Consequential Loss (Fire) Insurance: Gross Profit, Indemnity Period and Average
Consequential Loss Insurance tests the separate loss-of-profit cover that follows an insured fire or allied peril. The exam focuses on the CL policy's sum insured, gross-profit definition, indemnity period, increased cost of working and average condition.
Core rules
- A CL policy indemnifies loss of gross profit and increased cost of working due to business interruption following insured property damage. It does not pay for the physical damage itself; that is the fire policy.
- Gross profit is normally net profit plus standing charges (fixed expenses). Wages may be separately insured or included, so check the definition. Rate of gross profit = gross profit / turnover.
- The sum insured must represent gross profit for the indemnity period, not turnover and not annual net profit. The indemnity period is the maximum period allowed to restore turnover; choose it realistically.
- Claim formula: (lost turnover x rate of gross profit) minus savings in standing charges, plus increased cost of working. Increased cost must be reasonable and must not exceed the loss avoided. Then apply average if the sum insured is below gross profit for the indemnity period, and deduct any excess.
- Supporting rules include the auditors' certificate, trend-of-business adjustment and accumulation clause. Fines, penalties and loss of market are usually excluded.
Worked example
Annual turnover is INR 5 crore and gross profit is INR 1.5 crore, giving a rate of 30%. The sum insured is INR 1 crore and the indemnity period is 12 months. Fire interrupts business for 4 months and lost turnover is INR 1.2 crore. Lost gross profit = 1.2 crore x 30% = INR 36 lakh. Savings in standing charges are INR 4 lakh and increased cost of working is INR 3 lakh (avoiding a INR 10 lakh loss). Pre-average claim = 36 - 4 + 3 = INR 35 lakh. Gross profit for the indemnity period is INR 1.5 crore, so the average ratio is 1/1.5. Claim = 35 x 2/3 = INR 23.33 lakh, less excess. The policy is underinsured because the sum insured should have been INR 1.5 crore.
Traps that cost marks
Insuring turnover instead of gross profit; forgetting savings in standing charges; choosing a 6-month indemnity period for a business that needs 12 months to recover; treating increased cost of working as an unlimited separate benefit; ignoring average; assuming CL cover is automatic with a fire policy.