In case of a serious physical damage, a company will most likely be obliged to suspend totally or partially its activities leading to important financial losses or even worst leading to the closure of the company. Business interruption insurance exist to minimize the financial loss and mitigate the risk of closure. In our previous article we explained that scope of coverage may vary between different type of business interruption insurance, the most common one being the loss of gross profit insurance. In our today’s article, we will explain what is the purpose of business interruption insurance and how the loss of gross profit insurance will help a company survive a serious physical loss.
1 – What does it cover?
The object of the loss of gross profit insurance is to compensate the decrease of the turnover while the activity is totally or partially suspended. It will pay the expenses of the business that keep running and set the company back into the same financial situation than the one it would have known if there would have been no physical loss.
Thanks to this cover, a business will be able to maintain the relation with the clients and suppliers, it will be able to keep the staff and to pay the rent until the moment when the company is back on track to the level of turnover pre-loss.
The loss of gross profit insurance will be triggered following events who are covered within the property damage insurance = fire, water damages, typhoon, flood, explosion. It could be as well mechanical failure of the equipment if this cover is included in your property damage insurance. An important point to notice is that loss of gross profit insurance in general will not work if there is no physical loss to your premises, your stock, or your equipment. The financial losses following the suspension of the activity because of the COVID 19 are unfortunately not covered.
The indemnity period of the insurance could vary between 3 months and 24 months. To choose the appropriate period, we need to take into consideration the delay to replace your equipment or to reinstate the stock as instance. If you are a retail shop with no heavy equipment and a stock easily replaceable, an indemnity period of 3 to 6 months should be enough. However, if your shop relies heavily on one specific season, a longer period must be chosen. The common period for small and medium size business is 12 months.
2 – How does loss of gross profit insurance work?
Let us imagine a company producing bread and having the following simplified loss and profit account:
- Annual Turnover 20,000,000 HKD
- Variable charges 8,000,000 HKD (sales bonuses, commission, utilities invoices ..)
- Fixed expenses 11,000,000 HKD (rent, salary, insurances)
- Gross profit 1,000,000 HKD
Let us then imagine that a fire is destroying half of the producing equipment leading to a decrease of the turnover by 50%.
Without business interruption insurance, the very simplified loss and profit account would become
- Annual Turnover 10,000,000 HKD
- Variable charges 4,000,000 HKD
- Fixed expenses 11,000,000 HKD
- Gross profit (5,000,000 HKD)
With the business interruption insurance, the very simplified loss and profit account becomes now
- Annual Turnover 10,000,000 HKD
- Variable charges 4,000,000 HKD (sales bonuses,
- Fixed expenses 11,000,000 HKD
- Indemnity 6,000.000 HKD
- Gross profit 1,000,000 HKD
Considering the case above, the insurance company will reimburse the company HKD 6,000,000 to be in the same financial situation with a gross profit of HKD 1,000,000.
As we could see, the business interruption has therefore filling its purpose by putting the company in the same financial situation it was before the loss.
3 – What are the advantage of the loss of gross profit insurance?
The loss of gross profit insurance is the essential complement to the property damage insurance. It represents the great advantage to be the only insurance whereby the insurer and the insured share the same interest which is to restart the activity as quick as possible.
Indeed, for the insurer, the longer the business remains out of the market and the larger the indemnity will be. Therefore and as a priority, the insurer will settle the property claim in a very fast manner so that the insured is in a position to pay the suppliers to fix the damaged premises and equipment and to reinstate the stock. Once this is done the insured and the insurer will join forces to put in place some measures to support the company to reach the same level of turnover as it was prior to the loss.
With the loss of gross profit insurance, the company has better chance to survive a serious loss.
4 – How much does it cost?
The rate of premium depends on the nature of your activity, the indemnity period, the difficulty or not to replace the equipment, the existence of back up option, the number of potential suppliers … As a rule of thumb, the rate will most likely be the same rate as for the property damage part. It will be applied on the
Still having question about the purpose of the business interruption insurance in Hong Kong
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