Business success typically relies on a business carrying out its planned activities uninterrupted. It can, therefore, be beneficial to have insurance to cover lost income, should an unexpected event prevent business as usual – but only if the insurance policy has been taken out correctly.
Business Interruption insurance is the cover that can step in to put the business in the same position after its loss, as if the loss had not occurred. When taking this out, a business has to calculate its anticipated income and costs and insure for the difference between the two – the estimated gross profit. That is where the business benefit from brokers guidance.
Many businesses think about their gross profit estimate in accounting terms, using figures their accountant produces for their end-of-year figures. That is not, however, the figure an insurer uses. When it comes to insuring gross profit for Business Interruption purposes, it is an Insured Gross Profit (IGP) figure that is required not Accounting Gross Profit (AGP).
The difference between the two is a fundamental one. IGP is the business’s sales, less any costs varying directly with sales – the uninsured (specified) working expenses. AGP, on the other hand, is calculated on the basis of sales less the total cost of sales. Here, the costs deducted from income include wages, whereas, for insurance purposes, the cost of wages should not be deducted. That is because it is rare for all wages to be variable and influenced by the sales generated.
Another mistake relates to rent. Some businesses assume this too is a variable and that, if they could not trade, rent would not be charged, and rates and utility costs not incurred. This might not be true. Partial building damage would still see rent paid and other costs charged.
Not including such costs would leave the sum for IGP at too low a figure, effectively leaving the business underinsured. If they claimed, the insurer could take one of two actions. They could either completely refuse to pay, if they believed IGP under-estimation had been deliberate to keep the premium down or could apply the law of average to the amount paid out. Here, they would base the payment on the ratio of the declared gross profit to the actual sum required, only paying out a fraction of the figure the business anticipated receiving.
This could be a very costly mistake and it is one the law adjudges the individual business’s responsibility, even if they use a broker.1 The law believes it is not for a broker to question figures provided by the client. What the law does expect is for the broker to explain the difference between IGP and AGP, so the client can produce their figures accurately. A broker should also ask relevant questions, both when the policy is first taken out and at renewal.
However, it is for the business itself to calculate IGP and provide the figures, as well as deciding the maximum indemnity period for the policy – the length of time for which they will be covered. A broker will usually explain that a year is not enough. Following a major loss, such as a flood or fire, few businesses can get back to where they were pre-loss within a year. Premises may need to be completely rebuilt, with a lengthy planning permission process required.
There may also be long lead-times for acquiring specialist new equipment. Major contracts are often signed well in advance. It may take time to win clients back. A business may have seasonal demand, so may require two years to accrue the benefits from such seasonality. Again, however, it is for the business to decide on the indemnity period it requires, not the broker.
The broker needs to annotate all discussions and receive confirmations in writing from the client that the figure they have provided is the one they wish to provide to the insurer.
So, if you wish to insure your business against the losses that business interruption could bring, make sure you calculate your gross profit correctly, before supplying your figures. If not, the peace of mind you thought you had secured may not materialise.