Indemnity periods in business interruption insurance – what do you need to know?

Business interruption insurance is intended to help an organisation get back to the same trading position it was in before a disaster, such as a major fire.

The big question is: how long would that take? Knowing how to calculate the indemnity period and what you need to consider could mean the difference between full recovery or business failure.

Insurers will pay claims, covering wages, bills, and loss of profits, up to a maximum indemnity period, beyond which businesses are on their own.

In this guide, we’ll explore the factors you need to take into account when calculating an adequate indemnity period, the pitfalls to avoid, and the risks of getting it wrong.

What is a business interruption indemnity period?

Business interruption insurance covers your reduced income while you cannot trade because of an insured event.

However, financial losses will only be covered for a maximum time period specified in your policy schedule – known as the maximum indemnity period (MIP).Indemnity periods are typically for a minimum of 12 months, but often extend to 24 or 36 months, or even longer. Most insurers specify that indemnity periods are set in six month increments.

On expiry of the MIP, any further loss of profit is not insured, so it’s vital to set a sufficient indemnity period to help your business re-establish itself following a loss.

What are the risks of getting your indemnity period wrong?

As we’ve discussed, once the indemnity period has expired, your insurer will stop paying for any reduced income the business may be experiencing because of the insured event.

Business interruption is intended to get your business back to the same trading position - making the same profit or similar level of earnings - as prior to the event, not simply to get your business trading again, or the property rebuilt.

For example, your manufacturing plant and all of its machinery are totally destroyed by fire, and you have a 12 month business interruption indemnity period.

Your plant is rebuilt and your machines are replaced within 12 months, but while you were temporarily out of business your customers found alternative suppliers.

It may take you a further 12 months to get your profits back to where it was before the fire but, as your indemnity period has expired, you must fund these losses yourself. In a worst-case scenario, if you didn’t have the capital to fund the business whilst rebuilding your profits then the business may have to cease trading altogether.

How to calculate your business interruption indemnity period

A key part of your business planning should include a business continuity plan and a disaster recovery plan, both of which will become important documents when calculating your indemnity period.

A business continuity plan will set out how you may best keep your business running during a range of scenarios, while a disaster recovery plan focuses on how you can get back to trading following a catastrophic event.

The documents, combined, are a good starting point when considering how long it would take you to reinstate your business following an incident.

There are many factors to consider when calculating your indemnity period, not only internal and unique to your business, but also external influences such as the effects of the war in Ukraine, Covid-19 supply chain issues, and Brexit.

Key factors to consider when fixing your indemnity period

How long will it take to repair or rebuild your premises?

This could depend on several factors, including:

whether the building is Listed, or of non-standard construction;
time taken for demolition and site clearance;
discovery and removal of any hazardous substances, such as asbestos;
you may need fresh planning permission, and building regulations and disability access requirements may have changed since the property was first built;
the need to hire architects and surveyors;
time taken for any tendering process.

Do you lease your premises?

If you lease your premises from a landlord, are they obliged under the terms of the lease to find you alternative accommodation?

Bear in mind you will not be in direct control of any rebuild, although it is likely to be in the landlord’s interest to move quickly as they may well have a time limit on their own loss of rent insurance.

Are alternative premises available?

If you own your own premises, you may be able to lease an alternative property to reduce your potential losses.

The costs of this can be covered under business interruption insurance, under an ‘increased cost of working’ clause, as long as the cost of the alternative accommodation will reduce your claim for loss of profits.

It may, however, take time to find a suitable premises for your needs and ensure that it is suitably set up for you to operate from.

How quickly can you replace machinery?

What are the lead times on replacing specialist machinery? Since the Covid-19 pandemic, certain types of equipment have suffered from global supply chain issues, leading to long delays if importing from outside the UK. Carefully research how long it would take to replace vital equipment and monitor this in case it changes drastically.

Similarly, if your stock is imported how long would it take to replace? The indemnity period for a business that sources stock from within the UK could be shorter than for one that relies on stock from China, for example.

The lead time on machinery could also have an effect on how long it takes to rebuild the property. If specialist machinery is needed for the rebuild, how long will it take your contractor to source what’s required?

Can work be subcontracted?

If you can subcontract work to others to fulfil customers’ orders, you may be able to retain their custom until you are able to get back to business yourself.

If not, you will need to factor in how long it is likely to take you to either win back lost customers or replace them with new ones.

Are there any Health and Safety Executive (HSE) inquiries?

If the HSE, or any other regulatory body, is investigating the incident that has triggered your claim, you may have to wait until its conclusion until you can fully get back in business.

How easy is it to recruit and train staff?

Your business interruption insurance will cover your wages while you are out of business, but it’s still possible some staff may find other positions. How easy is it to recruit staff in your sector, and how long will it take to train them to get them up to speed?

Is your business seasonal?

If your business is seasonal, and disaster strikes at the start of your peak period, will you be back up and running in time to take advantage of the following year’s peak?

If not, and your indemnity is for 12 months, you may miss out on two years of profits - only one of which would be covered.

How can an insurance broker help you get it right?

An insurance broker can provide invaluable experience of previous claims and point out risks that business owners and managers may not be aware of.

Business interruption policies can be purchased online, but most brokers advise against a one-size-fits-all, 12 month indemnity period because it proves insufficient in many cases.

A broker will also keep abreast of global issues that may affect your ability to recover trading - such as Covid-19 and Russia’s invasion of Ukraine - and recommend adjusting your indemnity period mid-term, not just on renewal of your policy.

And finally, a broker can make recommendations on how you could reduce risk – for example, by putting in a supply chain management plan.

FAQs

What is a waiting period for business interruption insurance?

Most business interruption policies have a waiting period, which is the number of hours or days following a physical loss (fire, flood etc) that must pass before the insurer will start paying out.

This is commonly 72 hours, or three days, though some insurers may provide the option to waive this in return for additional premium.

How are business interruption premiums calculated?

Business interruption insurance premiums are calculated based on a sum insured (usually gross profit) over the indemnity period required.

Can I extend my business interruption insurance indemnity period?

Yes, it’s possible to extend the business interruption indemnity period as long as you don’t have an active claim, subject to a revised premium.

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