’ll go through the process of making a business interruption insurance claim, what it can cover, and the formula for making the BI calculation.
What is Business Interruption Insurance?
Business interruption insurance (BII) compensates a business for income lost as a result of having to close or limit its operations due to specific situations. Many businesses’ operations have been disrupted and income has been lost as a result of the COVID-19 pandemic. Some of these companies had business interruption insurance (BII) policies and filed claims with their insurer. However, policies vary greatly, and although some firms were protected under the circumstances of their claim, others were not.
Who Requires Business Interruption Insurance?
There are several elements that determine whether or not a business requires business interruption insurance, but the most important one is whether or not considerable damage to the business’s property or physical assets will impede its capacity to trade for an extended period of time.
In the event of a flood, for example, a sole trader who relies solely on a laptop and an internet connection to work would have little difficulty locating a replacement machine and a temporary location from which to function. A huge business with a lot of stock or equipment, on the other hand, would be more vulnerable if its assets were harmed or destroyed.
Since there is no legal requirement for business interruption insurance, it is the owner’s responsibility to evaluate the risks and determine whether a major disaster will impair the business’s ability to operate. If the answer is “no,” then a business interruption policy is unlikely to be required. However, if the answer is “yes,” the business is most likely in need of business interruption insurance.
What Does Business Interruption Insurance Cover?
Business interruption insurance typically covers the following:
- Profits: A policy will compensate you for profits that would have been generated had the event not occurred based on previous months’ performance.
- Fixed costs might include operating expenses and other business-related charges.
- Temporary location: Some plans cover the costs of relocating to and operating out of a temporary business site.
- Commission and training costs: Following a business interruption event, it is common for a corporation to need to replace machinery and educate employees on how to utilise the new machinery. Business interruption insurance might be able to cover these costs.
- Extra expenses: Business interruption insurance will reimburse reasonable expenses (above and beyond fixed costs) that allow the business to continue operating while it regains its footing.
- Ingress/egress of civil authorities: A business interruption incident may result in government-mandated closure of business premises, resulting in immediate financial loss. Forcible closures due to government-issued curfews or street closures relating to a covered event are examples.
- Employee wages: Wage coverage is critical if a business does not want to lose employees when closing down. When a business owner is unable to function, this coverage might assist them in making payroll.
- Taxes: Even when a crisis strikes, businesses must continue to pay taxes. Tax coverage ensures that a business can pay its taxes on time and avoid fines.
- Loan payments: Loan payments are frequently made on a monthly basis. Business Interruption coverage can assist a business in making such payments even when it is not producing revenue.
Business interruption insurance is sold as an add-on to a current insurance policy rather than as a separate policy.
What Doesn’t Business Interruption Insurance Cover?
According to the website of the Insurance Information Institute, business interruption insurance will not cover:
- Items that have been broken as a result of a covered occurrence or loss (such as glass)
- There is a separate policy that covers damage from earthquakes or floods.
- Undocumented income that is not reflected in your company’s financial records
- Utilities
- Pandemics, viruses, and infectious diseases are all possibilities (such as COVID-19)
Special Factors to Consider When Purchasing Business Interruption Insurance
It is important to note that the insurer is only liable to pay if the insured suffers a loss as a result of the interruption. The business will not recover more money than what the policy allows.
What is the Duration of the Business Interruption Indemnity Period?
The indemnity period for business interruption insurance is the time period during which a business’s earnings are covered under the terms of the insurance policy. The ‘maximum indemnity term’ is the amount of time (typically 12, 24, or 36 months) that the insurer will cover business interruption losses beginning with the date of the claim incidence.
When determining an indemnity period, examine the greatest amount of time it would reasonably take for your business to be able to trade again independently, taking into consideration issues such as the time it would take to rebuild damaged facilities and replace lost stock and equipment. As a result, it may be preferable to have an overly liberal indemnification period rather than one that may fall short.
Purchasing Business Interruption Insurance Cover
Business interruption insurance is frequently included in, or given as an optional addition to, business insurance packages that bundle many policies under one cost. It can also be added as an add-on to building and contents insurance plans.
How can I file a Business Interruption Insurance Claim?
Due to the intricacies and forensic nature of business interruption claims, having a specialist on your side to help calculate the claim on your behalf might be beneficial. This is when a Loss Assessor can come in handy. A Loss Assessor is an insurance professional who works on your behalf to prepare, present and negotiate reasonable compensation in a timely and effective manner.
The Loss Assessor will evaluate your company’s profit loss and ensure that the claim includes both tangible and intangible losses. Importantly, the assessed loss should be based on business expectations (what would have been accomplished if the event had not occurred) rather than just the previous year’s earnings. All contributing elements, such as seasonal variations and anticipated expansion, should be considered. Using a Loss Assessor alleviates most of the stress associated with filing a claim, allowing you to focus on getting your business back on track.
Advice from the FCA
The FCA has developed a policy checker to help small firms determine if the wording in their policy is identical to, or very similar to, the sample policy wording evaluated by the Supreme Court. It cannot, however, establish if a claim is valid or the amount owed, and firms should seek guidance.
In addition, the FCA has lately produced:
A list of insurers deemed capable of responding to COVID-19 by insurers as a result of the test case.
While having a policy on this list is certainly beneficial, the outcome of a specific claim must still be assessed on a case-by-case basis.
Also, there could be a variety of reasons why an insurer has left a policy off this list, such as if it contains language that the test case does not evaluate.
