Make your business interruption policy work for you

The impact of the COVID-19 pandemic on global economies highlighted business interruption as the most important business issue to confront in 2021, according to the 2021 Allianz Risk Barometer. The annual survey by the internationally recognized insurance company noted “companies need to prepare for a wider range of business interruption triggers and extreme events” as a result of pandemic-related disruption. The report further highlighted pandemic outbreak (with related health and workforce issues) and cyber incidents (in part due to increased remote workforces) as the second and third greatest threat facing business, respectively.

These survey results bring to light the heighted awareness of the threat of disruption in the current business environment. All disruption events – from global supply chain issues to cyber incidents and more traditional property damage – are challenging to manage effectively. And as noted throughout 2020, even the most prepared are not completely able to insulate themselves from business interruption losses.

After a loss event occurs, businesses trying to quantify their losses from interruptions face numerous challenges, not least of which is trying to manage the quantification process at the same time as the disruption itself. To further complicate matters, insurers in Canada have had varied responses to business interruption claims since the outset of the pandemic, resulting in numerous ongoing lawsuits to settle legal policy wording questions. Considering this state of affairs, it is imperative businesses take an opportunity to better understand the composition and nature of their business interruption insurance before a disruption event.

Review your coverage

Although policy wordings differ between insurers, business interruption coverage typically covers short-term financial losses (typically 12 months) arising from the interruption of a company’s operation from covered events. Coverage can extend to include lack of access to a premises and interruptions in the supply of goods or services – critical issues that reared their head during the pandemic.

Like all coverages, business interruption policies are subject to typical exclusions, such as business losses due to strikes, break or lapse of leases, contract penalties, etc. Understanding the full scope of the business interruption insurance that is in place is key to executing an effective loss strategy and business interruption analysis. An important aspect of this is understanding policy definitions, two of which are indemnity period and measure of recovery.

Indemnity period

 The indemnity period refers to the period of insurance protection, starting on the date of the event or damage and ending at the time defined in the policy. Generally, an indemnity period will end with either the length of time to rebuild, repair, or replace damaged items, or when the business returns to normal operations, depending on the policy wordings. 

Gross earnings, or similar terms, generally refer to the period to rebuild, repair, or replace, while gross profits wordings generally refer to when the business income returns to normal. Although superficially similar, the difference in terms can greatly affect the indemnity period and resulting loss of income. Gross earnings policies’ indemnity periods end when the final damage is rebuilt, repaired, or replaced, regardless of how customers react once that is complete. 

Once the business reopens and is operational again, it could take time for customers to return, especially after long-term closures. Gross profits policies are where the indemnity period continues until the business returns to normal. Unlike gross earnings polices, where the indemnity ends on completion of repairs, etc., gross profits policies run after the damage has been rebuilt, repairs, or replaced, until income returns to normal. You will need an analysis of current sales and historical trending to develop an accurate projection of what would have occurred but for the insurance event. 

Measure of recovery

Based on the policy wording, the policyholder is eligible to recover their loss of gross profit or gross earnings, or whatever other measure as defined in the policy, produced by applying the rate of gross profit to any reduction in turnover caused by the insurance event.

Business interruption insurance is intended to cover the unavoidable fixed costs and loss of profit in the event of an unexpected loss of sales or revenue. To determine the actual loss sustained, you need to review your business’ income statement for the last completed fiscal year or 12 months prior to the date of loss. 

Determining fixed and variable expenses is necessary and essential to determine the gross profit or gross earnings rate. Fixed costs are those costs that continue regardless of any sales or production occurring. Variable costs include items such as purchases and credit card fees, or any expenses which can be avoided if sales or production is suddenly suspended. When the business is closed for an extended period, some costs may straddle the line between fixed and variable costs and described as semi-variable costs. For example, utilities will generally stay stable during a short loss, however for longer interruption periods, power usage may fall.

Consider extra expenses

Extra expense insurance is often added as additional coverage to a standard business interruption policy. Extra expense insurance covers additional costs in excess of normal operating expenses the company incurs to continue operations while its insured property is being repaired or replaced after having been damaged by a covered loss. These costs can include temporary property rentals to set up operations and rental of equipment, such as portable generators to continue partial operations.

Extra expense insurance allows the insured to spend in excess of any amount it will save on the loss of gross profits. It is important to work with an advisor with experience classifying and organizing these expenses for expediated submission, to obtain maximum benefit of extra expense insurance as part of the business interruption analysis.

Conclusion

Getting a handle on a business interruption claim starts well before the event takes place. By being proactive and developing plausible business interruption scenarios before losses occur, businesses can do much to lessen the confusion and frustration common to the claims process. 

First off, develop and understanding of your policies and coverage. Next, within the context of a business interruption loss, work to ensure you have the right data on hand; quantifying a loss is centred on review and analysis of your business’ financial statements, past performance and business trends. Work with an experienced advisor to review your policies and prepare an interruption analysis that coincides with the language of your policy coverage. The analysis and report will support your business being better prepared for a potential disruption event and getting back to business as soon as possible by providing the information needed to deliver on your policy.