Over the past month or so, I have been inundated with questions regarding moving from reinstatement and replacement conditions to indemnity, in reducing Sums Insured and reducing indemnity periods. Over the next couple of days, I will address each of these and I will start today with Indemnity Periods.
Back when I first wrote my blue book on Business Interruption insurance in 2001, I was often confronted with indemnity periods of 3 or 6 months and my aim with the book and training sessions, was to move to 12 months being the minimum. Since that time, it has become more and more apparent that 12 months is not sufficient even for many risks, particularly property owners and manufacturing risks. When I say property, this includes infrastructure such as airports and tourism resorts.
If you add to this the complexity of a natural disaster, where the resources of the insurance industry, along with builders, engineers, right down to town building and planning departments, this only exasperates an already crucial problem.
As such, over the last 5 – 10 years, I have really been pushing for indemnity periods, particularly on larger risks which are insured under an ISR, to have a minimum of 24 months or at least 18 month indemnity periods. Speaking to underwriters and brokers, it has been pleasing to see that this advice has been accepted by many insureds.
What is alarming me, is that with the rate increases which are filtering through of late, many clients and/or brokers are reducing the indemnity periods back to 12 months. Yes, there is a premium saving, however, at what risk?
Going beneath 12 months, I believe, is complete folly for the rating of business interruption insurance is not simply a pro rate based on the length of time set for the indemnity period.
Statistically, my research shows that about 75% of business interruption losses have a period of disruption of 3 months or less. As such, if a client was to insure for a 3 month indemnity period, no insurer in their right mind would charge 1/4 of the premium that 12 months cover would cost, for they are going to pick up 75% of the claims, and even with claims which extend beyond the 3 months, they are likely to pick up the biggest burden during that first 3 month period.
Typically, the difference in premium for a 6 month indemnity period and 12 month is less than 10% of the fire rate applied to the full 12 months Insurable Gross Profit figure.
When considering the indemnity period, I have set out under the heading “How long should I insure for?” in the BIExplained section of the LMI Business Interruption Calculator all the things that should be considered when setting an indemnity period. You will note, the cost of insurance is not one of the criteria.
Speaking to underwriters about the situation, one of the reasons they have had to increase the premium rate, is that they are not getting the growth in premiums that they require. This is because we are not increasing Sums Insured as we should each year. If we are going to reduce cover, this is only going to create more problems moving forward as insurers are forced to increase rates again to make up for the lost revenue of people reducing their coverage. I know in the property insurance for LMI Group, there is two things about the program, the first is that we tend to over insure for we see first hand what happens to businesses when they under insure and we would rather pay a little extra premium rather than risk not being fully indemnified in the event of a loss. Secondly, we review our insurances every year, this being the case, we have found our rate has been retained.
Next post, I will go into a bit of detail about the risk of moving from reinstatement and replacement to indemnity conditions.