Loss of Profits Policy

 

Businesses run smoothly when all the parameters are in equal pace. A small glitch in operations can result in a loss. For instance, the effect of the Covid pandemic on the   manufacturing sector was damaging to say the least.

There can be many causes like fire, flood, earthquake, terrorism etc. that can cause severe loss, yet the unseen losses are the loss of profits in any enterprise.

Normally a fire policy is purchased for business activity to cover the property, plant & machinery, stocks from various perils. This policy covers loss/damage to property only.

But what about the anticipated profits   which were not   made out of the business, as a result of the operation of a peril? In such cases, the operations can come to a complete halt due to the force of a peril, the projected profits cannot be realized and a loss of profits can occur.

Insurance policies cover such losses through the ‘Loss of profits’ or LOP policy.

What are the perils covered   in a loss of profits policy?

All perils covered under the material damage policy and any additional perils if covered under fire policy may be included. This has to be decided at the time of inception of policy.

Important points:

Ø  It is a prerequisite that the property to be covered under loss of profits policy   should have a material damage fire policy and fire or other perils must occur at the insured’s premises i.e. claim must be admissible under the fire policy

Ø  Property must be destroyed or damaged

Ø  Business must be interrupted or interfered with, as a consequence

 

Types of Loss of Profits (LOP) policies:

Fire LOP (FLOP)

Machinery LOP(MLOP)

Obviously, the FLOP policy covers loss of profits due to fire loss or fire perils to the insured property.

MLOP covers the loss of profits due to   damage to the machinery by insured   perils   and this in turn results in a loss of profits due to stoppage of work.

What is insured under a LOP policy?

The subject matter of insurance in a loss of profits policy is the gross profit.

What is the gross profit?

Gross profit is the sum of net profit and the standing charges i.e. Gross Profit = Net profit + Insured’s standing charges.

Net Profit: The net trading profit (exclusive of all capital receipts and accretions and all outlay   properly   chargeable to capital) resulting from the business of   the insured at the premises

Standing Charges: charges which do not vary in direct proportion to any reduction in business and continue to accrue in spite of stoppage of business.

Examples are:

·       Salary, wages, all social security contributions, perquisites, pension   interest on loans, bank overdraft & deb.  rent, rates and taxes   depreciation power / electricity charges (minimum charges), water, heating, lighting etc.

·       Increase in cost of working: overtime wages, additional rents, advertising charges

How to choose the sum insured for a loss of profits   policy?

Sum insured should include all these points above for adequacy of amount in the event of a loss. Sum insured is the gross profit that is   likely to accrue in the business. A higher sum insured must be opted at the inception of the policy. This will ensure that there is no underinsurance as and when any claim is reported.

The policy can be adjusted at the end of the policy period by comparing the sum insured with the actual utilized   sum insured and excess premium, if any shall be refunded by the insurers. Let us understand through an example:

A shop owner had taken a fire policy and a loss resulted in damage to his goods. Claim was paid under fire policy, however the loss of profits due to damaged stocks caused a stoppage in his operations and the ensuing profit. One month of operations were affected.

If loss of profits policy was taken the policy will pay the one-month profits that would have accrued if there was no loss. To arrive at the loss amount the standard turnover and annual turnover are compared.

Important terms of the LOP policy:

Period of insurance: The annual period during which the insurance company bears the risk.

Indemnity period: This represents insured’s estimation of the maximum period required for normal business operation to be restored following a loss. Can   be any period between 3 months to 36 months. This is chosen by the insured according to his nature and business and the time taken to bring back the business into   operation.

Interruption period: The actual period of interruption starting from the date of loss/ damage till the date normal operation has been restored.

For the purpose of loss assessment following a claim the terms given below   are necessary and relevant.

Turnover: The money paid or payable to the insured for goods sold and delivered and for services rendered in course of the business at the premises.

This gives the actual sales amount that the business earns over a period.

Annual turnover: The turnover during the twelve months immediately before the date of the damage. This gives the actual sales amount that the business earns for a year.

Standard turnover: The   turnover during that period in the twelve months immediately before the date of the damage which corresponds with the indemnity period.

This gives the actual sales amount that the business has earned during the 12 months immediately before the loss.

 

The importance of profits and the loss of profits cannot be ignored for any business since the main aim of any business would be to make profits. Proper planning of risk and risk mitigation measures makes the business plan financially viable and leads to long term benefits.

We at Zen Insurance assist in choosing the right insurance cover for your business units. Plan your insurance program wisely and contact us for assistance.

Disclaimer:

Zen Insurance Brokers is an IRDAI registered broker which facilitates quick & accurate insurance broking services. We deal with only regulator approved products of insurers. We do not underwrite the products.