The question that I chose to answer as a post today from the myriad I received leading up to the end of the Financial Year renewal period reads:
Is our understanding correct that if a client elects to insure for Additional Increased Cost of Working Only & not cover Loss of Revenue, that a traditional business interruption wording automatically covers both Additional Increase in Cost of Working and Increase in Cost of Working?
We have clients from time to time who do not envisage a loss of revenue if their office premises are damaged or destroyed, but acknowledge that they could have increased operating costs. The particular client in this instance is a large civil contractor with mobile plant at several sites at any one time.
In their view damage or destruction at their office, is not going to stop the machines working & therefore generating the same revenue for the organisation.
I just want to be sure that the item we have insured under the policy labelled Additional Increase in Cost of Working, is also going to cover Increased in Cost of Working & we do not have the insurance carrier and or their loss adjuster splitting straws & paying for Additional Increase in Cost of Working but refusing to pay for the reasonable increased costs = Increased Costs of Working.
I look forward to hearing from you.
Paul [surname and email provided]
You are not alone in asking me this question and I would like to have had a dollar for each time it has been asked of me.
The answer is quite simple. No your client will not be caught out. The reason is that the Increase in Cost of Working cover has 5 tests of which 1 is key to this discussion.
If I take the Industrial Special Risks (“ISR”) Policy as an example Increase in Cost of Wording reads at Item 1 (b) under Section 2, Consequential Loss of Profits:
Item 1(b) [Loss of Gross Profit in Respect of an Increase in Cost of Working}.
“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.”
The test of interest is known as the Economic Limit Test. In simple terms, it means that an Insured cannot claim more as an Increased Cost of Working item than was saved by way of avoiding a claim for loss of insured Gross Profit.
We test this by comparing the expenditure incurred (say $25,000) to the loss of insured Gross Profit avoided. Where insured Gross Profit, Gross Rentals or Gross Revenue is not Insured then the expenditure fails the test and nothing is able to be claimed as an Increase in Cost of Working.
Any amount not paid as an increased cost of working may be considered under the wider cover of Additional Increased Cost of Working, if this is insured up to the Sub-Limit as recorded on the Policy Schedule.
Most Business Pack policies operate the same way with similar words or words with the same meaning but it is always important to check the actual wording involved.
Additional Increased Cost of Working
The cover provided by Additional Increased Cost of Working is much broader than that provided by Increase in Cost of Working as is clear from the following definition, which again has been taken from the ISR Mark IV wording.
Item 4 [(Additional) Increased Cost of Working]
“The insurance under this item is limited to increase in cost of working (not otherwise recoverable hereunder) necessarily and reasonably incurred during the Indemnity Period in consequence of the damage for the purpose of avoiding or diminishing reduction in Turnover and/or resuming and/or maintaining normal business operations and/or services.”
This wider cover allows increased costs that maintain the business or service, but which do not necessarily reduce or avoid a Loss of Turnover during the Indemnity Period.
Further, the Additional Increase in Cost of Working cover is not subject to the Economic Limit Test mentioned above.
By definition, any reasonable (reasonable being one of the 5 tests mentioned earlier) increase in cost of working from $1 up is claimable as an Additional Increase in Cost of Working.
From experience, I and the team at LMIG find this to be a very valuable cover. It allows an insured to make quicker decisions as they do not have to justify expenditure before incurring it. If it is prudent and reasonable then it should be covered by the Policy.
One final benefit is that the Additional Increased Cost of Working cover is not subject to any adjustment for under-insurance. In all policies where you can insure for it, the Sub-Limit or sum insured is a first loss limit. However, it is important that the cover is adequate to allow the businessperson to take all reasonable steps to protect their business during the period of the crisis.
Additional Increased Cost of Working Cover only
As you suggest some Insureds believe that they do not require full business interruption insurance as they will not lose any sales but may incur some additional expenses to maintain sales and customer service. This may be true for some service companies. They claim that they can quickly relocate or have their staff work from home. If this is true then this cover, purchased as a stand alone cover may be appropriate.
We would certainly not recommend this for a manufacturer or retailer. In most cases, it is found that the cover does not adequately indemnify a wholesaler.
If the office or service risk involves specialised equipment such as a dentist, again we would recommend the business take out full business interruption cover.
A word of warning. When it came to major events, such as for example the interruption of a public utility, it may not cause any damage to property but could result in a significant loss of insurable Gross Income as we saw with the Longford Gas Crisis in Victoria
, which cost industry $1,300 million, and the Mercury Power Crisis
in Auckland and countless similar events across Australia and the world, that businesses that thought that they only needed Additional Increased Cost of Working found that they did lose significant revenue and therefore insurable Gross Profit that they did not expect that they would.
Before making the decision, the business owner is strongly encouraged to discuss the pros and cons with their insurance broker or adviser.
On this issue, I have found that to purchase full business interruption cover with a reasonable Additional Increase in Cost of Working Sub-Limit is often not much dearer than just purchasing a high Level of Additional Increase in Cost of Working bearing in mind you do not have to purchase as much with full business interruption due to the coverage afforded by Item 1(b) Increase in Cost of Working described above.
This is one of those areas of the business interruption cover that is quite complex. The overview provided above has been given to give you a good grasp of the cover. The points to take away are:
- Increase in Cost of Working should never be sub-limited.
- Increase in Cost of Working Cover is subject to 2 main tests, the “Sole Purpose” and “Economic Limit” tests and is also subject to average.
- Every policy should have some coverage for Additional Increased Cost of Working.
- While Additional Increased Cost of Working only cover does have it place its use should be carefully discussed with your insurance broker or adviser.
To understand it more, particularly in a claim situation please read Understanding the ISR Policy
(Manning, 2006) Volume 1, Section 8.1.1(b) pages 152-157.