Business Interruption Insurance Cover

Working as a freelancer (or even as a limited company), you no doubt understand the importance of carrying insurance cover for your prized asset – your kit.

You may also carry Public Liability cover and, if you employ others to work for you, then you should be carrying Employers Liability by law.

We find that there is one section of an insurance policy that we see very few freelancers (in particular) opting for, and that is Business Interruption cover.

Business Interruption insurance will compensate your business for the shortfall in either your gross revenue or gross profit, or pay any increase in your usual working costs, following an insured loss.   The important words here are “following an insured loss”.   If the item that suffered a loss isn’t insured (even under a different policy), or the claim isn’t covered, then your Business Interruption cover won’t operate.

For example, many businesses were affected by flooding a few years ago, and were unable to trade for extended periods whilst the damage was rectified, their stock replenished, or their properties rebuilt.  This could mean that they were unable to retain staff, unable to pay their bills and ongoing commitments, and unable to pay suppliers.

For those that didn’t have Business Interruption cover, we fear many now cease to exist or have had to drastically re-think their operations.

So what could go wrong for a freelancer or limited company?  Well, even if you don’t have a shop-front property (i.e. you work from home), the risks are still the same.  If your house is destroyed by fire, or if your kit is stolen or damaged, then your income could suffer as a result.

At Performance, we often hear “My insurance policy will pay to replace my kit”.  That is true, but what if the payout takes a couple of months?  What if your kit is on back-order for a period?  Even a short period of being unable to work can have a knock on effect for an extended period.

In the event of your home (if you work from home) being destroyed or made uninhabitable, then you also have to remember that your attention at this point is probably going to be focussed on finding somewhere for you and your family to live, rather than keeping your work ticking over.  You may have additional costs, such as having to pay to put your kit in storage, or paying to outsource your work to someone else in order to keep the goodwill of your clients. Again, Business Interruption cover can soften the blow in these circumstances.

Business Interruption comes in a number of flavours.  The three main bases on which you can choose to insure on are Gross Profit, Gross Revenue and Increased Cost of Working.

The first two – Gross Profit and Gross Revenue – are pretty similar.  To give a very simplistic explanation, if you insure on this basis, then your Business Interruption cover will, in the event of an insured loss, make up the difference between where your Gross Profit or Gross Revenue should have been prior to the loss, and where it is following the loss.

In order to arrange cover, your insurance advisor will need a note of your current and projected Gross Profit or Gross Revenue figures, and will also need to factor in an Indemnity Period (see below) for you.

Increased Cost of Working (ICOW) cover provides funds to your business to meet additional expenditure following an insured loss.  For example, if you have to relocate premises, then you may have costs such as additional rent, communications to let your clients know where you are, telephony and IT costs.   It usually states something along the lines of:

“The additional expenditure necessarily and reasonably incurred for the sole purpose of avoiding or diminishing the reduction in Turnover which, but for that expenditure, would have taken place during the Indemnity Period in consequence of the damage, but not exceeding the sum produced by applying the rate of gross profit to the amount of the reduction thereby avoided.”

Usually, the policy will pay a proportion of your annual limit of indemnity over a certain period.   This may be 25% of your maximum limit for the first 3 months following the loss and the remainder in proportion each month thereafter.  In this example, if you have an annual ICOW cover of £100,000, then £25,000 would be paid over the first three months, with the remainder at £8,333 per month thereafter.

If insuring on this basis, you will need to ensure that you arrive at a suitable limit of indemnity for your business, so speaking to your insurance advisor is essential.

Indemnity Period

When arriving at an indemnity period (i.e., how long your cover will operate for), you should not only consider how long it will take to rectify the damage, but also how long it will take you to return your turnover to exactly the same position as it was prior to the loss.  Things to consider are – debris removal of premises, planning and building consents and permits, lead times on kit, and winning back lost customers.

Usual indemnity periods are 12, 18, 24 or 36 months, and your limit of indemnity will be extrapolated over this period (e.g. if you have a revenue figure of £100,000 per annum, then your limit of indemnity would be £200,000 over a 24 month period).

Forecasting/Projecting

One final piece of the jigsaw on Business Interruption cover is ensuring that your limit of indemnity (i.e. how much cover you have) is sufficient to cover future losses.

Take the following example:

– Buying Business Interruption on 1st January 2016 with a 12 month indemnity period:

– If your revenue for the period Jan 2015 – Dec 2015 was £100,000 and you forecast 5% year on year growth:

– Projected revenue for Jan 2016 to Dec 2016 = £105,000

– Projected revenue for Jan 2017 to Dec 2017 = £110,250

Therefore, you should be looking for cover on 1st January 2016 with a limit of indemnity of £110,250.

Why is this?

Your Business Interruption cover begins to operate for the indemnity period you have selected (in this case 12 months) from the date of the loss.

Therefore, if you suffer a loss on the last day of your insurance policy period – 31st December 2016 – this means that your Business Interruption cover will operate for 12 months from this date, meaning that it should have a limit of indemnity sufficient to cover your reduction in revenue from 31st December 2016 to 30th December 2017 (at which point you would have been trading at the higher revenue figure).

With the examples we have provided above, there are only minor differences, but if you choose a longer indemnity period (such as three years), or your revenue amount is higher, or the amount of growth your business is experiencing is greater, then the difference between your current revenue and future income could be vast.

Remember, you don’t have to calculate these figures yourself – your usual insurance advisor should be able to help you arrive at a reliable, robust figure that is suitable for your business, and I would recommend that you enlist their expertise on this.

There is a bit of crystal-ball gazing involved here, and no one knows what is around the corner.  However, as the cost for business interruption cover is not particularly prohibitive, then erring on the side of caution to ensure that you have suitable funds available to continue trading would seem the sensible option.

With the above in mind, do remember that under-insuring will result in any claim you make being reduced by the same proportion you are under-insured by –  whilst having no cover at all would mean that, should the worse happen, you have to fund your own recovery programme at a time when your income has been most impacted – and that could have a devastating impact on your ability to trade.