Prof. Allan Manning

Blog Reader Question: Business Interruption Gross Profit Calculation

I received the following question from a reader and reproduce it and my answer below for you all:

Dear Mr Manning,
There is something I may be missing in the calculation of Gross Profit under the BI policy.

The policy states:
GROSS PROFIT
the amount by which:
(a)      the sum of the Turnover and the amount of the Closing Stock and Work in Progress shall exceed
(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.
Why does it start with the opening stock?
Closing stock less production plus opening stock will give as a result production available for sale. If the Gross Profit I need to know refers to products sold then I calculate, for example, the cost of raw materials used in the product sold as: Opening stock of raw materials plus raw materials purchased less Closing stocks opening stock.  The resulting amount less turnover will comprise all costs and expenses from which I deduct not insurable cost and expenses. I shall be obliged if can explain me the policy definition and if I am wrong or missing something.

Thank you very much for the attention you may give to this query-
Carlos [last name and email withheld]

 

I replied to Carlos as follows:

We add closing stock to the turnover to the business to get one figure.

From this new combined figure you deduct the sum on opening stock and the expenses, such as purchases you do not need to insure.

If I am reading your question right you are asking about opening and closing stock.

What the formula is doing is looking to include the difference in the opening and closing stock as this is another form of profit.

For example if a business was to increase its stock level from say $50,000 at purchase price at the start of the accounting period to $100,000 at the end. The value of the business if everything else stayed the same would be $50,000 more. ($100,000 closing stock -$50,000 opening stock)

This is profit to the company. One way to look at it, is, that the business chose to invest in more stock so they could provide a better service (faster or offer wider range than before). Whatever the reason this increase in stock is profit in the form of stock instead of cash but it is still valuable acne still profit reinvested in the form of stock.

I hope this helps.

Allan

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Product Recalls Australia – 23 October 2017

This week’s product recalls includes:

Polaris Sales Australia Pty Ltd — Victory Cross Country, Victory Cross Country Tour, Victory Cross Roads, Victory Magnum and Victory Hardball

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Earth and Stone Outdoor Centres — Ethanol Burner

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Peugeot Automobiles Australia — Peugeot P4008 SUV

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Permobil Australia — Corpus Powered Wheelchairs with fixed seat and elevator inner tubes

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Polaris Sales Australia Pty Ltd — Polaris ACE 325 (MY2014-2016)

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Daimler Truck & Bus Australia Pacific Pty Ltd — Mercedes-Benz Actros Trucks

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FCA Australia Pty Ltd — Fiat Ducato F1A

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Tesla Motors Australia Pty Ltd — Tesla Model X (MY2016 and MY2017)

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For more please visit https://www.productsafety.gov.au/recalls

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Be aware, Unicode URL phishing scams are on rise!

LMI Group’s head of cyber security has issued the following warning to all of our team on the proliferation of phishing scams out there.

This is such an important topic I thought I would share it with you.

I found this to be one of the hardest scams to spot and one anyone could easily be caught out.

 

This is a quick update to inform you about Unicode phishing scams,  below are screenshots of two different sites (one is legitimate and other is a fake).

Now, see if you can spot the difference.

Site A-

 

 

 

 

 

 

Site B-

 

 

 

 

All looks OK at a glance, right? Even has a green ‘site secure’ SSL notification. However, notice what looks like a little comma under the ‘r’? This is an entirely different character, which means that we are not at bittrex.com, we are at a phishing site. A pretty clever one too, as it turns out.

Always make sure to check the URL properly before you enter the credentials and always type the URL on the browser instead of using Google search for it.

 

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Alarming Trends – Part 2: Reinstatement and Replacement Conditions vs Indemnity Conditions

Previously, we have addressed the topic of indemnity periods and I expressed my concern on the number of questions I have had come through from Insurance Brokers and Underwriters where the indemnity period for a client was being reduced in this time of increasing rates.

Another issue which has resurfaced as a result of these rate increases is the move to reduce the cover from reinstatement replacement conditions, to indemnity conditions.

Up until the late 1960’s and early 1970’s, the vast majority of insurance policies were settled on indemnity conditions. One of the great innovations and improvements in insurance was to move to reinstatement and replacement conditions, also known as ‘new for old’. This proved, and continues to prove, to be an enormous benefit to an Insured who in the event of a partial or total loss, does not have to find the funds to make up the difference between the, let’s call it market value for the sake of convenience, than the actual cost of replacement.

Subsequently, the insurance industry went one step further by introducing extra costs of reinstatement, which meant not only did we bring the asset back to a condition as new, but also brought it up to date where required to meet any statutory or regulatory requirements.

Not only is there a significant financial benefit to the Insured in the event of a loss, there is also a significant saving in time for there is no need to have the haggle to agree indemnity value which in most cases is based on the replacement value, less an allowance for its age and condition (again, I stress that this is not universally across).

I find that in my discussions with Insureds that wish to consider this option, that they are thinking of a total loss situation and they are factoring in what I call the “it will never happen to me” syndrome. Most losses are partial, and the most common type of loss, say to a building, is not a fire but rather storm damage.

So, let’s say that an insured owns a commercial property and there is a hail storm and the roof requires replacement. If the Insured is reluctant to pay the premium on insurance, how will they feel when they have to meet the cost differential between the cost of a brand new roof, particular if it requires upgrading to meet requirements, and the depreciated replacement value based on the age and condition of the old roof.

If the building is only a few years old and there is going to be no depreciation anywhere, there is no benefit in insuring for indemnity conditions for the value between the replacement value and the depreciated replacement value will be negligible in any event. It is only when the building is older that there is any benefit in premium, but then the question is, at what cost to protection?

