Business interruption values for property insurance

Buildings, machinery and stock look like the easy part of the value request, but they aren't read off the books. Business interruption values for property insurance are the number sites get wrong most often, because nobody at the site has been asked to imagine a year or more without production. This post covers what the cover pays for, the two numbers every site has to report, and the five places the answer goes wrong.

First, a word on property values

A site's fixed-asset register holds purchase prices and depreciated book values. Property is insured at reinstatement value: what it costs to rebuild and re-equip today, new for old, including demolition, debris removal, fees and current building codes. For an older building the gap can be large.

Stock is not on the fixed-asset register at all. Raw materials and work in progress are normally insured at cost price. Finished goods can be insured at cost or at selling price. At selling price, the margin on that stock is covered under the stock item and is excluded from the business interruption claim, so it is not paid twice. The basis is in your policy and belongs on the request to sites. Whichever basis applies, the value that matters is the seasonal peak, not the year-end balance.

If a site copies book values into the request, it is underinsured before the renewal starts.

What business interruption cover pays for

Property damage cover pays to rebuild the hall and replace the machines. Business interruption cover pays the gross profit the site loses because turnover falls after the damage. That gross profit includes the fixed costs that keep running with no output, such as salaries, rent and depreciation. The cover also pays the increased cost of working, which is the extra spend to keep customers supplied, for example temporary premises or outsourced production. A fire costs the rebuild once. It costs the lost gross profit every month until results are back where they would have been.

So the declared BI value rests on two things per site: what the site will earn, and how long it would take to recover. Both come from the site, and both change every year.

The two numbers per site

The business interruption value is the gross profit the site would lose over the indemnity period. Most programmes declare it on a gross profit basis. Some use gross revenue or gross earnings instead. The basis is defined in your policy, and it is the first thing to put on the request to sites.

Insurance gross profit is not the gross profit in the P&L. The policy typically defines it as turnover, adjusted for the change in stock, minus the working expenses the policy lists as uninsured. These are the costs that stop when production stops, such as raw materials. Accounting gross profit usually deducts wages and depreciation as well, so a site that copies it from the income statement declares too little. A site that reports turnover on a gross profit programme declares several times too much. Ask your broker for the definition and write it on the form.

The maximum indemnity period is the number of months the value has to cover. It is not the time to rebuild the building. It is the time to rebuild, re-equip, get the permits, re-qualify with customers and bring results back to the level they would have reached. The period is set at programme level with your broker. What the site contributes is an honest estimate of its recovery time. Twelve months is the most common default for smaller programmes, and many larger programmes run 18 or 24 months. For a site with a specialised line and a supplier who quotes fourteen months for a replacement, the honest answer may be longer still.

Put the two together, and a site's declared BI is its expected annual gross profit for the period ahead, scaled to the length of the indemnity period. It is a forecast, not last year's actuals. A site that expects 20% growth and moves from a twelve-month to an eighteen-month period has a BI value 80% higher than last year, and that is correct.

It matters because underinsurance on BI does not only affect the declaration. Under the average clause, every claim is reduced in proportion to the shortfall.

Five places the number goes wrong

1. Copied forward. Last year's BI value comes back unchanged while turnover grew. On a portfolio of thirty sites this is the most common error and the hardest to see, because the number looks plausible. A value built on last year's actuals, with no projection, has the same problem in a milder form.
2. The value doesn't match the period. The site reports one year of gross profit, but the programme has an eighteen-month indemnity period. Or the site reports eighteen months against a twelve-month policy. Either way, the number and the period were answered by different people.
3. The wrong basis. The site declares turnover where gross profit was asked for, or the other way round. Or it copies gross profit from the income statement instead of using the policy definition. The same applies to stock: finished goods declared at selling price on a cost-price policy are overstated, and finished goods declared at cost on a selling-price policy leave the margin uninsured. This is why the definitions belong on the request, not in a separate email.
4. The period is a guess. A plant manager writes twelve months because that is what the form suggested. The real question is how long the longest-lead item takes to replace. Ask it that way.
5. Dependencies are misplaced. A site that stops because a key supplier or customer is down is a contingent business interruption question. A site that stops because a sister plant is down is an interdependency question. In both cases, the loss the policy pays is the dependent site's own lost gross profit, so nothing should be added to its figure. What the site should report is the dependency itself: which sites and suppliers it cannot run without. A bottleneck plant's worst-case loss can far exceed its own declared BI, and that is what the underwriter needs to assess the maximum loss.

How to ask sites for the number

Send one request with the basis and definitions written on it. Ask for two answers per site: the value on that basis, and the recovery time in months from a fixed list. Send it to the person who has the management accounts and budget, not only the plant manager. Then compare each answer against last period. A change without an explanation, or no change at all, is where the review time goes. The property insurance renewal checklist has the full sequence from twelve weeks out.

The total business interruption across sites plus the total property damage is the total insured value the broker takes to market. If BI is a third of it, a third of the declared values rest on the answers above.

How 21RISK records business interruption values

In value collection in 21RISK, business interruption and the BI period are fields on each site, per period, next to buildings, machinery and stock. Each collection period defines which BI periods sites may choose, from six to sixty months, so a site picks from the list you agreed with your broker instead of typing a number. Total BI and TIV are calculated per site and for the portfolio. The values table shows the change from last period, so a BI value that has not moved since last year stands out in the column.

The change history shows who entered each figure and when, across periods. When a broker asks why a site's BI doubled, the answer is one filter away rather than a search through last year's mail. Sites that keep their figures in a workbook can import values from a spreadsheet, with the BI period as whole months and a preview of every change before anything is written. If the values still live in one workbook, Excel vs 21RISK for value collection lists what the workbook cannot tell you about them.

Nilfisk collected values in Excel and email across its plants for years. Steen Dandanell estimates that 21RISK saves about 75% of the time they used to spend collecting and analysing the data. Read the Nilfisk case, or talk to us to see how BI values are collected on your own sites before the next renewal.