Co-Insurance and Business Interruption – Nothing to be Afraid Of

In our experience, the concept of co-insurance in relation to business interruption is one of the least understood and most feared topics by all parties involved.  Many brokers don’t have a good idea of how best to set appropriate policy limits for business interruption, many adjusters don’t fully understand how to determine co-insurance compliance and many insured’s feel unfairly penalized when co-insurance requirements are applied following a claim.

Any business interruption policy which isn’t classified as Actual Loss Sustained (ALS) is subject to some degree of co-insurance requirement, typically ranging from 80% to 100%.  The idea behind co-insurance requirements is to force the Insured to purchase an adequate amount of insurance relative to the size of their business.  If the Insured purchases less insurance than is required to cover the business in the event of a total loss then they become their own co-insurer and are responsible for a proportionate amount of any loss incurred.

Setting policy limits with co-insurance

When the limits for insurance are set one of the most important factors to consider is what the potential maximum indemnity period for a loss would be.  The limits must be set considering the absolute worst case scenario.  The typical worst case scenario is illustrated by the following example:

A business interruption policy with a maximum twelve month indemnity period and a one year renewal is put into place on January 1, 2015 with the policy expiring on December 31, 2015.  On December 31, 2015 the business suffers a total loss fire and will be unable to resume operations for the maximum twelve month indemnity period.  The indemnity period would then stretch to December 30, 2016, two years from the inception of the policy.

The above scenario highlights the need to consider not only the requirements of the business at the time the policy is purchased but the requirement to estimate the performance of the business for the next two years.  Failure to consider these changes in a business which is growing could have significant negative impacts in the event of a loss.

Common mistakes when setting policy limits

Some of the most common mistakes we see with regard to the setting of policy limits include the following:

  • Failure to consider annual growth or the potential value of new contracts, resulting in underestimating future profits and expenses;
  • Failure to consider all the fixed expenses of the business, as opposed to those which cease during a loss period;
  • Insuring multiple locations under one policy with insufficient limits to cover all locations on the basis they all are down at the same time.
  • Deducting expenses which would be expected to be saved in the event of a loss. Saved expenses are not taken into consideration in determining co-insurance compliance.
  • Setting limits based on revenue only. This would result in over insuring the business as the variable expenses would not be insured in the event of a loss.
  • Setting limits based on net income only. This would result in significant under-insurance as none of the fixed expenses of the business would be considered.

Obviously all of the above issues can impact the insured…and unfortunately it is often not identified until a loss occurs.

Checking co-insurance compliance

In the event of a loss, co-insurance compliance would be determined by the following two part formula:

Part I

Projected Annual Sales for the 12 Months Following the Date of Loss

Multiplied by: Gross Profit/Gross Earnings Rate

Equals: Annual Gross Profit/Gross Earnings

Multiplied by: Co-Insurance Requirement (80%/90%/100%)

Equals: Limit of Insurance Required


Part II

Actual Policy Limit

Divided by: Limit of Insurance Required

Equals: Loss Recovery Rate

If the actual policy limit is in excess of the limit of insurance required, then there will be no co-insurance penalty and the recoverable loss will be 100%.  However, if the actual limit is less than the limit required, the recovery rate on the loss will be less than 100%.  The difference between the recovery rate and 100% will represent the portion of the loss the Insured will be responsible for or the insured is co-insuring.

Final Thoughts

When all parties involved have just a basic understanding of what co-insurance is and what it’s impact can be in the event of a claim the entire process from policy purchase to the conclusion of a claim can go very smoothly.  While it may seem complex a first it is not really that scary to deal with and ADS is always available to help you out.

Key Payroll vs. Ordinary Payroll – Not all Payroll is the Same

One of the most contentious issues in any business interruption matter is often the treatment of payroll.  While the employees who are deemed to be “Key” to the business are insured under any business interruption policy wording, the treatment of “Ordinary” employee payroll varies wildly from policy to policy.

In dealing with business interruption coverage it is necessary to establish from the day the coverage is purchased what portion of the business’s payroll relates to key versus ordinary employees.  This distinction is a requirement of determining both the best coverage type for the business and necessary for the purposes of setting policy limits.  But what are key and ordinary payroll?