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General questions and answers for business interruption insurance policyholders: This provides a link to the final guidance on demonstrating the existence of COVID-19 in order to file a claim. If a business is unable to demonstrate a case within any relevant radius indicated in the policy, it may be unable to file a legitimate claim. You should check our instructions to determine whether a case of coronavirus was present so that you can make a claim under your coverage. If you are unable to demonstrate a case within the policy’s applicable radius, you may not have a legitimate claim. The FCA has issued final instructions on demonstrating the presence of coronaviruses.
Claims data were collected from all concerned insurers to demonstrate the status of their non-damage BI claims. The FCA has directed insurers to engage directly with policyholders who have filed claims/complaints that may be affected by the Supreme Court’s decision. If a company is dissatisfied with its insurer’s answer, it should seek guidance on the next steps.
Calculation of Business Interruption Insurance
The formula for business interruption insurance calculation is summarised here.
BI = T x Q x V
where:
BI stands for business interruption.
and:
T = the number of time units (hours, days) in which operations are halted
Q = the usual number of commodities produced or sold per unit of time utilised in T
V = the monetary value of each unit of production, commonly expressed in profit.
Let’s go over an explanation of this business interruption insurance calculation formula and look at some of its applications.
Quantity
One of the most difficult aspects of a Business Interruption insurance claim calculation is determining quantity, or a definite number or amount. When specific production is lost, the figures can be simpler. However, when output varies due to unanticipated demand, the claim becomes more complicated. When a manufacturing plant’s output is reduced or halted as a result of an insured loss, forecasting what output levels would have been becomes speculative. How much money could we have made?
A claim preparer traditionally compares planned, budgeted, or predicted output against historical output and trends. When the loss period is exceptionally protracted or when the business lacks previous data, this approach gets more complicated (e.g., start-ups or new product introductions). The time, effort, and documentation required to compute the amount are also up to interpretation, as these frequently vary with the comfort level and experience of the insurance company’s adjusters and accountants.
Time
Time is one of the few non-replaceable commodities. While in the Business interruption formula, time refers to the length of the loss period, this is where many of the most difficult claim arguments arise. For example, in the United States, the end of the indemnity or loss term is often defined as “the period of time until physical repairs are complete” or “frequently until business returns to normal.” However, in the United Kingdom, the Lost Profits Form frequently specifies a specific term of loss.
When the adjuster and insured cannot agree on scope, time is variable. Physical repairs, according to the adjuster, should take 8 months, but the policyholder believes they will take 10 months. Who is responsible for the extra two months—the insurer or the insured? Is the difference shared and/or bargained for? The BI formula is relevant in this case for various reasons:
- An exact cost for the two months in question can be computed; and
- if time is of the essence, either side can hire an engineer or a consultant to perform a critical path analysis or use other methods to resolve the doubt.
Value
Value complicates the business interruption model by introducing the worth of each unit of production. When determining value, questions such as What price per unit would have been charged? What kind of gross margin or profit margin was anticipated? And how much money would have been saved if the expenses had not been ongoing? While “saved expenses” appears to be a simple concept, there is still an opportunity for disagreement between the policyholder and the insurer.
Forecasting sales or production entails a number of procedures. The crucial variable is documentation, which is used to estimate the type and amount of business that would have occurred during the business interruption claim period. For example, if the business is seasonal, it may take several years of expertise to build a production and sales profile.
Forecasts and budgets might reveal what management expected for the time period in question, especially if previous forecasts were true. External economic predictors, such as trade association data, industry information, or Department of Commerce statistics, should be reviewed and incorporated into the model as needed.
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With all of the variables introduced by the value inquiry, it’s no surprise that the calculation might be complicated. Most business interruption insurance claims do not have a single issue or item to remedy, but rather a mosaic of challenges to overcome, comprising each of the issues of time, quantity, and value.
A wonderful example would be the real estate corporation that specialized in transforming troubled properties into profitable timeshare properties—a claim that is further complicated by some legislative concerns. This real estate firm purchased three Caribbean resorts from a company on the edge of bankruptcy. Three months following the sale, the new owner had managed a 30 percent rise in sales over the previous year—a remarkable feat given that those three months were also the slowest time of year for resort properties.
The claim preparer established a mechanism to consider the adjuster’s concept of deferred or delayed realisation of sales while still reimbursing the policyholder for the loss through extensive analysis, including educating the insurance adjuster to better understand the typical sales life of a timeshare property and considering the inherent business risk in maintaining such a property.
One of the numerous approaches to valuing the claim was proven by using a “present value” strategy of future sales, as well as a “diminution in value” approach. Both incorporated the BI formula’s mechanics. The claim preparer provided enough choices for both the policyholder and the insurer to work towards an acceptable loss valuation by presenting multiple estimates as well as additional horse-trading in the property claim.
Business Interruption Insurance FAQ’s
Are business interruption insurance proceeds taxable?
There is no exception for proceeds received from business interruption coverage for lost income. Furthermore, because such proceeds compensate for income that would otherwise be taxable, they are taxable. On a company’s tax return, the proceeds are simply reported as an item of ordinary income.
How do you calculate loss of income for business interruption?
One method for calculating revenue lost due to a business interruption is to first determine the difference in sales and then remove the expenses saved as a result of not having the sales. To put it another way, calculate predicted sales, remove actual sales, and then subtract expenses saved as a result of not having those sales.
Does insurance claim count as income?
No, insurance claims payments return you to your previous state and do not constitute income. Insurance claim payments, on the other hand, diminish deductions for medical bills, casualty, and theft losses.
