For business clients, an underinsurance shortfall can be disastrous. When clients experience business interruption they often find their cover falling short, which may mean they are unable to continue trading i.e. they could be forced to close their business. According to Karin Lombard, manager in the Santam Complex Claims Unit, underinsurance is the biggest reason for unhappiness at claims stage. We have identified three of the most common pitfalls to watch out for.
1. Calculating Gross Profit correctly
The most common errors that are made when insuring for business interruption occur when the Gross Profit of a business is miscalculated. The client is insured against applying the rate of Gross Profit to the reduction of turnover, not against the total reduction in turnover;
The Gross Profit sum insured should:
- Include VAT;
- Reflect a 12-month period where the maximum indemnity period is 12 months or less; or the appropriate multiple of the annual turnover where the maximum indemnity period exceeds 12 months;
- Cater for trend, taking cognisance of a loss that may occur close to or at the end of the insurance period.
2. Understanding the difference between Financial and Insurance Gross Profit
The Financial Gross Profit often takes account of various direct manufacturing costs, for example, wages, factory overheads, water and lights etc. The Insurance Gross Profit, however, takes account of the uninsured costs as chosen by the client. These uninsured costs would be indicated on the policy schedule, and as standard would include “purchases; bad debts; and discounts received and allowed”. By calculating the Insurance Gross Profit based on only the uninsured costs, the rate of Gross Profit would be higher, enabling the client to pay the on-going expenses i.e. wages, factory overheads, water and lights etc.
3. Ensuring that an adequate indemnity period is chosen
The indemnity period chosen needs to be sufficient to allow for the building re-instatement, sourcing/ordering and commissioning of a new plant, equipment, machinery etc. as well as returning to the pre-loss production and turnover levels – in other words, the recovery period. The length of the period would need to be sufficient to cover from the date of the incident until the business is no longer affected by the disruption.
As you can see, it’s important for intermediaries to fully understand the nature of a client’s business. You may have to call upon your client’s auditors or accountants to provide further insights and information.
If in doubt, speak to your Relationship Manager or get in touch with Santam as we are on hand to answer any questions to make the process as smooth as possible. You can also read more about the South African business underinsurance conundrum in this article.