Ordinary Payroll Coverage

Depending on the policy Ordinary Payroll could be treated in any one of the following ways:

  • Insured for the entire indemnity period within the business interruption coverage;
  • Not insured under the business interruption or any other coverage;
  • Insured under the business interruption coverage for a specified period (typically either 90 or 180 days);
  • Insured separately from the business interruption coverage, subject to different limits, co-insurance requirements, and maximum periods of indemnity.

At the time a policy is being sold it is important to consider which of these coverage types will best suit the insured and at claim time it is important to know which of these options is to be considered as each will have its own set of considerations.

Key vs Ordinary Payroll

The payroll records of any business are rarely neatly split between different groups of employees based on role or titles.  Most of the time when reviewing payroll records all the employees of a business will be found in a single list of records.  So how do we establish who is key and who is ordinary?

We can start by looking at some definitions commonly found in policy wordings.  One of the most common definitions of Ordinary Payroll you will find in a business interruption policy is as follows:

Wages and salaries other than salaries to permanent staff and wages to foremen and important employees whose services would not be dispensed with should the business be interfered with or interrupted

Typically this wording is interpreted to mean that the Key employees of the business are those who are in management or supervisory positions or employees with unique skill sets required by the business.    However, the term “important employees” is often open for interpretation and an employee’s services may be viewed differently in terms of the value added to the business by different parties.

Key employees would often be the most difficult for the business to replace, and have the greatest impact on the business if they had to be let go or laid off.  As such, in the event of a loss requiring the business to cease operations for an extended period of time, the employees the Insured’s management decides to lay-off versus continuing to pay will provide good insight into who the business considers Key.

In the event of a dispute over which employee should be considered Key vs Ordinary following a loss, one option is to review the original worksheet from when the policy was purchased to consider what dollar value was allocated to Key and Ordinary payroll respectively.

Owners of the Insured Business

It is important to note the owners of the business, if on the payroll, are always considered Key, regardless of the actual work they contribute to the business.  This is because the wages paid to the owners are entirely at the owner’s discretion and essentially this represents a distribution of the profits of the business.

Final Thoughts

As payroll is frequently one of the largest expenses incurred by a business, it is important to ensure the allocation of Key and Ordinary payroll is done carefully and consistently with the original intent when the policy was written.  As the expense is often large its treatment will have significant impact on the profit rate of a business which will directly impact co-insurance compliance.

Business Interruption Policies…Things are a changing!

(Gross Profit vs. Gross Earnings vs. Hybrid Policies)

Traditionally, business interruption insurance policies have fallen under one of two styles, Gross Earnings or Gross Profits.  In recent years the consistency in policy styles has been eroding and new hybrid style forms are starting to become more prevalent.  These policies rely on components from each of the two traditional styles.

As a result of the changes many policies have undergone in recent years, it is important to understand the traditional characteristics of each form, and subsequently how they integrate into the new hybrid policies.

Traditional policy characteristics

Below is a brief comparison of the two traditional styles based a few key coverage characteristics. While every policy can vary, the information listed below is most common based on our experience:


Gross Profit

Gross Earnings

Indemnity Period Business returns to normal operations Period to Rebuild, Repair, or Replace the damaged property
Measure of Recovery Gross Profit Rate:  Net Income plus Insured Standing Charges (Fixed Expenses) Gross Earnings Rate: Sales less variable expenses
Ordinary Payroll Not insured Insured
Co-Insurance Hidden in the policy wording at an implied rate of 100% Specifically stated in the wording at varying rates, typically either 80%, 90%, or 100%
Additional Expenses Referred to as an Increase in Cost of Working Referred to as Expense to Reduce Loss

Hybrid policies

There is an increasing variety of hybrid type business interruption policies available in the market place. These policies incorporate components from each of the above traditional lists, and often make even further modifications. For example, it is no longer uncommon to find a policy which will feature an indemnity period based on a return to normal operation calculated using a gross earnings rate with no co-insurance requirements.  Sometimes, these hybrid type policies will be developed in an attempt to market them at specific business types, for example restaurants.  As a result you may see these policies named in such a way that incorporates their target market into the policy wording title.  As such, it is important to thoroughly review the policy you are dealing with when assessing a claim.

What further complicates the claims process, are the terms used within the industry. Terms such as “Business Income”, “Business Earnings”, and “Loss of Income” have been adopted by many insurers to name their business interruption coverages in place of the more traditional Gross Earnings or Gross Profits titles.  Even between two insurers, a single term such as “Business Income” may refer to either a profits style wording or an earning style policy.

