HISTORY OF BUSINESS INTERRUPTION INSURANCE

HISTORY OF BUSINESS INTERRUPTION INSURANCE

undefinedundefinedDespite modern fire insurance being developed in the late 1600’s in Germany, then in England following the Great Fire of London of 1666[1], the development of Business Interruption insurance, as we know it today, was not started for another 102 years. 

This was despite the realization that only insuring the Insured’s physical assets was not enough. To fully protect a business from significant losses and often financial ruin following a fire, storm, lightning, hurricane, tornado, tsunami, or the myriad of other perils covered by insurance, it is obvious when you think about it. In simplest terms, the United States Postal Service does not stop delivering the bills when the fire department has driven off. Quite often it is “fire today, gone tomorrow” even with full property insurance.[2]

To fully protect a business’s survival, the investment of the stockholders and creditors, the jobs of employees and management, an Insured needs to insure their business income. The basic premise of Business Interruption insurance is explained in the next section.

The reason for the slow development is that despite the principle of utmost good faith that underlies every contract of general insurance, insurers require a high degree of certainty that the amount they are to pay out is the genuine loss sustained by the Insured.

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Despite this, from as early 1797, Minerva Universal a United Kingdom based insurer attempted to introduce consequential costs, for example to cover the inability to pay interest however the lack of accounting standards prevented its success.[3] 

undefinedIn 1817, the “Hamburger General-Feur-Kasse” [English Hamburg Fire Office] offered the first loss of rent coverage as a supplement to fire insurance. [4]

The next development came quickly afterwards in 1821 with the development of a Time Loss policy introduced in England. This product also known as the per diem principle or system which offered daily or weekly compensation.[5]

Uniform accounting standards, so important in the development of business interruption insurance commenced in Great Britain with the formation of The Edinburgh Society of Accountants (formed 1854), the Glasgow Institute of Accountants and Actuaries (1854) and the Aberdeen Society of Accountants (1867). Each granted a royal charter almost from their inception. The three bodies did not merge though till 1951, becoming the Institute of Chartered Accountants of Scotland.

Meanwhile, a solution to providing business interruption protection continued. In 1857, in Alsace France, Chômage Insurance (which means standing still or standing idle as in a factory or a stoppage or cessation of labor, i.e. unemployed) introduced the systeme fortaitaire, [flat system]. This cover provided a flat additional cover, say 10%, for stock to cover a proportion of the loss of profits that the sale of that stock would have generated for the business. This is a similar concept in Marine Insurance where the basis of settlement is CIF + 10% [Cost Insurance Freight +10%].

It is understood that some insurers in the United Kingdom adopted the concept and the first known cover in the London was places around 1868.[6]

undefinedEngland and Wales followed the lead of the Scots with The Institute of Chartered Accountants in England and Wales (ICAEW) being established by royal charter in 1880.

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A few years later, in 1887, when the American Association of Public Accountants (AAPA) was formed which is known today as the American Institute of Certified Public Accountants.
 

In 1880, Boston (USA) based insurance agent Dalton, introduces the expression “use and occupancy”, already familiar in fire insurance, for the insurance of loss of production following a fire. Until the 1940’s In the United States, Business Interruption insurance continued to be known as “Use and Occupancy” insurance. The term survived in boiler and machinery insurance until the late 1970.s[7]. Most of the Use and Occupancy Policies were value policies with a set dollar amount each day where the Insured was prevented from conducting operations[8].

undefinedundefinedWhat was the forerunner of the British loss of profits system was developed by actuary and insurance broker, Ludovic MacLellan Mann (1869-1955) in Glasgow [Scotland] in 1899. Originally it was known as Consequential Fire Loss Indemnity it later became universally known as Consequential Loss Insurance or Profits Insurance. The key feature of this new product was that turnover was the base of the calculation, while it covered both the profit and the ‘standing charges’ of the business. This new form of coverage was marketed by the Western Assurance Company.[9]

