If you’re involved in any type of business with fixed monthly overheads…then business interruption insurance should grab your attention.
The show must go on…
Never before have the lyrics of Queen (the rock music group) had so much meaning!
Imagine for a moment owning a large industrial concern with 120 staff.
One day a fire breaks out at your premises and the entire factory is razed to the ground. Suddenly you’re sitting with:
- A massive salary bill,
- Vehicle payments that need to be made,
- Water and electricity accounts that need to be paid (never mind your Telkom telephone bill)
…and no money coming in with which to pay them all!
So what would you do? Dismiss all your staff and declare bankruptcy?
Well, if you’re a forward-thinking business owner you would have made certain that you had business interruption – also known as ‘loss of profits‘ or ‘consequential loss ‘ – cover in place.
The purpose of business interruption cover is simple…it provides indemnity against:
- Fixed costs – those expenses that continue regardless of your loss of turnover. Also known as ‘standing charges’.
- Net profit – The net profit that would have been earned had the business not been interrupted
- Additional costs – The extra costs that are incurred so that the business may recover much sooner.
How would you successfully claim under this section?
The turnover of the business after the damage is compared with the turnover for the corresponding period in the previous year. Remember, that if your business has seasonal fluctuations, that these are also taken into account!
The rate of gross profit (see the loss of gross profit section below in order to see how it’s calculated) is then applied to the shortfall in your turnover.
Business owners are occasionally loathed to insure for their true gross profit amounts simply because the insurer could disclose these figures to the South African Revenue Services.
Failing to disclose accurate figures could come back to bite in the event of a claim!
So how does this insurance cover work?
Basically, you must have submitted a successful claim under any of the following three sections of your policy:
- Fire insurance
- Buildings combined insurance
- Office contents insurance
From the date of a claim arising under the business interruption section, the insured has 30 days after the indemnity period expires in which to submit all the relevant documentation supporting the claim. If this is not done then any amounts already paid by the insurer are repayable.
(The indemnity period is the period beginning with the commencement of damage and ending not later than the number of months stated in the schedule)
You may insure for loss of any of the following:
- Loss of gross profits
- Loss of gross rentals
- Loss of revenue
- An additional increase in the cost of working
- Loss of wages
- Fines and penalties for breach of contract
Let’s take a look at each of these separately…
Loss of gross profit
There are two methods used to calculate your loss of gross profit. Both methods should get you to the same answer although you will need to specify which method at the onset of your insurance coverage.
An amount is also factored in for the increased cost of working. This is limited to a reasonable increase in expenses in order to maintain the normal operation of the business. An example of this is if you need to continue your production at separate premises.
The amount payable under the loss of gross profit section is calculated by applying the gross profit % to the amount of reduction that was avoided by incurring the additional expense. You may also purchase additional increase in the cost of working cover which we’ll get to a bit later.
- Gross profit (Difference basis)
This is calculated as follows:
The amount by which the sum of the turnover and the amount of the closing stock exceeds the sum of the opening stock and the uninsured costs (Costs which vary dependant upon the volume of turnover. e.g. delivery and packaging).
Basically, gross profit is calculated by deducting the uninsured costs from turnover!
- Gross profit (Additions basis)
This is calculated as follows:
The sum produced by adding to the net profit the amount of the standing charges (Expenses which continue to be payable in full regardless of the reduction in turnover)
Basically, gross profit equals net profit plus standing charges!
Loss of gross rentals
This section is more applicable to the buildings combined cover and therefore to landlords!
A successful claim under your buildings combined section will allow you to raise a claim under the business interruption section.
The loss is limited to:
- Loss of gross rentals (rental turnover). The amount by which the gross rentals will fall short of the standard gross rentals as a result of the damage to your premises.
- An increase in the cost of working caused by trying to diminish the loss of gross rentals. This amount must not exceed the loss of gross rentals you’re trying to avoid.
Loss of revenue
Ideal for service type businesses!
The loss is limited to:
- Loss of revenue (turnover). The amount by which the revenue will fall short of the standard revenue as a result of the damage to your premises.