Final Thoughts

After a long period in which business interruption coverages didn’t change significantly, the push for customization for everything in recent years and the desire for insurers to differentiate themselves has resulted in a lot of changes in recent years, not always for the better.  The ever decreasing standardization of these policies has made it more important than ever to take the time to carefully review and understand the policy you are dealing with.

HST … it has value in the claims process too

Not all businesses have to file Harmonized Sales Tax (“HST”) remittances.  For those which do, they can be a valuable source of information in the claims process…especially when other documentation was destroyed or is incomplete.  The key is to know what the remittances tell you.

A little about HST Remittances

All businesses whose sales exceed $30,000 annually are required to register with Canada Revenue Agency (“CRA”) for the purposes of collecting and remitting HST.

In preparing an HST remittance, a business is also permitted to claim tax credits for the HST they paid to others on purchases made by the business for expenses such as inventory and supplies.  As a result, it is beneficial for all businesses to register for HST, not only businesses with sales in excess of $30,000 annually.

Depending on the sales levels of a business, CRA requires remittances to be filed either annually, quarterly (every 3 months), or monthly.  The higher the revenues of the business the more frequently they will be required to file HST.

How an HST remittance is used in a claim

In the event of an insurance claim, HST remittances can be a valuable source of information.  Line 101 of the HST Remittance will list all revenues of the business during the period the remittance covers.  Regardless of whether a particular stream of revenue is tax exempt, it must still be reported on line 101 of the remittance.  This information will allow for reconciliation between other sales records provided for purposes of a claim.

If needed, adjustments for sales which are HST exempt are made on subsequent lines of the HST remittance.

The filing date is also of great value.  The remittance indicates the date on which the document was filed and assessed.  Records prepared prior to a loss are often considered more credible, and as such, determining if the income was reported on time and prior to the occurrence of the loss is of value.

Finally, in the event the Insured contends that all documentation regarding the sales of a business was destroyed in a loss incident such as a fire, copies of historical HST remittances can be obtained from CRA with only a few weeks wait time.  This may prove to be a valuable alternate source for records, outlining revenue, in the event of a loss.

Final Thoughts

HST remittances don’t provide the detail you may find from other source documentation.  But in situations where nothing further is available, or as a means of confirming the completeness and accuracy of other records provided, HST remittances can be a valuable resource in the claims process.

Lost Sales aren’t Always Lost (What are Make-up Sales?)

When a business suffers a loss it will often lose the ability to sell products or services to its customers. These lost sales, however, are not always permanent and at times the insured can “make-up” the losses after the business resumes operating. Without giving consideration to this fact claim costs may increase, and the insured may be over-indemnified.

But, how do you know when a sale is truly lost and how do you determine what may be made up later?

Questions in assessing “make-up” sales

Assessing if sales completed after an insured resumes operations following a loss incident include any component which makes up for sales lost while closed, can be extremely difficult.  To assist, there are a few things you will need to establish:

1. What was the performance of the business immediately upon resuming operations?

When a business reopens it is not uncommon to see a spike in sales for a short period immediately after reopening. The portion of the sales spike in excess of normal projected sales is often what represents the make-up sales.

The period of the sales spike can vary from a few days to a few weeks depending on many factors.  However, if a sales spike following resumption of operations last more than a few weeks, you may need to re-evaluate your sales projection methodology (See related blog posts on Sales Projection Methodologies)

In evaluating the performance of the business following the resumption of operations you should apply the same methodology which was used to project lost sales during the period in which the business could not operate.

2. Is it reasonable the business could have make-up sales?

Make-up sales are not possible for all types of businesses. Factors can include the types of product sold or service offered, seasonality, and the level of local competition.

Products which are unique to the insured’s business, expensive, or non-essential are more likely to be made-up following the resumption of a business’ operations.  Examples may include furniture stores, high-end clothing stores, custom products, and jewellery stores.  As the products which customers purchase from these types of business are typically planned in advance, decided based on customers specific tastes, and customers are often willing to wait to purchase the specific product they want, these types of business’ are likely to experience make-up sales in the event of a loss.

Sales of goods which are perishable or purchased more impulsively are less likely to experience make-up sales.  If a customer chooses to go to a restaurant on a Saturday night and that restaurant is closed due to a loss, it is more likely that customer will simply find another restaurant rather than waiting for the business to reopen before purchasing their meal.

