Connor Campbell
Rhiannon Philps
Floods, fires and all manner of other disasters can come out of nowhere. Just look at the Covid-19 pandemic.
These kinds of unexpected events could mean that your business is forced to close for an extended period, which is likely to have a significant financial impact.
Business interruption insurance is there to cushion the blow of such events and minimise any financial losses. It can even help prevent your business from going under in the face of a true worst-case scenario.
For example, if trading is brought to a halt due to a flood at your shop, a business interruption policy can help to tide you over until you are fully back on your feet.
To find out what business interruption insurance covers and whether you need it, read on below.
How does business interruption insurance work?
Business interruption insurance covers you if your business is affected by a disaster or other emergency event. In other words, if your normal business activities are interrupted and you can’t trade or work as normal, this insurance should financially compensate you for what you would have earned in normal circumstances.
As long as the incident is covered by your policy, you can make a claim for the money you have lost out on. This can help you to pay employees and any other fixed costs such as rent, utility bills and loan payments to keep your business going until you can start trading again.
Bear in mind that, to get business interruption insurance, insurers will typically require you to have buildings and contents insurance.
You will then need to have a valid claim on your property or contents insurance if you want to claim on a business interruption policy for any loss of income caused by damage to your property.
This is so the insurer knows the cost of sorting out the damage itself is covered, which should help to minimise the time your business is out of action. This clause is known as a material damage proviso.
How is business interruption insurance calculated?
Business interruption insurance claims are calculated based on an estimate of how much income you lost during the period of time you were forced to close. The following factors will be used to work this out:
- How long your business is expected to be out of action for.
- The actual revenue of your business for that period (if you were able to trade at all).
- The costs your business had to pay, such as wages and other fixed payments, or the cost of moving to temporary premises.
- Your projected income for that period had your trading not been interrupted, considering seasonal and industry trends, the state of your business before the incident, and your performance in previous years.
What is covered by business interruption insurance?
Typically, a business interruption insurance policy would be designed to cover lost income and other expenses if your business premises, including essential equipment, is damaged or disrupted.
For example, it may cover your business in the event of:
- fire damage
- flooding
- storm damage
- electrical faults
- theft
- restricted access to your property
- damage at a supplier or customer’s premises
- disease
However, not every policy will cover all of the above as standard, and policies will come with strict terms and exclusions.
For example, many businesses tried to claim on their business interruption policies for the disruption caused by the Covid-19 pandemic and subsequent lockdowns, only to find some insurers wouldn’t pay out because it wasn’t on the policy’s list of specified diseases or because businesses couldn’t prove the presence of coronavirus at their premises, for example.
Because there was lots of uncertainty about whether businesses could claim on their policies for the financial loss caused by the pandemic, the Financial Conduct Authority (FCA) went to the High Court to get clear answers on this subject for customers and insurers.
The Covid-19 pandemic is a specific, one-off example, but it highlights how important it is to read and understand your policy documents in full.
» MORE: How to apply for a Coronavirus business interruption loan
Which costs are covered by business interruption insurance?
The costs that business interruption insurance will compensate you for will depend on the details of your policy. It can include, but is not limited to:
- Loss of gross profit and gross revenue the business would be earning if not for the disruption.
- Increased cost of working, such as renting a new, interim space or equipment.
- Ongoing operating costs, such as wages, rent or mortgage, taxes and utilities.
- Loan payments for loans taken out before the period of inactivity.
These costs will be covered for the length of the stated indemnity period.
What is the indemnity period?
Arguably the most important part of your business interruption policy is its indemnity period. This is the maximum length of time your business interruption losses will be covered by the insurer.
It is vital that you realistically assess how long it would take your business to trade again after a disaster or disruption, to ensure your business interruption policy covers you for the appropriate amount of time. This includes any rebuilding or restoration that might be required, and replacing lost or damaged stock.
The standard time frame for the indemnity period is between 12 and 36 months.
» MORE: What is professional indemnity insurance?
What is not covered by business interruption insurance?
What business interruption insurance doesn’t cover, however, is the actual cost of replacing or repairing any damage to the property or equipment itself. For this you would instead need buildings and contents insurance, equipment insurance, or commercial property insurance.
If employees or customers are injured at your place of work during the event, meanwhile, those claims would be covered by employers’ liability or public liability insurance.
Business interruption insurance policies typically come with several terms and exclusions, so make sure you read your policy documents carefully to know exactly what is and isn’t covered.
» MORE: What is business insurance?
Do I need business interruption insurance?
While there is no legal requirement to take out a business interruption policy, it is a form of insurance that should not be overlooked.
Without business interruption insurance, your business would have to pay any fixed costs, such as wages and bills, and cover any loss of income itself if something happened that forced it to stop trading.
While the cost of repairing or replacing any property that may be damaged should be covered by buildings and contents insurance, only business interruption would cover the cost of lost revenue and any extra expenses you had to pay during that period.
The main factors to think about when considering business interruption insurance are:
- whether or not you have a business premises
- whether any damage or disruption to that property, including any stock or essential equipment it may contain, would cause a material loss of future income
- how quickly your business could recover from an unexpected event causing disruption
- whether your business premises are located in an area frequently affected by natural disasters, such as flooding or wildfires
It’s up to you to think about the effect any unexpected incident would have on your business and your ability to work as normal. If it’s likely to have a significant financial impact that could make it difficult for your business to survive, then taking out insurance to cover this might be worthwhile.
So, for instance, if a fire or flood at your business premises would mean you could not trade for a significant period of time and you’d struggle financially to get by, you may want to take out business interruption insurance.
This is especially true for bricks and mortar retailers, which might have zero income if their premises were to close, or store large amounts of stock that would have a serious financial impact if stolen or damaged.
On the other hand, businesses that rely on an internet connection and little else – say a freelance writer working on a laptop, or a small business with employees who could work from anywhere – may not necessarily require business interruption insurance.
» MORE: Should I get business insurance?
How much is business interruption insurance?
Business interruption insurance will often be bundled together with other business insurance packages as an optional extra. However, it’s worth checking your policy in detail to ensure you are covered, as it may not be included as standard.
You can often add this cover to policies dealing with business properties, such as building and contents insurance.
Before deciding on the scale of your business interruption policy, it is important to carefully assess the potential loss of income your business would suffer in the event of damage or disruption to its premises, a realistic recovery time, and the costs you are liable for during the inactive period, such as mortgages, rents, wages, utilities, loans and taxes.
The insurer will then also take into consideration the risks associated with your industry, the location of your business premises, and any previous claims made.
All of these factors will help inform the level of coverage you need to take out and the cost of your overall premium.
Given the complexity of business interruption insurance policies, you may want to look into using an insurance broker, to ensure you get the right level of coverage.
Image source: Getty Images
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