BI Additions versus Difference Method – beware the difference
When Business Interruption Insurance was developed in the early 20th Century, the method of calculating insurable Gross Profit was to start with the Net Profit and add to it the business expenses that were likely to continue should there be a disruption to the business. These listed insured expenses were known as Insured Standing Charges. This became known as the “Additions Method” for obvious reasons.
Two problems were identified over time. The first is that the list of Insured Standing Charges is long, or ought to be, to fully protect the business and secondly, if the broker or insured omitted on inadvertently, the insured was uninsured for that expense.
During the 1970s and 1980s much of the industry moved to what is known as the difference method for calculating Insurable Gross Profit. With this method, the basis of calculating Insurable Gross Proft was literally turned upside down with the starting point being the turnover of the business and then the Uninsured Working Expenses are listed and the amounts of these expenses deducted from turnover to arrive at Insurable Gross Profit. These Uninsured Working Expenses should be those expenses and only those expenses that vary in direct proportion to sales.
The advantages of the Difference Method is that the list of Uninsured Working Expenses is much shorter and if one is omitted, the business is over-insured thereby reducing Professional Indemntiy claims against the broker or accountant who may be assisting with the calculation. While I have a preference for the Difference Method for the reasons outlined, the result, if done correctly, should be exactly the same.
The purpose of this article is to stress the importance of understanding which method of calculation the policy you are considering uses. In Australia the Industrial Special Risks (“ISR”), both Mark IV and Mark V versions, use the difference method as does CGU and most business pack policies although they may have slight variations in an attempt to assist the broker and or insured. For example, Zurich lists four Uninsured Working Expenses as standard, namely: purchases, freight, packaging and bad debts. Additional Uninsured Working Expenses can be added if required. In New Zealand, South Africa, and the United Kingdom the move to the Difference Method is almost universal as well.
I do see, from time to time, where a broker has listed the Insured Standing Charges on an ISR policy, for example, not realising that its Gross Profit is calculated using the Difference Method. The result of such an error can be catastrophic to the business owner in the event of a claim. While the Difference Method has almost replaced the Additions Method in most modern policies, it is not universal. For example, the SRS Compack Policy Wording (version 01.11) uses the Additions Method to calculate insurable Gross Profit. I would refer you to the Definitions section of the Business Interruption section on page 12 which states:
GROSS PROFIT: The sum produced by adding to the Net Profit the amount of the Insured Standing Charges or if there be no Net Profit the amount of the Insured Standing Charges bears to all the Standing Charges of the Business.
Please understand I am not criticising the SRS policy in any way. As I explained above, the answer you get and the coverage afforded by this policy in respect of a claim for insurable Gross Profit would be no different than if the same risk was protected by an ISR Policy — as long as the person calculating the insurable Gross Profit at the time the Policy was taken out was cognisant of the fact that this wording uses the Additions Method. I understand that SRS can offer the Difference Method by endorsement for those that prefer this basis of calculation.
Due to the marked differences between the business pack wordings on the market and the risk to brokers or an insured in not getting the sum insured correct, I developed www.bicalculator.com back in 2006 which has an individual calculator for a wide range of wordings. As soon as BIcalculator.com’s Manager became aware of the SRS Compack Policy Wording, he commissioned a calculator for this particular Policy. It will be up on the site as soon as it is completed.
The site has proven very popular and is now available in 6 countries with 2 more under development. The satisfying result for me is that not one broker that has used the site has been successfully sued for wrong advice. In fact by using the site, several brokers have been able to successfully defend actions against them.
Summing up, please keep the following in mind: 1) the myriad of Business Interruption policies available do not have a uniform method of calculating insurable Gross Profit; 2) BIcalculator.com is a powerful tool to assist brokers and clients to get the declared value or sum insured correct; and 3) if you use a policy that is not up on either PolicyComparison.com or BIcalculator.com, let me have a copy and I will remedy the situation.