The presence of the material damage proviso in a business interruption insurance policy is at the very core of the nature of the insurance but what is the material damage proviso and what effect does it have on any claim under the policy.
To understand the need for the material damage proviso we must first accept what the purpose of business interruption insurance is. The policy is designed to protect the policyholder against the adverse financial effects of an interruption to their business as a result of a property damage claim. To us a classic example, let’s assume a fire in a factory causes significant building damage and damage to stock and business equipment. Production will cease or be reduced dramatically and turnover will be reduced by lack of sales. It is not our purpose here to explain the intricate workings of a business interruption policy so we will just accept that there is a reduction in turnover and a consequential loss in the top and bottom lines of the business. The business interruption policy is designed to plug this gap until such time as the policyholder can resume trading at the pre-loss levels….subject to the material damage proviso.
What does the material damage proviso say?
There are a few variances in the actual wordings of the proviso but fundamentally the material damage proviso states that in order for the business interruption policy to respond there must be a property damage insurance in place in respect of the policyholder’s interests in the property and that a claim must be admitted/paid by the insurer in respect of this property damage.
The property insurance does not have to be arranged on the same policy nor even with the same insurer, although in the vast majority of circumstances this will be the case.
What is the purpose of the material damage proviso?
As stated the business interruption policy is designed to protect the policyholder financially in respect of financial loss until they are in a position to trade “fully” again. If there is no property damage insurance in place or a claim is not admitted under the property insurance then the policyholder may not have the financial resources to make the necessary repairs in order to start trading again. Viewed from this perspective the application of the proviso makes perfect sense, otherwise an insurer could be bound to pay out for the full indemnity period under the policy with no mitigation of losses and little chance of the business recovering..
A secondary, an far less significant effect of the proviso is that it allows business interruption claims to be handled more effectively, there is still a lot of work involved in calculating the actual loss under the policy but insurers will not concern themselves with policy warranties or further investigation into the circumstances of a claim if the property damage claim has already been accepted.