Is There a Need to List Uninsured Working Expenses in a Traditional Business Interruption Policy?

Broke Business Man

Business Interruption cover needs to cover all ongoing business expenses

First up, it depends on the policy. Many business packs have now been written so that only 1, 2, 3, or 4 uninsured listed working expenses are taken into consideration. The most common ones listed in a such a policy may include some or all of the following:

  • purchases;
  • packaging;
  • freight; and/or
  • bad debts.

To see just what expenses should be taken into account in calculating the sum insured under a business pack is to read the definition of Gross Profit in the policy. This is made a little more difficult with the move, which I do support, to change the name from Gross Profit to terms like Annual Turnover, Turnover, Annual Income, Income, or Standard Takings, to name a few.

Arguably, an easier way is to go to the Financial Inputs Screen on LMI BIcalculator.com and you will see the standard Uninsured Working Expenses listed for the particular policy you are using.

On the other hand, the Industrial Special Risks Policy, along with many popular business packs such as Allianz’s Retailer’s Pack, CGU’s Business Insurance Policy, or Calliden’s Premium Business Pack, to name a few, require any Uninsured Working Expenses to be listed. Even those such as Zurich Business Insurance Policy, which lists set Uninsured Working Expenses still allows the inclusion of further Uninsured Working Expenses if they are deemed appropriate.

For advice on whether a particular expense should be insured, go to http://www.bicalculator.com/KC/kc1.aspx?id=43.

Turning back to the question of whether the Uninsured Working Expenses need to be listed, in such cases I think the easiest way to explain the answer is by way of example.

Let us assume that the broker calculated the Declared Value for Business Interruption for a particular client as follows:

Sales                                                                                           $1,000,000

Opening Stock                                     $100,000

Plus Purchases                                    $500,000

Goods Available for Sale                        $600,000

Less Closing Stock                               $100,000

Cost of Goods Sold                               $500,000                           $500,000

Accounting Gross Profit                                                                 $500,000

Less Uninsured Working Expenses in addition to Purchases

Freight                                                 $100,000

Packaging                                            $100,000

Selling Expenses                                  $100,000

Total Uninsured Working Expenses

(excluding Purchases)                           $100,000                           $300,000

Insurable Gross Profit                                                                  $200,000

If the broker failed to show the Uninsured Working Expenses on the Schedule the loss adjuster acting for the Insurer would turn to the definition of Gross Profit set out in the ISR Policy which defines insured Gross Profit as:

“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.

Note: The amounts of the Opening and Closing Stocks and Work in Progress shall be arrived at in accordance with the Insured’s normal
accountancy methods, due provision being made for depreciation.”

[emphasis mine]

If there are no Uninsured Working Expenses set out on the Schedule as the definition requires then, the loss adjuster will typically only allow Purchases. In fact, there is one loss adjuster in Australia which is reluctant to even grant this expense as uninsured.

The loss adjuster would then calculate the insurable Gross Profit in accordance with the policy for the purpose of testing for under insurance as follows.

Sales                                                                                           $1,000,000

Opening Stock                                      $100,000

Plus Purchases                                     $500,000

Goods Available for Sale                  $600,000

Less Closing Stock                               $100,000

Cost of Goods Sold                              $500,000                           $500,000

Accounting Gross Profit                                                                    $500,000

Less Uninsured Working Expenses in addition to Purchases

None listed                                                                                              $0

Insurable Gross Profit                                                                $500,000

The test for Under-insurance/Average would in this case then be:

Declared Value

Value at Risk as calculated by the Policy     X       the Loss

This equals:

$200,000

$500,000            X        the Loss

The Insured would therefore only receive 2/5 of their loss or 40%. The cruel  irony is that if there were savings in the Uninsured Working Expenses of freight, packaging and selling expenses these would have been deducted from the loss adjusters calculation of Loss of Gross Profit before the test for Under Insurance/Average and so would have copped a double-whammy.

My strong recommendation is that the broker should list the Uninsured Working Expenses on the Placing Slip and that they should in turn be listed on the Policy Schedule. This is in the spirit of the important underlying principle of insurance, namely Utmost Good Faith, so that everyone knows the rules before the claim and no one is unfairly penalised.

For the sake of completeness I would say that in the case Spika Trading Pty Ltd -v- Royal Insurance Australia Limited (1985) 3 ANZ Insurance cases 60-663, the judge concluded that where there were no Uninsured Working Expenses listed that the “…the plaintiff is clearly entitled to the figure of loss arrived by the application of ordinary accounting principles.”

What is meant by “ordinary accounting principles” is far from clear. Ideally, it would give the client the best result and reflects a premium being paid on what is claimable and not something that would be deducted as a saving.

I was asked in one case if Direct Factory Wages could be regarded as an expense that should be deducted using Ordinary Accounting Principles. The fact is that Direct Factory Wages may or may not reduce in direct proportion to sales and therefore may or may not be regarded as ‘ordinary’.

The words are ambiguous and while they may offer some ability to bring in unlisted Uninsured Working Expenses, my strong recommendation remains that all Uninsured Working Expenses including Purchases be listed on the Schedule. It certainly takes away any uncertainty and reduces delays in settling a claim if they are recorded on the Policy Schedule before the start.

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Disclaimer: This post has been prepared as a guide and is not intended to be exhaustive. While the utmost care has been taken in the preparation of the article, it should not be used or relied upon as a substitute for detailed advice or as a basis for making a business, financial or insurance decision.

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