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Terminologies in Business Interruption Insurance

Turnover

This is the income from goods supplied or services rendered by the business. This is arrived at by multiplying the total sale by the price at which the goods or services were sold. From turn overall the costs of running the businesses must be paid before a net profit is produced. And such running costs, being charges on the business, are referred to either variable charges or standing charges. From this, it should be clear that turnover consists of three components, Net profit, fixed costs and variable charges.

 

Variable Charges/Uninsured Working Expenses.

Variable charges are charges which vary direct proportional to turnover or activity of the business, e.g. are purchase of raw materials, packing materials and transport expenses for carries of good. Where turnover is reduced due to damage, there will be a proportionate saving directly variable expenses and the proportion of expenses which goes to meet those expenses need not therefore insured.

 

 

Standing Charges

Standing charges are also known as fixed expenses and are the charges which remain constant despite reduction in production or trading. Hence when the operation of peril slows down or stops, these expenses must continue to be met. They include, rent, ground rates payable to county authorities, interest on loans, bank overdraft charges, fixed cost of water and electricity bills

 

Gross Profits

If a business is disrupted by the operation of a peril, net profits will be affected as it can only be made if turnover more than the combined variables and fixed costs. But since variable charges vary with the level of activity but their disruption cannot involve the insured in loss. it is therefore the net profit and standing charges which are known as gross profit.

Gross profit is arrived at using the following approaches;

Turnover = Net Profit + Standing Costs + Variable Cost

Gross profit = Net Profit +Standing costs

Gross profit = Turnover – variables

 

Calculations of Gross Profit

This is the amount by which the sum of turnover and the amounts of closing stock and work in progress shall exceed the sums of amounts of the opening stock and the work in progress and the amount of uninsured working expenses.

Working Out of Gross Profit

Gross profit for the period 1.1.2010 to 31.1.2010

Amount of turnover/sales

30,000,000

Opening stock and work in progress

6,000,000

Closing stock or work in progress

5,000,000

Purchases + W.I.P

10,000,000

Total

35,000,000

Total

16,000,000

 

Gross profit = turnover + closing stock and W.I.P – (Opening stock +Purchases+ W.I.P + Uninsured working expenses)

Thus:

Gross profit is (KES 35 million minus 16 million) equal 19 million

 

 

The uninsured working expenses (in KES)

Salaries                             2,000,000

Wages                               11,000,000

Insurance premium       350,000

Transport    costs            450,000

Raw materials                 300,000

Packing materials           200,000

TOTAL                               14,300,000                             KES 14.3 Million

 Net profit is equal to KES 19 million minus KES 14.3 million and is equal to KES 4.7 million.

 It can be seen from the above that the gross profit is the total of the insured working expenses plus the net profit, those are the figures covered by the business interruption policy.

 

The Sum Insured

 The gross profit calculated above is KES 19 million. To work out the sum insured from this one has to consider the points below

The financial period

Our starting most current published accounts or business records. We shall assume the period to be January 2010 and 31st December 2010. The gross profit during this period is KES 19 million.

 

Period of Insurance

The policy is to run from 1st January 2010 to 31st December 2010. The KES 19 million gross profit is a historical figure and needs to be adjusted to cater for inflation and business trends and expansion.

 

Period of Recover

This should be taken into account the time that the loss has occurred. There is always a possibility that it can occur on the last day of insurance and the business may take some time to recover. The period begins when an insured event occurs to end when the level of business income and profit margin ceases to be affected by the same. we can assume the recovery period will take 12 months.

 

 

 

Increase of Gross Profit Over a 12 Month Period (in KES)

Financial Period

Period of insurance

Loss on 31st December 2010 which will take 12 months to recover

1.1.2009 to 31.1.2009

1st January 2010 to 31st December 2010

1st January 2011 to 31st December 2011

KES 19 million

19 million plus 10% which is 1.9 million =20.9 million

20.9 million plus 10% which is 22.99 million

 

The sum insured will therefore be KES 22,990,000

 

Indemnity Period

This the period beginning with the occurrence of the damage and ending not later than maximum indemnity period thereafter during which results of the business shall be affected because of the damage.

 The maximum indemnity period

This is the number of months stated in the policy as the period of which the insurer will provide cover. It is the indemnity period which with a specified period. The period is stated in one month with the usual period being 12 months but periods of 18,24, and 36 months are also common. It is the duty of the insured to fix the indemnity period which they can deem suitable for their business. The longer the period, the higher the sum insured and hence the higher the premium will be.

When deciding the maximum indemnity period, the proposer needs to take into account the following,

  • Nature of business – some businesses may be able to recover faster than others
  • The time it would take to repair or replace specialized machinery
  • The time it would take to recover the customer base
  • How long it will take to recover the lost market share

 

Maximum Indemnity period for 12 months

Period of insurance

 

Loss on 31.12.2010 – 12 months cover

Sum insured/estimated gross profit

01/01/2010 to 31/01/2010

31.01.2011 to 31.12.2011

 

1st January 2011 to 31st  December 2011

KES 20.9 million

KES 20.9 million 10%

KES 22,990,000

 

 For a 12-month indemnity period, the estimated gross profit or sum insured will be KES 22,990,000. If the indemnity period is longer, the figures will be worked in a similar manner

For example, for indemnity period of 24 months, we shall add 10% on KES 22,990,000 i.e. 10% of KES 22,990,000 equals 25,289,000. The sum insured for the month will be:

KES 22,990,000 plus KES 25,289,000 which equals to 48,279,000

 

Material Damage Warranty

A business interruption policy is essentially a fire policy. The perils, conditions and warranties incorporated in the policies are to a large extent the same. The business interruption policy contains a material damage provisio which indicates that, there must be fire be a fire material damage policy in place before arranging a BIP. further, in the event of a claim, the material damage policy must admit liability for a claim to be admissible in the BIP, the reasons for these provisions are:

  • The existence of the material policy ensures that business interruption loss is not aggravated by lack of capital to replace, reinstate, or repair the property lost or damaged.
  • It secures for business interruption policy for protection of all the conditions clauses and warranties which appear upon the material damage policy. This avoids inclusion of different wordings under the business interruption policy.
  • Material damage insurers will have satisfied themselves that there is a valid claim under their policy and no further investigations need to be made into the cause thus saving effort and expenses
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