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 Wo

rk 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 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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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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Blog reader question: Theft of goods on consignment

I received a question from a blog reader as follows:

I have had a crystal stolen from my shop which was on consignment. My insurance is refusing to pay out as buried in the small print it states that shoplifting is not covered (the theft was when the shop was open & trading). The crystal was on consignment. Can you advise who is responsible for the insurance on this item, me or the owner. The theft was a team including distraction group, & we only have one staff on at a time, so could not have been prevented by us doing anything differently. It was too big to be under lock & key.

Thank you
Angi [Surname and email provided]

My response to Angi read:

Hi Angi,

Sorry to hear of the theft. We need to bring back stocks and or public floggings. I think all of us are appalled at the rising crime rates and the slap across the wrist with a wet tram ticket if they do get caught.

When you say on consignment, I assume you mean, the everyday meaning that being you hold the item on trust until it is sold, it would depend on the terms of the consignment. If it had just been delivered and you are referring to a consignment note, then this is something different.

If there is no terms and condition in the consignment agreement, then in the first instance, I am sorry to say, you would be regarded as a bailee and as such you would be responsible unless you can show that you have exercised reasonable care.

I think this is going to be a challenge on the information you have advised.

If you would like me to read the consignment agreement and give you more specific advice I am happy to do so. My email is allan.manning@lmigroup.com. There would be no cost for this service.

Sorry again to hear of the loss and the situation you find yourself in. It is probably worth installing a CCTV system if you can to offer yourself some protection or at least as a deterrent.

 

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The need for continued learning

One of the great things about general insurance claims is that it covers such a wide diversity of issues, industries and of course people. Whenever I can, I attend seminars or conferences alike that will add to my professional knowledge.

Last night, I attended an excellent one run by The International Association of Arson Investigators at the Police Forensics Laboratory in Macleod in Melbourne. For the very modest cost of $20, we were provided the choice of a hot meal, followed by coffee. The reason I raise this is that the cost should not be an issue.

What was the key reason for attending was 4 excellent speakers from the Victorian Institute of Forensic Medicine. While there were well over 100 attendees, I was personally disappointed that there were no loss adjusters present where as 20 years ago there would have been 10-15.

Good claims adjusters cannot be arm chair detectives, and while they should never pretend to be something they are not, they should be satisfying themselves that the reports they receive are credible and is in keeping with their own observations.

It has been quite a week for me in reflection as to how we can do things better as an industry, which again flows from the Mansfield Awards last week and the work we have been doing on ClaimsComparison.com.

One of the issues I had to confront was whether or not my membership of the Australasian Institute of Chartered Loss Adjusters was value for money, and when I considered the cost vs the benefit, it was overwhelmingly apparent that my subscription was better spent elsewhere. This again, was extremely disappointing for me as I was the deputy president of the Australasian division of the Chartered Institute of Loss Adjusters and along with the then committee worked extremely hard to merge three separate loss adjusting associations. Instead of it raising the standard of the profession, it appears to me we have slid down below the lowest common denominator.

I will retain my membership of the Chartered Institute of Loss Adjusters out of the United Kingdom, the International Institute of Claims Preparers and work with The Financial Services School to develop a comprehensive course for claims professionals.

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The combustible panel issue has to be addressed before it is too late

Source: The Daily Telegraph

I was looking through my library of photos in preparing an earlier blog today and my eye was drawn to this photo of two young girls trying to escape from a fire in Sydney back in 2012. My mind immediately thought what would have happened had that, what appears to have been older building, been retro-fitted with the combustible paneling?

In that post titled. Fire Safety in High Rise Buildings a Must, I recommended anyone wishing to invest in a high rise building obtain a report on the fire safety of the building, particularly if you wish to live above the 7th floor which is about as high as the fire brigade can reach with their current equipment (It may be less in some areas).

