Welcome to our Autumn 2014 Edition and 47th Claim Solutions’ Newsletter.
We have been presented with claim problems daily since the 1980’s and with almost 30 years of claims history this places us in a unique position to identify claim solutions.
In this newsletter we explore the Business Interruption cover and explain Gross Profit, Increased Costs and Savings.
Business Interruption insurance is a product just like any other and only by understanding these concepts can you know what the product offers.
In addition we provide a summary of one of the major insurance events over the past quarter – Severe Tropical Cyclone Ita.
If you, or your clients, have suffered loss or damage we wish you a speedy recovery.
We are available to assist you and welcome any claim enquiries.
The Business Interruption or Consequential Loss section of an insurance policy insures several items including a Loss of Gross Profit. “Gross Profit” – it seems such a simple term and yet it causes so much confusion.
What is Gross Profit? What is being insured?
Without an understanding of the meaning of Gross Profit, it is impossible to know what is being insured or whether it is even relevant.
In accounting Gross Profit may mean Revenue less discounts, Sales less stock movements and purchases or sales less direct (i.e. variable) costs. It differs from one business to the next. In accounting there is no one concept of Gross Profit.
We cannot rely on the accounting industry for a definition of Gross Profit relevant to Business Interruption insurance. As in accounting, Gross Profit also has many different meanings in the insurance industry.
No wonder confusion reigns.
The Mark IV Industrial Special Risks Policy defines Gross Profit as: -
“The amount by which (a) the sum of the Turnover and the amount of the Closing Stock and Work in Progress exceeds (b) the sum of the amount of the Opening Stock and Work in Progress and the amount of the Uninsured Working Expenses as set out in the Schedule.”
It is a cumbersome definition but it is not too difficult to interpret.
While turnover is defined as sales (less discounts) and opening and closing stocks are easily determined, uninsured working expenses are not defined.
An explanation of Uninsured Working Expenses is necessary to understand Gross Profit and what is intended to be insured.
As the name suggests, an “Uninsured Working Expense” is an expense which can be uninsured i.e. it is an expense which can be deleted from the cover. These usually include expenses which vary directly with the level of turnover (sales) e.g. power in a manufacturing plant, wrappings in a retail store.
There is no need to insure these expenses as if sales are lost the expenses will not be incurred. Why insure them? Why pay premium on them, when they will not be spent?
A popular Business Pack policy defines Gross Profit as: -
“The turnover less the net cost of goods, materials and services relating to that turnover”.
This definition does not mention opening and closing stocks or the term “uninsured working expenses”.
With such varied concepts of Gross Profit in both the accounting and insurance industry it is important to be clear which definition applies.
The only definition of Gross Profit which is relevant for Business Interruption insurance purposes is the definition of Gross Profit which is contained in the insurance policy being considered.
If the definition does not fit your industry it may be prudent to locate an insurance policy which is relevant or carefully endorse the definition to make it relevant.
The insurance policy is a product just like any other. Without an understanding of the concept of Gross Profit contained in the policy it is impossible to determine if the product is fit for purpose.
We have been involved in many claims where the insurance policy and its definitions are inconsistent with the nature of the business. For example we have seen insurance policies which insure Gross Profit issued for a client in a service industry. It did not have any stock and potentially no working expenses which needed to be uninsured. A policy which insures Gross Revenue would have been more appropriate. Similarly we have seen policies which insure Gross Revenue applied to a trading entity where a Gross Profit wording is appropriate to allow the deduction of stock movements, purchases and uninsured working expenses.
Settlement of claims is often subjective and issues or differences in opinion are common. It is best to minimise the scope for ambiguity by ensuring that the insurance policy is relevant to the business being insured.
We cannot overemphasise the importance of understanding the product when it is being sold or purchased. Surprises when a claim occurs can be unpleasant.
In addition to a Loss of Gross Profit a Business Interruption policy insures increased costs. Most insurance policies contain a condition that all reasonable action must be taken to minimise the loss. Failure to do so may prejudice the Insurer and understandably the full extent of the loss may not be reimbursed.
For example if a fire at a motel results in rooms which cannot be occupied it may be possible to minimise the Reduction in Turnover by transferring guests to alternate accommodation nearby at an increased cost. Failure to do so may exaggerate the claim and the Insurer may restrict the payment to the loss which would have been sustained if the guests had been relocated.
But what is an increased cost? As with Gross Profit, careful attention must be paid to the definitions in the policy to determine whether an apparent increased cost is covered.
The Mark IV Industrial Special Risks Policy explains an increased cost as: -
“the additional expenditure necessarily and reasonably incurred for the sole purpose of avoiding or diminishing the Reduction in Turnover which, but for that expenditure, would have taken place during the Indemnity Period in consequence of the Damage, but not exceeding the sum produced by applying the Rate of Gross Profit to the amount of the reduction thereby avoided.”
This is a wordy explanation but it clearly states the criteria which must be met for an increased cost to be covered. It must be: -
• Incurred solely to minimise the Reduction in Turnover
• Within the Indemnity Period.
Failure to meet any of these tests may mean the increased cost is either not covered or only partly covered. For example an advertising campaign which produces additional sales both during and after the Indemnity Period may not be covered in full. The portion of the advertising cost which generates sales outside the Indemnity Period may not be claimable.
