At a glance
- Choosing the right maximum indemnity period is vital to ensure a business interruption policy provides the expected protection in the event of a loss
- Customers often underestimate how long it will take them to recover to their pre-loss position, increasing the risk of underinsurance
- We discuss the key considerations when choosing a maximum indemnity period
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Business interruption (BI) insurance policies are designed to return companies to the position they were in before a loss. Whilst that sounds quite simple, there are wide-ranging and complex factors that can undermine the effectiveness of a BI policy – and increase the risk of underinsurance.
One of the most common causes of underinsurance in BI policies is when sums insured are not set at the correct level, which is often due to misunderstandings about how to calculate gross profit.
Another leading cause of underinsurance is when businesses choose an insufficient maximum indemnity period (MIP) – the time during which claims can be made under a policy.
This is typically due to a failure in understanding the full range of factors that could delay recovery. Setting an adequate MIP is vital because once this period ends, the claim payments will cease, even if the sum insured has not been exhausted.
In order to set the correct MIP, businesses must account for a wide range of potential circumstances and factor in worst-case scenarios.
These circumstances could include: planning delays, inquiries and investigations, long-lead in times for replacement equipment and the time and cost of winning back lost business.
One piece that insurers must account for is any future increase in the business’s turnover. Whilst the policyholder will provide an estimate of the turnover and gross profit for the coming year, the insurer will apply an automatic increase to these figures to account for growth. Insurance provided in this format is called Declaration Linked coverage.
In the event of a total loss, such as following a large fire, a business will have to gain approval from the relevant local authority before demolishing and rebuilding affected properties.
Planning permission is not guaranteed and strict conditions may be imposed before work can begin. A typical example will be with the type of materials that can be used; this is especially relevant for listed buildings.
Businesses may also have to undergo expensive and time-consuming surveys, e.g. ground contamination, noise, flood risk etc.
Other factors that could add to delays include:
- Debris removal
- The discovery of hazardous materials during demolition, such as asbestos
- Investigations and inquiries into how the damage occurred (e.g. by the Health and Safety Executive)
Replacing lost equipment and machinery
While it might be relatively straightforward for an office-based company to quickly return to business after a major loss event, customers in industries such as manufacturing may find it more challenging to source suitable alternative premises and replace specialist equipment and machinery.
This is particularly true if equipment needs to be shipped in from overseas. A recent Insurance Age article highlighted concerns about the potential impact of Brexit. As one broker put it, “if a crucial piece of machinery needs bringing in from overseas, then there may be more delays and higher costs.”
Winning back lost business
Once a property has been reinstated, it may still take a significant amount of time to win back lost customers, train new staff, and integrate new equipment. When selecting an MIP, a company must therefore factor in the maximum time it could take to return to its former business level.
In light of the issues outlined above, the most appropriate MIP will typically be for at least 24 months. However, it is not uncommon for businesses to choose an MIP of only one year or a year and a half. It is important to remember that a shorter MIP significantly increases the risk of underinsurance in the event of a major loss. Indeed, it has been estimated that as many as 40% of BI insurance policies may be underinsured.
Of course, no two businesses will face exactly the same set of exposures. In order to ensure an adequate MIP is chosen, brokers and customers must work together to understand both their exposures and the business continuity measures in place to prepare for worst-case scenarios.