Blog Question # 1 on Business Interruption – Difference v Additions Method
I have an account due 1/6 that we follow on.
Client is a manufacturer & distributor of industrial chemicals for swimming pools, waste water treatment, cosmetics.
Large client pays in excess of $250,000 before charges on his Property program. Policy renewed last year with conventional Sect 2 cover effected i.e. Gross Profit & seperate Pay-roll.
During policy period, broker amended Section 2 methodology & cover is as follows: Net Profit $6m, Standing Charges $5.8m + Payroll (4 months) + Additional Increase in Cost of Working and Claims Preparation covers to a total of $12.8m.
I have concerns & have tried to steer broker down a path of consulting with a BI practitioner etc. For the sake of a fee which as a % of total insurance cost would be miniscule.
ISR is based on the difference method. Policy wording has not been altered. By now insuring on a Net Profit basis + standing charges does this marry with ISR Mark IV Modified Wording? Square peg into round hole? Can I have some guidance/commentary on the matter?
Kevin [Surname and email provided]
I responded as follows:
You are right to be concerned that the Policy has not been endorsed to reflect the definition of Gross Profit that has been used to arrive at the Declared Value. The Additions Method as you know was the original way that Gross Profit was calculated under Business Interruption policies. That is Net Profit was defined and then the Insured Standing Charges (those expenses that were to be insured) were listed on the Schedule. This methodology went out of vogue in the late 1960’s early 1970’s following the lead from the United Kingdom where the method of calculating Gross Profit moved to the Difference Method.
The move was made for two primary reasons. The first is that the list of Insured Standing Charges was long and so took more work but more importantly, if one was missed the client/Insured was self insured for that item.
The Difference Method starts with the Turnover of the Business and then deducts those expenses that are not to be insured. These expenses are referred to as Uninsured Working Expenses. The benefit is that typically there are far fewer Uninsured Working Expenses to list compared to Insured Standing Charges and if a Uninsured Working Expense is missed then the Insured is over insured.
The Difference Method is the method defined in the Mark IV Industrial Special Risks (“ISR”) Policy which came out in 1987 and all those that followed. It is also the method used in most of the business pack wordings out in the Australian market including but not limited to Allianz, Calliden, CGU, and QBE. Vero and Zurich stipulate standard Uninsured Working Expenses to simplify or guide the Insured and or Broker.
If done correctly the same answer is arrived at for insurable Gross Profit which ever method is used but the Basis of Settlement for insurable Gross Profit has to reflect the methodology used.
I do not see this problem too often but I have come across it in the past and so drafted an endorsement for the Mark IV ISR which changes the Basis of Settlement to the Additions Method. I attach a copy of this wording along with my coach’s comments for your convenience.