Consequential Loss: Increased Cost of Working versus Saved Standing Charges
A packaged-food manufacturer suffers a fire at its only plant. The fire policy pays for the physical damage. The consequential loss policy has a 12-month indemnity period, an increase in cost of working clause, and covers loss of profit on a turnover basis. The plant is out of action for four months. To keep sales, the insured hires a third-party co-packer at an extra cost of ₹1.80 crore. Because the plant is idle, it saves ₹40 lakh in insured standing charges such as power, insurance and some salaries. Without the co-packing, turnover would have fallen by ₹4.00 crore; the gross profit ratio is 30%, so the gross profit lost would have been ₹1.20 crore. The insurer says the ₹1.80 crore increase in cost of working is not payable because it exceeds the ₹1.20 crore loss avoided; alternatively, it should be reduced by the ₹40 lakh saved. The insured argues that expenditure reasonably incurred to avoid or diminish the loss is payable in full and that savings are irrelevant.
1. State the principle governing increase in cost of working and determine whether the ₹1.80 crore is payable, in whole or in part.
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Increase in cost of working (ICOW) is not an unlimited indemnity. It is recoverable only where it is reasonably incurred to avoid or diminish a loss that would otherwise be payable, and it is subject to the economic test: the expenditure must not exceed the loss avoided. Here, without the co-packer, the insured would have lost turnover of ₹4.00 crore; at a 30% gross profit ratio, the gross profit lost would have been ₹1.20 crore. The ICOW of ₹1.80 crore exceeds that by ₹0.60 crore. On the standard wording, the insurer is liable for ICOW only up to ₹1.20 crore; the excess is the insured's own commercial decision. The ₹0.40 crore saving in insured standing charges must also be brought into account. If the policy applies savings against the total indemnity, the calculation is: loss of gross profit (nil, because sales were maintained) plus recoverable ICOW ₹1.20 crore minus savings ₹0.40 crore = ₹0.80 crore. If the wording applies savings only against lost gross profit, the ICOW recoverable is ₹1.20 crore and the saving is not deducted twice; the policy wording controls. The insurer should not reject the whole ICOW merely because it exceeds the loss avoided; it should pay the capped amount and explain the balance.
2. Compare the claim if the insured had not hired the co-packer with the claim under the ICO W route, and explain which course was financially better for the insured and for the insurer.
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Without the co-packer, the claim would be: turnover lost ₹4.00 crore × 30% = ₹1.20 crore gross profit, less savings in insured standing charges ₹0.40 crore = ₹0.80 crore. With the co-packer and the cap, the claim is also ₹0.80 crore on the first interpretation, but the insured keeps its customers and market share, which is a real benefit not measured in the immediate claim. For the insurer, the ICOW route pays no more than the no-ICOW route on that interpretation, and it avoids a larger future loss of gross profit if customers switch. The insured, however, spends ₹1.80 crore and recovers only ₹0.80 crore, so it bears ₹1.00 crore. On the second interpretation, the insured recovers ₹1.20 crore and bears ₹0.60 crore. The lesson is that ICOW should be planned with the insurer before expenditure; a large ICOW that exceeds the loss avoided is inefficient and may not be fully indemnified. The insurer may still approve it if the long-term loss avoided, including permanent loss of customers, can be demonstrated.