The major risks facing business in 2018

Business Interruption, cyber attacks, and natural catastrophes are, not surprisingly to us in the industry, the leading business risks this year, according to more than 1,900 risk experts from 80 countries polled for the latest Allianz Risk Barometer.

The survey by Allianz Global Corporate and Specialty reveals that cyber attacks and business interruption remain the leading two risks in Australia. What remains disappointing is that both cyber and business interruption coverage is often not taken out by many small to medium enterprises, commonly at their peril.

I continue to urge all business owners and managers to discuss these and other risks with their insurance broker.

Changes to legislation/regulation and natural catastrophes are also high on the list.

To read the excellent full report please visit: http://www.agcs.allianz.com/insights/white-papers-and-case-studies/allianz-risk-barometer-2018/ 

I conclude with their very insightful infographic.

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When does the Indemnity Period end?

At LMI Group, we have an issue which comes across, almost in waves, in regards to a number of claims which needs to be addressed before the next flavour of the month adjustment to reduce an Insured’s claim.

The one we have just overcome is where the adjuster has made a “notion” adjustment, without explaining the basis for it. Now, we have come across on a number of claims, particularly involving restaurants, clubs and hotels is for the indemnity period to be cut off by the loss adjuster and then the Insured being asked to prove that the loss extends beyond the period allowed by the adjuster and then also prove that the ongoing disruption is as a direct result of the damage or other insured event which gave rise to the initial claim.

One of the great frustrations for us is that often this judgment call is being made by a Forensic Accountant or an adjuster who has not been to the site, met the insured, or if they have, it has been only one short visit. Without understanding the insured’s business, their assumption that the business should have been back to normal may well be completely ill founded and at times appears to be linked to the fact that the initial reserve placed on the disruption by the adjuster or forensic accountant has proved to be inadequate. That means the claim is then being adjusted within the confines of that initial reserve.

With this background, I thought that it was appropriate to review the typical Business Interruption cover and in particular, to look at the onus of proof issue.

There are differences in the market with business interruption policies and so, for the sake of this exercise, I will use the Industrial Special Risks (“ISR”) Mark IV Modified wording.

The trigger for a claim under Business Interruption under the Mark IV ISR reads:

In the event of any building or any other property or any part thereof used by the Insured at the Premises for the purpose of the Business being physically lost, destroyed or damaged by any cause or event not hereinafter excluded (loss, destruction or damage so caused being hereinafter termed “Damage”) and the Business carried out by the Insured being in consequence thereof interrupted or interfered with, the Insurer(s) will, subject to the provisions of this Policy including the limitation on the Insurer(s) liability, pay to the Insured the amount of loss resulting from such interruption or interference in accordance with the applicable Basis of Settlement.

Assuming that the loss falls within the triggering provision of the policy, it advises that the claim will be settled in accordance with the “applicable Basis of Settlement”. The Basis of Settlement reads:

The insurance under this item is limited to actual loss of Gross Profit due to: (a) Reduction in Turnover and (b) Increase in Cost of Working and the amount payable as indemnity thereunder shall be:

(a)   In respect of Reduction in Turnover:

the sum produced by applying the Rate of Gross Profit to the amount by which the Turnover during the Indemnity Period shall, in consequence of the Damage, fall short of the Standard Turnover.

(b)  In respect of 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.

In both Section (a) and Section (b), the policy makes note that the Insured is to be indemnified during the Period of Indemnity. It is therefore important, that we look at the definition of Indemnity, which reads:

INDEMNITY PERIOD: The period beginning with the occurrence of the Damage and ending not later than the number of months specified in the Schedule thereafter during which the results of the Business shall be affected in consequence of the Damage.

In Summary, this definition states that the Policy starts on the date of the Damage, which may be before any disruption to the business starts and ends when the business is no longer effected in consequence of the Damage, or the number of months stated in the Schedule.

Often, it is a case of res ipsa loquitur which simply means, the facts speak for themselves.

