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How payroll classification can impact business interruption values

The importance of understanding and accounting for overall loss of income exposures.
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By Brian Hudecek , 

Senior Vice President, Risk Consulting

20/08/2024 · 4 minute read

In today’s property insurance market, underwriters are placing increasing emphasis on the accuracy of their insureds’ reported business interruption (BI) values. Unfortunately, businesses frequently report values that are misstated, typically due to a misclassification of payroll and/or incorrect valuation. By correctly applying payroll classifications, organisations can better position themselves with insurers, which can help them secure appropriate coverage for their business needs. 

For many organisations, the importance of including property insurance in their risk management plan is obvious. However, far fewer recognise the value BI insurance can provide and invest the time necessary to fully understand their exposures. Without adequate BI coverage, an insured that suffers a covered property event may not be fully reimbursed for their loss. Understanding and accounting for overall loss of income exposures can be critical to an organisation’s finances, operations, and overall success.

How BI insurance works

BI coverage typically indemnifies an insured business for its loss of operating income, as well as the necessary continuing costs and expenses incurred following an insured loss. Also known as fixed or standing charges, examples of continuing costs and expenses may include general and administrative expenses, lease payments, property taxes, utilities, and payroll.

The importance of accurately reporting BI values

When applying for or renewing your BI coverage, you will need to provide your broker with BI values that correctly correspond with your business’s anticipated operating profit and continuing costs and expenses for the upcoming policy period. Your broker will then use these values to recommend appropriate limits of coverage for your business and work with underwriters to place your policy. If you provide inaccurate BI values, these limits may be insufficient. Under these circumstances, organisations risk unknowingly self-insuring large loss amounts in excess of existing limits, in turn stymieing their financial recovery.

Recently, underwriters have become increasingly focused on receiving auditable analysis from businesses that can confirm the accuracy of reported amounts. Without clearly stated BI values, underwriters may be more likely to make conservative assumptions, which may lead to more restrictive coverage and higher premiums.

Correctly evaluating your BI values can depend on a few factors, with one of the largest contributors typically being payroll. Therefore, properly classifying your payroll expenses is critical to reporting accurate BI values.

Ordinary payroll and key personnel — what’s the difference?

An organisation’s payroll is typically split into two categories to measure BI values — key personnel and ordinary payroll.

Key personnel typically includes the wages and related fringe benefits for officers, executives, and other management level employees, whose pay would need to continue following a loss event. In addition, employees who would not be subject to furlough or dismissal under any circumstance following a loss should be classified as key personnel. Wages and benefits for these employees are treated as a fixed cost/expense of the business.

Conversely, ordinary payroll consists of wages and related fringe benefits for all other employees not considered key personnel. For the purposes of calculating BI values, these are employees who would, in whole or in part, be unable to perform their normal job functions due to damage to insured property. Organisations can opt to exclude ordinary payroll coverage from their insurance policy or limit it to a specified number of days.

Selecting optimal ordinary payroll coverage

By considering the likelihood of events that could cause business interruptions and evaluating the potential financial losses associated with these events, businesses are better able to determine how much coverage is appropriate for their organisation.

Choosing a number of days of coverage that does not correctly correspond to your organisation’s intent and ability to pay these workers can lead to the purchase of more coverage than might be needed (days of coverage exceeding actual wages paid) or uninsured loss amounts (days of coverage less than actual wages paid).

Many businesses decide to purchase insurance for a number of days of ordinary payroll that would, at a minimum, cover a short-term loss — typically 30 to 90 days — as turnover or retraining the workforce and resuming operations may be more costly than continuing wages.

For long-term interruptions to your business, there may be a point in the loss timeline where you decide it is prudent to control wages through furlough or dismissal, particularly if your current employees can be immediately rehired after a loss and/or new hires are expected to be readily recruited. Whether to include or exclude ordinary payroll coverage on your BI policy is unique to your business. The decision should be based on your assessment of the amount of coverage needed to wholly indemnify your organisation after a loss, as well as your risk tolerance.

Essential payroll considerations

It is important to properly define which employees should be deemed key personnel and which fall under ordinary payroll. When classifying your payroll and selecting the days of coverage, here are a few things to consider:

  • Highly trained or skilled employees may be more difficult to replace.
  • Workforce availability in certain areas may be limited.
  • Provisions in union contracts may compel coverage for a minimum period.
  • Payroll in certain geographies may need discrete treatment based on employment law (such as the US versus Europe).
  • It is possible to insure payroll for different coverage periods based on the department or role of an employee (for example, hospital care providers versus facilities personnel).

Payroll can materially contribute to your reported BI values. Properly classifying employees as key personnel or ordinary payroll helps organisations accurately report their risks to insurers. Aligning your policy with the needs and risk tolerance of your business will help you avoid purchasing too much or too little coverage and result in insurance that will help protect your business when you need it most.

Taking a multipronged approach to managing your risk profile

Marsh brings together capabilities from across our organisation to help you develop the most effective risk mitigation and transfer strategies. As you face an ever-increasing range of risks that are contributing to a more difficult property insurance market, our specialists will work with you to address your current and future risk profile. To learn more please contact Marsh’s Advisory Property Consulting Solutions or reach out to your Marsh representative.

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