Any business owner understands that an immense amount of time, money and effort goes into organising, planning and running a business. So the idea that a fire or natural disaster could happen and throw a massive spanner in the works is not an enjoyable thought. 

However, major interruptions is one of the most significant risks a business will face regardless of the size or industry. It’s difficult to pay employee wages, suppliers or even the power bill if there are no sales or revenue. 

Despite their alarming frequency in Australia, natural disasters are typically unexpected and difficult to prevent. Between 60%-80% of businesses fail within two years of a major disaster happening without insurance and other financial support. 

Floods, fires, hail and cybercrime have shown time and time again to dramatically impact and disrupt business operations around the country. And while the devastating impact of disruptions is not new, we have seen a new wave due to the COVID-19 pandemic. 

While most property and business interruption insurance policies have no or very limited cover for Covid-19 disruption, they are essential to help businesses recover quickly following major disasters that damage property. 

As one of the most universally important business insurance covers, what exactly is business interruption insurance, who should consider getting this insurance coverage, and how is it calculated?

What is Business Interruption Insurance?

Business Interruption or Loss of Profits insurance is a specialist insurance policy that business owners can depend on to replace weekly revenue or income following a shutdown of the business due to damage to the premises. Therefore, this insurance has been specifically designed to help businesses survive in unprecedented times and provide invaluable financial assistance to help get the business back to where it was. 

In the case of Business Interruption Insurance, it effectively works to pay fixed expenses, such as heating, lighting, power, bank loans, wages and transport etc., plus net profit expected from any loss or reduction in sales. 

What does it cover?

Ultimately, Business Interruption Insurance compensates business owners from the time of the loss or damage until the business returns back to normal. This period could be one month or 12 months, depending on the circumstances of your business and loss. Each business and its insurance policy is slightly different in terms of how it will be compensated. 

The insurance will pay net profit and fixed costs, not costs that vary with turnover. For example, wages would be fixed, at least in the meantime, while supplier costs would diminish as your factory could no longer operate to use these items. 

Key factors to consider when choosing the best basis of cover include:

• Indemnity period: How long do you need the cover for? Depending on the situation, how long will it take your business to return to pre-loss trading. 
• Payroll: Consider how many employees you have to pay throughout the interrupted period to determine whether/how much of your payroll you insure and for how long. 
• Claims preparation fees: Consider how much money will be sufficient for your business to complete the claims process. 
• Growth: Consider what makes adequate coverage if your business is currently growing.
• Economic cycles: Consider what will happen if you need to claim throughout seasonal fluctuations or economic cycles where business operations are not static.  
• External damage: How effective would your coverage be if a customer or supplier suffers significant damage and would your business suffer as a result?
• Additional or increased costs of working: Will you have to spend more money than usual? For example, if you own a building that’s been damaged by a fire and need to rent alternative premises, this will be a new additional cost. 

Who Needs This Type of Cover?

Most businesses will benefit from having Business Interruption Insurance, particularly in the wholesale, manufacturing and retail industries. Basically, any business that depends on operating and working out of a specific location where goods or plants are located would benefit. 

However, as there are different businesses, it takes specialist knowledge to work out the correct sum insured as different businesses would benefit from certain covers more than others.  

Unfortunately, even if your business can no longer trade and there are no sales or no revenue being generated, it doesn’t mean your business won’t still have expenses to pay. The stress of interruptions can be overwhelming enough, in addition to finding the money to pay ongoing expenses.

Key items to consider when deciding whether your business requires interruption insurance include:

• Do you need to continue paying your and your employees wages?
• Do you need to pay loans or rent?
• Do you need to pay your suppliers?
• Do you need to protect your net profits?

Ultimately, if the answer to any of these questions is yes, business interruption insurance is bound to be an invaluable risk management strategy for you. However, it is important to understand the way covers are calculated in order to choose the most suitable option.

How Is It Calculated?

How this type of insurance is calculated comes down to the way you buy it. Ultimately, you choose this insurance cover based on specific business data so that you and the insurer understand and agree on what you are covered for.

That being said, there are two main ways to purchase this type of insurance:

1.  Based on weekly income/sales
2.  Based on annual gross profit (turnover/revenue less variable expenses)

Loss of gross revenue

Generally, insurance for business interruption under this type of cover is taken out by smaller or service-based businesses with revenue and fewer variable expenses. For example, solicitors, investment consultants and medical or dental practices. 

Insuring under ‘loss of gross revenue’ calculates the value by taking the prior year's turnover and applying it to the expected growth for the upcoming period. So, all the businesses seeking insurance cover need to know is the total turnover of their business for the length of the indemnity period. If calculated correctly, the insurance will cover:

• The reduction in turnover following a loss; and 
• Any increased costs of working

However, one of the biggest mistakes businesses make when taking out interruption insurance is underestimating the time it can take to get back up and running again, so seeking the advice of an insurance professional before purchasing is always advised. 

Loss of gross profit

Loss of gross profit cover is the main type of insurance issued by insurers for business interruption cover. This not only covers losses to your business net profits but also covers ongoing fixed costs and expenses, including wages, mortgage payments, utilities and advertising. 

So the gross profit is the turnover adjusted for trends, less uninsured working expenses, purchases, stock, consumables and freight and transport. 

It is important to note that the most common instance of underinsurance with this cover type is not correctly specifying the correct sum insured if more than 12 months indemnity period is required. So, the gross profit sum insured for 18 months is 150% of the 12 months sum insured etc. 

In Summary

Major storms, natural disasters and fires are regular occurrences in Australia. Major interruption is one of the most significant risks a business will face regardless of the size or industry. It can be difficult to pay employee wages, suppliers or even the power bill if there are no sales or revenue. Between 60-80% of businesses fail within 2 years of a major disaster, without insurance and other financial support. 

If you are looking for ways to be prepared for the unexpected, contact Insurance Advisernet today. Our team of insurance specialists know the ins and outs of policies, so you don’t have to and can help you find the best cover to keep your business running as smoothly as possible. 

Important Information 

This communication including any weblinks or attachments is for information purposes only. It is not a recommendation or opinion, your personal or individual objectives, financial situation or needs have not been taken into account. This communication is not intended to constitute personal advice.

We strongly recommend that you consider the suitability of this information, in respect of your own personal objectives, financial situation and needs before acting on it. This document is also not a Product Disclosure Statement (PDS) or a policy wording, nor is it a summary of a particular product’s features or terms of any insurance product. If you are interested in discussing this information or acquiring an insurance product, you should contact your insurance adviser to obtain and carefully consider any relevant PDS or policy wording before deciding whether to purchase any insurance product.