Cover vs. Price - Loss of gross profit and the high cost of getting your sums wrong

This is the first in series of “Cover vs. Price” where we address the risks of purchasing insurance focused on price alone.

We fully understand and accept the suggestion of a reduced insurance premium is the main motivator for some clients to consider switching insurance.  But a skilled insurance broker will initially steer their client towards considering the right cover levels for their business which in addition allows cover levels offered by insurers to be compared like for like. It is only once the right basis of cover has been agreed that a broker should approach insurers and look to lever a competitive premium.

Gross Profit Insurance (Business Interruption)

Insurance for gross profit is one of the most critical insurance covers you will buy. Your fire/theft/flood insurance will insure your loss or damage to property. But what about the resulting loss of profit due to inability to trade or a reduction in production? What about the additional costs to trade if you need temporary premises, you need to hire equipment or you need to outsource some production to fulfil orders? It is well known that many companies will fail shortly after a significant claim as their gross profit insurance cover has not been considered and found to be inadequate, from a sum insured and/or indemnity period perspective.

You may not know but the duty to provide adequate sums insured falls upon the policyholder. So many insurance brokers don’t even help their clients consider their cover levels or sums insured and rely on historic figures initially provided by their client. It is only at the point of claim that underinsurance may become apparent. This type of broker will not commit the time or have the skills to review the risks correctly and can only focus on one thing – price.

The definition of “Gross Profit” in an insurance policy is different from accountants and other business people which is why a gross profit figure simply taken from the latest year end accounts is almost certainly inadequate. Following a major loss you will still want to retain key staff and will incur wages. Removing wages from the gross profit calculation is one of the major reasons for underinsurance.

Setting the length of the Indemnity Period is also very important. Most Gross Profit insurance covers provide a 12 month indemnity period which is okay for some and disastrous for others. Once the indemnity policy runs out then all cover will cease. If you are still waiting for planning permission, delivery of bespoke equipment or your gross profit level has not yet returned to the same pre loss level, then you could have a significant shortfall which could force closure of your business.

Mitchell Charlesworth can normally work with your accountant with your agreement to help calculate a suitable sum insured. Contact Richard Gorst to discuss this topic further.

Registered to carry on audit work in the UK and Ireland by the Institute of Chartered Accountants in England and Wales and authorised and regulated by the Financial Conduct Authority for investment business