What is business interruption insurance?

Whether you’re running your own business or employed by one, business interruption insurance is something that everyone should be familiar with and everyone should have at least some coverage from.

Business interruption is one of the top three business risks in the world in 2022, the others being cyber attack incidents and natural disasters. 

But what exactly does it cover? A lot of people think that insurance only covers physical damage to assets such as cars, buildings and equipment, but it actually covers much more than that in the event of a catastrophic loss. 

Businesses exist to generate income for their owners, operators and employees. Business interruption insurance is a special type of insurance that can protect your business from financial ruin.

Insurance exists to protect us from risks we can’t predict or avoid, such as sudden injuries or property damage.

For business owners, it also insulates you from unexpected interruptions to your business that could hurt your bottom line and send you into debt. Business interruption insurance (BI) covers you in case there’s an unforeseen delay in your ability to run your business, whether due to injury or damage to your store or building. 

Insurance has existed in some form for thousands of years, and it’s one of the best methods people have come up with to protect themselves from unforeseen and potentially harmful events, such as the loss of income due to unexpected medical bills or natural disasters that damage your property. 

Business interruption insurance provides protection from losses that occur because of unexpected events that prevent you from being able to run your business as usual.

What is business interruption insurance? How does it work? What risks does it cover? We’ll look at these questions and more in this article on what business interruption insurance is and what it covers.

One of the best ways to be ready for any financial setbacks that may come your way is to have an insurance plan in place, especially if you’re running your own business.

However, there are many different types of insurance, and it can be confusing trying to figure out what you need and what you don’t, so here’s an explanation of business interruption insurance—what it covers and how it works.

Most business owners would rather avoid risk as much as possible, which is why business insurance has become so popular in the last century or so.

But what exactly does business insurance cover, and how do you figure out whether you need it? Business income insurance, also known as business interruption coverage by some insurance companies, covers many of the costs that businesses may incur if their operations are interrupted due to external events.

Here’s what business interruption insurance is.

Business interruption (BI) insurance is designed to help small businesses protect against financial losses that may have been caused by an unrelated event, such as a natural disaster, resulting in the forced closure of the operations of the business. 

It’s essential to note that business interruption insurance relates only to external causes.

Changes in market demand for your business’s products or services, or supply chain issues where you cannot get enough product to sell, are not external to your mode of business, and cannot be insured against.

However, consider, for example, if a covered event, such as a fire in your building occurs and causes physical property damage. Suppose it takes you several weeks or months to restore the building.

In that case, a proper business income insurance policy will kick in and start to cover fixed expenses like rent, bank interest on loans or mortgages, wages and costs incurred if you have to operate at an offsite location. At the same time, the property is closed for repairs and restoration.  

Business income insurance will also reimburse you for your lost profits that would have otherwise been gained if the business remained operating as normal. 

Business interruption policies can be bundled together with a Business Owner’s Policy (BOP) that includes commercial property and liability coverages, such as General Liability insurance.

BOP insurance is available to companies with fewer than 100 employees and annual sales of up to $5 million.

Here’s what’s not covered by Business Interruption insurance

Putting it simply, business failure is not covered by business interruption (or business income) insurance. If you made a bad business decision, such as switching a product line, or changing your advertising campaign, then there’s no protection from business interruption insurance.

The cause of the interruption must be nothing personal, for example, your business must suddenly be unable to operate due to damage that prevents customers from accessing the business premises or employees from working.  

The insurance cover does not cover economic slowdowns. It only covers events that stop your business operations over a significant length of time. It also does not usually begin until a few days after business had to be suspended.

The protection does not go on forever. Many insurers stop paying out after your business has been closed for a year.

BI doesn’t cover costs other than lost net income, relocation expenses, and other specified expenses unless you have signed endorsements on the policy, which will increase the premiums.

Ensure you read your insurance policy’s terms and conditions carefully. Discuss with your agent or broker the situations in which you may file a claim.

There can be a big difference between how you view your claim and how the insurance company looks at its liability for the loss.

Even if you have insurance, you should do everything you can to prevent or minimize losses, because the insurance companies will consider all the precautions you took before paying out.

For example, did you install proper sprinkler systems or smoke alarms? Having business interruption insurance does not mean that you can stop mitigating against interruptions.

Remember, insurance companies start off fighting against claims if they can.

Insurance companies and business owners lodging claims may argue over the actual total losses that should be eligible for a refund under a business interruption insurance policy.

If this occurs, you may be well advised to get an attorney who is used to dealing with insurance claims to get a fair amount of your losses paid.

Suppose it becomes necessary to go to court. In that case, an attorney who is experienced with denied claims should represent you before the judge.

Why small businesses need insurance against natural disasters.

According to the Federal Emergency Management Agency (FEMA), about one quarter of businesses are unable to reopen if a natural disaster strikes.

As well as the immediate problems that come with fires, earthquakes or floods, there can be disruptions to basic services like power, roads, transport and other such vital commodities that can make it impossible to operate your business properly for weeks or even months.

During all this time, you will still have your standard expenses, like rent, wages, interest on borrowed finances. On top of that, you will be unable to draw your own income. How will you pay your own personal expenses, down to the basic level of food?

The type of business you have will determine the levels of risk and what insurance coverage you need to consider.

For example, service suppliers are at high risk for business interruption because they rely on their suppliers to provide them with raw materials or products.

