Written by William Paull
Co-Founder & Account Director
On this page
- What does business interruption insurance pay for?
- Why is my "gross profit" figure for insurance different from my accountant's gross profit?
- Does the underinsurance penalty apply to a declared profit figure the same way it applies to a building?
- What does "indemnity period" mean, and how long should yours be?
- Why would spending money to reopen faster ever cost me money?
- Am I covered if I can't trade but nothing at my own premises was damaged?
- FAQ
What does business interruption insurance pay for?
Business interruption insurance restores the profit position your business would have been in if the loss had never happened. If a fire costs you $500,000 in sales, the costs you save while you cannot trade come off the claim. The real gap is the profit you missed, plus the costs that kept running.
On the business packs we place, business interruption is an optional section of your business insurance, beside the cover for your contents and stock. It pays only after insured damage, for the period on your schedule.
Business interruption or loss of rent? Loss of rent is the building owner's cover for their rental income, not yours as a trader.
Why is my "gross profit" figure for insurance different from my accountant's gross profit?
Because the two take different costs off your turnover. An accountant's gross profit takes off the cost of goods sold. On the business packs we place, the policy's gross profit starts from your turnover, adjusted for the movement in stock. It then takes off the working expenses you choose to leave uninsured. On most, those expenses are listed on your schedule, and they are usually the purchases that stop when trading stops.
Where your accounts count wages or overheads in the cost of sales, the insurance figure can be much larger than the gross profit they show. That is why we set the figure with you at quote stage.
Most wages don't stop, at least not immediately, so they stay inside the insured figure unless you choose to leave them out. If your lease keeps your rent running while the premises are unusable, the rent sits inside the figure too. Our page for business owner-tenants sets out what else a tenant insures.
Picture a suburban clinic or trade business turning over $800,000 a year. If it had to close, about $40,000 of materials and consumables would stop, but $350,000 of wages and overheads would keep running. Its insurance gross profit is then $760,000, and its net profit $410,000. Declare the net profit, and the figure falls $350,000 short.
Does the underinsurance penalty apply to a declared profit figure the same way it applies to a building?
Yes, in proportion, though the figure it tests is different. Most of the packs we arrange compare your gross profit figure with 80 per cent of a year's gross profit, or more where the indemnity period runs past 12 months. Fall short, and a claim can be cut, whether the disruption is partial or a total shutdown.
If your figure falls short, the insurer can cut the loss in the same proportion, and your figure stays the limit on what it pays. A claim worth less than 10 per cent of your figure is usually not cut. A hairdressing salon declared far too low a figure. A cafe's period ran out before its trade came back. Both ended up before the Australian Financial Complaints Authority (AFCA), and our business interruption insurance page tells what happened to each.
A figure set on an insurer-approved calculator. Most of the same packs also switch off the underinsurance clause for a figure worked out on a business interruption calculator the insurer approves. The calculation uses the GST-exclusive sales from your latest 12 months of Business Activity Statements. Some policies want the calculation done within two months of the start or renewal, and some of those want it redone each year or the figures and workings kept on file. On some, the calculated figure has to become your sum insured, so insuring for less leaves the clause in place. The switch-off applies to your gross profit figure, on most policies also to cover set on annual revenue, and on a few to a building owner's loss of rent cover. On some policies, business interruption has no underinsurance clause to switch off. Some wordings call the calculator's result a guide only. Either way, the sum insured is still the most the policy pays for that loss.
What does "indemnity period" mean, and how long should yours be?
The indemnity period is the maximum length of time your business interruption policy will keep paying. It has to allow for two clocks: the time to repair or rebuild, and the time for trade to recover. Twelve months is a common choice, and it can run out before trade has recovered.
Clock one: getting the doors open again. Assessors, contractors, council approvals, materials, then the rebuild or re-fit.
Clock two: getting trade back to where it was. Regular customers may have found somewhere else, and staff who left may not all come back. Every week of that slow climb uses up your indemnity period, even with the building finished.