Since London, I have spoken to a lot of people and one suggestion came from a very talented engineer was to install either sprinklers or drenches, (a drenching setup is a one goes off, they all go off system).  I questioned this as I felt it was only a band-aid solution.

Advice I received from experts in the United Kingdom, where what may appear following the Grenfell Tower tragedy, the insurance industry has been a lot more focused on the issue and fighting council and government to stop its installation. Their approach is that the sprinkler or drenching system is not the answer for the following reasons:

  • The volume of water required compared to the existing water supply
  • As it is on the exterior of the building what happens on a day of high winds?
  • The difficulty of getting the water in behind the metal cladding to the combustible insulation material.

As such, the only workable safe solution is for this type of material to be removed. There will be a significant cost but the risk as we have seen in London, Dubai and Melbourne is just too great for this material to be left.

To me, for the Metropolitan Fire Brigade to say they have a number of buildings under ‘special watch’ I think is not the answer. I, like many within the industry do not what to have a Grenfell tragedy in this country before any meaningful action is taken.

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Happy Birthday Blog

Today marks the 3rd birthday of this blog starting on 10th April 2014.

Since then, 950+ posts have been published and by sharing it on LMI and my own personal Linked In, Twitter and Facebook pages over 10,000 subscribe and over the total reads has been over 1,000,000.

The posts that get the most attention are when I have a rant but this cannot and should not be faked and so they do not come along too often.

Over half have been answering questions put to me and these have come from 6 continents and just under 50 countries. I do not post all the questions and answers for a variety of reasons but where appropriate I do.

The accountant in me records the time I spend on the posts as I soon realised that writing a blog post takes a lot more time than I thought. Checking today, I was staggered to see that if I were to charge for the time at my standard charge out rate the cost in writing the blog has been over $250,000 plus the cost of subscribing to Bigstock photos so that I do not breach copyright with any images.

The way I look at it is that each time someone reads a post the investment is around 0.25cents but more importantly if just one client is better protected, one Professional Indemnity claim is avoided, if the general insurance industry is better regarded and understood, then the investment is well worth while.

The blog is not a chore as I write on topics I love and the thought of helping people is extremely satisfying. I too learn from the experience as I do not always know the answer of a question off the top of my head and then I go and research it and so am better off for it as well.

For the budding blogger, please use a good system. Mine has had 96,410 malicious attacks and the worst bit until I put a spam filter on the site is that you get bombarded with spam comments. Since I put on the filter about 18 months ago, it has blocked 46,628 spam comments.

I do have to be careful to ensure that I know where the question comes from and that I have all the facts particularly where I sense it is a live claim. I do get frustrated when the person asking is just using me and claiming it as their own work or they have engaged an expert for a fee who has not been able to answer the question and then expects me to address some complex issue for free. I do expect to be treated fairly and not just used.

I am looking forward to posting my 1,000 post in a month or two, a milestone that has been reached a lot quicker than I thought and I have no plans to stop just yet as there are no doubt heaps more questions to answer and just as many issues that will pop into my head that I wish to share and debate.

So keep the questions coming.

PS, several people have contacted me saying that surely it has been more than 3 years. It turns out that the system I use only records the last 3 years. When I went back and looked at the first post, it was 4th October 2011 so it is really 5 1/2 years of blogging. Talk about time flying when you are having fun.

I double checked the other stats and except for the total number of posts and subscribers which are correct as reported above, the reads, attacks, spam comments etc are only for past three years. It is therefore more widely used that I realised.

Thanks to all that have contacted me via email etc to say how much you enjoy the articles.

 

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More books for the library and looking for an article – Can you help

I was delighted to get a wonderful collection of insurance texts on a wide range of topics from Mr Keith Wehl. Thanks Keith, you really made my day when you dropped them in.

The books have all been cataloged and included in our ever growing insurance library. These take our collection to just over 1900 books.

The library is available for use by anyone in the insurance industry. To learn more about the service please click here.

