What does your CFO/risk manager know about BI insurance? The English court clarifies the extent of an insurance broker’s duties owed to a commercial client when placing Business Interruption insurance and confirms it is for the client to calculate the appropriate sum insured and indemnity period.
Business Interruption (BI) insurance is a form of insurance containing unique concepts which are not necessarily known by laymen or company finance officers. Unfortunately, the standard UK form BI policy does not always contain sufficient certainty to allow all parties to understand what information needs to be provided to insurers at placement or how the policy should respond.
Some of these unique issues were identified by The Insurance Institute of London (ILU) and Chartered Institute of Loss Adjusters (CILA) 2012 publication1. The publication addressed: (i) the different meaning of Gross Profit as defined in a UK form BI policy as compared to the meaning of gross profit used in everyday business, which often results in businesses being significantly under insured; (ii) the consequent effect of under–insurance on the amount an insured can recover under its BI policy; and (iii) the way indemnity periods are calculated.
In the recent decision in Eurokey Recycling2, the English Court addressed the issues of which insurance brokers (and by inference, CFOs and company risk managers) need to be aware when placing Business Interruption insurance for corporate clients.
The court noted the purpose of a BI policy is to maintain the turnover of the business during the indemnity period to enable it to resume trading at its anticipated pre-loss trading levels. However, where the policy is based on a gross profit basis, the insured will not necessarily recover its variable costs: “the experts agreed the simple and straightforward [approach] was simply to take turnover less purchases.” In addition, when considering the length of the indemnity period it is future, not past, gross profits which are relevant, so a 24 month indemnity period is a more realistic period within which to get the business back to its pre-damage levels, but policyholders invariably take a shorter period to save on premium.
Whilst the legal principles underlying a broker’s standard duties owed to its client were not argued3 the judge did note there were “several points arising out of the particular nature of business interruption cover on which [he] should state [his] views”.The judge then set down the following principles which apply to BI insurance, which must be read as being in addition to the standard duties owed by the broker:
- The broker must provide sufficient explanation to the commercial client to enable the client to calculate the BI sum insured and indemnity period
- To do so the broker must take reasonable steps to ascertain the nature of the client’s business AND its insurance needs
- The broker has a duty to take reasonable steps to ensure the client understands the term “Insurable Gross Profit”
- The nature and scope of a broker’s obligations to assess a commercial client’s BI insurance needs will depend on the particular circumstances:
- Levels of client sophistication will vary tremendously but it should not be assumed that a SME will have any understanding of the nature of insurance
- The need for repetition of advice provided annually pre-renewal will depend on the levels of continuity of client personnel
- If a client “who appears to be well informed about its own business” provides information to the broker the broker need not verify that information unless there is reason to do so. (The court did not comment on the extent of the broker’s obligation when dealing with a less well informed client but the broker should assume it might need to verify in those circumstances.)
- Where a broker is given express instructions as to the extent of cover to be obtained, it must satisfy the above obligations, and take reasonable steps to adhere to the instructions
- Where a broking firm offers additional enhanced services it does not reduce its duties set out above
To the above expressly stated principles, we would add that the broker has a duty to ensure it has taken reasonable steps to ensure the commercial client understands the meaning and effect of under-insurance (average) on the amount of any potential indemnity4
It is also worth noting that the court determined that if the broker had been in breach of its duties, there was contributory negligence on the part of the client for providing incorrect data for the Sum Insured.