Case study: how does business interruption insurance work?

This article provides an example of a real loss that was incurred by a restaurant in Singapore following sewage damage. The restaurant was closed for 1 month due to decontamination and renovation performed by the landlord. The month’s closure had a serious financial impact on the restaurant’s cash flow. This case study will show how business interruption insurance is key for businesses in the event of unexpected setbacks, and what you need to keep in mind when you buy this insurance.

1. How to calculate your insurable gross profit

Insurable gross profit is the amount that must be declared to the insurance company. The premium for business interruption insurance is based on this. So, the calculation discussed below is paramount to making sure your business is well covered:

Monthly Turnover x 12 months x Gross Profit Rate

Gross profit rate is the division between gross profit and net sales. For example, if the gross profit of your restaurant is $2 million and the cost of goods sold is $750,000, the gross profit margin is 62.5 %. In the example given below, the gross profit rate was 60.19%.

2. Case study

The table below compares the actual turnover with the average monthly turnover that was recorded by the restaurant before the incident, in order to show the actual loss of income.

Based on the said restaurant’s accounting records from the recent past, the average monthly turnover was S$60,437.05 and the rate of gross profit was 60.19%.

The loss of gross profit (during the interruption period) would work out to S$65,039.27 as follows:

Loss of gross profit = shortfall in turnover x rate of gross profit

= S$117,056.63 x 60.19%

= S$70,456.38

The total amount the insurer will pay as loss of profit for this case should then be S$70,456.38.

3. Risk of being under-insured

In our example, the gross profit that was declared to the insurer was S$300,000.00 for 12 months which was inadequate against the projected annual gross profit of S$436,524.72 (i.e. S$60,437.05 / month x 12 months x 60.19%). As a result, the loss of gross profit would be pro-rated as follows :

[sum insured S$300,000.00 / value at risk S$436,524.72] x Adjusted Loss : S$70,456.38 = S$48,420.89

As the assured sum of S$300,000 is lower than the projected annual gross profit of S$436,524.72, the payout was not able to fully cover the actual loss of profit. The restaurant received only S$48,420.89 as compensation instead of S$70,456.38.

It is therefore important to review annually to ensure that the figures declared to the insurer are correct and regularly adjusted in order to follow business growth.

We can help you find the solutions that would best fit your business insurance requirements. Contact us at Clema Risk Solutions if you want to know more.

You can also visit our website to find out about the insurance services we offer for SMEs in Hong Kong, or to get a quote.