The level of competition in the area the business operates will also directly impact the likelihood of make-up sales occurring.  A furniture store in a large urban area with a large amount of competition selling the same brands may have no opportunity for make-up sales.  On the other hand a grocery store in a remote area with little competition may experience make-up sales as customers delay purchases due to lack of alternative options.

Final Thoughts

Consideration of make-up sales when determining a business interruption loss will require the review of additional records beyond the time a business resumes operating. This will extend the length of time required to complete the claims process.  However, failing to consider this possibility may also increase claim costs as the insured’s business will be over indemnified for their losses.

Saved Expenses – Overlooking These Can be Costly

Following a business interruption loss, you can expect many changes in the business to occur.  Revenues may drop, expenses could increase or decrease, and for a period the business may even cease operating.  Often when a business interruption loss occurs, the business is likely to experience a savings in certain expenses which would normally be a fixed monthly cost.  The longer a business is unable to operate, the more likely it is for otherwise fixed expenses to cease.  The degree to which expenses change is often dependent on the amount of damage which occurred.

This post is about the saved expenses which occur following a business interruption loss.

Common Expense Changes

There are a few types of expenses which are commonly impacted in the event of a loss.  It is important when assessing a claim, to review these expense categories to determine how they have been impacted by the loss.

  • Rent – The changes to rent payments following damage to a rental space is typically specified in the lease agreement. In commercial leases we most commonly see three types of rent abatement:
    • If the rented space is damaged in such a way that a portion of the space is still usable, then a portion of the rent will abate.
    • If the rented space is entirely unusable but can be repaired within 120 days, then rent will cease until repairs are completed.
    • If the rented space is entirely unusable and cannot be repaired within 120 days, the rent ceases and the lease is terminated.

It is important to understand which of these three rent abatements may be applied, as they would be considered a saved expense.

  • Repairs and Maintenance – These expenses are typically incurred periodically rather than on an ongoing basis. During a period in which the business is being repaired as a result of a loss, the repair expenses are typically paid by the insurer and the insured will not incur any normal repair expenses relating to the damaged area.  Accordingly, it is reasonable to treat this expense as a savings.
  • Utilities – In the event the premises is entirely destroyed all utility costs would cease. However, in the event the premises is only partially damaged it is likely that utilities will continue, although possibly at a reduced rate. In the situation a business is closed for repairs, although the utilities normally consumed in operating the business may cease, the utilities consumed to perform the repairs may off-set any savings.  Each situation must be assessed to determine what if any the saved expense would be from utilities.
  • Advertising – Advertising expenses may cease or be reduced depending on the nature of the advertising done by the business, and the severity of the damage. While annual contracts may not change, costs associated with short-term advertising such as radio and newspaper ads may cease or be reduced.  Further, depending on whether the entire business is closed for an extended period, or only a portion, will impact whether the business continues to draw clients to its premises.
  • Amortization – The treatment of amortization as a saved expense is often the most controversial item. Many insured’s will argue that as it is a non-cash expense it really is not an expense and therefore the savings in amortization should not be considered.  However, in determining the profit of a business, amortization is a very real expense and has direct implications on the amount of taxes paid by a business.  When the assets is subsequently replaced the Insured will have the advantage of being able to fully depreciate a brand new asset, reducing future tax liability.  If the savings in amortization is not considered following the destruction of an asset, and in the period in which the business is unable to operate, the insured would be over indemnified as the insured would recover both the insured value of the asset plus an allocation of the original cost.

Final Thought

There is no set amount to consider for saved expenses, and the expense categories listed above do not comprise all categories in which savings may be realized.  Instead, it is important to understand the business operations before and after the incident, and the impact on each expense category.

What is the Indemnity Period?

Business interruption policies exist to cover an insured following a loss incident. The two main issues are what is covered, and for how long.  In this post we address the issue of the indemnity period…the period over which losses are insured.

There are generally two styles of indemnity periods which can be found in policies, often referred to based on an abbreviation of their main characteristic: Repair, Rebuild, Replace or Until Normal Operations.

What do these terms mean, and how do they impact the loss payable?

Repair, Rebuild, Replace

A typical business interruption policy wording which is of the Repair, Rebuild, Replace style will include the following definition, or a version of this definition, with regard to the indemnity period:

“Indemnity Period means the period beginning with the occurrence of the damage and ending not later than such length of time, not exceeding 12 calendar months, as would be required with exercise of due diligence and dispatch to rebuild, repair or replace the lost or damaged property.”

