Business interruption cover

According to a recent poll, economic conditions have forced 38% of businesses to cut their level of insurance, with one in seven small business owners saying they are operating without adequate insurance.

Business interruption (BI) is vital for virtually all businesses if they are to survive a major disaster; yet it is often tempting for policyholders to reduce or dispense with cover altogether when things get tough.

This is a false economy; one that brokers and insurers should re-emphasise to their clients. If a business has to close for any length of time, it cannot survive without revenue, particularly in times of limited credit.

Inadequate BI cover can be extremely damaging. Weeks or months without sales, or reduced sales, will affect cash flow and can, in some cases, lead to business failure.

Cashflow is crucial to staying in business and if a company can’t meet its short-term commitments, such as paying staff and suppliers, it faces an uncertain future.

The most common problem with BI cover is underestimating the maximum indemnity period. Many companies choose 12 months simply because it is the policy period or they estimate that it’s going to take only 12 months to rebuild.

But the maximum indemnity period should be set to reflect what might happen in the event of a major incident, not what will probably happen. Take the Buncefield oil storage disaster

and the London bombings in 2005 or the 2007 floods as examples. In each case, many businesses were left devastated and could not start trading again as quickly as they would have anticipated.

Many factors affect the ability of a business to regain its previous trading position when incidents of this scale happen. Contractors, builders and the raw materials needed for reinstatement are often in short supply, which will obviously impact on indemnity periods.

Planning permission is likely to come under serious scrutiny and debate, and there may be police investigations, health and safety inspections and a public inquiry into the events. All of these factors will seriously impact on the ability of a business to resume trading.

Planning permission, in particular, is becoming more of an issue, with businesses having to cater for increased energy efficiency to meet climate change targets.

After a fire in London, one policyholder had to wait seven months for planning permission.

Several discussions were held with the relevant local authority about changes to the original rebuilding plan to cater for environmentally friendly design and use of energy. For more hazardous risks, the process can be even longer.

And, of course, businesses still face perennial problems when setting maximum indemnity periods; replacing machinery or specialist equipment from overseas, setting lead times on replacement stock, and retrieving the loss of data stored on computer systems all must be factored in.

To plan efficiently and accurately for an interruption to trading, brokers must ensure their clients have taken all these factors into consideration.

We now have real evidence from many incidents over the past few years that a 12-month maximum indemnity period is not enough, especially in a recession.

My view is that now, more than ever, brokers should be recommending periods of no less than 24 months for most businesses.

Insurers also must do more to encourage this. Aviva has made a start, with 24 months being the standard maximum indemnity period within all of its small business packages, but the industry needs to do more.

Another common problem is simply understating the sum insured; it is imperative that the correct sum is set. To do this, brokers must always make sure that their clients are looking forward, not using the previous years’ profit, which has already been banked or spent.

We always encourage a business to consider the worst-case scenario and assume that it will suffer a loss on the last day of the forthcoming period of insurance.

Therefore, if the period of insurance is from 1 April 2009 to 31 March 2010, it must look at the potential loss of gross profit for the period 1 April 2010 to 31 March 2011 as a starting point for calculating the BI sum insured.

It also must consider other less obvious factors, such as inflation, and unforeseen circumstances, such as a main competitor going bust, or the business performing better than expected.

We always encourage over-insuring for BI, as virtually all BI insurances are on a declaration basis and premiums can be returned to the policyholder when the true figures for the period of insurance are declared.

Cutting insurance costs – on the proviso that a disastrous event may never happen and is an expense that can be saved – is a high-risk strategy. Without adequate cover, total business failure is not a foregone conclusion, but it is a gamble.

And what company wants to play roulette with its future?

Martin Singleton is Aviva’s technical manager