Naturally, as part of the calculation and/or assessing process, the person preparing the claim and/or assessing the claim, would carry out tests to determine whether or not some other factor has arisen which has caused a downturn in the business, and for that matter, may have caused an upturn of the business, unrelated to the Damage which would have taken place had the Damage not occurred.

The reasoning behind this, is that at its heart, the traditional business interruption policy is a contract of indemnity. That is, of course, to put the Insured back to near as money will allow to the position they would have enjoyed but for the loss. I stress that this is the underlying principle of the majority of business interruption policies in the market, however, there are some policies which are in fact agreed value policies, where the Policy stipulates a formula which may well over or under indemnify the insured.

To ensure that the principle of indemnity is maintained, the policy contains what to me is arguably the most important clause in the contract of insurance and the one that creates the greatest conflict between the insured and the insurer.

This clause is the adjustments clause, which reads:

Adjustments shall be made to the Rate of Gross Profit, Annual Turnover, Standard Turnover and Rate of Pay-Roll as may be necessary to provide for the trend of the Business and for variations in or other circumstances affecting the Business either before or after the Damage or which would have affected the Business had the Damage not occurred, so that the figures thus adjusted shall represent as nearly as may be reasonably practicable the results which, but for the Damage, would have been obtained during the relative period after the Damage.

While the Indemnity Period is not specifically mentioned in the clause, what is in effect occurring when the indemnity period is being cut short, is that the insurer or their agent is suggesting that the turnover that would have been achieved had the business not been affected by the Damage, would have been reduced for some other event, and as such, the period of disruption caused by the Damage is at an end.

Just as an insurer would take a dim view of an insured who came along with an unsubstantiated request to increase the standard turnover of the business, I’m of firm belief that if the insurer or their agent suggests that there is a special circumstance that reduces the standard turnover, then the onus of proof is on the insurer to prove this and not simply make an unsubstantiated claim that the business ought to have been back at that point.

I’m the first to admit that the adjustments clause is not an exact science and that no one can ever be 100% certain as to what the business would have achieved but for the loss, other than in the rarest of circumstances. There is always room for negotiation but both sides ought to provide some logical reason for any adjustment that they wish to make to the standard turnover. For the sake of completeness, I include the definition of standard turnover which reads:

STANDARD TURNOVER: The Turnover during that period in the 12 months immediately before the date of the Damage which corresponds with the Indemnity Period.

To further put this into perspective, the position I hold is that it is inappropriate for an insurer or their agent to simply say that the business should have been returned to normal, say a week after a restaurant reopens when the business had a track record of performing well prior to the event and has recovered to their pre-damaged position at a period longer than was expected by the insurer for the Indemnity Period to be cut off unilaterally and the Insured required to prove that the ongoing disruption beyond their stipulated cut off point is as a result of the Damage.

In fairness, how can this ever be proved?

It leaves the insured in a helpless position, starved of cash and with no logical way they can prove the ongoing loss, other than for the fact that their revenue has not returned to normal. Whether I am acting as a loss adjuster or claims preparer, my role would be to carry out an analysis and look at industry figures, the possibility of new competitors entering the market and all other factors to see whether the position I have adopted in my calculation of the claim is fair and reasonable to all parties concerned.

I have never attempted to cut off an Indemnity Period without any reasonable foundation for doing so. It appears that we will be taking at least one of our current claims to court to examine this whole issue of onus of proof and I look forward to the outcome which may resolve this, to me, inequitable position that many insureds are confronting.

 

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Learning from the past to protect against today’s hazards

During the very hot summer of 2008-2009, that included the Black Saturday bush fires, our Melbourne office was left without power due to both the fires and the inadequacy of an electrical sub-station across the road.

As it is imperative for us to provide our claims services during periods of natural catastrophe, so we are able to assist people in need we installed a backup generator in our building. Some within the business questioned the cost of installation and the ongoing maintenance, but I felt that as part of our risk management and business continuity management plan installing the generator was the way to go.

We have had reason to call on it only about 4 times until this year. Due to power outages, often associated with storms, it has meant that recently we have been able to maintain phone, email and web services at a time of high demand.

