The Gross Profit section of a Business Interruption policy covers Loss of Future Profit. To avoid underinsurance penalties the terms "Future" and "Profit" need to be understood.
Future
Most insurance policies including the standard Mark IV Industrial Special Risks policy refer to the term "future" as the "indemnity period". This is the period from the date of loss to the date the results of the business return to normal. The time it takes for the results of the business to return to normal must be nominated after considering factors such as the period required to rebuild, reinstate contents, relocate to alternative premises, re-employ & train staff, win business back from competitors, etc. In our experience it usually takes longer for the results of the business to return to normal than originally anticipated. Most claims prepared by us have an indemnity period of 12 months or more.
If an "Indemnity Period" of 12 months is selected it is important to recognise an insured event may occur on the last day of the period of insurance. If so the indemnity period commences on this date and the cover may respond over the following 12 months. As a result it is not only necessary to consider the results of the business over the period of insurance but over the following twelve months. If an indemnity period in excess of 12 months is required the results of the business need to be considered further into the future.
Profit
A Business Interruption policy most commonly insures Gross Profit. The insurable Gross Profit may differ from the accounting Gross Profit. The insurable Gross Profit is defined in the policy. The Gross Profit used to determine the Declared Value must be consistent with this definition. Many Industrial Special Risks policies define Gross Profit as the Sales (i.e. turnover) (net of discounts) plus Closing Stock less Opening Stock less Uninsured Working Expenses. The most recent annual Profit & Loss Statement needs to be reviewed prior to renewal of the cover and extract the Sales (net of discounts), Closing Stock & Opening Stock. Uninsured Working Expenses also need to be extracted. These are the expenses that do not need to be insured. They should only include those expenses that vary directly with the level of sales. They differ from one business to the next but may include purchases, freight, energy, etc. Remember, the longer the list of uninsured working expenses the greater the risk of underinsurance.
Once the historical, insurable Gross Profit is determined this should be expressed as a ratio to sales to determine the insurable Rate of Gross Profit. If a similar rate will be obtained in the "future" it may be used to determine the Declared Value. If not, it needs to be adjusted to reflect the rate expected to be achieved in the "future".
The Declared Value on Gross Profit.
The Declared Value on Gross Profit is determined by applying the adjusted Rate of Gross Profit to the maximum annual sales over the renewal period and beyond, depending on the selected indemnity period.
CONCLUSION
Underinsurance on the Gross Profit section of a Business Interruption policy is common but can be avoided with proper consideration and explanation.
Author
Published with permission of Claim Solutions Pty Ltd.
Insurance Policy
Country: - Australia
Policy Description: - Mark IV Industrial Special Risks (ISR) and many Fire policies
Insurer: - Various
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