In order to determine how much coverage you need, your insurance professional will base it on your educated guess about your future business profits.
There are substantial coinsurance penalties for under-insuring on your business for business interruption.
A coinsurance penalty is a deduction applied by the insurer to the claim amount which is paid.
This penalty can be anywhere from 20% to 50% of a claimed loss.
This requirement exists in order to keep businesses from under-reporting their income in order to pay lower premiums.
The amount of coverage required is figured in gross earnings, which is usually nothing even close to the method your business accountant would use. That being the case, you will have to make sure that your accountant figures the gross earnings in the way that is described in your policy’s definitions.
Each policy will be different and so your policy’s definition must be reviewed and understood carefully.
To illustrate what we mean, let’s say your business has gross earnings of $100,000 and that your policy has a 75% coinsurance requirement. This would indicate that your business needs to buy at least $75,000, or 75% of the $100,000, in coverage.
If your business does not have at least 75% in coverage, a penalty would be applied. That penalty is found by dividing the amount of coverage your business actually carries by the amount that should be carried, multiplied by the loss.
So let’s say that your business, as laid out above, has a business interruption of $50,000, but carries only $50,000 in coverage.
The amount of coverage you carry ($50,000) divided by the amount that should be carried ($75,000). That amounts to .67.
Then we multiply that .67 by the amount of coverage your business actually carries ($50,000), which comes to $33,500, which is the amount of the insurer payout. Simple subtraction of the insurer payout from the amount of the loss leaves, in this case, $16,500.
Because of the dangers inherent in the estimation of this type of insurance policy, many insurers have started including in their policies the “premium adjustment endorsement,” which allows the business to over-insure, thus eliminating the consequences resulting from the consequences of estimating too low.
Your company can safely avoid losing money by over-estimating, because at the end of the policy period, excess premiums paid are returned to the insured.