The definition means that regardless of the state of the business, once repairs are completed the indemnity period for any business interruption coverage ends.  As a result, any losses incurred beyond this period would not be insured.  Typically this type of wording is found in traditional style Gross Earnings type business interruption policies.  However, in our experience, with the increase in hybrid style wordings this type of wording is becoming much less than it was even five years ago.

Although not specified in the definition above, the maximum indemnity period may be greater than 12 months if a longer indemnity period has been purchased by the insured and is specified on the Declarations Page.

Until Normal Operations

A typical business interruption policy wording which is of the Until Normal Operations style, will include the following definition, or a version of this definition, with regard to the indemnity period:

“Indemnity Period means the period beginning with the occurrence of the damage and ending not later than 12 consecutive calendar months (or such other period if so specified on the “Declarations Page” as the maximum indemnity period) thereafter during which the results of the business shall be affected in consequence of the damage.”

This style of wording means the business will be covered for any loss which occurs until such time as the maximum indemnity period is reached or the business has returned to its normal operating capacity.  There is no specific consideration in the indemnity for the length of time taken to complete repairs.

This type of wording is most appropriate for businesses which may take a longer period of time to regain customers or normal sales levels after being closed due to damages.

Two policies in one

A variation on business interruption policies which we see on occasion is a two form business interruption coverage.  These types of policies have one set of wording which covers the period from the occurrence of the damage to the completion of repairs, and an optional extension that covers the period from the completion of repairs until the business resumes normal operating levels.

When reviewing these types of policies, you will note the existence of both definitions discussed above.  In situations such as this it is important to fully review both wordings and determine how they will interact with each other.

Final thought

It is obvious that the indemnity period within a policy can drastically impact the loss payout.  As such it is important that you are thorough in your understanding of the indemnity period, both at the time of purchase and following a loss incident.

The Basics of Calculating a Business Interruption Loss – Profits vs Earnings

Regardless of the specific language used, the rate applied in measuring business interruptions losses will fall under one of two different styles.  For ease of reference we will refer to these styles by their traditional names – profits and earnings.

While the following calculation methodologies outlined below are pretty basic, it should never be forgotten that the underlying assumptions which are used to calculate the rates can at times be very complicated.

Profits (& Insured Standing Charges)

Under a gross profits style wording the profits rate is calculated as:

Net income (profit or loss in the period prior to the damage)

Plus: Insured Standing Charges

Divided by: Sales

Most policy wordings will define Insured Standing Charges based on what they specifically exclude, such as amortization of stock, bad debt, and ordinary payroll.  Rarely if ever do they actually define an Insured Standing Charge.  The commonly accepted meaning of an Insured Standing Charge is an expense which does not vary with the sales of a business, specifically a fixed expense.  Common examples will include rent, insurance, and bank charges.  The actual fixed expenses incurred by a business will vary by business size and industry.


Under an earnings style wording the earnings rate is calculated as:


Less: Variable expenses

Divided by: Sales

Like fixed expenses, the variable expenses incurred by a business will vary from business to business and between industries.  Typically, the largest variable expense is Cost of Goods Sold. These are the expenses directly incurred in the generation of revenue.  Cost of Goods Sold can include items such as materials, direct wages and subcontracts.


Each policy will likely specify which of the above two methodologies is to be applied in calculating a business interruption loss.  However, if the allocation of expenses between fixed and variable is consistent, both methods should yield the same result.  That is, the rate produced by adding fixed expenses to net income and the rate produced by deducting variable expenses from sales will be the same.

To illustrate this principle that each policy should yield the same result, we have included an example:

Income Statement

Gross Profits

Gross Earnings







Sales 5,000 100% 5,000 100% 5,000 100%
Cost of Sales 2,500 50% 2,500 50%
Gross Margin 2,500 50%
Other Variable Expenses 500 10% 500 10%
Fixed Expenses 800 16% 800 16%
Total Expense 1,300 26% 3,000 60%
Net Income 1,200 24% 1,200 24%
Gross Profit/Gross Earnings $2,000 40% $2,000 40%

Final Thought

Trying to determine the appropriate methodology to use in assessing a business interruption loss, profits vs earnings, can be challenging, especially with all the different terms being used to describe the same basic things.  While it is important to be accurate and follow the specific terms of your policy, in the end you can arrive at an accurate number under either methodology.