Allow for the full time it could take to repair the damage and recover your trade. Say the doors are shut for five months and trade takes seven more to come back. That uses up a twelve-month period exactly, with nothing to spare if the recovery runs slow.
Case
We have watched the clock run out on our own files too. One tenant's claim shows what a short indemnity period costs: their twelve-month period ran out long before the business was back in its own shop.
To cover both clocks, we recommend at least 18 months, and often 24 or 36 depending on your business, because a longer period leaves you better placed at claim time. In our experience, business interruption arranged properly can be one of the dearer parts of a business pack, so some owners leave it off and carry the risk themselves. Whether you take it, and for how long, is your call.
Whether the cover has started, and how long the loss ran, can both end up in dispute. In a matter that went to AFCA, a business was sabotaged repeatedly over several weeks, its systems locked out and key equipment disabled. The insurer accepted the equipment damage but disputed that business interruption cover had been triggered, offering a fraction of the claim. AFCA found the cover was triggered and ordered a proper assessment of how long the loss ran.
Why would spending money to reopen faster ever cost me money?
A standard policy only refunds extra costs you spend to keep trading, such as temporary premises or hired equipment, up to the amount those costs save the insurer. Spend more and you pay the difference, unless your policy carries the extension that removes the ceiling, usually called Additional Increased Cost of Working.
Say $40,000 on temporary premises only reduces the loss from $100,000 to $85,000. Under the standard cover, you're reimbursed the $15,000 it saved, not the $40,000 you spent. You're $25,000 worse off for getting back on your feet quickly.
The extension can reimburse the full reasonable cost of getting back to trading, even above what it saves the insurer, up to its own limit. It comes as standard on most of the packs we arrange. The limit is $25,000 or the amount you set, whichever is greater, for any one claim, and it sits inside your business interruption sum insured. In the example above, the extension can meet the $25,000 gap, and the limit can be set higher where reopening would cost more.
Am I covered if I can't trade but nothing at my own premises was damaged?
Sometimes, yes. On the policies we arrange, your cover can also pay when the damage is away from your premises: at a supplier or customer, to a utility, or nearby where it stops people reaching you. Each still needs physical damage of a kind the policy would cover.
- A supplier or customer. Damage at a supplier's or customer's premises in Australia, including ones you have not named. It pays up to 20 per cent of your business interruption sum insured, or more where your policy sets a higher limit.
- Power, water and other utilities. Damage to the supply of electricity, gas, water and sewerage, or land-based telecommunications. Where the damaged part is not at or next to your premises, most policies need the interruption to last more than 48 hours before the cover applies. Some set a separate limit.
- Damage nearby that stops people reaching you. Damage near your premises that stops you or your customers getting in. The policy sets the distance, often 10 to 50 kilometres, and can cap what it pays.
These extensions are built for a fire at your main supplier, a storm that damages the substation or a fire next door that closes the street. A power cut with no damage anywhere does not count, and a flooded road that keeps customers away counts only where the flood has damaged property nearby. On many business packs, flood is covered only if it has been added to your policy.
Business interruption and loss of rent together. If you also own the building you trade from, you may need both, often through two entities. Owner-occupier insurance explains how they fit. Loss of rent insurance for a commercial property sets out when rent cover pays, and the commercial landlord's insurance guide covers the rest.
FAQ
How is business interruption insurance calculated?
On the gross profit basis we generally arrange, the policy takes the rate of gross profit your business earned in the year before the damage, adjusted for how the business was trending. That rate is the share of each sales dollar that is gross profit. It applies that rate to the fall in your turnover during the indemnity period, up to the gross profit figure you insured. Savings in costs that stop because of the damage come off, and reasonable extra costs of reopening sooner are added. Consolidated Insurance Brokers helps you set that figure and your indemnity period.
Can I lengthen my indemnity period after something has gone wrong?
Not after the event: once the indemnity period ends, payments stop however trade is going, and there is no retrospective extension. A longer period has to be in place before a loss happens.