It is important to recognise that the criteria which must be satisfied to determine if an increased cost is covered may also vary under different insurance policies.
For example a popular Business Pack policy contains all of the criteria in the Mark IV Industrial Special Risks Policy with one notable addition i.e. the insurer must provide their consent to the expenditure before it is incurred. Failure to do so may mean the increased cost will not be covered!
Obtaining consent for every item of increased cost while attempting to recover from a disaster situation may not always be practical.
Just as it is important to understand Gross Profit it is equally important to appreciate the criteria which must be met to enable an increased cost to be claimed.
Increased costs can be significant and the refusal by an Insurer to accept a cost after it has been incurred can be a difficult issue to resolve.
As well as an increase in expenditure, some costs may decrease as a direct consequence of the loss.
For example, if a fire occurs at a restaurant casual staff (waiters and waitresses) are unlikely to be employed and a reduction in the wage expense may occur. If a fire occurs in a manufacturing plant power, fuel, oil and maintenance expenditure may decline resulting in savings in costs.
Most policies contain a “savings” clause to recognise the decrease in expenditure.
The Mark IV Industrial Special Risks Policy states that the settlement should be: -
“less any sum saved during the Indemnity Period in respect of such charges and expenses payable out of Gross Profit as may cease or be reduced in consequence of the Damage”.
Without this clause an Insured would make a profit from their insurance claim. If a cost is included in Gross Profit cover and it reduces it must be deducted from the settlement to prevent over indemnification.
If a cost is not included in Gross Profit cover, i.e. it is deducted as an uninsured working expense, it should not be deducted as a saving. This is because it is not payable by the insurer as part of the Loss of Gross Profit. Think back to the explanation of Gross Profit above. Purchases are not insured. They are not payable within the claim for Gross Profit. They will reduce if the sales are not made but as they are not insured within Gross Profit a saving cannot be deducted. They have already been deducted by excluding them from the Gross Profit item.
An Insurer cannot deduct what it has not covered.
Our business is the preparation of insurance claims. Many of these are for Business Interruption or Consequential Loss. We also prepare claims for Property Damage, Economic Loss, Fidelity Guarantee, Product Recall and recovery of Uninsured Losses.
Business Interruption Conclusion
Business Interruption insurance requires an understanding of both the movements in turnover (sales), the Gross Profit contained in the turnover and the movements in expenses which have been insured. Once this has been clarified it is important to ensure that the claim is made in accordance with the Basis of Settlement provided by the policy.
On 9 April 2014 the Bureau of Meteorology issued a cyclone watch in relation to Cyclone Ita predicting it could be the most severe storm since Cyclone Yasi which hit the north Queensland coast in 2011.
North Queensland is no stranger to cyclones and tourists and staff were evacuated from Lizard Island holiday resort on 10 April 2014. Community cyclone shelters were activated in some towns in northern Queensland.
Fortunately the system decreased its intensity upon making landfall at Cape Flattery. Nevertheless it was accompanied by 160 km wind gusts and heavy rains and flash flooding in some areas as it moved southwards along the Queensland coast. The greatest damage was inflicted by flooding rains.
Preliminary estimates suggest losses from Cyclone Ita are in excess of A$1 billion.
On 12 April 2014 the Insurance Council of Australia issued a Media Release declaring a catastrophe for parts of north Queensland affected by Ita.
News reports indicate that by 15 April 2014 some 680 insurance claims with an estimated value at A$8.4 million had been received.
Cyclone Yasi in 2011 was reported to have caused insurance losses of A$1.4 billion and Cyclone Oswald in 2013 resulted in losses estimated at A$1.1 billion.
In the 2013-14 season, 4 severe tropical cyclones have made landfall in Australia. As many as 9 have occurred in previous seasons including 1991-92, 1995-96, 1998-99 and 2005-06.
Fortunately the 2013-14 season has not been as severe as prior years.
There are many benefits of appointing a Claim Preparer to handle your claims.
Experience – Claim Solutions is constantly exposed to insurance policies, their interpretation and application. This practical experience is available to you.
Independence – We provide prompt, independent advice on loss quantification and the extent of any insurance cover.
Efficiency – Our many years of measuring financial loss allow us to identify losses sustained and costs incurred, gather the necessary documentation and present progress claims to facilitate prompt payments vital to restore cash flow.
Completeness – We ensure all losses sustained and costs incurred are claimed.
Practicality – We provide practical solutions to complex claim issues.
Time - Appointing us to prepare the insurance claim allows management to devote more time to loss minimisation and ongoing business activities.
Cost – The cost of your time to prepare a claim is unlikely to be covered by the insurance policy. The cost of our time may be covered under your insurance cover.
Please do not hesitate to contact us for assistance with your or your client’s claims.
Claim Solutions provides a specialist insurance claims service. Our firm is recognised as one of the leading practices in this field with both national and international companies featuring amongst our clients. Our aim is to provide an efficient, professional and complete claims service which responds to your needs in times of crisis. We are available to assist you and your clients.
The Articles which appear in this Newsletter are not intended to be a substitute for specific technical advice.