Beware BI underinsurance

COVID-19 is depressing most economies around the world. Consequently, nearly every industry sector is suffering reduced profits, or enhanced losses.

So it’s understandable that many companies are considering a reduction in their level of BI cover to save on premium. But before taking this decision, it is worth summarising the steps that build up to the total BI sum insured:

Typical policy requirement – declare not less than:

1. Calculation of gross profit as defined in the policy;

2. Over the declaration basis period in the policy;

3. Increased proportionately for periods over 12 months;

4. Minimum declaration required by the policy;

5. Is this sufficient? You can declare more than the minimum (eg if there are very strong growth trends);

6. Business Interruption declared value;

7. Policy uplift for unforeseen growth (typically 133.33%), and

8. Maximum amount claimable if a loss is suffered.

Most (UK) corporate gross profit policies are written on a declaration-linked basis. A gross profit amount is declared by the policyholder at the start of a policy period and, in theory, that’s compared to the retrospective declaration given at the end. The premium paid is adjusted in line with the difference.

A key aspect of the declaration-linked basis of cover is that there’s no proportionate reduction (average) clause. So, there’s no contractual remedy in the policy if a declaration is materially wrong. Insurers have no recourse other than to treat it as a breach of the Duty of Fair Presentation and void the policy. But nobody wants that.

To avoid the possibility of such drastic action, our advice, which ties in with the diagram above, is as follows:

1. Gross profit calculation

It’s safest to assume that gross profit in policies doesn’t mean the same as gross profit in any set of company accounts. Gross profit in an insurance policy is usually defined as turnover less purchases (adjusted for stock movement), and maybe carriage/freight, as well as bad debts. This is in contrast with the rest of the business world, where there’s no specific definition of the term gross profit. So, remember:

• Be aware of your policy definition;
• While the term ‘purchases’ is often undefined, it’s understood by insurers to mean material/consumable purchases;
• Are your material purchases even fully variable?
• Be sure that the costs you deduct from turnover are those listed in the policy;
• Keep the deductions from turnover to a minimum;
• Just because you can foresee a scenario in which a cost will reduce in line with turnover, that may not be the case in all scenarios, and
• This calculation isn’t a means to an end, producing a sum that you can claim up to. It defines the rate of pennies recovered for each turnover pound lost if you need to make a claim.
  

2. Declaration basis period

You need to check your policy – declaration basis periods vary between insurers, and include:

• The last set of statutory accounts;
• The 12 months before the policy period;
• Expected results in the policy period;
• Expected results in the accounts most closely aligned to (co-terminous with) the policy period, and
• The 12 months from the date of damage.

A survey conducted by the Chartered Institute of Loss Adjusters (CILA) in 2017 found that 44% of policies required declarations based on the last set of accounts. If last year was buoyant, your policy might require a declaration of an amount not less than that – even if the coming year looks poor.

Again, if your policy requires a declaration based on expected performance from the date of damage, that could occur on the last day of the policy period – that’s essentially year two from inception, not year one. So, if the business is expected to bounce back in year two, the declaration should sufficiently reflect that.

Key point – don’t assume that the basis period for the declaration is the policy period – notwithstanding that it might be.

3. Indemnity period

Twelve-month maximum indemnity periods are inadequate for almost every business – even a corner shop. Twenty-four months was found to be the minimum for a café – Café de Lecq v Rossborough, 2012.

Fundamentally, the indemnity period should be sufficient to allow not only for repair/reinstatement, but also for the subsequent recovery of the business.

4. Minimum declaration

The product of this calculation is the minimum required by the policy. If you declare at least this amount, there’s no policy issue at stake. But for a growing business, is it enough?

5. Is this sufficient?

The amount derived from the basis period, set out in the policy, is just a minimum. You’re not constrained by it.

6. Declared value

The declared amount is the sum you believe will be generated over the policy basis period –an honest expression of belief at that moment in time.

7. Policy uplift

Declaration-linked policies allow for an uplift – usually 33% – to cover unforeseen growth, but that’s irrelevant to the reasonableness of the declaration. The declaration must be sufficient at the time it’s made. The uplift is only relevant at the point of a claim.

8. Maximum amount

Following the steps above, you arrive at the maximum amount claimable.

Substantial under declarations continue to be a regular problem. And while nobody wants to pay unnecessary premiums, it’s essential to carefully examine and be clear on your policy wording.

Jo Suppiah is head of Forensic Advisory Services, UK, Sedgwick International and Damian Glynn is head of Financial Risks, Sedgwick International UK.