This week the generator has come into its own. With the apparent uncontrolled or at best inadequately proliferation of high rise developments in the area, now that Melbourne has had its first taste of summer, the infamous sub-station across the road caught fire and will not be replaced for at least a week from the time of failure. Whether the privatised carrier simply puts back the same size unit or upgrades it to cover the increased demand no one can advise us.

The apparent reason for the failure was that at after 5pm there was an electrical demand surge when everyone came home and turned on their air conditioners and the system could not cope.

In any event the ongoing outages of power to the area have not effected LMI due to our addressing the issue when it first arose nearly 9 years ago. The generator kicks in every time there is a black out or equally damaging brown out.

Of course, we are not the only business in Melbourne feeling the effect of the infrastructure not keeping pace with development. I heard on the radio this morning that homes and businesses in Blackburn and/or Box Hill have power outages. South Australia had their own issues recently.

Bearing in mind, this is only the start of summer, this issue is clearly not going to be an isolated case and all businesses are encouraged to revisit the business continuity plan and if they do not have one, consider creating one.

The issue of inadequate infrastructure is not just limited to electricity. Storm water and telecommunications are also proving inadequate and I will share examples of this issue in upcoming posts.

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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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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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NSW Government continue to bend the facts to hide their ineptitude.

Like all rate payers in New South Wales, I received this (image) flyer from the New South Wales Government on the emergency services levy.

I cannot accept that deferring the levy is going to help those that are currently bearing the cost of funding the fire and emergency services.

Fact 1: everyone in New South Wales benefits from having an efficient, well funded, well trained and equipped fire and emergency services.

Fact 2: the men and women that do this work deserve our full support for doing some of the most dangerous and stressful work in our society to protect all of us and our property.

Fact 3: it is completely unfair that only a percentage of the community bear the bulk of the cost and not everyone.

Fact 4: by deferring the changes, it means that those that insure go back to bearing the brunt of funding the fire and emergency services.

Fact 5: this, in turn, means that to avoid paying the levy people do not insure or do not insure fully. Putting an even greater burden on the prudent and risk averse who insure fully.

Fact 6: Currently, the Fire and Emergency Services means that many insurance policies are 40% higher in New South Wales than say Victoria. If you add the triple taxation of Goods and Services Tax being imposed on the Fire and Emergency Services and then the State Government Stamp Duty on insurance premiums, Fire and Emergency Services Fees, and the GST component any fool can see the inequity of having the levy on any product or service.

Fact 7: Every single study on Fire and Emergency Services shows that the fairest way for the community to fund the service is to have as broad a tax base as possible. This is property rates where everyone pays, whether you are a tenant or an owner occupier.

Fact 8: In 2012, the New South Wales Government issued a White Paper and called for input from the community on moving the levy away from insurance, rightly pointing out that it was inequitable in the current form. This means the NSW government have had 5 years to get this right as well as the benefit of consulting with all the other mainland states who successfully made the transition from insurance to property rates.

Armed with these facts, I am sure that you will agree with me that this is a monumental and inexcusable balls up by the New South Wales government.

I am pleased to see the issue is getting some time in the Sydney Morning Herald  which sheds more facts on the waste involved here and how the new levy was so wrongly calculated. For a home owner who fully insures it should logically have gone down with the broader tax base.

We cannot put the toothpaste back in the tube but what we need is some honesty on the part of the Government that they and only they got it wrong and secondly an honest time line as to when the reforms will be implemented.

My guess is that it is in the too hard basket for this government, that is, it is beyond their ability and that we may be stuck with it for another generation.

Of course, this is not the only issue this government has failed us on. The water issue from the Murray Darling is a complete story of failure in itself.

We all deserve better!

 

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Business Interruption Issues Series – Part 5 – Time Excesses – Part D – Possible Solutions

After addressing 3 common problems in time excesses last week, I return to the topic with some possible solutions.

What is the Answer?

I would suggest there are several answers to the problems of time deductibles, and would like to explore three with you.

