The Magic of Business Interruption Insurance
Part 1 – Calculating your Gross Profit
Many businesses can suffer badly in times of a crisis, which may even mean having to close for an indeterminate period of time. Or worse still, for good! Whatever the disaster – whether fire, theft or flood, or maybe your entire IT network is hacked or corrupted – you need to protect it. Do you have the necessary Business Interruption insurance to counteract a disaster?
Many years ago I attended a British Insurance Brokers’ Association training course entitled “The Magic of Business Interruption Insurance”. It was a great course not just because it was well delivered and interactive, but also because it taught me two crucial elements when looking at Business Interruption (BI) insurance – how to calculate the Gross Profit (GP) sum insured, and the importance of setting the correct Indemnity Period (IP).
As this is a complicated area of insurance, and to avoid the onset of rigor mortis, I have broken it down into two parts, with the second blog (focussing on indemnity periods) to be published shortly.
How to protect your income and profits
BI insurance is designed to compensate your business for any trading interruption resulting from an insured event such as fire, theft or flood. Paying for any loss of income and additional expenditure incurred following such damage, it helps your business to regain its pre-loss trading position. You may be surprised to learn that one in five businesses suffer a major disruption every year! So it is essential that as a business owner you know how to protect your income and profits.
Gross Profit calculation – don’t use the figure from your Profit & Loss Accounts!
This is one of the main problems in setting the correct GP sum insured. Getting it wrong – which can frequently happen – often leads to underinsurance. Many businesses simply use the GP figure from their Profit and Loss Accounts. Accountancy GP is calculated as: Turnover less Cost of Sales, which represents costs such as:
- materials purchased
- factory overheads
In most disaster situations, losses suffered tend to be partial. For instance, trade could be interrupted but production may continue on a reduced level, meaning that production wages and overheads still have to be met. But if they have been deducted from the Gross Profit calculation, then payment cannot be made for them in the event of a claim. Which could be disastrous for your business.
Insurance Gross Profit Definition – take care when deducting UWE
For insurance purposes, most policies define GP by the formula shown in the box here.
Uninsured Working Expenses (UWE) is where the insurance gross profit differs from the accountancy gross profit. These are costs which vary directly in proportion to turnover, e.g. transport costs, discounts, packing, etc. So if your turnover reduces by 20%, then the cost will reduce by 20%. Very few costs vary exactly in proportion to turnover, so you should take great care when thinking about deducting these. Many insurers include a definition of UWE within the policy wording, and reference should be made to this with your broker.
Always adjust for future business trends
Best practice dictates that we should project our GP figure to the last day of the policy year to allow for inflation and growth during that period. Do remember to take into account any predicted growth in your business up to the expiry of the Indemnity Period and adjust your figures accordingly. For instance, if you expect a 15% growth over the next 24 months, then this should be reflected in the gross profit sum insured.
Avoid underinsurance with a Declaration Linked Policy
Where possible, a Declaration Linked sum insured should be used. Ask your insurance broker about this for your specific business, but in effect it provides a 33.3% uplift on the sum insured, helping to overcome some forecasting problems and avoiding underinsurance. Do bear in mind, though, that even with a Declaration Linked policy it’s still essential to provide as accurate an estimate as possible to adequately protect your business.
The Gross Profit basis is more appropriate for manufacturing businesses. The basis of sum insured required will depend on your type of business and how you operate. Again, discuss this with your insurance broker for the best advice tailored to your business.
Don’t be one of the 40%!
A significant number of businesses that suffer serious losses don’t ever recover, often ceasing business 12 months later. So consider this: If you’re using the gross profit figure from your accounts in your business interruption gross profit calculation, then you are likely to be one of the 40% of UK businesses that are underinsured.
Doesn’t bear thinking about, does it?
Business Interruption insurance can be the difference between your business recovering from a disaster and successfully achieving growth, like a phoenix rising from the ashes in all its glory, or it no longer trading and you ending up in debt.
Put the magic into your business … protect it from a crisis with Business Interruption insurance through Spencer Insurance Brokers!
For further information on this or any other insurance query please get in touch on 01235 868535 or [email protected]