The question posed of me by a broker was:
I would appreciate your position on what is the correct figures to provide for business interruption , I am often asked by clients if they have to insure their full turnover.
I am reviewing a Hotel next week with a turnover of 6.2 million, I will advise that BI [business interruption] will cover not only their own needs & commitments, but allow them to retain staff that have been part of the business success albeit there can be a reluctance to pay the correct premium on correct turnover.
Ron [surname and email provided]
My response read:
The vast majority of insurers offering business interruption insurance have a penalty for under insurance.
Let us assume that your client insures for business interruption, for $2,000,000. They suffer a business interruption loss of $1,500,000.
The insurers determine that the business interruption should have been insured for $4,000,000. The business owner was therefore under insured by 50%. Although the owner may think that the $2,000,000 cover he has is sufficient to cover the financial loss of $1,500,000, the application of the Co-Insurance Clause declares means that this business owner is in fact an insurer himself for part of the risk.
Insurers typically allow some tolerance for being underinsured; this is often set at 20%. Note in the standard Mark IV or Mark V Australian Industrial Special Risks (“ISR”) policies, there is no tolerance at all.
The calculation for the situation I have just described, if it were insured under most Business Pack Policies would be calculated as:
$2,000,000 (Sum Insured) ÷ 80% of the true amount to insure at the start date of the Policy ($4,000,000) x $1,500,000 means:
The Insurer pays $937,500 less any policy deductible/excess of the $1,500,000 loss while,
the Business Owner wears $562,500 plus any policy deductible/excess.
The penalty of underinsurance is real and can destroy an otherwise viable business. Therefore it is important that the full insurable gross profit is insured.
As the premium is tax deductible, I would strongly recommend against under insuring. As a claims preparer I see the devastating effects every week.
Banks/finance companies and other creditors still need to be paid and again I stress it is not worth the risk.
Two tools may assist. The first is BIcalculator.com, where the BI explained section has two areas that you may like to show your clients.
1. It will never happen to me!
2. what happens if I under insure.
The other tool is the free underinsurance phone app. You can plug in the true figures and get the result. At the end you can email the calculation to the Insured with a cc to yourself as proof that you had the discussion with the Insured and you clearly showed them the financial risk they run by under insuring. The app is just as good on property losses as it is on business interruption. In fact, it has proved invaluable to explaining average /co-insurance under any policy that has such a penalty.
Ron quickly replied:
Thanks Allan appreciate your response, you may be surprised how difficult it can be to get clients and their accountants to face this problem. Your explanation will be most useful in getting them to understand.