The first is to replace the excess/deductible with a franchise. If the insured business is disrupted due to an event for a period less than the franchise of say 1, 2 or 3 days, then the loss will be at the full expense of the Insured. If it extends beyond the period of the franchise, then the entire amount would be met by the insurer. This would mean that the Insured would carry the risk for minor periods of disruption, but beyond that they would have the comfort of having full insurance subject to adequacy of insurance etc.

I appreciate the insurance industry need not be there to protect short term, what we call working losses. The cost of doing so in just calculating such losses often proving they are not real losses in any event but just delayed sales would increase the cost of business interruption insurance prohibitively. However, the cost of working out a time excess can be significant and cause the Insured to feel cheated. I know that is how I feel every time I put in a health insurance claim when I consider the premium I pay each year.

I would rather see the client get the amount rather than it go to loss adjusters and claims prepares trying to agree an equitable allowance.

Some underwriters are worried that an insured can manipulate the stop time and so get a claim paid. I think in disruption such as in failure of public utilities, or closure by public authority, the Insured has no chance to influence when the issue is resolved. As such, I do not see this as an issue. It has certainly not come up in the claims I have handled under business packs where time franchises are more common under high quality wordings.

The second solution is to apply a monetary deductible, which both the Insured and insurer know and understand in advance. I would suspect that this would be easier for the underwriter to underwrite and the Insured would be in a much clearer position as to the effect of the deductible in the event of a claim. It would also reduce the stress and claims handling costs following a loss.

The third alternative is simply a combination of the first two. The monetary deductible would apply after the franchise period had lapsed or it could be the “greater of”.

1.2                 Summary of Chapter

Space limitations have only allowed three case studies to be provided. Underwriters, claims staff and Insureds who lodged a claim following any business interruption claim with a time deductible can provide similar examples of complications arising from their experiences of the interpretation of time deductibles.

At the very least, time deductibles need to be reviewed to incorporate clear details in the policy as to how they should operate. Alternatively, they should be replaced with a franchise, a set monetary deductible, or a combination of both. Food for thought to improve what, in the main, is a very good product.

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Business Interruption Issues Series – Part 4 – Time Excesses – Part C

 

Insurance should not be a game of Russian Roulette

This is the third post in this series on time excesses and the fourth on common business interruption issues that started on Monday 10th April 2017.

 

I continue the examination of time excesses using another case study.

Case Study 3: The Policy will not Cover Losses within the First 48 Hours

The third case involves a wording that states the policy will not cover losses within the first 48 hours. In many cases of smaller commercial and industrial premises, the Insured was not advised to shut down their gas until after 5.00pm on Friday, 25 September 1998. 

If they had no planned production within the next 48 hours, they suffered no losses and, as such, the time deductible did not apply. Had the shutdown occurred at the same time on Sunday, Monday, Tuesday, Wednesday or Thursday, then the same time deductible would have applied, but this time with a financial penalty being borne by the insured business.

On the other hand, taking restaurants for an example, Friday and Saturday evenings are often their busiest nights. They, therefore, were penalised by pure chance due to the fact that the disruption caused by the Longford Gas Explosion occurred on a Friday. For them, if it had occurred on a Sunday or Monday, the reduction in the claim due to the application of the deductible would have been much less.

Rather than know their respective positions when a loss occurs, it could be said that the insurers and operators of businesses that do not operate 7 days per week are both playing Russian Roulette with a revolver holding 5 bullets in a 7-chamber gun. That is, 5 working days in a 7-day week.


Tomorrow is Good Friday and as it is a religious holiday for many, coupled with the fact that many in the industry have been working their tails off with the cyclone claims, I, while not wishing to follow the approach of a TV soap opera, will hold off till next Tuesday to provide some alternative solutions.

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Business Interruption Issues Series – Part 3 – Time Excesses – Part B

Today, we continue our discussion on time deductibles. As I did yesterday, I draw on a case study to explain an issue.