- An increase in the cost of working caused by trying to diminish the loss of revenue. This amount must not exceed the loss of revenue you’re trying to avoid.
The additional increase in the cost of working
The amount insured is limited to the reasonable additional expenses incurred with the permission of the insurance company. The purpose of these expenses must be to maintain the normal operation of the business.
Loss of wages (Based on a number of weeks)
Here the loss is limited to the payment of wages for a specific number of weeks following the damage. This will be the actual amount which you will need to pay to the employees whose services cannot be used by you during this time. Beware of underinsuring here!
Fines and penalties for breach of contract
This section provides cover for any fines or penalties that become payable as a result of non-completion or late completion of orders.
What else can be added to this type of cover?
There are a number of extensions which can be added to this section of your policy.
- Specified suppliers/sub-contractors extension
Interruption of your business as a result of damage to the premises of specified suppliers/sub-contractors is covered here.
- Unspecified suppliers extension
Interruption of your business as a result of damage to the premises of specified suppliers is covered here. This excludes damage to public suppliers such as water, electricity, or gas.
- Prevention of access – extended cover extension
Damage to property within a 10 km radius which prevents access to the premises. This applies even though your property might not be damaged.
Interruption to your business as a result of damage to customers’ premises.
- Public utilities – insured perils only
Damage to the property at electricity substations by the insured perils resulting in an interruption of the supply of gas, electricity, or water to your premises.
- Public telecommunications – insured perils only
Damage to the property of Telkom as a result of an insured peril which results in the interruption of your business.
- Public telecommunications – extended cover
Interruption of your business caused by an interruption of the telecommunications facilities to your premises. This extension does not cover damage caused by drought, a fault on your premises, the suspension of your line by Telkom, or any of the general exceptions appearing on your policy (War, nuclear explosion, etc)
- Public utilities – extended cover
Interruption of your business caused by an interruption of the water, gas, or electricity facilities to your premises. This extension does not cover damage caused by drought, pollution of water, shortage of water, a fault on the installation belonging to the premises, the suspension of your water and electricity by your municipality, or any of the general exceptions appearing on your policy (War, nuclear explosion, etc).
- Accidental damage
Any interruption of your business and for which a successful claim was lodged under the accidental damage section of the policy. The amount paid under both this section and the accidental damage section is limited to the amount insured under the accidental damage section.
Say, for example, you are insured for R100, 000 accidental damage cover. You then claim R80, 000 under the accidental damage section and R50, 000 under the business interruption section. The insurer will only pay R100, 000!
What else is automatically included?
- Accountants clause
The insurer will accept your accountants’ certified copy of your accounts as the basis for the claim.
- Accumulated stocks clause
The insurer will take into account if any shortfall in turnover is postponed simply because turnover is being maintained from excess stock
- Departmental clause
If your business is conducted at several branches, and each branch has its own set of accounts, then the loss of gross profits, loss of revenue, and loss of rentals section will apply separately to each branch.
- Deposit premium clause
If the actual premium is calculated on 75% of the sum insured, and the actual gross profit/rentals/revenue is less (or more) than the sum insured, then a pro rata premium will be refunded or charged.
- Output clause
You may elect to use the term ‘output’ instead of ‘turnover’ which shall mean the sale value of goods manufactured at the premises. Using this clause will make the accumulated stocks clause mentioned above invalid!
- Salvage sale clause
Should you decide to hold a salvage sale during the interruption period, then the gross profit earned from the sale will be deducted from the gross profit calculation.
- Extensions to other premises
An interruption of your business as a result of damage to another person’s property will be seen as damage to property used by you.
Storage, transit, and vehicle provides for your property which is stored while in transit or where your vehicles are kept off-site.
Contract sites provide for any situation where you are carrying out a contract off-site.
Prevention of access to your insured property caused by damage to a property within a 10km radius.
Additional premises include any newly added premises but you need to notify the insurance company as soon as possible. Premises you’ve been renting for the past two years won’t qualify under this clause!
And there you have it…an in-depth discussion of business interruption cover!
In our next instalment, we’ll take a look at the accounts receivable section of your business insurance policy.
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