Suppose those suppliers have a disruption in production or distribution caused by a disaster. In that case, it will affect your own business’s bottom line.

That disruption would also be felt by your clientele in the form of delayed shipments or out-of-stock products.

This can have a flow-on effect, because your business can lose its reputation and customer base. Even if you manage to shift operations to a different physical location, the business may simply have disappeared.

Insurance covers that can be included in Business Owners’ Policy

General liability insurance protects your business from claims that your business was negligent and this resulted in bodily injury or property damage to a third party. In a BOP, the general liability policy can also cover against claims of libel or slander.

General liability insurance will pay for all associated medical expenses if someone is injured and sues. The insurance company is also responsible for mounting the defense if someone files a lawsuit against your business.

Commercial property insurance, this coverage protects the business’s location and physical property, such as equipment, inventory, and furniture. Commercial property insurance covers repair or replacement costs if a covered peril such as fire, earthquake, flood or lightning causes physical damage to a building where you conduct business.

It also ensures the replacement cost of business assets inside the building, such as computers and other office equipment.  

Optionally, property that has been damaged in riots, civil commotion, and vandalism can also be included by special endorsement of the policy. This can increase the cost of the cover, especially in urban areas where there is a higher degree of risk.

Business interruption insurance covers the expected net income that has been lost due to the closure of business. It can cover property rent or lease costs, relocation expenses, employee wages during closure, and loan payments.  

Standard business interruption insurance does not cover losses from interruption of business due to flooding, mudslides or earthquakes. However, you can specify additional coverages for these specific perils.

Business interruption insurance companies can offer a special protection known as civil authority coverage. Suppose a government office (a state, local, or federal body) prohibits access to your business premises or location, and this forces the businesses to temporarily close.

In that case, BI insurance that includes civil authority coverage will cover lost income. The civil authority clause in a standard BI policy will stipulate the exact provisions that trigger coverage.

Civil authority coverage usually applies after natural disaster events in which physical damage has occurred within a specified distance from your business, even if the area itself is not damaged.

For example, suppose a tornado strikes an area of your suburb that causes structural damage to roads and bridges and the authorities restrict traffic in the area.

Now you and customers cannot access the business property and you must temporarily close the business. Each insurance company’s policy is different, and the wording of the cover may be unique. You should consult with qualified insurance agents or brokers to ensure that the cover is relevant.

What are the options in Business Interruption Insurance policies

There are optionals as riders to a standard business interruption policy.

Contingent business interruption (CBI) protects against losses coming from supply chain disruptions. These may occur when the flow of goods from suppliers or vendors that your business relies on are themselves interrupted.

For example, consider a plumber working on a contract that has stipulated specific piping types that have to match existing joints. If the supplier company goes out of business, CBI will recover lost business revenues due to the supplier’s closure.

These policies provide your business with a cash flow to help cover payrolls, rents, and other expenses to help keep the business open. 

Extended business interruption (EBI) covers the period from when you are able to restart business operations and income is restored to pre-loss levels.

Who Should Buy Business Interruption Insurance Coverage

How much do you depend on your income from the business you run? If it’s just a sideline and you have a solid source of monthly income, then you can maybe do without the cost of insurance.

But if you depend on the income to meet your daily bills, or if you have responsibilities such as paying your own employee’s wages even though the business cannot operate normally, then you should definitely have the backup of adequate business interruption insurance. 

You may also want to purchase insurance for your home, vehicle and other property that could be at risk in a disaster or interruption.

How Insurers Calculate the Premiums

Insurance companies calculate premiums based on the levels of risk. For example, a company that manufactures candy bars has more risk than a company that distributes them.

Premiums for the manufacturer will be higher because there is a greater chance that an interruption in production will lead to large losses if it doesn’t get covered by insurance.

How much does Business Interruption insurance cost?

Because the premium for business interruption cover is most usually bundled up in a BOP package, it’s hard to judge exactly how much the independent cost of the policy is. If you are buying it separately, a small business can expect to pay between $500 and $3,000, depending on aspects like commercial property location.

If your property is in a high-risk area known for natural disasters, the premium will be higher. For example, locations in areas with higher crime rates pay more for insurance than ones operating in 

If the work your business does has higher risks, such as a restaurant with open fires, the premium will be higher than for a business that consists of a few people working at desks in an office building.

Revenue, or more exactly profit levels, is probably the most important factor because the policy is meant to compensate for lost revenue while not operating.

An experienced insurance agent or broker will help you by estimating how much coverage you should have and which company offers the best and most affordable cover,

FAQ

What is included in business interruption insurance?

Business interruption covers the calculated lost net income caused by the temporary closure of the business due to external forces.

These amounts can include rent or vacant premises as well as relocation costs to a viable workplace, employee’s wages when not working as well as a computed amount for lost earnings from profits.

How is business interruption insurance calculated?

There is a formula known as the business interruption formula that’s calculated as:

Claimable amount (BI) = the number of time units  that operations have been shut down (T)  * the average value of sales or services in an equivalent period of normal trading (Q) *  the expected profit earned for each unit of production (V)

BI = Q*T*V

What is the importance of business interruption insurance?

Business Interruption Insurance helps to protect businesses in case of a serious event outside of its control.

The financial losses a business owner could sustain in such a case of long-term interruption of trading can lead to bankruptcy.