Case Study 2: 24 Hours after Cessation of Supply

This case study involves another large manufacturer. In this case, the wordings for the time deductible is contained within the Public Utility clause provided that cover does not commence until “24 hours after cessation of supply”.

To avoid major damage to the insured plant at a large production facility, the gas supplier allowed the Insured to implement a staged shutdown of the gas supply over the site, which took 11 hours. In other words, it took 11 hours from when gas supply was cut to the first machine, until it was cut to the last machine. Does this mean that the Insured in fact suffers a 35-hour time deductible? That is, 24 hours from the cessation of supply, plus the 11 hours of disruption they suffered during the phased shutdown. The wording of the deductible did not match the intention of either the insurer or the Insured.

In this case, using the Departmental Clause, it was possible to identify the loss by machine, and the claim was settled by applying the 24-hour time deductible on a machine-by-machine basis. A much more difficult adjustment and negotiation would have been required to achieve the agreed intention of the time deductible had the method of claim calculation used not been possible.

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Business Interruption Issues Series – Part 2 – Time Excesses – Part A

Following on from yesterday’s article on part insuring a standing charge, I move to time excesses for the rest of this week.

When I wrote the first edition of my book on Business Interruption, time excesses were relatively new, except for particularly large risks, especially in the mining industry.

The large number of business interruption claims that arose from the gas crisis in Victoria, Australia in September 1998 highlighted the inherent problems associated with time deductibles. Many of the issues have again been seen following the Western Australian gas crisis 10 years later, in June 2008 as well as natural catastrophe claims and the 2014 Sydney Hostage Crisis.

The purpose of the post today and the next few days is to highlight through case studies, some of the many problems that can arise with the interpretation of a time deductible. And second, equally important, the purpose is to offer suggestions for alternative forms of deductible that may assist each party to the insurance contract in understanding their respective position in the event of a loss.

Case Study 1: 3-Business Day Time Deductible

The first case example is in respect of a large manufacturer that has a Section 2 Deductible of “3 business days”.

The loss of 7 days’ production caused by the gas outage was made up by the Insured through working weekends and public holidays between the date when the gas supplies resumed and the end of the Indemnity Period. The loss was confined to the Increase in Costs of Working associated with making up the lost production.

The position that should be adopted with such a disruption being considered under a policy with a time deductible is that regardless of when the costs are incurred, they should be matched to the benefit that the increased costs have generated. For example, if within the first 3 days the Insured had incurred significant costs, say several million dollars, to convert their production facilities to run on LPG rather than natural gas, but the benefit of this expenditure was not realised until after the first 3 days and was therefore to the entire benefit of the insurer, then the insurer should, in equity, meet the entire cost of the Increase in Costs of Working. This is logical even though it was incurred during the first 3 days.

Conversely, any costs associated with making up lost production suffered during the first 3 days, for instance by way of overtime etc, should be at the expense of the Insured; the first 3 days being the period of time deductible.

This is in line with not only the generally accepted accounting principle of matching revenue with expenses, but also with the spirit of the underlying principle of indemnity which, as we have discussed elsewhere in the text, is to “put the Insured back, as near as money will allow, to the same position that they would have enjoyed but for the loss” [1].

In this case, an accountant acting for the Insured as a claims preparer, argued that there were no lost sales during the first 3 days and, as such, there was no loss suffered by the Insured. They went further to argue that as the Insured ‘stood down’ employees during this period, there were savings made. However, as these were made during the 3-day deductible, these costs should not be taken into consideration in adjustment of the claim. If this was to be accepted (and it was not), it would have converted the deductible into a positive benefit to the Insured. This is because the insurer was being asked to meet all the additional costs to make up the lost production, but was not being granted any benefit of the savings made during the period.

This is a nonsense argument that goes against the underlying principle of business interruption insurance as explained above. What this case study does, however, is highlight the problems that can arise in adjustment of a claim involving a time deductible.

The lesson to be learnt from this case is that the policy must clearly state how the deductible is to be applied.

To learn more please refer to Business Interruption & Claims, Chapter 18.

[1]     Castellain v Preston (1883) 11 QBD 380.

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