Introducing Loss of Profit/Consequential Loss (Fire) Insurance
A major accident at a business premises cannot only destroy the assets but also bring the business to a standstill, leading to loss of gross profit.Depending on the size and nature of business, it can be severalmonths before the business can get back on track. This is usually a period of great financial stress for businesses, as fixed expensessuch as rent, remuneration of employees, etc.continue to accrue regardless of the extent of damage and production loss.
Consequential losses to the insured business are specifically excluded under a standard Fire and Special Perils Insurance policy that covers only physical damage to the assets. This is where a Loss of Profit Insurance policy is useful, as it covers the loss of Gross Profit of a business arising from an insured loss under its Fire policy.
Learn about Consequential Loss of Profit (Fire) Insurance with an example
Mr. Andrew bought a Fire and Special Perils policy to cover his textile factory. He purchased a Loss of Profit/Consequential Loss Policy as well.
A major fire caused property damage to the finishing section of his factory, which led to disruption of business for 2 months.
Loss of goods and damage to machinery amounted to Rs. 1 crore, which was covered by the insurance company under the Fire and Special Perils Policy.
There was also a significant loss of turnover since the factory was closed after the fire.
This loss was aggravated by the fact that Mr. Andrew was required to continue paying standing charges such as rent and wages even through the period of closure.
Since Mr. Andrews had a Consequential Loss Policy also, he could file a claim to cover the reduction in Gross Profit.
As the closure of the factory was caused by the operation of a peril covered under the Fire Insurance policy, the insurance company also admitted liability under the Loss of Profit policy. A claim amount of Rs. 2.50 crore towards loss of Gross Profit was paid.
Scope of Cover
The policy covers loss of:
Net Profit + Standing Charges + Expenses incurred necessarily and reasonably to bring the business back on track
A Loss of Profit Policies may carry anexcess/deductible expressed in number of days. This indicates the days immediately after the loss, which would not be included while computing the reduction in Gross Profit.
The policy can be extended to cover:
Accidental failure of public electricity/gas/water supply
Damage to customer's premises due to perils covered under Fire Policy
Damage to Supplier's premises due to perils covered under Fire Policy
Lay –off and/or retrenchment Compensation with or without Notice Wages Liability
The sum insured under Loss of Profits policy should represent the gross profit of the indemnity period selected.
The indemnity period is the maximum period required to put the business back into normal operation after damage to insured property by an insured peril. The indemnity period could vary from 6 months to 3 years.
For indemnity periods up to one year, the annual gross profit should be selected as sum insured.
For indemnity periods longer than one year, the Gross Profit (GP) should be proportionately increased. For example:
|1 year (12 months)
||Annual Gross Profit × 1
|2 years (24 months)
||Annual Gross Profit × 2
|2.5 years (30 months)
||Annual Gross Profit × 2.5
|3 years (36 months)
||Annual Gross Profit × 3
For the purpose of Loss of Profit insurance, Gross Profit (GP) is commonly understood to be the net Trading Profit plus Standing Charges (fixed charges). Usually, insurance companies will cover only those Standing Charges which have been specifically declared at the time of proposal.
Gross profit can be insured on one of the following basis:
Premium depends upon the annual gross profit, the chosen indemnity period and the selected extensions.
Loss of gross profit due to a peril not covered under the Fire policy
Difference between the value of stock at the time of fire and at the time of subsequent replacement
Deterioration of undamaged stock after fire
Cost of documentation for Fire and Loss of Profits claim
Loss of goodwill
Third party claims
Other exclusions stated on the policy
Consequential Loss policy will pay only when liability for the incidenthas been accepted by the insurer under the Fire and Special Perils Insurance Policy, covering the same property.
The loss of profit is calculated as:
Reduction in Turnover x Rate of Gross Profit = Loss of Gross Profit
Add: Increased Cost of Working (ICOW) and amounts towards additional coverage Less: Any savings during the period
A Loss of Profit claim will normally be assessed at the end of the interruption period or the indemnity period, whichever is earlier. The insured is required to produce all documents necessary to establish the reduction in turnover/output/revenue.
An independent Loss Adjuster, usually a Chartered Accountant is appointed to examine the books of account and verify the insured’s claim of loss of profits and insured expenses.
Maintaining clear documentary records of all transactions for the period of indemnity helps speed up the assessment and ensures quick payment of claim.