Additions v Difference Method – An Analysis – Part 4 – a Claim Gone Wrong

In Part 3 of this series of articles, I showed how calculating the Sum Insured / Declared Value under a Business Interruption Policy arrived at the exact same answer whether the method used was the Difference or Additions Method.

If everything is done as it should be, there will be no problem at the time of a claim and the Insured will be fully indemnified.

A serious problem does arise, even when the sum insured is done correctly, when the broker and/or Insured do not realise that the policy is written on a different method than what they assumed.

Using the figures from Part 3 of this series, let us assume the following:

1. The broker assumed incorrectly the policy was written on a Difference Method, when in fact it was written on the Additions Method.

2. The Sum Insured was nevertheless correctly calculated at $799,772,

3. Under a heading Insured Standing Charges as shown on the Electronic Placement  or Proposal, the Broker recorded the following Uninsured Working Expenses:

a. Agent’s Fees

b. Bad Debts

c. EFTPOS Fees

d. Freight /Deliveries

e. Packing Materials

f. Purchases

 Special Note: These expenses have been chosen for the purpose of this example and are not necessarily Uninsured Working Expenses for every business.

4. A claim has occurred and to keep it simple, we will assume they do no trading whatsoever, it is a total loss for the full 12 month Indemnity Period, that there is no Average /Co-insurance, no Increase or Additional Increase in cost of Working items.

5. All policy warranties and  conditions have been fulfilled, including the one that states the Insured cannot decide to go out of business.

6. The Insurer has accepted the claim and instructs the loss adjuster to adjust the claim in accordance with the Policy wording, i.e. the Additions Method.

5. The Insured is seeking their full sum insured in settlement.

6. There is no adjustment necessary to the Standard Turnover

The insurable Gross Profit under the Additions Method would be calculated exactly the same as the Sum Insured, but instead of using the actual Uninsured Working Expenses the adjuster would be required to use the expenses listed in the Schedule as follows.

As can be seen, this figure is over a 1/4 million dollars ($264,094 to be exact) lower than the Sum Insured the client paid the premium on.

This of course is not the end of the story. It gets worse. A Policy using the Additions  Method contains a saving clause (the Standard  Difference Method wording does as well) which reads:

less any sum saved during the Indemnity Period in respect of such of the Charges and Expenses of the Business payable out of Gross Profit as may cease or be reduced in consequence of the damage.

This means that any saving in the six listed Insured Standing Charges are to be deducted from the claim. As these expenses are, in fact, Uninsured Working Expenses and by definition truly variable to sales, the full amount of all the listed Insured Standing Charges, i.e. $390,683 would be deducted from the settlement. This means the client would end up with $144,995 in full and final settlement of their claim. This represents only 18.13% of the Sum Insured.

The error of not appreciating that the policy being used to place this risk was formulated on the Additions Method and not the Difference Method cost the client in this example $654,777 ($799,772 the correct Sum Insured/Adjusted Loss -$144,995 paid).

This, of course, would leave the Insured’s broker exposed to a sizeable Professional Indemnity claim.

I hope this and the three preceding articles clearly explain the importance of understanding the wording of the policy you are using.

Finally, if you are in doubt, you can always contact me or one of my colleagues at LMI for assistance. There may be a modest charge depending on what is required of us, but it is well worth the peace of mind for you and your client. LMI have developed www.BIcalculator and we are now working to build a calculator for the SRS Compack Policy (Version 01.11) that triggered this series of articles. Many insurers are now waiving co-insurance where the broker has used the calculator. The major lesson learned from this series, and it is true for all insurance.

Again please, never assume anything. Before you give any advice please check the actual policy wording.