Canada: Co-Dependant

When it comes to business interruption co-insurance, there are a number of common mistakes that insurance professionals make. A clear understanding of co-insurance, a complex component of business interruption losses, is key to avoiding miscalculations that can have a significant impact on a claim for both the insurer and the policyholder.

Many insurance professionals involved in commercial insurance claims cringe when it comes to co-insurance because, stated bluntly, they do not understand the mechanics of its application in a claim. Miscalculating co-insurance leads to the insured's claim being either over- or under-paid.

Perhaps fortunately for the insurer, most policyholders are not savvy enough to verify whether or not co-insurance was calculated correctly, which is punitive to the policyholder. On the other hand, overpayment results in unnecessary expense to the insurer. In either situation, one party is penalized.

That being the case, insurance professionals should know some of the most common mistakes they make in calculating co-insurance under a standard profits form. Knowing some of the things to avoid will help simplify a seemingly complicated issue.

Under a standard profits form, the policyholder is required to have insurance in force equal to 100% of the projected annual defined gross profit. If the policyholder does not have 100% of the required insurance, any business interruption (BI) loss is proportionately reduced by the amount of under-insurance.

This reduction is known as the co-insurance penalty. Consider the simple calculation below:

Insurance in force: $1 million
Insurance required (annual defined gross profit): $1.5 million
Business interruption loss: $500,000
Rate of recovery: $1 million (did have) / $1.5 million (should have) = 66.67%
Recoverable loss: $500,000 × 66.67% = $333,350
Co-insurance penalty: $500,000 - $333,350 = $166,650


#1: insurance required (annual defined gross profit) is calculated entirely based on historical financial results

The BI policy insures future profits, not historic profits. The most common mistake made by experts calculating the insurance required is basing the calculation entirely on the historic, instead of projected, financial results of the business.

The reason for this error lies in the policy wording, which indicates that the annual defined gross profit should be "based on the financial results of the business in the most recent 12 months or fiscal year immediately prior to the incident, adjusted for trends, variations and other circumstances that, but for the incident, would have occurred during the relative period after the incident."

Many insurance professionals ignore the impact of the adjustment clause and simply rely on the financial results achieved by the policyholder in the most recent 12 months or last fiscal year.

What is the possible impact of calculating the co-insurance penalty based on historical versus projected financial results? Consider the example below of a policyholder that experiences an incident on June 30, 2015, and whose last fiscal year was December 31, 2014. In May of 2015, the policyholder entered a new agreement with a supplier that would reduce its cost of goods sold by 20% for the next three years. No other changes to revenue or expenses were expected in the 12 months following the incident (see chart below)

In this instance, if the insurer relied upon the historic financial results instead of the projected financial results, it would overpay the claim by 9.8%.

Historic Results
Last Fiscal Year
Forecasted Results
20% Reduction in Cost of Goods Sold
Sales $1,000,000 $1,000,000
Cost of goods sold (variable expense) $400,000 $320,000
Insured standing charges (fixed expenses) $500,000 $500,000
Annual net profit $100,000 $180,000
Historic Results (Incorrect)
Last Fiscal Year
Forecasted Results (Correct)
12 Months Post-Incident
Annual net profit $100,000 $180,000 A
Insured standing charges $500,000 $500,000 B
Annual defined gross profit (insurance required) $600,000 $680,000 C = A + B
Insurance in force $500,000 $500,000 D
Rate of recovery 83.3% 73.5% E = D / C
Co-insurance penalty 16.7% 26.5% 100% E

#2: annual defined gross profit (insurance required) does not include ordinary payroll as a standing charge when it is insured or ignores the period of ordinary payroll coverage

Unlike the gross earnings form, which includes ordinary payroll (unless specifically excluded) in the calculation of insurance required, the standard profits form may or may not include ordinary payroll coverage. When ordinary payroll is insured under a profits form, it is either fully insured throughout the indemnity period or it is purchased for a specified coverage period, typically ranging from 30 to 180 days.

When ordinary payroll is fully insured throughout the entire indemnity period, it is included as a standing charge for the purpose of calculating the insurance required. However, when coverage is included for only 30 to 180 days, it creates confusion for many claims professionals.

