It is extremely important to make sure that insurance is adequate in the event of a loss. In small and medium enterprises, the problem of under-insurance is at its worst.

In my own experience from over 35 years in handling claims, I have found that over 85% of Business Interruption claims for small and medium-sized enterprises are reduced by not being fully insured. The worst case was where the Insured only received 6.13% of their loss. This was an extreme case, but it is not uncommon to see the claim cut down by over half due to an inadequate Sum Insured or Declared Value.

The Insurance Council of Australia report that non-insurance and under-insurance is at its worst on Business Interruption policies.

STEP 9.2: CHECK FOR ADEQUACY OF INSURANCE CONTINUES

We turn now to the Adjustments Clause, which was discussed under Step 1. This clause stated that adjustments could and should be made to four calculations to reflect the trend and special circumstances of the business. We have already discussed adjustments to Standard Turnover and the Rate of Gross Profit. Annual Turnover is another of the calculations that should be adjusted.

The same process as was adopted for the calculation of the Adjusted Standard Turnover, should be utilised. In many cases, but not all, the same growth rate may be applicable for both the Annual Turnover and Standard Turnover. However, it should be borne in mind that this is not always the case. It is, of course, much easier to estimate the growth factor for Annual Turnover if the loss occurs quite late in the period of insurance, i.e. near the anniversary of the date of inception of the policy, as the actual growth that was achieved can be calculated. It is emphasised that the growth rate for Standard Turnover and Annual Turnover need not be the same. For the sake of this example, however, the growth rate is taken to be the same.

Using the growth rate of 18.6%, we can easily calculate the Adjusted Annual Turnover. This is done in Table 10 below.

STEP 9.3: THE COST OF UNDER INSURANCE

Unfortunately for the owners of Australasian Dry Cleaners, their claim will be reduced by the application of Average. The adjustment of the claim is made using the following formula.

 

In this case, the claim would be adjusted as follows.

 

The claim calculation process is not quite over yet. There are at least two, sometimes three, other sections to consider. If Wages are insured separately, then they need to be addressed as well. This is a complicated area, deserving a section of its own, and is covered in detail later in this site. Ignoring Wages for the moment, two areas still need to be addressed. These are Additional Increased Cost of Working (the wider cover for Increased Cost of Working) and Claims Preparation Fees. These are looked at after the Application of Average as neither section is subject to Average.

 

STEP 10.1: ADDITIONAL INCREASE IN COST OF WORKING

As we saw at Step 7, Item 1B – Increase in Cost of Working has two limitations; expenditure must be for the sole purpose of reducing Turnover, and it is subject to an economic limit test. The cover provided by Additional Increase in Cost of Working is broader, as is clear from the following definition, which again has been taken from the ISR Mark IV wording.

 

“The insurance under this item is limited to increase in cost of working (not otherwise recoverable hereunder) necessarily and reasonably incurred during the Indemnity Period in consequence of the damage for the purpose of avoiding or diminishing reduction in Turnover and/or resuming and/or maintaining normal business operations and/or services.”

This wider cover allows increased costs that maintain the business or service, but which do not necessarily reduce or avoid a Loss of Turnover. For example, the Insured may employ additional accounting staff to ensure debt collection is maintained at the normal rate while their normal staff assist in other areas. As mentioned above, this cover is not subject to the economic limit test, which can be a great advantage, particularly if the expenditure ensures the retention of customers well after the expiration of the Indemnity Period. The costs, however, must be reasonable and incurred in consequence of the damage.

 

Finally, the cover is not subject to any adjustment for under-insurance. However, it is important that the cover is adequate to allow the businessperson to take all reasonable steps to protect their business during the period of the crisis.

STEP 10.2: A LITTLE KNOWN BENEFIT OF ACIOW

In our example case, all the increased costs of working incurred by the business (that is, the air freighting of the replacement machine at a cost of $5,000) appears to have been met as an Increased Cost of Working item. However, this section of the claim was reduced due to under-insurance. Under many Additional Increase in Cost of Working covers, the shortfall caused by under-insurance on Item 1(b) – Increase in Cost of Working (ICOW) items is claimable as an Additional Increase in Cost of Working item. This is because the Additional Increase in Cost of Working cover is not subject to average and is by its very definition designed to cover increases in a business’s cost of working that are not recoverable elsewhere under the Policy. Under the definition provided above, that portion of the $5,000 which has not been met due to under-insurance is, in fact, claimable under the Additional Increased Cost of Workingcover.