Another scenario that crops up is that an Insured, particularly in the manufacturing sector, makes the claim that if there was a total loss and they lost 46 production machines, they would move their operation to China and therefore there is no benefit in having reinstatement and replacement conditions. I again point out that most losses are partial. What happens if fire or water damage makes only 1 or 2 machines irreparable? Would the Insured move their operation overseas having only lost a small portion of the equipment in Australia? Invariably, the answer is no.

In my discussions with insureds where we have a meaningful discussion about the additional risk that is being accepted by the insured by moving from reinstatement and replacement to indemnity conditions that in the vast majority of cases when the Insured considers all the facts, they elect to remain with reinstatement and replacement conditions.

I can not recall a single claim that I have handled in my 45 year career where the Insured has been insured for indemnity conditions and where it is proved to be a good outcome for the business or the principal stakeholders.

 

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Product Recalls Australia – 12 October 2017

This week’s product recalls includes the following –

 

10 OCT 2017

5 OCT 2017

Evermore Group Pty Ltd — New Choice Assorted Jelly Cups

A jump from last week.

If you are interested in more product recalls please visit: https://www.productsafety.gov.au/recalls 

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Alarming Trends – Part 1: Indemnity Periods

Over the past month or so, I have been inundated with questions regarding moving from reinstatement and replacement conditions to indemnity, in reducing Sums Insured and reducing indemnity periods. Over the next couple of days, I will address each of these and I will start today with Indemnity Periods.

Back when I first wrote my blue book on Business Interruption insurance in 2001, I was often confronted with indemnity periods of 3 or 6 months and my aim with the book and training sessions, was to move to 12 months being the minimum. Since that time, it has become more and more apparent that 12 months is not sufficient even for many risks, particularly property owners and manufacturing risks. When I say property, this includes infrastructure such as airports and tourism resorts.

If you add to this the complexity of a natural disaster, where the resources of the insurance industry, along with builders, engineers, right down to town building and planning departments, this only exasperates an already crucial problem.

As such, over the last 5 – 10 years, I have really been pushing for indemnity periods, particularly on larger risks which are insured under an ISR, to have a minimum of 24 months or at least 18 month indemnity periods. Speaking to underwriters and brokers, it has been pleasing to see that this advice has been accepted by many insureds.

What is alarming me, is that with the rate increases which are filtering through of late, many clients and/or brokers are reducing the indemnity periods back to 12 months. Yes, there is a premium saving, however, at what risk?

Going beneath 12 months, I believe, is complete folly for the rating of business interruption insurance is not simply a pro rate based on the length of time set for the indemnity period.

Statistically, my research shows that about 75% of business interruption losses have a period of disruption of 3 months or less. As such, if a client was to insure for a 3 month indemnity period, no insurer in their right mind would charge 1/4 of the premium that 12 months cover would cost, for they are going to pick up 75% of the claims, and even with claims which extend beyond the 3 months, they are likely to pick up the biggest burden during that first 3 month period.

Typically, the difference in premium for a 6 month indemnity period and 12 month is less than 10% of the fire rate applied to the full 12 months Insurable Gross Profit figure.

When considering the indemnity period, I have set out under the heading “How long should I insure for?” in the BIExplained section of the LMI Business Interruption Calculator all the things that should be considered when setting an indemnity period. You will note, the cost of insurance is not one of the criteria.

Speaking to underwriters about the situation, one of the reasons they have had to increase the premium rate, is that they are not getting the growth in premiums that they require. This is because we are not increasing Sums Insured as we should each year. If we are going to reduce cover, this is only going to create more problems moving forward as insurers are forced to increase rates again to make up for the lost revenue of people reducing their coverage. I know in the property insurance for LMI Group, there is two things about the program, the first is that we tend to over insure for we see first hand what happens to businesses when they under insure and we would rather pay a little extra premium rather than risk not being fully indemnified in the event of a loss. Secondly, we review our insurances every year, this being the case, we have found our rate has been retained.

Next post, I will go into a bit of detail about the risk of moving from reinstatement and replacement to indemnity conditions.

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California wild fires

In what is the end of the Northern Hemisphere’s summer it is terrible to see the impact in areas of California, including the Napa Valley, as well as East of Los Angeles Metropolitan area, being affected by bush fires.

The full details of the catastrophe are still coming in, but the early reports indicate that over 1000 structures have burned with 1000’s more under threat. Reports so far put the death toll at 13.

The cause of this fires is that it has been the especially dry conditions, similar to what we have experienced for much of our winter here in Australia, a long with strong winds. Australia is heading for another hot summer, and it is a reminder to any of us who live in bush fire areas to carry out a risk management audit of their property and review their evacuation procedures.

PHOTO: Wildfires whipped by powerful winds have swept through northern California. (AP: Jeff Gritchen/The Orange County Register)

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Product Recalls – 3 October 2017

It is a milestone week this week in the product recall sector with only 1 product!

Honda MPE — Honda CRF450R 2015YM-2016YM

29  September 2017

 

For further information please visit: https://www.productsafety.gov.au/recalls

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Call for papers

Between the 11th and 14th June 2019 there is going to be a technical insurance conference looking in detail at risk and the insurance business in history from the middle ages.

The event is drawing experts from all around the world and I for one will certainly be attending.

The organising committee is seeking proposals for sessions and I attach the documentation so if you are interested in presenting or know someone who may be.

Call for sessions 2.0 Combined

2017-07-18_UNIA_Web_RISK_Dossier_Carpeta

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Product Recalls Australia – 26 September 2017

This week’s product recalls includes the following:

Knog Pty Ltd — Knog Frog Strobe Bicycle Light

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Mazda Australia Pty Ltd — Mazda BT-50

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Cyclingdeal — Road Mountain Bike Bicycle Cycling Adult Helmet

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Lenoxx Electronics Aust Pty Ltd — Electric Blanket

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