What it means
Business interruption insurance, also called loss of profits insurance, pays when an insured event such as a fire stops or reduces trading. It does not simply cover the physical damage, which is handled by the property policy.
It covers the income the business loses while it is repairing, rebuilding and winning customers back. The period of indemnity is the maximum duration of that cover.
It is chosen when the policy is bought, commonly twelve months, although it can be shorter or longer. A longer period costs more in premium, and a shorter one leaves a gap if recovery is slow.
The key point is that the period starts at the date of the damage, not at the date when the business is ready to reopen. Rebuilding, ordering equipment, obtaining permits and rebuilding a customer base all use up the period.
Many firms underestimate how long this takes, particularly where specialised machinery has long delivery times. When choosing a period, a business should consider the realistic time to restore premises, replace equipment and return to normal trading, then add a margin for delays.
A manufacturer with imported machinery may need 24 months, while a small shop may need six. Some policies include an extended period of indemnity to cover the time after reopening during which sales are still below normal.
A nuance is that the period of indemnity is different from the maximum sum insured. A policy can run out of time while money is still available, or run out of money while time remains, so both limits need to be checked and set sensibly.
In practice
Real-world examples.
Example
A hotel is closed by a flood and needs 14 months to rebuild. Its policy has a 12-month period of indemnity, so the last two months of lost profit are not covered. The owner absorbs that loss from reserves or borrowing.
Example
A print shop chooses a 24-month period because its presses must be ordered from overseas. The policy costs more, but the owner knows that cover will last until the new equipment is installed. The broker also adds cover for extra delivery costs.
Example
A restaurant reopens after a kitchen fire but customers return slowly. Its policy includes an extended period of indemnity that covers the lower sales for a further three months. Without it the owner would have borne the slow recovery alone.
Formula
Calculation
Claim = insured monthly loss x number of months of disruption within the period of indemnity
Suppose a bakery earns a gross profit of $80,000 a month, a fire closes it, and restoration takes 9 months. With a 12-month period of indemnity the claim is 80,000 x 9 = $720,000. If the policy had only a 6-month period, the claim would be 80,000 x 6 = $480,000. The uninsured shortfall is 720,000 - 480,000 = $240,000.Case study
Seen in the real world.
Eastbrook Furniture is an illustrative, fictional manufacturer that insured its factory with a 12-month period of indemnity to keep premiums low. The monthly gross profit of the business was $150,000.
A fire destroyed the main production line. The insurer paid for the rebuild, but the replacement machines came from overseas with a 16-month delivery time, and the factory restarted only in month 17.
Business interruption cover paid 150,000 x 12 = $1,800,000, while the lost profit over 16 months was 150,000 x 16 = $2,400,000, leaving $600,000 unprotected. The illustrative lesson is that the cheapest period is not the best value when recovery takes longer than expected. After the fire Eastbrook moved to a 24-month period, paying a higher premium to remove the gap.
Watch out
Common mistakes.
- Choosing the shortest period to save premium without checking how long it would take to restore the business.
- Assuming the period starts when the business reopens, when it starts at the date of the damage.
- Forgetting that sales may stay low after reopening, which an extended period of indemnity can cover.
Questions
People also ask.
How long should the period of indemnity be?
It should be at least the realistic time to rebuild and replace equipment plus the time to recover trade, with a margin for delays, and 12 months is common but is often too short for complex businesses.
Is the period of indemnity the same as the waiting period?
No, a waiting period is the initial time before cover begins, while the period of indemnity is the length of cover once a claim starts. Both appear in the policy schedule and should be read together.
Does a longer period cost much more?
Premiums are usually based on the gross profit insured and the length of the period, so a longer period raises the cost, but the increase is often small compared with the protection gained. A broker can quote several lengths side by side.
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