Business interruption insurance is designed to provide compensation to an organization if a designated disaster shuts down its operations for a period of time. This policy covers lost profits from business interruption, as well as the reimbursement of actual expenses incurred during the period when a business cannot conduct its normal operations. Though the probability of a major business interruption is usually low, this coverage may be critical when a claim does occur, and may keep a business from being forced into bankruptcy. It can be expensive insurance for manufacturers, which have a larger base of fixed costs to cover during periods when they are inoperable.
The amount of profit to be reimbursed by the insurer is based on the amount of lost sales or customer orders, which are estimated based on historical sales information. The calculation of compensation can be quite subjective, involving the roll-forward of historical performance into the period of loss. The company’s lost profits are then estimated based on the amount of lost sales and its historical profit percentage.
The amount of reimbursement under this policy is based on a firm's profit history. If an organization has a continuing history of sustaining losses, the insurer will not reimburse it for lost profits, since there were no profits to lose. However, the insurer may still issue payments to reimburse the entity for certain fixed costs.
The policy will also reimburse the insured party for normal operating costs incurred during the shutdown period, including payroll. Depending on the policy, this can include extra expenses incurred that would not have been incurred if there had been no property damage or suspension of operations. Examples of these extra expenses are relocation costs and the incremental increase in costs required to subcontract work to third parties.