For many of your clients, filling out a Business Interruption (BI) worksheet probably ranks right up there with filing their taxes or visiting the dentist. However, it is an important step in understanding their business earnings and the foundation in quantifying any related exposures. Here are a few helpful tips for tackling BI worksheets.
The importance of accurate BI values
Before getting started, we should talk about why calculating accurate BI values is so important. There are three important reasons: To ensure adequate limits, to understand the exposure, and the specific terms and conditions of how the policy will apply.
First, it's important to make sure you have the appropriate coverage, which is particularly important due to location and policy sublimits often placed on BI coverage. If a client has a US$10 million sub-limit for business interruption, but their actual exposure is closer to US$20 million, they may not be made whole after a loss.
One of the policy terms and conditions is how the deductible will apply in a loss. Consider a client in Miami whose policy has a 5% wind deductible. The percentage deductible is calculated based on the actual BI value at the time of the loss. This client had been reporting US$5 million in BI for several years, but had not actually filled out a BI worksheet or gone through the calculations. After a hurricane loss, it was determined that their actual BI value was US$10 million. So instead of a US$250,000 deductible, they would have a US$500,000 deductible on this loss.
It's also important to note that even if a client fills out a worksheet at renewal, their BI exposure can change over the course of the policy term, particularly if their revenue streams are changing rapidly.
Calculating BI values
So how can you complete BI worksheets with the least amount of frustration? When you break it down, the BI value can be calculated one of two ways:
Option 1: The Build-Up Method
This is calculated by adding net profit plus fixed/continuing expenses.
Option 2: The Deduction Method
This is calculated by taking net revenues and deducting all variable/non continuing expenses.
Both methods produce the same results; however, the deduction method is generally easier to calculate and closely resembles the way companies already measure annual performance.
Additionally, here are few areas that can cause some confusion:
Lost in translation: Sometimes insurance terminology can cause confusion. Here are a few tips about insurance terms:
- Continuing Expenses = Fixed Costs (salaries, administrative operations, property taxes, interest expense)
- Non-Continuing Expenses = Variable Costs (raw materials, direct labor, commissions)
- Business Interruption Value = Contribution Margin
- Ordinary Payroll = Direct Labor and Benefits
Semi-Variable Expenses: Some costs are not 100% fixed—such as utilities, advertising, maintenance—so you will need to estimate how much of these expenses are fixed and what percentage would not continue in the event of a loss.
Ordinary Payroll: Is considered a non-continuing or variable expense. Often clients have questions as to which type of payroll and benefits should be included in this calculation. A good way to think about this is to determine which employees would not be retained during a shutdown after a loss. Typically, production employees would not be retained during a shutdown, so payroll and benefits for these employees would be considered variable and thus Ordinary Payroll. Executive and administrative staff (and perhaps some of the maintenance staff) would likely be retained so their salaries/payroll would be considered continuing or fixed expenses.
Establishing accurate BI values is a vital step in calculating exposure to loss for any client. For any additional questions about BI calculations, contact your Production Underwriter. In addition, BI worksheets and additional resources to assist with accurate BI calculations can be found on AFM Online.