On a slightly different topic I am trying to track down an article which either appeared in The Journal or the Insurance and Banking Record back in the late 1970’2 to mid 1980’s titled: Whither Insurance. 

If you happen to have a copy would you please share a copy with me for as I recall, many of the issues outlined in this article are with us more seriously today and I would like to do a comparison.

Finally, back on the library, remember I will always give a good home to insurance books, policies, and memorabilia / realia from the insurance industry so that it is preserved for current and future generations.

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ANNOUNCING: LMI RiskCoach OnTheGo

LMIGroup are pleased to announce the next evolution in its award-winning system LMIRiskCoach with RiskCoach OnTheGo. RiskCoach OnTheGo brings industry specific risk information from over 7000 industries and puts it in the palm of your hand.

The system allows users to research industry specific risks across 12 classes of insurance, look up significant exposures and explore risk checklists like never before. Go one step further and within seconds you can generate and send a co-branded tailored report with your company logo and business name right from the app.

The best part is that RiskCoach OnTheGo is available to all existing LMIRiskCoach users as part of their subscription.

To get started simply download the RiskCoach OnTheGo App from the Apple App Store or Android Play store! Or to learn more, contact LMIGroup via customerrelations@lmigroup.com

iOS: https://itunes.apple.com/au/app/lmi-riskcoach-onthego/id1184053199?mt=8
Android: https://play.google.com/store/apps/details?id=lmigroup.riskcoachonthego
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Steps To Take Immediately Following A Loss

STEPS TO TAKE IMMEDIATELY FOLLOWING A LOSS

Below is a small section of a Guide which assists you to prepare a business insurance claim. It explains a raft of issues such as GST, under insurance and much more.

If you would like a free copy please email, vic@lmigroup.com

  •  Report the claim to your insurance broker/adviser or if you do not have one, contact your insurance company direct.
  • If you need assistance in mitigating your loss and or preparing your business / business interruption claim by an expert contact LMI Claims. They act for you and their fee is typically covered under your insurance program.
  • Do not admit liability to any party for any damage caused by the cyclone/storm. This may prejudice your insurance claim.
  • Limit access to the premises to those who have a legitimate reason for being on the premises. (Insurance loss adjusters or others acting for neighbours, customers, etc have no right to enter your premises. If in doubt consult your LMI Claims Preparer).
  • Take immediate action to minimise the loss.
  • Protect undamaged property from loss.
  • Appoint one person to represent your company and protect your interests in preparing the insurance claim (your LMI Claims Preparer). Provide the LMI Claims Preparer with a copy of your full Policy wording including the Policy Schedule.
  • Implement a methodology to capture all costs and expenses that the business will incur, e.g. create a separate and specific account number in the company’s financial accounting records.
  • Take photographs and/or video the damage. The more the better.
  • Set up clear lines of communication with the insurance loss adjuster appointed by the Insurer and ensure that all personnel understand the functions of the loss adjuster, your appointed claims preparer, insurance broker/adviser, etc. It is extremely important that nothing is misunderstood or misconstrued as this may well delay the claim or reduce the settlement. For this reason it is important that your LMI Claims Preparer be present during all discussions with the loss adjuster and that no email, letter or other communication go direct from you to the loss adjuster. LMI use a Claims Management Plan which is regularly updated so that you, your insurance broker and the claims preparer know the current position of your claim.
  • Consult contractors for an initial estimate of the scope and cost of repairs.
  • Identify temporary measures needed to resume operations and the associated extraordinary expenses that are incurred.
  • Retain all damaged property if at all possible as proof of ownership and damage to the loss adjuster. I appreciate this is not always possible when it comes to perishable foodstuffs which may create a health hazard but in such cases, photographs and videos mentioned above are important along with weights and or an accurate count.

I originally wrote this to assist people following Cyclone Debbie. Thinking about it a few weeks later and realising that due to the heading it could be pulled up at some future time, I would add that details of any third party that may have caused the incident needs to be kept along with any physical evidence of the cause and damage.

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