Business interruption and underinsurance - a guide

This article is intended to help you when insuring for Business Interruption under your Business Insurance policy. This type of cover can also be known as Loss of Revenue or Consequential Loss Insurance.

At Morton Michel, we have been working very closely with Covea and Sedgewick Loss Adjusters on the Covid-19 claims and we felt the following would be useful information for all childcare businesses to consider when reviewing their insurance needs.

What is Business Interruption intended to cover?

If Material Damage insurance cover protects the physical assets of your business then consider Business Interruption cover as insuring the financial health of your nursery.

In simple terms, insurance is designed to put you back in the situation you were in before the event occurred.  After a significant incident it is very likely that your revenue will reduce, and whilst some of your operating costs will reduce too, you will likely find you are faced with higher outgoings as you attempt to get back to normal.

It is essential that you insure for the correct amount as failure to do so can have significant negative consequences which can include the level of insurance payment you receive when making a claim and therefore the ongoing recovery of your business.

If the actual amount you should have insured for is much higher than the level of cover you actually have in place you are ‘underinsured’. This means you will have paid less premium than should have been paid to adequately insure the risk.

What is Average?

Insurers regulate this situation by applying a condition normally known as “Average” which states that if you are underinsured then the amount that you are paid out is reduced proportionately – whatever the size of the actual loss.

For example:

If you have told insurers your total loss risk is £300,000 but it actually is £500,000 then you would be paid 3/5 of the value of your valid claim.

Clearly in such circumstances you will recover less than you have lost.

Setting the right level of cover

We recognise there is scope for confusion in setting the correct sum for Business Interruption. 

The key point to remember is that you are insuring for Gross Revenue.

Your latest set of accounts will tell you what this was for the last financial year, it is top centre in the Profit & Loss account: it might be called

• turnover,
• revenue
• income or
• sales.

All of the above amount to the same in this instance i.e. how much money is coming into the business. 

You must remember to include all revenue sources, including income from Parents, Local Authority, charity or any other form of income.

Knowing your revenue for the last financial year is one thing but you must also consider how trading has been and will be for the next 12-18 months. Is your business growing? Are fees increasing? Have you developed other sources of funding?

Therefore, you must ensure you allow for growth within the declared revenue figure to help you avoid any underinsurance penalties. 

Setting the right maximum Indemnity Period

In addition to setting the correct amount you must also consider the period for which you wish to insure (known as the Indemnity Period).   Insuring your financial health for just 12 months may not be long enough.   You need to consider the knock on effects to the business of a long interruption to trading and that whilst you may have repaired all of the physical damage within a year there may be ongoing effects to the business.   If you are closed for a significant period, parents may have to look elsewhere for service, and if they do then it may be difficult to persuade them to come back. Given that siblings, friends and neighbours tend to follow existing cohorts then there is a potential for the revenue to remain reduced for many months to come.    In addition you should consider the position in respect of the building you are in.

• Do you own it? If not, you may not have control over the period of any significant repair.
• Are there any unusual features (Listed building, non- standard construction etc) – again, any such features may lead to delays in physical repair with the consequent effects on the ongoing financial position of the business lasting much longer than anticipated.

Given the above you should consider insuring the Loss of Revenue for a longer period than 12 months. Policies usually have 12, 24 and 36 month Indemnity Periods available to you.

Case Studies

Take a look at these case studies from customers who chose the correct level of cover and Indemnity Period:

Case study - Flood interruption to business

Case study - Large fire to nursery-owned premises