Business Interruption Insurance NZ: Are You Underinsured?

The Business Interruption Insurance Problem

Business interruption (BI) insurance — also called business income insurance or loss of profits insurance — is designed to replace the income your business loses when it cannot operate following an insured event such as fire, flood or storm damage.

The problem is that BI insurance is widely misunderstood by business owners, and as a result, many businesses that hold BI cover are significantly underinsured. When a claim arises, they discover their policy doesn't provide anything like the financial support they expected.

This article explains how BI insurance works, how to calculate the right cover amount, and the common mistakes that leave businesses exposed.

How Business Interruption Insurance Works

BI insurance is designed to work alongside your commercial property insurance. When a physical event — fire, storm, flood, earthquake, malicious damage — causes damage that prevents you from operating your business, your property insurance covers the cost of repairing or replacing the physical damage. Your BI policy covers the financial losses during the period your business cannot operate normally.

BI typically covers:

• Loss of gross profit — the revenue you would have earned during the interruption period, less the variable costs you don't incur while not trading
• Additional costs of working — expenses incurred to continue operating at reduced capacity, such as temporary premises, overtime costs or outsourcing
• Fixed ongoing costs — expenses that continue whether you are trading or not, such as rent, loan repayments, essential salaries and utilities

The Two Critical Decisions in BI Cover

1. The Sum Insured (Gross Profit or Revenue)

The sum insured on a BI policy represents the maximum financial loss the policy will cover. For most policies , this is based on the business's annual gross profit.

Gross profit for BI purposes is not the same as accounting gross profit. In an insurance context, gross profit typically means:

• Annual turnover/revenue
• Plus opening stock value
• Minus closing stock value
• Minus the cost of raw materials and production labour directly related to sales

This is sometimes called the insurance gross profit formula. Getting this calculation right is essential — underestimating your gross profit means your sum insured is too low.

The sum insured should also include a buffer for business growth. If your business is growing at 10–15% per year, insuring at last year's figures means you'll be underinsured if a claim occurs in the second half of the policy year.

2. The Indemnity Period

The indemnity period is the length of time your BI policy pays out — typically expressed in months from the date of the loss. It is entirely separate from the time it takes to repair the physical damage.

The indemnity period must be long enough to cover the time from the incident to the full restoration of your pre-loss revenue levels. This includes:

• Time to assess the damage and obtain building consents
• Time to repair or rebuild premises
• Time to replace equipment and stock
• Time to re-engage staff and suppliers
• Time for clients/customers to return

For many businesses, 12 months is insufficient. Post-earthquake Christchurch provided stark evidence of this — businesses that chose 12-month indemnity periods on cost grounds found themselves still struggling to restore revenue when the policy expired.

Recommended Indemnity Periods:

• Businesses in leased premises with alternative options: 12–18 months minimum
• Businesses requiring new construction or fit-out: 24–36 months
• Businesses with specialist equipment or long lead times: 24–36 months
• Businesses with high customer loyalty and strong revenue: 36 months

Common BI Underinsurance Mistakes

Basing the Sum Insured on Net Profit Rather Than Gross Profit

Many business owners confuse accounting gross profit with the insurance gross profit formula. If you insure only your net profit, you will have no cover for the ongoing fixed costs you must continue to pay during an interruption.

Choosing Too Short an Indemnity Period

The most common BI mistake . Business owners choose 12-month periods to save on premiums, not realising that recovery from a major insured event typically takes longer. When the indemnity period expires, the policy stops paying — even if your business is still struggling.

Failing to Update the Sum Insured

BI cover needs to be reviewed at every renewal to reflect changes in revenue, business mix and inflation. A policy set three years ago at $500,000 may be wholly inadequate if your business has grown to $800,000 in annual gross profit.

Not Including Additional Costs of Working

Some BI policies exclude additional costs of working unless specifically included. These costs — moving to temporary premises, expediting repairs, outsourcing production — can be substantial and should be included in your cover.

Assuming a Small Business Doesn't Need BI

Even a single-person business with modest revenue can face catastrophic consequences without BI. If your business depends on specific premises or equipment, and you have fixed costs (including your own salary) that continue while you cannot trade, BI is essential.

Business Interruption and Natural Disasters

the earthquake risk is significant and well-documented. The Canterbury earthquakes of 2010–2011 demonstrated how BI claims can overwhelm businesses that have not planned adequately.

Key considerations for earthquake-exposed businesses:

• Ensure your commercial property policy includes earthquake cover
• BI triggered by earthquake follows the property claim — both must be in place
• Earthquake-related BI claims can be extraordinarily long — 24–36 month indemnity periods proved inadequate for many Canterbury businesses
• Leasehold improvements and your ability to retrade from alternative premises should be factored into your BI planning

Reviewing Your Business Interruption Cover

We recommend reviewing your BI insurance at every renewal with specific attention to:

1. Recalculating your gross profit using the insurance formula 2. Reviewing whether your indemnity period reflects realistic recovery time 3. Updating for business growth and inflation 4. Checking that additional costs of working are included 5. Considering whether seasonal revenue fluctuations are adequately addressed

An insurance adviser can help you calculate the appropriate sum insured and indemnity period for your specific business. Contact us through this website to get expert advice on business interruption cover.