Business interruption: ensuring protection keeps pace with your risk

The retail sector has undergone significant transformation in recent years. Disruptions including the Covid-19 pandemic, natural catastrophes and the Suez Canal blockage have underlined the fragility of global supply chains, fuelling interest in nearshoring. At the same time, retailers who have embraced automation and robotics have been rewarded with new levels of operational efficiency, helping them to reduce staffing concerns, minimise costs, and facilitate new consumer offerings, such as next- and same-day delivery services.

But as retailers change, so does their risk profile. To mitigate against a potential loss event, it’s important to regularly review business interruption cover. Failure to do so could leave a retailer underinsured, and a shortfall in payment for a large claim may make it more difficult to get back up-and-running following an incident.

Business interruption values and loss limits likely to be out-of-date

Business interruption (BI) insurance is designed to cover losses of gross profit along with increased cost of working that a business experiences during periods where it cannot carry out its usual activities due to an insured peril. The cover should protect the business until it has fully financially recovered. It is an indemnity-based coverage which aims to put the business back into the position it would have been without the event occurring.

Typically, the level of BI insurance required (the BI value) is calculated based on gross profit calculations, using insurance definitions (as expanded upon later) rather than accounting definitions. Businesses will also need to select an indemnity period, reflecting the anticipated timescale required to reinstate damaged assets and return to pre-loss trading levels.

Given the significant changes to have taken place within the retail sector in recent years, there is a high likelihood that Property Damage and Business Interruption (PD/BI) policy limits, if not updated recently, are out-of-date for most retailers. Relevant factors may include:

  • Stock management – some retailers continue to hold a larger volume of stock post­–Covid-19, having sought to insulate themselves from supply chain disruption and extended stock replenishment cycles. The size of potential losses at a fulfilment or distribution centre are likely to be higher than previous calculations and erode PD/BI loss limits more significantly.

  • Online sales – an increasingly multi-channel environment raises the risk of immediate revenue reduction and gross profit loss in the event of a loss at a critical fulfilment or distribution centre.

  • Rising labour costs – the product of a tight labour market, these may also impact on allowances for additional payroll costs in previous calculations. Shortages in labour may also impact the time it takes to reinstate operations.

  • Transportation costs – business continuity plans often rely on the option to air-freight goods to expedite stock replacement. Soaring transportation costs in recent years may render previous cost estimates inadequate to support this strategy.

  • Inflationary pressure – rising property reinstatement values may have eroded the balance of any loss limit available for business interruption losses.

  • Increasing levels of automation – these have reached extreme levels in some distribution and fulfilment centres, helping to drive operational efficiencies and facilitate new product offerings. However, in a disaster scenario, previous assumptions regarding the cost of labour will be required to be updated where there is a need to revert to more manual operations, since alternative distribution centres are unlikely to be available ready automated.

  • Extended lead times – current labour shortages are increasing the time it takes to reinstate key plant, machinery, and equipment. Furthermore, suppliers of bespoke automation systems typically have long order books. Securing priority attention will be a challenge without a prior commercial relationship.

  • Warehouse availability – given the shortage of large distribution centres in the UK, retailers may need two or more temporary facilities to replace lost capacity. Leases will be regarded as short term, and will likely be expensive. Temporary IT systems will also need to be duplicated at each site, and may take some weeks to become operational.

Business interruption reviews – keeping cover up to date

A significant loss event, should one occur, will have relevance for stakeholders throughout a business. Without appropriate cover, retailers may be unable to rebuild their operations in their entirety, leading to unfulfilled customer demand, or employees losing their jobs. Shareholders may also be impacted by a fall in the retailer’s valuation, which could lead to complications for the directors and officers accountable.

Given this, BI risks deserve specific investigation, through what’s known as a ‘BI review’. These reviews interrogate fundamental aspects covered under PD/BI insurance programmes, and should be undertaken regularly. BI reviews will cover a range of factors used by insurers to rate retailers’ risk. As a result, the outcome of a review will influence the eventual premiums paid for BI cover.

Typically, BI insurance reviews will consider:

  • BI value – establishing the BI value a business wishes to declare to insurers using the insurance definitions. This involves taking planned sales for the forthcoming year(s) and deducting the planned variable costs (uninsured working expenses) it wishes to exclude from BI coverage, along with the usual opening and closing stock adjustments. This approach enables the business to take control of the composition of the BI value, and is willingly endorsed by insurers.

  • Policy limit adequacy – i.e. is the size of the loss limit appropriate? This will be determined based on the retailer’s risk appetite e.g. whether installed sprinklers are assumed to operate as required, or whether to make provisions for their failure.

  • Indemnity period – how long will it take to reinstate potential major damage to assets, and then recover to pre-event planned revenue levels?

  • Interdependency – will damage at one location have knock-on effects for undamaged operations elsewhere?

  • Accumulation – could a single event affect multiple locations, generating a larger BI exposure?

  • Resilience/business continuity – how prepared is a business for a range of loss scenarios? For instance, retailers may be able to fulfil ecommerce sales via stores should their fulfilment centre not be available.

  • Contingent exposures – e.g. what key exposures might arise from potential disasters affecting key suppliers?

Through a BI review, retailers also gain access to bespoke recommendations for both BI insurance coverage and strategic business continuity. These ensure the policy is tailored to the BI exposure, and that improved business recoverability options are made clear.

Case study – the benefit of BI reviews

Although many retailers will need to be wary of the possibility that they are underinsured, it is also possible that retailers may be paying too much for their BI cover, due to unnecessarily high limits. Here again, regular BI reviews can help to minimise the likelihood of overpaying on insurance.

One case involved a retailer with £10bn annual turnover. The retailer had 12 main distribution centres for retail, and one for wholesale. The loss of one distribution centre for retail could be managed via the nearest of the other 11 sites with only nominal loss of insurable gross profit and under £20m of increased cost of working over 36 months. However, the one wholesale distribution centre presented a £200m PD/BI risk over two years, as it was not integrated with the retail operations and mitigation options were minimal.

It was recommended that the retail BI placement should be for increased cost of working only, but it remained unchanged for the wholesale element. The policy limit of £250m was found to be providing too much coverage and £200m was recommended.

For further information, please visit our Retail page, or contact:

Michael Kay ACII – Head of Retail Practice Group

E: (opens a new window)

Our latest retail insights


London Market Insurance Update H1 2024