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Increased Costs of Working cover vs Additional Increased Costs of Working cover

In this article we discuss the differences between Increased Cost of Working (“ICOW”) cover and Additional Increased Costs of Working (“AICOW”) cover that are often found in commercial property insurance policies. We explain the key features of each and what insureds should consider when determining the level of cover that is required.

Commercial property insurance intends to cover the cost to repair or replace damaged physical property resulting from an insured peril (otherwise known as section 1, material damage) and business interruption (otherwise known as consequential loss) as a result of the damage.

The most common commercial property policies are Industrial Special Risk Policies (ISR) and Business/Office Pack Policies. The former is targeted at businesses that hold property with an insured value of >$10,000,000. The latter is targeted at smaller property risks.

Cover may be extended under these policies. By way of example, insurers may agree to cover loss to the policyholder where a third party’s property is damaged. That damage may interrupt or interfere with the policyholder’s activities and cause them to suffer loss. An example of that might be where excavation work is being done on a road adjacent to the premises and the digger cuts a power cable that provides electricity to the insured’s business, causing a shutdown of plant or machinery.

Insureds may also nominate a maximum period that the interruption to the business will be covered. The longer the period, the greater the premium. In cases where cover is sought that extends to possible interruption over multiple years, the insured is required to declare an estimated loss of revenue over that period. Again, the higher the estimated loss of revenue, the greater the premium.

ICOW and AICOW are two key policy features that provide cover for additional expenses incurred following a claim. The purpose of these clauses is to enable an insured to incur costs and expenses that are over and above the normal operating costs of the business that will mitigate a loss of business revenue. For example, in the above example of a broken power supply, an insured might determine that it is economic to hire or purchase an industrial diesel generator so that the business plant and machinery can continue to operate until the mains power is restored.

However, both classes of cover offer more limited coverage than full business income protection insurance, with ICOW cover providing the most restricted coverage of the three. We explain the key differences between ICOW and AICOW coverage below.

ICOW cover

The following elements must be satisfied to claim for additional costs and expenses under an ICOW clause:

  1. there must be loss or damage to physical property that triggers the policy;

  2. the policyholder must have incurred expenses in addition to their normal fixed and variable costs;

  3. the additional expenses must have been incurred during the indemnity period;

  4. the additional expenses must have been incurred with the sole purpose of reducing the loss of turnover caused by the material damage; and

  5. the additional expenses were less than the reduction in turnover (i.e. the saving must exceed the cost of the additional expenses). in other words, uneconomic expenditure will not be covered.

These features of an ICOW clause are often referred to as the “Sole Purpose” and the “Economic” tests.

The Sole Purpose Test restricts policy coverage to cover only additional costs and expenses that are incurred to mitigate the loss of revenue that flows directly from the damage to insured property. Costs and expense that are incurred that go beyond this will not be covered. For example, following a material damage event, if a business decides to employ more accounts staff to maximise invoicing efficiencies and collection from debtors, such loss will not be covered under an ICOW clause as these expenses are not incurred solely to reduce the loss of revenue caused by damage to property. In some cases, complex disputes can arise between insured and insurers as to whether a particular category of expenses incurred was or was not incurred solely for the purpose of reducing the loss of revenue.

Under the Economic Test you are unable to claim more as an increased cost of working item than could have been mitigated against by avoiding a claim for loss of gross profit.

Ordinarily, ICOW cover is not sub-limited but you should check the policy schedule to be certain.

AICOW cover

AICOW cover provides broader policy coverage than ICOW cover but in contrast to ICOW cover, AICOW cover is almost always sub-limited.  AICOW cover forms part of the declared insured values, which correlates with premium allocation.

There are two important distinctions between the ICOW and the AICOW basis of settlement clauses:

  1. AICOW does not require that saving in the reduction of turnover outweighs the cost of the additional expenses incurred to mitigate the loss caused by damage to the insured property; and

  2. In addition to the expenses being incurred for the purpose of reducing the loss in turnover, under an AICOW cluse the expenses can also be incurred to assist in resuming and/or maintaining normal business operations.

