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Insurance for Business Interruption

Preamble

This content is independent of any content coming from insurance brokers or insurers or law firms. Commercial insurance is rarely taught in schools, and when it is it’s mostly done through the lens of brokers or insurers. There are many misconceptions around Business Interruption Insurance, just like many topics in commercial insurance, due to bad habits acquired through over reliance on insurance brokers or insurers or information providers who are lobbied by them. It is also important to note that insurance has both an operational aspect and a legal aspect, on which we put weights of 95% and 5% respectively in terms of importance to protecting a business and its investors (the point is that going to court to enforce coverage defeats the purpose of buying insurance, so you want to make sure that whatever insurance you buy protects your business right and pays out fast on large losses).

What is business interruption insurance? 

It is insurance in case a business stops operating due to some incident and loses income as a result, whether it’s through a reduction in revenue or an increase in expenses or both. The business interruption insurance, if reworded and triggered correctly by independent risk experts, will pay back the business for its lost revenue or profit up to a certain amount depending on the business interruption insurance limits purchased.

What is contingent business interruption insurance?

It is insurance in case a business loses income because another business that is their supplier or customer stops operating due to some incident. For example, a food distributor loses on income because their food supplier stopped operating due to an explosion in their plant, which resulted in the food supplier halting its operation and not being able to provide its produce to the distributor. There are many other business interruption examples ranging from simple to complex supply chain risks and across various industries.

Supply Chain Risks Management

If a business relies on a supply chain or is an integral part of it, then any interruption in the business’ operations or those of its suppliers or customers can trigger deep losses throughout the entire chain resulting in various forms of financial losses, ranging from lost profits, financial liability, to anti-competitive pricing to consumers. The management of supply chain risks deals with such issues to avoid or minimize financial losses, this includes the effective use of commercial insurance. In this article, we focus on the insurance aspect of supply chain risks management, which is the second line of defence a business should pay attention to after having identified and measured its priority supply chain risks. Some risk experts consider the implementation of controls to reduce risks as a second line of defence, however we see the use of business interruption insurance as equally or more important mainly due to technical risks tied to control implementation. That said, while it is important to understand what is business interruption insurance and how it protects a specific business, it is as important to pay attention to what is contingent business interruption insurance, as well as to audit the insurance of suppliers and customers.

Before jumping into details, let’s talk about how insurance for business interruption risks failed the world during Covid19 because it is important for readers to realize that a commercial insurance policy, as worded by an insurance company, is flawed in general in that it statistically benefits the insurance company because it does not cover relevant business risks. The insurance broker is employed or compensated by the insurer to sell such a policy, sometimes with minor window dressing amendments through coverage endorsements. It is therefore of utmost importance that any commercial insurance policy be reworded and/or managed by risk experts independent of any insurance broker or company. The failure of insurance to pay out to businesses during Covid19 was the biggest evidence of that. So let's cover that next and then circle back on specifics regarding the business interruption insurance policy wording, what it covers, what it costs, how to claim it, and more, tying it all back to ensure that your business interruption risks, whether physical, cyber, or financial in nature, are protected against, which ultimately impacts your supply chain risks management.

The biggest insurance failure in history

Covid19 destroyed the operations of millions of businesses around the world and is considered to be one of the largest business interruption risks in modern history. Many businesses in the US carried property insurance with an extension for business interruption coverage yet when they tried to claim on their insurance, insurance companies denied payout arguing that Covid19 as a virus did not represent direct physical damage to property.  

While each policy is different, coverage would depend on the business interruption insurance policy wording that a business had signed up for. But the large majority of businesses did not seek the assistance of risk experts independent of insurance brokers or companies, which resulted in them signing up to the original wording designed by insurers and which ultimately led to little or no business interruption insurance payout.

What ended up happening is businesses, a lot of them SMEs, filed lawsuits against their insurers with the assistance of various law firms. But did they ultimately win their fights? The following summarizes the results of their efforts in U.S. courts:

Court results on covid suits against insurers

The above chart shows us that insurance companies will go to great lengths defending their positions and file for appeal in order for cases to be diverted to Federal Court, which produces a much lower rate of success for the plaintiffs (SMEs). Now let’s take a look at the types of businesses that launched lawsuits against their insurers. As you will notice in the chart below, various industries were represented, most notably those that were directly impacted by Covid19 disruptions.

Covid suits against insurers by industry

Finally, the following chart shows that the problem of the insurance for business interruption not paying out was systemic across the insurance industry and not just tied to a single or a couple of insurers. The large majority of commercial insurance policies designed by insurers are sold by insurance agents or brokers. It is clear in this case that insurance brokers did not benefit businesses whatsoever. While this may be a surprise to businesses, it is simply because insurance brokers do not have the business models to be independent risk experts.

