In August 2014 Thompson & Bryan (UK) Ltd were appointed to deal with a major loss claim following an arson attack on a commercial laundry premises in North Devon. A deliberately set malicious fire caused severe damage to the laundry’s production area including a range of heaving duty machinery including washers, driers and ironers. The extent of damage was such that the production machinery was written off in its entirety. The damage to the building, owned by a separate freeholder, was also extensive with an approximate reinstatement period of nine months. The client’s business interruption cover had a maximum indemnity period of twelve months. Given the extensive disruption to the business and the significant proportion of turnover relating to contract linen customers, it was imperative that the business was able to maintain servicing these customers following the fire which occurred at the tail end of the peak summer holiday season.
Subcontracting of the laundry work was arranged as quickly as possible albeit it a greatly increased cost. The increased costs rose partly from capacity issues with competitors who were also very busy during the peak holiday season but also as a result of some degree of opportunism on their part. Given the substantial proportion of turnover relating to four or five main holiday park customers we secured agreement to meet subcontracting costs as an increased cost of working despite the fact that in the short term the costs incurred were uneconomic in comparison to the gross profit at risk, However, given the significant gross profit at risk over the twelve month indemnity period that would arise in the event that we lost one or more significant customers the argument that incurring such significant subcontracting expenditure was a reasonable loss mitigation cost was successful. The absence of any uneconomic additional costs of working cover on the policy did, however, create a risk that not all of the subcontracting costs would have been recoverable. Generally, in our experience, the inclusion of additional costs of working cover is an important benefit to a policy holder.
The maximum indemnity period of twelve months proved ultimately to be sufficient in this case albeit it could have very easily have been otherwise. Had the building taken a month or two longer to repair and/or the lead time on the replacement machinery been longer than was experienced in this particular case, the business would not have fully recovered from the effects of the fire within the maximum indemnity period. This supports the argument and the increasing trend towards considering maximum indemnity periods of twenty-four months or longer.
The calculation of rate of gross profit in this case was also interesting in the sense that there is a significant distinct difference between accounting rate of gross profit, wherein heat, light and power and other premises related costs can be included and the insurable rate of gross profit wherein sales are adjusted only for the direct cost of sales i.e. purchases which are generally minimal in a commercial laundry environment. The net result of this is that typically, for insurance purposes the rates of gross profit in these businesses are very high (typically 80-90% or more). Care should be exercised in the calculation of a rate of gross profit for businesses such as commercial laundries as failure to correctly calculate the rate of gross profit can result in under-insurance issues. In this case, whilst there was an element of under-insurance this arose primarily from the significant positive trend in the business projecting an annual gross profit for the indemnity period in excess of the sum insured on the policy. This informs us that consideration of underlying trends in a business and notably evidence of growth should be considered when calculating a business interruption sum insured.
The insured ultimately successfully reinstated their laundry operation and, aside from a minor under-insurance adjustment arising from their significant growth in the pre-fire period, their losses were fully recovered under the policy. The issues surrounding maximum indemnity period, trend and gross profit however are interesting indicators of issues that should be considered carefully when setting up business interruption cover for a business of this nature.