Arriving at the correct sums insured

The importance of getting your sum insured correct on your insurance policy & other guidance notes

It is important that you ensure that you have an adequate sum insured on the buildings or the contents, otherwise in the event of a total loss or a partial loss, the insurers may make a deduction for under-insurance.

Please read the following notes carefully, they are important and will assist in the understanding of your insurance.

Reinstatement as new

The current practice for insurance of building, contents  or plant and machinery is to insure them on a “reinstatement basis”, i.e. new for old. Insurers undertake to settle the insurance claim on the basis of the cost of repairing or replacing the lost or damaged property by similar property, equal to but not better or more extensive than when it was new, subject to the limitation of the sum insured. No deductions are made for depreciation, wear or tear.

However the actual work of reinstatement must be carried out .If you decide not to replace or repair the lost or damaged property the Contract reverts to one of indemnity and cash payment will be made with deductions for depreciation, wear and tear.

Under Insurance

Most Material Damage Policies contain the "Average” Condition whereby a contribution will be called for, where under-insurance exists and a claim has occurred,
For Example:-
Sum Insured                          £100,000
Established value at time of loss            £150,000
Established Loss                    £  50,000
Settlement:-
£100,000 (Sum Insured)
£ 150,000 (Value)    X   £50,000 (Loss)               =  £33,333 Paid By Insurer

Therefore Policyholders under-insurance costs them £16,667

Getting the sum insured correct under your Business Interruption Insurance

Business Interruption Insurance (Loss of profits) – a very important cover!
Under-insurance can also apply to business interruption insurance, so it is important to ensure that your sum insured is adequate.  Many businesses make the mistake of insuring the Gross Profit figure that appears in their accounts.  However the definition of Gross Profit within an insurance policy is usually very different from the Gross Profit that is shown in your accounts.  To determine the figure that should be insured, you should usually take the income from the provision of sales and services and deduct the expenditure on purchases (purchases being directly consumable items of stock and raw materials and not to purchases of equipment & machinery, utilities, office supplies and the like).  This figure can then be adjusted to take into account the difference in the opening and closing stock.  If you require specific advice or guidance on this issue, please let us know.

Equally important, can be ensuring the maximum indemnity period for your loss of profits is sufficient.  We recommend a minimum indemnity period of 24 months, and in some cases it may need to be even longer.  In the event of extensive damage to your business premises, it can often take 10 – 12 months  to rebuild the premises.  However the turnover and profits of the business can be affected for a substantial period after the premises have been reinstated.  Some factors that can influence the time required to recover the trading position of the business include:-

• buildings – local construction market,  asbestos contamination, planning permission problems, site pollution, authority controls and regulations, site access problems

• machinery – machinery manufactured in the Far East, machinery that requires modification, specialist machinery, extended installation and commissioning times

• customers –  reliance on large customers, competitiveness of the market and the availability of alternative suppliers, customer loyalty, ability to obtain new customers

Again, if you would like further advice on this issue, please let us know.

Examples of under-insurance on Business Interruption policies from Aviva Insurance:-

Brian Wallace, Head of ARMS, summarised by saying, “It is very easy to make mistakes, but expert advice from Aviva or a broker can be really useful. Whatever you do, don’t follow the example of these customers who unfortunately got it badly wrong.”

• In a vegetable packing company the brokers had asked for the gross profit sum insured to be calculated excluding carriage, packing and freight. Unfortunately, the company counted all its direct wages as ‘packing’ in their financial accounts. When a serious fire destroyed the premises the gross profit figure was found to be less than 15% of what it should have been. To make matters worse, the chosen maximum indemnity period was 12 months – but the total rebuild time was two years. The company narrowly survived.

• A printing company had been deducting wages, power and plant maintenance when calculating its gross profit. The result: the company’s insured gross profit sum was 40% of what it should have been. The chosen maximum indemnity period was, again, 12 months, but the specialist machinery took 15 months to replace. The business took a cash settlement and closed with the loss of jobs.

• A company with a new food product won British Retail Consortium approval to supply the major supermarkets. They built a new factory to cope with the anticipated increase in orders but didn't increase their gross profit figure as, to quote the customer, ‘no one knew what we would make’. At the time of the loss, projected turnover would have risen from £2m to £10m so they were 80% under-insured. The company found itself heavily in debt and couldn't afford to reinstate the business.

• A roadside cafe took out Business Interruption insurance, knowingly ignoring wages as, quoting the customer, ‘we would not pay them if we were shut’. A fire destroyed the premises but the customer was able to erect a temporary building on-site to keep trading. Turnover dropped, but staff wages did not. The result: the rate of gross profit used to calculate the claim was only about half of what it should have been.

Insurance_Rebuilding_Costs.pdf Advisory Notice from Evolution Underwriting  - Insurance Rebuilding Valuations and Underinsurance - What are the issues?

Want to calculate your Business Interruption sum insured ?- click here to access the Business Interruption sum insured calculator from Claims Advantage.