Tag Archives: commercial property

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.

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.