The most common mistake made in claims when ordinary payroll coverage is purchased for a specified period is that it is not included as an insured standing charge in the calculation of annual defined gross profit (insurance required). The proper methodology is to calculate the defined gross profit for the period of ordinary payroll coverage and prepare a separate calculation during the period when ordinary payroll coverage ceases within the indemnity period.

To illustrate, consider a situation in which a policyholder has 90 days of ordinary payroll coverage, and the policyholder's sales and expenses are incurred evenly throughout the year. In this case, projected financial results are as per first chart below.

Insurance professionals should take note that the incorrect methodology (see second chart below) is to calculate a single annual defined gross profit (insurance required), either excluding or including the entire annual ordinary payroll as an insured standing charge. There is a clear difference in outcome when using the correct methodology (see third chart below).

Forecasted Results
Sales $12,000,000
Cost of goods sold (variable expense) $3,600,000
Key payroll $2,400,000
Ordinary payroll $1,200,000
Other insured standing charges $3,600,000
Annual net profit $1,200,000


(Exclude Ordinary Payroll) (Include Ordinary Payroll)
Sales $12,000,000 $12,000,000
Cost of goods sold (variable expense) $3,600,000 $3,600,000
Key payroll $2,400,000 $2,400,000 A
Ordinary payroll - $1,200,000 B
Other insured standing charges $3,600,000 $3,600,000 C
Annual net profit $1,200,000 $1,200,000 D
Annual defined gross profit $7,200,000 $8,400,000 A+B+C+D

This involves preparing two calculations of annual defined gross profit (insurance required), segregated at the 90-day mark, including ordinary payroll for the first 90 days (assumed to be equivalent to three months) and excluding ordinary payroll for the remaining nine months of the indemnity period.

 In this instance, if the insurer incorrectly excludes ordinary payroll as an insured standing charge in the calculation of annual defined gross profit, the insurance required for the purpose of calculating co-insurance would be $300,000 less than the correct amount, which would result in an overpayment. Conversely, if the insurer included all ordinary payroll and not just for the first 90 days, the annual defined gross profit would be $900,000 higher and would result in an underpayment for the policyholder (increased co-insurance penalty).

(First 90 Days)
(Include ordinary payroll)
(Remaining Nine Months)
(Exclude ordinary payroll)
Sales $3,000,000 $9,000,000
Cost of goods sold (variable expense) $900,000 $2,700,000
Key payroll $600,000 $1,800,000 A
Ordinary payroll $300,000 - B
Other insured standing charges $900,000 $2,700,000 C
Annual net profit $300,000 $900,000 D
Defined gross profit $2,100,000 $5,400,000 A+B+C+D
Annual defined gross profit $7,500,000

#3: the co-insurance penalty is not applied when the BI loss is less than the insurance in force

A misconception with co-insurance is that if the insurance in force is greater than the BI loss, then the co-insurance penalty does not apply. This is incorrect, since the insurance in force and the insurance required are both determined on an annual basis, whereas a BI loss may relate to a period of time that is less than a year. 

An apples-to-apples comparison must be made between the BI loss and the limits of insurance. As such, the proper methodology is to calculate a rate of recovery, based on the insurance in force and the annual insurance required (the projected annual defined gross profit) and apply the rate of recovery to the BI.

The most common mistake made in claims when ordinary payroll coverage is purchased for a specified period is that it is not included as an insured standing charge in the calculation of annual defined gross profit (insurance required).

#4: extra expense is included as a component of the BI loss and reduced by co-insurance

Extra expense coverage is often included in commercial insurance policies and is frequently incurred by an insured in conjunction with a BI claim. In addition, extra expense coverage is often confused with an increase in the cost of working, which is included in the standard profits form and is subject to co-insurance. Further, an increase in cost of working is also assessed on a mitigated recovered loss basis, which requires the insured to reduce its profits loss by an amount in excess of the increase in cost of working.

For these reasons, it is often thought to be included with BI coverage. However, extra expense coverage is a separate stand-alone coverage and is not subject to any co-insurance requirements.

Co-insurance is a complex component of BI losses and miscalculating the insurance required can have a significant impact on a claim for both the insurer and the policyholder. Professional advice may help with ensuring that the proper insurance required is calculated, the policyholder is indemnified for the loss and an equitable outcome is achieved for all parties involved.

This article was originally written for and published by Canadian Underwriter, October 2015.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions