Article

Business Interruption insurance claims – getting it right

Forensic Focus - December 2016

The following Business Interruption (“BI”) insurance article has been reproduced from our 2011 Forensic Focus edition that was published following the Christchurch earthquakes.

Business Interruption insurance claims – getting it right

Business Interruption (“BI”) insurance should play an important role in funding the recovery of many businesses affected by the Christchurch earthquakes.  This article explains what BI insurance typically covers and what business owners and their advisers can do to ensure payment is obtained quickly.

What does Business Interruption insurance typically cover?

The BI coverage will depend on the policy wording, but typically it covers short term financial loss arising from interruption to a business’ operations as a result of damage to the business premises or equipment.  The cover is often extended to include prevention of access to the premises (e.g. premises within the cordon), and sometimes includes loss caused by interruption to supply of goods and services.

It is also important to check the BI insurance is not subject to any exclusions detailed in the insurance policy.  For example, some BI insurance policies will not cover the loss arising from property damage caused by natural disasters - including earthquakes.  

Importantly, BI insurance does not normally cover the financial loss arising from any general decline in demand following an earthquake.

How are Business Interruption insurance claims calculated?

The intention of business interruption insurance is to put you back into the same financial position you would have been had the damage and consequential interruption not occurred. Normally, business interruption insurance covers four key aspects:

+ Loss of gross profit / rent

+ Additional expenses incurred (e.g. hire of portable building for temporary premises)

- Savings in expenses

+ Reasonable claim preparation costs (e.g. accountant’s costs)

The approach to calculating your claim will depend on your BI policy, your business and the records available. An example business interruption claim calculation is shown below:

Example BI calculation

$

+ Expected sales (i.e. if the premises had not suffered damage)

 

100,000

- Actual sales

(20,000)

Reduction in sales

80,000

- Cost of sales (say 30%)

(24,000)

 

= Reduction in gross profit

 

56,000

 

+ Additional expenses (e.g. rental of temporary premises)

 

 

10,000

-  Cost savings (e.g. lease of damaged premises)

(20,000)

+ Claim preparation costs (e.g. accountant’s costs)

5,000

 

= Total BI Claim

 

$51,000

 

The calculation is conceptually straight forward.  However, applying it in practise can quickly become challenging when faced with the realities of:

  • Incomplete records;
  • Seasonality and trends;
  • Determining the level of sales that would have occurred had the premises not been damaged given the change in demand following the earthquake;
  • Determining the level of business successfully transferred to other branches.

What is the indemnity period? Why does it matter?

The indemnity period is the period of insurance protection.  It normally commences from the date of the event or damage and normally ends when your business is fully operational again or when the specified indemnity period has expired, whichever occurs first. 

Referring to the example above, if this loss of $51,000 occurred over a six month period, but the indemnity period is for three months, then some of the loss suffered will not be covered by the BI insurance policy.     

The indemnity period should be defined in your policy or schedule.

What is the sum insured?  Why does it matter?

The sum insured is the level of insurance cover in place.  It is the maximum amount of BI cover you have for your business.  Referring to the example above, if the sum insured is $40,000, the last $11,000 of the loss will not be covered by the BI insurance policy, leaving aside any excess.

What can I do to ensure my Business Interruption insurance claim is accepted and payment is received quickly?

Insurers have been inundated with insurance claims following the Christchurch earthquakes.  Having a robust, well presented claim that the insurers can quickly understand will maximise the chances of the claim being accepted and payment being received quickly.

When putting together the BI claim it will be important to consider:

Policy

The BI insurance policy underpins the claim.  It sets out what is and isn’t covered and the definitions to be applied in your situation.

Damage to the property

The BI insurance policy normally requires there to be damage to the business premises or other property, although the business interruption may be covered by extension.

Extensions

Your BI policy (or schedule) may include extensions or items that are covered in addition to loss arising from damage to the premises.  Extensions may include:

  • Prevention of access to the premises (e.g. premises in the cordon);
  • Interruption to the supply of goods and services (e.g. loss of electricity and water);
  • Interruption caused by damage to the premises at suppliers and customers.

Sometimes the cover under extensions is limited to a percentage of the sum insured (e.g. 10% of the sum insured).

Exclusions

The BI policy will include a list of exclusions or items that are not covered by the BI policy.  Some BI policies specifically exclude the loss arising from damage caused by natural disasters including earthquakes. 

Financial loss

The financial loss suffered will normally need to be as a result of damage to the business premises (or covered by extension and not excluded).

Presentation

The presentation of your claim is critical.  The insurer processing your claim is likely to be dealing with thousands of claims and have limited knowledge of your business.  It is important that you provide your insurer with all of the relevant background and financial information needed to process the claim. We recommend you provide your insurer with the following:

a)    A brief covering letter setting out:

  • An overview of your business including the location(s) of your business;
  • Details of the damaged premises, details of prevention of access to the premises or details of interrupted supplies/utilities;
  • Current operations (e.g. are you trading from new premises or are you looking for new premises, etc);
  • Impact on trading (i.e. did your business completely shut down or were you able to partially trade);
  • A timeline of key events;

b)    Your calculation including any assumptions made (this should be cross referenced to (c));

c)    Supporting documentation for your claim calculation.

Review

Subjecting your claim to independent review by experienced forensic accountants will ensure it is robust and easy to understand. This will enable your insurer to process your claim efficiently, maximising the chance of timely payment of your claim for the right amount.  The independent review will also provide the insurer with additional comfort.

If you would like more information about Business Interruption insurance, please contact Jason Weir.

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