Accordingly, unlike ICOW cover, an AICOW clause does not impose the Economic or Sole Purpose tests.  By way of example, AICOW clauses will cover the cost of hiring alternative premises during the damage and repair stages;[1] the cost of additional finance; or the cost of undertaking an advertising campaign; provided that these costs are incurred to avoid or diminish loss of turnover or to, resume or maintain normal business operations.

Put simply, AICOW cover allows additional expenses to be incurred to get the business back on track.  Whilst the above example of employing additional accounts department staff may fail to satisfy the elements of the ICOW clause, such expenses are likely be covered under an AICOW clause.

As AICOW cover is usually subject to a sublimit, the policyholder needs to measure the level of AICOW cover insurers will offer against the cost of obtaining same.  As a general guide, the AICOW sub-limit should be between 5% – 10% of the total insured revenue, but this can vary depending on the specific circumstances of the insured’s business and an insurer’s appetite for the risk.

The language in the ICOW and AICOW clauses typically requires that the additional expenses be “necessarily and reasonably incurred”.  Accordingly, it is always recommended that policyholders obtain prior approval from the insurer before incurring ICOW and ACOW expenses to avoid any dispute after the costs are incurred.

When is AICOW suitable?

One question we often receive from clients is whether full cover to protect business income is essential if the policyholder has more limited cover for AICOW.

For some businesses it may be preferable to rely on AICOW rather than full income cover.  For instance, a policyholder may have a relatively mobile workplace and even a total loss at the policyholder’s premises may result in minimal ongoing interruption as workers can work remotely with laptops and mobile phones.

Bellrock was recently able to reduce a client’s declared gross profit figures by 66% after they decided to self-insure gross profit attributable to a call centre location. In that case the client had introduced new systems which allowed the call centre employees to work remotely.  This resulted in a significant premium saving.

In contrast, a retail shop or manufacturing location is likely to have its income much more closely tied to activities undertaken at the policyholder’s premises and therefore full business income cover is of much greater importance. Such cover is likely to attract a higher premium than more limited AICOW cover.

Underinsuring revenue

Policyholders should understand (as with declaring any insured sum) there are consequences for understating revenue.  Whilst tolerances are typically built into ISR and Business Pack policy wordings, where a policyholder under-declares its revenue insurers may be entitled to reduce indemnity on a proportionate basis.  For example, if a policyholder reported 60% of the gross profit, for every dollar they were paid as part of a claim, they would only receive sixty cents in the dollar.  Accordingly, policyholders should take care when calculating and declaring their gross profit figures for the indemnity period.

A practical working is as follows:

An insured declares gross profit of $1,000,000. A loss occurs and, after investigations, the insured determines that the actual gross profit for the business is $2,000,000 and the loss results in a total claim for lost profit of $500,000.

As a result of the declaration being 50% below the actual gross profit, the insurer is entitled to reduce the claim payment by 50%. The total payment by the insurer would be reduced to $250,000, leaving the insured $250,000 out of pocket.

Key points

Situations differ as to how businesses may risk transfer a loss of gross profit claim via ICOW and/or AICOW clauses. Policyholders should:

  1. engage with their broker to understand how the cover operates and how the policyholder’s business would deal with any interruption to their business activities following a material damage event.

  2. For larger and more complex businesses specialist forensic business interruption expertise will ensure values are correctly reported to the insurer. It will also mean that coverage is arranged which suits the needs of the business.

    In addition. such review will allow the policyholder to review at business continuity and disaster recovery plans and plan strategically for major events.

    Bellrock engages and coordinates with such experts for and on behalf of our clients. Given the impacts of COVID-19 on businesses it is prudent for business to commission a business interruption review as soon as practicable.

[1] Note: if the premises themselves were destroyed (being the relevant “Damage” to insured Property), then, provided that the Economic test is also met, operating out of alternative premises may also be covered under an ICOW clause, as the sole purpose of incurring the costs or expenses of hiring alternative premises is to mitigate the loss of revenue caused by damage to the insured Property