 

The claim for air freighting was $5,000, but was reduced by 13.09% due to under-insurance (as shown in Step 9). This equates to $655. After the inclusion of this item, the Adjusted Loss for Australasian Dry Cleaners calculates to $37,751 as set out in Table 12 below.

Table 12

Australasian Dry Cleaners – Insured Loss

The inclusion of Additional Increased Cost of Working cover can, in some policies, assist in recovering a portion of the under-insured loss. However, this is limited only to the Increased Cost of Working items and not for Loss of Gross Profit. The primary purpose of Additional Increased Cost of Working cover is not as a backstop for under-insurance, but rather as an extra cover in its own right for the reasons discussed earlier in this section. Adequate insurance on both Gross Profit and Additional Increased Cost of Working is strongly recommended.

STEP 11: CLAIMS PREPARATION FEES

The reader is asked to refer to the case study of Bancrofts Dry Cleaners,and to recall all the extra duties the management team and staff were required to deal with as a result of the loss. This was at a time when everyone, particularly the owners, were under great psychological stress.

As can be seen from this section, the calculation of the insured loss is typically not straightforward. It is clear the Insured needs assistance in first understanding how the policy works and then in gathering the data, calculating the loss and then presenting it in a suitable form to the Insurer and/or Loss Adjuster. More importantly, the Insured who has suffered the loss needs the assistance of someone who has attended a great many loss situations and can bring with them experience on loss mitigation strategies that have worked in the past. This is a time when decisions taken will not only affect the business in the short-term, but also for many years to come. While the crisis is a threat to the business, it also opens up legitimate opportunities that need to be considered.

The Insurers themselves employ experts, as many within the industry acknowledge that they do not have the expertise themselves to calculate a claim under this type of policy. Having seen the simple example of Australasian Dry Cleaners, would you have had the time or experience to prepare your own, or your client’s, claim?

The insurance industry also accepts that a business needs assistance at this time, and a wide variety of cover is available for professional fees. This can range from the services of a Public Accountant to wider covers that provide full claims preparation costs including assisting in disputes over policy liability and coverage.

The reality is that this is a complicated area, with each claim having its own nuances. It is more than an accounting exercise where an Insured is asked to ‘lend the accountant their watch to let them know the time’. As a result, many accounting practices refer their clients to a specialist Loss Manager/Claims Preparer when they are faced with an insured loss. The benefits of using a specialist Loss Manager are addressed further, under the heading “Need Help With a Claim”

As with the majority of areas covered in this website, it is necessary to read the actual insurance policy contract to ascertain the cover provided. A sample definition taken from theISR Mark IV is set out below.

“The insurance under this item is to cover such reasonable professional fees as may be payable by the Insured and such other reasonable expenses necessarily incurred by the Insured and not otherwise recoverable, for preparation of claims under the Insured’s material damage and consequential loss insurance policies, and the Insurers shall indemnify the Insured for such reasonable fees and expenses.”

This wording does not limit the fees to those of a Public Accountant as does some of the business packs. It accepts that management and preparation of the claim is not just an accounting exercise, but also requires other specialist skills.

It should be noted that this wording does not typically cover the time of the Insured’s own staff in preparing the claim. Considering that the Insured’s Accountant or Finance Director are typically salaried employees, the claim is prepared without any additional direct costs to the insured business. As such, the notional value in preparing the claim by such an employee is not covered. If overtime or some other payment to the employee is made, then the amount is recoverable but only to the value of the additional expenditure.

Finally, the cover is for claims preparation only and does not strictly cover negotiations after the claim has been submitted, to reach a final settlement. This is often quite difficult to differentiate, and the majority of Insurers allow some reasonable latitude in the definition.

Much of our work as Loss Managers arises in cases where there is a dispute between the Insured and the Insurer on policy liability. The expenses incurred in investigating the cause, which can include the appointment of an engineer or other specialist, are again not covered by the standard wording quoted previously in this Step. Similarly, the costs of dispute resolution are not covered, although wider cover is available.

In our hypothetical case of Australasian Dry Cleaners, they incurred costs of $13,400 while the policy had $20,000 coverage. As the claim was accepted as presented, the full $13,400 was claimable. In summary, the Insured’s adjusted loss (including Claims Preparation Fees incurred) totals $42,203 as set out in Table 13 below.