Mann later became Senior Partner and Managing Director of Mann, Ballantyne & Co, Insurance Brokers and Independent Neutral Advisors, with offices in London and Glasgow.[10]

Mann’s system was adopted in Sweden in 1906.[11]

The regulatory authority controlling insurance in Germany approved business interruption insurance following machinery breakdown in 1910.[12]

In 1938, the Gross Earnings policy also known as the US Model was introduced into the United States[13]. While I explain the different types of business Interruption insurance under a separate heading, I would explain here that Gross Earnings is a form of business interruption insurance covering the insured’s reduction in gross earnings suffered as a result of a disruption following direct damage. For a nonmanufacturer, gross earnings are essentially total sales less the cost of goods sold. For a manufacturer, gross earnings are the sales value of production, less the cost of raw stock from which the production is derived. Included in this coverage are profits, continuing expenses, management payroll, and ordinary payroll.

While a start it was not the solution. The problem for insurers was that until reliable financial accounts were regularly prepared by businesses, insurers had no certainty that the losses as claimed were reasonable. The accounting bodies, supported by government (the desire to levy company and other taxes) and business associations began to introduce the necessary standards in the early 20th century and these continue to be developed and modified to ensure international standardization, accuracy and transparency in reporting.

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It was Cuthbert Heath, who like Mann was one of the most innovative and influential insurance brokers of his day. Heath developed what we now recognize as the UK model of Business Interruption Insurance. The first modern policy, in the form still predominantly used, was issued in London on January 1, 1939[14].

Heath believed that the role of insurance was to protect and he actively looked for ways to do this. His new policy was designed to bridge the gap between traditional fire insurance and the business interruption coverage available at the time and develop a more comprehensive policy that took into consideration the time it takes for a business to get back to where they would have been but for the loss.[15]

There was as described at the time, a storm of protest with Heath summoned before the Chairman of the Fire Offices Committee,[16] where he was told he was ‘ruining fire insurance”[17]. The new policies, insurance companies claimed the new coverage was an open invitation to the public to defraud insurers. How could any insurance company hope to quantify the loss with any degree of certainty? What if the Insured ‘cooked the books’ was the term used?[18]

Heath’s biographer knows of no record of what was said, but Heath simply ignored the concerns and continued to write the policies. It was not long that the insurers realized the product was required and the sky would not fall in and followed his lead and offered the coverage.

Gibb later wrote: “there is probably not one fire office in the country that refuses to give cover for loss of profits: not one that does not value a branch of the business which Heath’s enterprise forced them to start so reluctantly”[19].

In 1956 the first independent or stand-alone fire business interruption policy was introduced in Germany.

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Back to the United States, the Insurance Services Office (“ISO”) recommended in 1986 to replace the gross earnings policy form with the Business Income Coverage form, which although modified several times, is still frequently the basis of coverage in the United States[20]. Prior to 1986, two “gross earnings forms” were used for business interruption insurance and the forms were attached to the direct damage policy form. One was for use with mercantile and non-manufacturing risks and the other was for manufacturing or mining risks. These forms were mostly replaced with a simplified commercial property program involving new forms and “business interruption” insurance was replaced by “business income” insurance.

undefined1987 saw Harry Dickinson Snr introduce “Instant Profits” coverage in Australia. The product was designed to simplify business interruption insurance with the rate of insured gross profit agreed in advance. The policy contained no average provisions nor a savings clause.

The march to improve business interruption coverage continued in the United Kingdom with the Association of British Insurers (“ABI”) publishing new Business Interruption wordings during the period 1989 to 1991.

Since the turn of the 21st Century, business interruption insurance has taken on much greater importance due to the globalization of industry and the supply chain risk that grows for business and the accumulation risk it poses for the insurance industry. Other factors which have influenced the interest and further development of business interruption insurance include:

  •                 The increased dependence on electronic data and cyber security risk
  •                 Terrorism events
  •                 The increase in frequency and size of natural catastrophe events including flood.

