This is the most frequently asked question of our team. It comes up without fail at every training session and seminar.
Anyone in business knows that it is much easier and less expensive to look after and service an existing customer than to lose the customer and have to replace them. The insurance industry accepts this notion, and realises that in the event of an insured loss, it is, on the face of it better to incur some increased costs of working to minimise the period of disruption and/or the shortfall in Turnover during the period of disruption. In other words they allow the business to claim some additional expenses not normally incurred to retain its market share.
To provide different levels of protection most policies offer two forms of cover. These are discussed below under two headings:
Most policies have a very similar cover although some policies limit the extent of the Additional Increase in Cost of Working Cover. Where this happens we warn you on the Cover Calculator.
INCREASE IN COST OF WORKING
When you declare a Sum Insured and Limit of Liability under any policy, you are selecting cover for loss of insurable gross profit.
Under the normal policy wording this is referred to as Item 1(a) Loss of Gross Profit as a result of a Reduction in Turnover.
Sharing this same Sum Insured is Item 1(b) Loss of Gross Profit as a result of Increase in Cost of Working.
What this means is that the insurer does not differentiate between a financial loss to the insured business as a result of a loss due to turnover having fallen due to an insured disruption or as a result of the business incurring increased expenditure. It will meet losses suffered by the business in either form or a combination of both up to the Sum Insured.
How the Policy does this is best explained by way of an example. Let us assume that a business has sustained fire damage to a machine worth £150,000. It will take 6 weeks for the machine to be sent by sea from Australia, its place of manufacture. For every week that the insured business is without the machine it loses £10,000 in revenue. This reduction in turnover results in a loss of insured Gross Profit of £4,000. If the Insured were to airfreight the machine from Australia to the United KIngdom it would cost an additional £25,000 but would reduce the disruption to the business by 5 weeks.
Under the terms of the Material Damage section of the Policy, the insurer will replace the machine, subject to a test for the adequacy of insurance. Replacement not only covers the cost of buying the machine in Italy but transporting to the Insured’s premises and installing it. This claim will be based on the cost of sea freight, the most economical form of transport.
The owner of the business decides to pay the difference of £25,000 and air freight the machine to the United Kingdom and eliminate the 5 weeks time delay and thereby minimise the disruption to his customers.
To determine what is claimable under Item 1(b) Increase in Cost of Working we need to review the wording. This is reproduced below:
“Item 1(b) [Loss of Gross Profit in Respect of an Increase in Cost of Working.]
ADDITIONAL INCREASED COST OF WORKING COVER ONLY
Some Insureds believe that they do not require full business interruption insurance as they will not lose any sales but may incur some additional expenses to maintain sales and customer service. This may be true for some service companies. They claim that they can quickly relocate or have their staff work from home. If this is true then this cover, purchased as a stand alone cover may be appropriate.
We would certainly not recommend this for a manufacturer or retailer. In most cases, it is found that the cover does not adequately indemnify a wholesaler.
If the office or service risk involves specialised equipment such as a dentist, again we would recommend the business take out full business interruption cover.
A word of warning. When it came to major events such as For example, the interruption of a public utility many not cause any damage to property but could result in a significant loss of insurable Gross Income that businesses that thought that they only needed Additional Increased Cost of Working found that they did lose significant revenue and therefore insurable Gross Profit that they did not expect that they would.
Before making the decision, you as broker, are strongly encouraged to discuss the pros and cons with the business owner.
This is one of those areas of the business interruption cover that is quite complex. The overview provided above has been given to give you a good grasp of the cover. The points to take away are:
- Increase in Cost of Working should never be sub-limited.
- Increase in Cost of Working Cover is subject to 2 main tests, the “Sole Purpose” and “Economic Limit” tests and is also subject to average.
- Every policy should have some coverage for Additional Increased Cost of Working.
- While Additional Increased Cost of Working only cover does have it place its use should be carefully discussed with your insurance broker or adviser.