Understanding of Fire Loss of Profit policy

We all know that a fire policy pays for the physical loss or damage to the property insured therein but what about the financial loss likely to be suffered by the policy holder on account of interruption of business activity for a period ranging from 3 to 6 months or even more, depending upon the severity of fire incident.

It is interesting to know that all Insurance companies have a policy called Business Interruption (Fire) policy, commonly known as “Fire Loss of profit policy”. This policy pays for the loss of gross profit suffered during the interruption period when the plant was either stand still or operated at reduced production capacity following loss or damage to insured property admissible under the policy.

The premium for this policy depends on the “sum insured” and the “Indemnity period” to be selected by Insured at the time of taking this cover. 

Before making final selection, we must understand these terms properly.

a) Sum insured of the policy must represent the estimated annual gross profit of the business activity. This can be calculated by applying the % trend of the business on the previous year annual gross profit. 

b) Similarly, indemnity period is to be selected by insured at the beginning of the policy. This is defined as the maximum period for which the insurance company will be liable to pay the financial loss suffered by the client following an admissible loss under the fire policy in respect of property at the same premises 

Following a physical loss or damage to the property, the insured may also suffer other losses like loss of market, loss of opportunities, penalties and fines etc but we must understand that the business interruption policy does not pay for these losses although they are consequential to fire damage to property.

Increased Cost of Working: In addition to loss of gross profit, insurance company also pays for the additional expenses incurred with the sole intentions of avoiding or minimising the loss of gross profit at the insured premises.

It is important to understand here that these expenses must be necessarily and reasonably incurred to avoid or minimise reduction in Turnover during the Indemnity period.

In case the amount of additional expenses exceeds the total amount of financial loss thereby avoided, company shall pay the increased expenses only up to the financial loss thereby avoided.

To understand this clause better, let us consider following example. 

After a physical damage to the transformer, in order to restore production if the insured brings a diesel generator set on weekly rent of Rs 2000 and ultimately pays Rs 10000 for 5 weeks then this amount of Rs 10,000 shall be paid if by using this DG set Insured has avoided loss of gross profit in excess of Rs 10000. Otherwise, the actual loss of Gross Profit so avoided shall only be payable irrespective of amount incurred by insured.

Hence, if after incurring a sum of Rs 10,000 Insured saves Rs 5000, then  Company would pay only Rs 5000 towards “Increased cost of working”. This is called Economy Limit.

Deductible: This policy is subject to application of minimum 7days “time excess”. This means that in case the interruption in the business is less than 7 days, nothing shall be paid but if the interruption is more than 7 days, the company shall pay the financial loss after deducting the std Gross Profit of 7 days. Higher deductible are applicable to policies where Sum Insured is high. 

Eligibility Criteria: In this context we must understand that the policy cannot be given to a client who has suffered “Gross loss” in the previous financial year. 

In case of “Net loss” situation, the policy can still be given after deducting the amount of “Net loss” from “Standing charges” of the company. 

No policy can be given to cover Standing Charges alone.

The “Gross Profit” of the company can be arrived after adding “Net Profit” to the “Standing charges”. This is known as the “Addition method” of computing the Gross profit”. This can also be calculated by subtracting “Specified working expenses” from the “Annual Turnover” of the company. This method is known as “Difference Method”. Ideally, the “Gross Profit” should be same under both the methods but the “Difference basis” method is much easier & accurate to compute “Annual Gross Profit” of the company.

Return of premium: 

There is a provision under the policy that after the expiry of policy if the “Actual Gross Profit” is found lower than the Sum Insured of the policy, Company will allows refund of premium not exceeding 50% of the original premium collected at the time of issuance of policy.

Material damage proviso:

The policy stipulates that a claim shall be paid only if there is a concurrent material damage policy and the material damage claim is admissible under the same.

Fixing of sum assured under BI policy:

Sum insured depends on the indemnity period selected by the insured. If the selected indemnity period is up to 12 months, sum insured must be equal to Estimated Annual “Gross Profit”. However, if  Indemnity period exceeds 12 months, sum assured shall be increased proportionately. For example, for Indemnity period of 24 months the sum insured will be double and for 36 months indemnity period it will be three times of estimated annual gross profit.

Coverage against failure of Electricity supply:

This policy extends to cover loss of business on account of interruption in production process due to failure of electricity supply at the insured premises on account of damage to property at public supply undertaking / sub-station from where the insured draws power supply, due to an operation of insured peril.

The indemnity period for this cover is 60 days which is equivalent to 17% of BI sum assured. There is also a waiting period of 24 hours for which no loss is payable under the policy.

Customer’s premises extension:

This extension covers loss of business on account of non-delivery of “Finished goods” from the insured’s premises caused due to loss or damage at the customer’s promises arising out of operation of insured peril.

It is immaterial that Supplier or Customer has a Insurance policy or not. The only requirement is that the peril causing the damage to property at Supplier’s or Customer’s premises, must be covered in the insured’s policy.

Supplier’s premises extension: 

This extension covers Loss of G.P. due to interruption in production process caused due to non supply of RM arising out of damage at the supplier’s promises caused by insured peril. It is interesting to note that Loss of GP is paid although there is no physical loss or damage to the plant and machinery at the insured premises.