Business Interruption Sum Insured: How It Works
How BI insurance sums insured are calculated on a gross profit basis — and why indemnity period selection and annual declaration updates matter so much. Indicative only.
What Business Interruption Insurance Covers
Business interruption (BI) insurance covers the financial losses a business sustains when it cannot trade normally following an insured event — typically a physical damage event such as a fire, flood, or equipment failure that is covered under the associated property policy. BI pays for lost profit and continuing fixed costs during the recovery period.
BI does not typically cover losses from events that do not cause physical damage to the insured premises — although extensions exist for some scenarios. Policy wordings vary significantly. This guide explains the sum insured calculation methodology, not the coverage terms.
Key Concepts
Gross Profit — Insurance Definition
For BI purposes, “gross profit” is not the accounting definition. It is defined in the policy, and typically means:
Uninsured Working Expenses = variable costs that cease when trading stops
(e.g. raw materials, goods for resale, trade discounts, commissions)
Fixed costs (rent, salaries, loan repayments, utilities) are generally
included in BI Gross Profit because they continue during the interruption.
Indemnity Period
The indemnity period is the maximum length of time for which the BI policy will pay out following an incident. It begins at the date of the insured event and continues until the business has returned to the same financial position it would have been in had the incident not occurred — subject to the maximum period selected.
Common indemnity periods are 12, 18, 24, or 36 months. Selecting too short a period is the most common cause of under-insurance in BI — a business that takes 20 months to fully recover with an 18-month indemnity period has an uninsured gap of 2 months.
The Sum Insured Calculation
The annual BI gross profit should be the projected figure for the period
of insurance — not the prior year's actual (particularly if the business
is growing).
Under-Insurance: The Average Clause
Most BI policies include an average clause (also called “condition of average” or “proportional clause”). If the sum insured is less than the actual BI gross profit for the indemnity period, the insurer will only pay a proportion of the loss — in the same ratio as the sum insured bears to the correct sum insured.
Example:
Correct sum insured: £2,100,000
Declared sum insured: £1,400,000 (67% of correct)
Loss incurred: £500,000
Claim paid: £500,000 × (£1,400,000 ÷ £2,100,000) = £333,333
Uninsured: £166,667
What-If: Indemnity Period Too Short
If a business selects a 12-month indemnity period but actually takes 20 months to return to pre-incident trading levels, the policy stops paying at month 12. The remaining 8 months of losses are uninsured. For the example above, at £1,400,000 annual BI gross profit, 8 uninsured months represent approximately £933,000 of uncovered losses.
What-If: Turnover Grows and Sum Insured Is Not Updated
If the business in the example grows turnover from £2,000,000 to £2,400,000 in the following year but does not update its BI sum insured, the correct sum insured rises from £2,100,000 to approximately £2,520,000 (assuming cost structure unchanged). The under-insurance gap of £420,000 would trigger the average clause at any partial claim.
Factors That Affect Recovery Time (and Indemnity Period Selection)
| Factor | Tends to lengthen recovery |
|---|---|
| Specialist equipment lead times | Bespoke machinery may have 6–18 month lead times |
| Planning or regulatory approvals | Rebuilding may require planning permission |
| Supply chain disruption | Key suppliers may also be affected by the same event |
| Customer relationship recovery | Customers may have found alternative suppliers during the interruption |
| Staff retention | Key staff may have left during extended closure |
Most insurance market guidance suggests that businesses underestimate their recovery time. An 18–24 month indemnity period is commonly recommended as a minimum for businesses with any material complexity, unless a specific shorter recovery scenario can be demonstrated.
What is the maximum indemnity period typically available?
UK commercial BI policies typically offer indemnity periods of 12, 18, 24, or 36 months. Some specialist policies for large manufacturers or complex supply chains extend to 48 months. The period should reflect the worst-case scenario for recovery — including rebuilding, equipment lead times, regulatory approvals, and customer reacquisition. Underestimating leads to cover running out before trading is fully restored.
How does the average clause apply to BI under-insurance?
The average clause (or co-insurance clause) applies when the declared sum insured is below the actual gross profit at risk. In that case, the insurer treats the policyholder as a co-insurer for the shortfall. Example: if gross profit at risk is £500,000 but declared sum is £300,000 (60%), a £100,000 claim is paid at 60% = £60,000. The policyholder absorbs £40,000 of a covered loss — despite paying for BI cover — purely due to under-declaration.
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