Globally there has been new products introduced along with many modifications to wordings to simplify the product, make it easier to understand for small to medium business and offer greater protection to reflect the ever-changing risk facing organizations.

Insurers in Australia moved away from the term Gross Profit to terms such as Income, Gross Revenue, and Standard Takings in an effort to avoid the confusion between insurable gross profit and accounting gross profit. Often the calculation remained the same, only the name changed, although for smaller clients many insurers moved to a similar calculation of Turnover less purchases, meaning the net profit/loss was insured along with all other business expenses other than purchases.

Following the launch of cyber insurance by AIG through agent, Steve Haase, cyber insurance[21] has moved from providing only third party cover, as it did in 1997, to include both first party and business interruption coverage in the first decade of the 2000’s. The coverage is now widely available.

LMI Group’s Allan Manning introduced the following advancements to simplify the process assist and small and medium enterprise business to be fully insured and reduce the likelihood of business failure following an insured event.

 

2007: BIcalculator.com now used by agents, brokers, and insurers in 10 countries. Higher rates of sales and fewer incidents of under insurance reported.[22]

2010: Revenue based wording where the premium is calculated based on a data base of indicative rates of insurable gross profit by industry. This coupled with fast track claims settlement for short period losses and “opt out” rather than chose to insure business interruption coverage sees much greater level of sales.

2014: automatic 25% increase in Indemnity Period/Period of Restoration (not sum insured) on the declaration of a natural disaster. This provides added protection to organizations dealing with the aftermath of a catastrophe event.

2017: BusinessIncomeCalculator.com launched in the United States.

Business Interruption insurance is regarded as so important to organizations that it is now available in some form attached to property, construction risks, cyber, machinery and marine cargo insurance just to name a few.


[1] Manning A, & Manning S.A., 2017, 1666 The Great Fire of London and the Birth of Modern Insurance, Mannings of Melbourne Camberwell, Victoria

[2] Manning A., 2005, Business Interruption Insurance & Claims: A Practical Guide to Business Interruption Insurance for Business Managers, Insurance Brokers and Agents, Mannings of Melbourne, Camberwell, Victoria, p.14.

[3] Swiss Re, 1997, Business Interruption Insurance, Swiss Re, Zurich, p.6.

[4] Ibid.

[5] Ibid.

[6] Manning A., 2005, Business Interruption Insurance & Claims: A Practical Guide to Business Interruption Insurance for Business Managers, Insurance Brokers and Agents, Mannings of Melbourne, Camberwell, Victoria, p.12.

[7] Insua, N.M. & Lewis, RP. 2016 Business Income Insurance Disputes, 2nd Edition, Wolters Kluwer, New York, § 3.01.

[8]  See Omaha Paper Stock Co v Habor Insurance Co. 596, F.2d, 283, 287, (8th Cir. 1979).

[9] Richie, J.N.G. 2002, Ludovic McLelan Mann (1869,-1955: ‘the eminent archaeologist’, “The Society of Antiquaries of Scotland, 2002, p.46.

[10] Ibid.

[11] Swiss Re, 1997, Business Interruption Insurance, Swiss Re, Zurich, p.6.

[12] Ibid.

[13] Ibid.

[14] Brown, A, 1980, Cuthbert Heath, Maker of the Modern Lloyd’s of London, David & Charles, London, p.69.

[15]  Ibid.

[16] The governing body of the insurers who set premium rates, and technical support since 1880.

[17] Brown, A, 1980, Cuthbert Heath, Maker of the Modern Lloyd’s of London, David & Charles, London, p.70.

[18] Ibid.

[19] Ibid.

[20] Swiss Re, 1997, Business Interruption Insurance, Swiss Re, Zurich, p.6.

[21]  Katz, D.M.,1997, “AIG Policy Covering Internet Security Risks Launched at RIMS”, Property Casualty 360, April 16, 1997.

[22] https://lmigroup.io/history/