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The importance of setting an appropriate indemnity period

At a glance

  • Business interruption policies are unique in that they are limited by both a sum insured and a maximum indemnity period (MIP)
  • Inadequate MIPs are a common cause of underinsurance, as customers often underestimate how long it would take to recover following a loss
  • Looking at a customer’s business resilience measures is key to establishing a suitable indemnity period

Underinsurance in business interruption (BI) policies is common, and can jeopardise your customers’ ability to fully recover following a loss.

Unlike other insurance classes, underinsurance relating to BI can come from two major sources: an inadequate sum insured, and an insufficient MIP.

In this article, we discuss MIPs, why they are frequently exceeded and how to ensure your customers have indemnity periods that are sufficient for their needs.

The importance of maximum indemnity periods

An MIP is the time during which claims can be made under a policy following a loss. If the MIP expires – be it 12, 18, 24, 36 or 60 months – then claim payments will cease, even if the sum insured has not yet been exhausted. Therefore, setting an adequate MIP is as important as calculating a correct sum insured in the event of a large loss.

More than just reinstatement

BI insurance is designed to help customers recover to the position they were in prior to a loss.

This does not simply mean supporting a business while it reinstates damaged property, such as repairing buildings or replacing machinery. BI policies are designed to provide the continued financial support a business needs to return to its previous status.

Even after property has been reinstated, it can take a significant amount of time for a business to win back lost customers, train new staff or integrate new equipment.

Consequently, MIPs must account for the maximum time it might take a business to return to its former level of profitability. Brokers should ensure they are communicating this to customers and providing guidance on how suggested MIPs have been calculated, particularly shorter ones lasting 12-18 months.

Plan for worst-case scenarios

MIPs must account for worst-case scenarios. This includes taking into account a vast range of circumstances that can add significant time to a customer’s recovery, for example:

  • Thinking and decision time
  • Making planning enquiries and applications
  • Dealing with residents’ objections to planning applications and demolition and site debris removal delays
  • Environmental issues
  • Meeting strict listed-building requirements
  • Delayed planning decisions, or additional requirements added
  • Long lead times for replacing plant, machinery and other essential property
  • Discovery of hazardous materials, such as asbestos
  • Potential Health and Safety Executive (HSE) inquiries or proceedings
  • Recruiting and retraining staff
  • Seasonality – a loss may cause a business to miss important trading periods
  • Difficulty in winning back lost customers and opportunities

“People are often overly optimistic about how quickly their business will recover to pre-loss levels,” says Graham Herridge, Major Loss Team at Zurich. “We frequently see customers who have chosen a 12 month or 18 month MIP but I would argue that there are very few businesses for whom the shorter period is adequate.

”Issues can so easily arise that add time to a business’s recovery. I am aware of claims where, as a result of unforeseen delays, the business has not even begun reinstating its premises a year after the loss.

”In my experience, the choice of an MIP of less than 24 months is likely to be difficult for a broker to justify, if advice has been given.”

How to set the correct length

BI insurance provides the cash flow needed to assist a recovery. However, this is just one part of the bigger picture. The wider issue that customers are most concerned with is one of business resilience and how they can minimise the impact of potential losses.

Working with customers on issues of business resilience, for example, creating or refining business continuity plans, is central to determining what length of indemnity period they will need.

“You need to identify their exposures and how they would respond to a loss before you can start setting a suitable indemnity period,” says Ian Dunbar, Risk Engineer at Zurich. “Every customer’s resilience and post-loss actions will be different, so only by looking at their business continuity management and planning can you piece together possible loss scenarios, and therefore determine the length of time it would take for them to recover.”

How we can help

Business interruption is recognised as a particularly difficult area for both brokers and customers, with an estimated 40% of policies thought to be underinsured.

To help your customers minimise the potential for underinsurance, we offer a range of information and tools, such as our innovative Business Interruption Calculator.

For more details about how we can help, or to gain access to our Business Interruption Calculator, please speak to your local Zurich contact.

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