Insurers in covid litigation

Please note that the illustrated charts are based on data of the Covid Coverage Litigation Tracker compiled by the University of Pennsylvania Law School in cooperation with the University of Connecticut School of Law, Insurance Law Center.

What is business interruption insurance (in detail)

Business interruption risk definition

Business interruption is a type of Operational Risk and relates to the risk of loss resulting from the interruption of the operations of a business caused by people, systems, processes, or external events. But is this the definition that is being used by insurance companies to cover the risk through a business interruption insurance policy? The answer is NO.

Let’s take a look at how an insurance company defines business interruption risk within a traditional commercial property insurance policy. Within the below snapshot of a business interruption policy wording, the coverage provided by the insurer gives you an idea of how they view business interruption risk, however keep in mind that every insurance company drafts their commercial insurance wordings and definitions differently.

business interruption insurance wording

An important thing to note is that this insurer’s wording, like many others, ties the business interruption coverage specifically to damage to a business’ property, premises, contents or those of its suppliers. So the definition of business interruption risk provided by this insurer relates to physical type risks only, as opposed to cyber or financial type risks.

Moral of the story? What businesses think is covered may not be covered simply because the way a risk is defined in general terms or in technical terms amongst the risk management community is the not the same way it is defined within the insurance community. That is certainly the case with insurance for business interruption as evidenced by Covid19.

How to claim business interruption insurance

Claiming insurance for business interruption has to be done by insurance consultants or experts independent of brokers and insurers, who work for or are hired by the business and not the insurer. There are various terms and conditions that need to be analyzed prior to notifying an insurance broker or company of the claim. This preparation phase is vital to the success of the claim. It is a lot less expensive for the business if they hire such independent insurance consultants (also known as insurance risk consultants) in the policy audit and rewording phase prior to a claim occurring.

It is important to note that successfully claiming any type of commercial insurance can contribute up to 50% of the insurance payout ratio and requires a methodical approach in order not to be offside with any policy wording and jeopardize a claim. What typically happens is that a business notifies their insurance broker, whom in turn notifies the insurance company, and from there on the claims process happens between the insurer, or the loss adjuster they assign, and the business directly. Note how the insurance broker is completely removed from the claims process.

In aggregate, businesses have lost many billions of dollars of insurance coverage paying out due to faulty claims processes. Some of those with sizeable resources at their disposal resort to hiring lawyers to negotiate and litigate against the insurers, which adds more cost and many of them are not even successful in court because they have either clearly signed up to irrelevant insurer wording or initiated a faulty claims process. These lessons certainly apply to claims on insurance for business interruption.

Business interruption insurance indemnity period

While the typical indemnity period for insurance for business interruption is 12 months, this can be negotiated depending on what the business needs. Risk management experts like ourselves model the operational data of a business to figure out its needs.

Business interruption insurance premium calculation 

Many insurers have their own in-house rating models that spit out a premium based on specific entries to their models. The premium calculated by one insurance company can be very different from another because of insurer specific cost of capital considerations that are taken into account and that are unrelated to the actual business interruption risks at hand.

Factors specific to business interruption risks that impact premium include: nature of the business and the type of industry in which it operates, the amount of revenues or profits it needs insured, the indemnity period, the coverage terms and conditions around what/when/how. To illustrate a very simple example, a retailer can pay business interruption premium of 20% of its total commercial property insurance premium, while a manufacturer could pay 50%, for similar revenues or profits insured, coverage terms and conditions, and indemnity periods.

Business interruption insurance online quote

If you are looking for a quote for tailored insurance for business interruption, you can contact us. Our team will have brokers compete for your business while auditing the wording you sign up to. We contractually guarantee cost and service to you.

Be careful of getting quotes from online broker platforms and signing up to them, which we strictly do not recommend unless you are simply looking to purchase the insurance to tick a box for regulatory purposes or contractual obligations. This is because the policy wording will in no way shape or form, be tailored to your operations and needs. Stay away from online platforms, many of which are simply licensed as insurance brokers yet make the process more efficient, until there is proven technology that rewords the policy online matching your operational needs and providing you proof of that.

Frequently Asked Questions

Does insurance cover business interruption?

Yes. However, there are different commercial insurance policies covering different types of business interruption depending on how they are worded. Your perception of coverage really depends on how you define business interruption. Please refer to the section above ‘Business interruption risk definition’ for more information.

Does business interruption insurance cover wages?

Yes but only when the insurance for business interruption is done on a gross profit basis (ie. covering lost profits as opposed to lost revenue). Remember that each policy designed by insurers is different and the devil is in the details so the wording must be analyzed word by word to figure out things like how ‘wages’ are defined and covered.

How much business interruption insurance do I need?

This depends on your business interruption risks, what their measures are, and what your operational data is.

How much is business interruption insurance?

It really depends on many things and cost may vary greatly from one business to another. Please refer to the section above ‘Business interruption insurance premium calculation’ for more information.

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