All too often, we see claims where an insufficient Maximum Indemnity Period (MIP) has been set — resulting in serious consequences related to the recovery of the policyholder’s business.
When the MIP — known as the time interval for insurance support after an incident — is assigned, it means that beyond that allotted time there is no cover, even if loss is ongoing. As such, the MIP needs to be long enough to take additional factors into consideration.
In most cases, the Maximum Indemnity Period begins when damage occurs and ends when the business is no longer impacted by the damage – or the MIP ends based on the set clause, whichever is sooner. In many commercial combined policies for smaller firms, covers have a 24 or 36-month minimum MIP. Unfortunately, once those firms are of a size that require bespoke cover — perhaps influenced by the higher premium a longer MIP entails — 12-month MIPs are frequently selected.
Selecting the Maximum Indemnity Period
When a business interruption (BI) loss presents itself in the scenario of physical damage, policyholders generally experience two phases:
Phase 1: The period of reinstatement, commonly known as the ‘mending period’, is when physical repairs are completed to buildings, machinery or other items, which form the material damage head of loss.
Phase 2: The subsequent period of recovery refers to returning the business to the position it would have been in, had there not been damage. This takes into account the recovery time to reinstate lost customers, retrain staff, etc..
Phase 1 is indirectly correlated with phase 2. The business recovery time can be exacerbated by how long repairs take; the longer phase 1 takes, phase 2 will be extended disproportionately. Therefore, when considering the MIP, the policyholder – with help from their brokers – should work on the assumption of a total loss and should also take into account a full recovery period (phase 2). For example, it may take six months to complete repairs to a building or replace machinery. However, it could take an additional 12 months to win back key customers lost during this period (or replace them with new customers).
Proportionately increasing gross profit for longer MIPs
Policies typically define gross profit as turnover, less uninsured working expenses (or specified working expenses), adjusted for movement of stock. Those will not be terms familiar to the policyholder, and gross profit in a policy maynot be defined on a basis consistent with how a policyholder uses the term gross profit in their accounts. Once this has been calculated correctly as an annual amount in line with the policy definition, it must be increased for longer MIPs. If an MIP of 24 months is selected, the gross profit figure must be doubled.
Most gross profit policies also offer cover for incurring additional costs to avoid gross profit losses happening in the first place (often termed ‘increase in cost of working’). This allows policyholders to spend money if it’s reasonable and necessary to avoid a reduction in turnover during the MIP. However, it must also be economical; insurers will allow policyholders to spend £1 to save £1, but no more. It stands to reason that a long MIP will allow more flexibility regarding this economic limit (the gross profit at risk over 2 or 3 years is greater than just 1).
Is 12 months long enough?
From experience, we can confidently say that a 12-month MIP is too short for almost all policyholders. The difficult question is, how long is enough? Ultimately, this should be an informed decision between the policyholder, their broker and insurer. There’s a myriad of potential issues that need to be thought through in detail when considering the MIP. This includes the site and premises – tenancy or ownership, use of buildings, space required, location – as well as retaining trained staff, outsourcing options, replacing plant and machinery, together with the time and cost of winning back business, and more.
With the financial implications of paying a higher premium (albeit for more appropriate cover), it may boil down to a question of economics. But with a robust disaster recovery strategy, policyholders should be able to make informed decisions on whether the MIP is adequate for their specific business needs.
We recommend that brokers offer a minimum MIP of 24 months to all policyholders, which should be committed to the written record. If somebody insists on only 12 months, give them the 24-month quote to avoid any misunderstanding when a loss arises and exceeds 12 months.