Loss of Profit: Gross Profit Rate, Savings and the Sum Insured Test
A garment exporter's stitching and processing unit at Tiruppur insures loss of profits under a Consequential Loss (Fire) Policy following the Standard Fire Policy on building, plant and stock. The sum insured on gross profit is Rs 3.00 crore and the indemnity period is 12 months. The last audited accounts show turnover Rs 20.00 crore, purchases and other variable working expenses Rs 16.20 crore, standing charges Rs 2.20 crore and net profit Rs 1.60 crore. A fire on 1 July put the processing section out of action; normal output resumed on 1 October, but lost export orders were never fully recovered. Turnover actually achieved during the twelve months from 1 July was Rs 12.00 crore against a standard turnover of Rs 20.00 crore (the business had no upward trend). The insured saved Rs 25 lakh of standing charges during the disruption and spent Rs 30 lakh on job-work charges at another unit, which the surveyor accepts preserved Rs 3.00 crore of turnover that would otherwise have been lost.
1. Compute the rate of gross profit and the amount payable under the policy, showing every adjustment and why it is made.
Read the worked answer
Rate of gross profit. Gross profit = turnover − variable working expenses = 20.00 − 16.20 = Rs 3.80 crore, which cross-checks against standing charges Rs 2.20 crore + net profit Rs 1.60 crore. GP rate = 3.80 / 20.00 = 19%.
Loss of gross profit. Shortfall in turnover = 20.00 − 12.00 = Rs 8.00 crore × 19% = Rs 1.52 crore.
Savings in standing charges - deduct Rs 0.25 crore. The insured spent less while shut, so without this deduction it would recover more than its actual loss.
Increased cost of working - add Rs 0.30 crore. It is economical: it preserved Rs 3.00 crore of turnover, i.e. 3.00 × 19% = Rs 0.57 crore of gross profit, comfortably more than the Rs 0.30 crore spent. The preserved turnover already appears in the Rs 12.00 crore achieved, so there is no double counting; had the Rs 30 lakh been spent on turning over business already counted, it would be inadmissible.
Average. Sum insured Rs 3.00 crore against gross profit for the twelve-month indemnity period of Rs 3.80 crore → factor 3.00 / 3.80 = 0.7895.
Claim = (1.52 − 0.25 + 0.30) × 0.7895 = 1.57 × 0.7895 = about Rs 1.24 crore.
The sum insured should have been 19% of annual turnover for the whole indemnity period, i.e. Rs 3.80 crore.
2. The insured also claims Rs 40 lakh for permanent loss of its export market, Rs 15 lakh for a penalty paid to a buyer for late delivery, and asks that the indemnity period be extended to 18 months because recovery was slow. Advise.
Read the worked answer
Market share and goodwill (Rs 40 lakh) - not payable. The policy indemnifies loss of gross profit caused by a reduction in turnover during the indemnity period. Lost future orders, damaged reputation and market share are not a reduction in turnover inside the period and are not loss of gross profit; they are uninsured business risk. The correct message to the insured is that the indemnity period measures time, not money: it must be long enough for turnover to be rebuilt.
Penalty to the buyer (Rs 15 lakh) - not payable. It is a contractual liability to a third party, not a reduction in turnover and not an increase in cost of working. The fire consequential loss policy does not cover contractual penalties; that would need an entirely different extension, and the insured should be told plainly rather than left to discover it at settlement.
Extending the indemnity period to 18 months - not possible after the event. The indemnity period is agreed and rated at inception; changing it now would retrospectively alter the contract. At renewal, if rebuilding turnover genuinely takes that long, take an 18-month indemnity period and set the sum insured at 18 months' gross profit (1.5 × Rs 3.80 crore = Rs 5.70 crore) plus an allowance for trend.
Proof and payment. The claim must be supported by audited accounts and books produced under the accountant's clause; the insurer's accountant may examine them and final adjustment is made when the accounts for the indemnity period are audited. An interim payment on account may be made where liability is admitted.