What it means
The purpose of the cover is to put a business back where it stood before the loss. A fire that destroys a bakery does not just remove an oven; it removes months of trading, a customer base and possibly a lease obligation that continues regardless.
Property policies are written to address that whole chain, not just the burnt equipment. Cover is usually built in layers.
The building itself, the tenant's improvements, the plant and machinery, and the stock each have their own declared value and sometimes their own sub-limit. Business interruption cover then sits alongside, replacing lost gross profit during an agreed indemnity period while the site is rebuilt or replaced.
The critical decision is the basis of settlement. Replacement cost cover pays what it costs to buy the equivalent asset new today, while actual cash value pays that figure less depreciation for age and wear.
A ten-year-old refrigeration unit might cost $40,000 to replace and be worth $14,000 on a depreciated basis, and the policy wording decides which figure you receive. Most commercial property policies also contain a coinsurance clause, which requires the business to insure at least a stated percentage of full replacement value, commonly 80% or 90%.
If the declared value falls short, the insurer reduces even a small partial claim in proportion. This is the single most common source of unpleasant surprises at claim time.
The nuance worth knowing is what is excluded. Flood, earthquake, gradual deterioration, wear and tear, and damage caused by faulty workmanship are frequently outside a standard policy and need separate extensions.
A business in a flood plain that assumes "all risks" means all risks is carrying a large uninsured exposure.
In practice
Real-world examples.
Example
A garden centre loses its main glasshouse to a winter storm. Its property policy pays $610,000 for reinstatement, and the attached business interruption section pays a further $180,000 of gross profit over the nine-month rebuild.
Example
A dental practice suffers a burst pipe above its treatment rooms. Because its tenant's improvements were declared separately at $340,000, the practice recovers the full cost of the specialist flooring and cabinetry that the landlord's building policy would never have covered.
Example
A distribution business increases its stock declaration from $900,000 to $1,500,000 before the peak trading season, paying an additional $2,800 in premium. A warehouse fire in November destroys $1,280,000 of goods and the claim settles in full.
Formula
Calculation
Claim Payment = (Insurance Carried / Insurance Required) x Loss - Deductible
where Insurance Required = Replacement Cost x Coinsurance Percentage
A light manufacturer occupies a building with a full replacement cost of $2,000,000. The policy carries an 80% coinsurance clause and a $10,000 deductible. To save premium, the business declared a value of $1,200,000.
Insurance required = $2,000,000 x 0.80 = $1,600,000
Coinsurance ratio = $1,200,000 / $1,600,000 = 0.75
A fire causes $400,000 of damage.
Recoverable before deductible = 0.75 x $400,000 = $300,000
Claim payment = $300,000 - $10,000 = $290,000
Had the business declared at least $1,600,000, the ratio would have been 1.0 and the payment would have been $400,000 - $10,000 = $390,000. Underinsuring cost the manufacturer $100,000 on a loss that was nowhere near the policy limit.Case study
Seen in the real world.
Verrow Ceramics is an illustrative, fictional tile manufacturer that had insured its factory for $1,200,000 for several years. Construction costs in its region had risen sharply, and the true rebuild figure was closer to $2,000,000, but nobody had revalued the building since the policy was first written.
When a fire in the kiln room caused $400,000 of damage, Verrow expected to receive $390,000 after its $10,000 deductible. The loss adjuster applied the 80% coinsurance clause, calculated a ratio of 0.75, and settled at $290,000. The $100,000 shortfall had to come from working capital in the middle of a rebuild.
The fictional postscript is instructive. Verrow's annual saving from underdeclaring had been roughly $2,400 a year in premium, so eight years of savings did not cover a third of the shortfall on a single partial claim.
Watch out
Common mistakes.
- Insuring a building for its market value rather than its rebuild cost. The two figures are unrelated, and in many locations rebuild cost exceeds what the property would sell for.
- Assuming the landlord's policy protects a tenant's fit-out. Landlord cover typically stops at the building structure, leaving shopfronts, partitions and specialist installations uninsured.
- Forgetting to raise stock declarations before seasonal peaks. Cover is based on the declared figure, not the value that happens to be in the warehouse on the day.
Questions
People also ask.
What does business interruption insurance actually pay?
It replaces the gross profit the business would have earned during the agreed indemnity period, plus any increased costs of working, not the full lost revenue.
Is flood damage covered as standard?
Usually not, because flood is commonly excluded or heavily sub-limited and needs to be added by specific extension or a separate policy.
How often should declared values be reviewed?
At least annually, and immediately after any significant fit-out, equipment purchase or change in construction costs.
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