Heather Parkinson

What is gross profit?

Accountant – deducts direct costs

Liability adjuster – deducts variable costs

Property / BI adjuster – deducts uninsured working expenses defined in the policy

Costing in general

Direct: Costs that are directly attributable to a unit of production.

Indirect: Costs that cannot be attributed to an individual unit of production

Costing in general
Chinese Takeaway - direct or indirect?

Meat and vegetables


Chef’s wages
Packaging materials




Gas and electricity
Counter staff wages
Telephone
Rent and rates

Costing in general

Variable: Cost varies directly with the number of units produced. If one more unit is manufactured, the cost increases proportionally.

Fixed: Cost remains the same irrespective of the number of units produced, assuming the business continues.

Costing in general
Chinese Takeaway - variable or fixed?


Meat and vegetables
Chef’s wages





Packaging materials
Gas and electricity
Counter staff wages
Telephone
Rent and rates

Manufacturer
Direct/Indirect Variable/Fixed
Raw materials
Production wages
Shift supervisor
Cleaning wages
Consumables/cleaning
Packaging materials
Packing wages
Factory rates
Group overheads
Depreciation

Manufacturer
Raw materials
Production wages
Shift supervisor
Cleaning wages
Consumables/cleaning Indirect
Packaging materials
Packing wages
Factory rates
Group overheads
Depreciation
Direct/Indirect Variable/Fixed
Direct
Direct
Indirect
Indirect
Direct
Direct
Indirect
Indirect
Indirect
Variable
Fixed
Fixed
Fixed
Fixed
Variable
Variable
Fixed
Fixed
Fixed

Standard costing

Common for manufacturing businesses

Check variance analysis

Costing in general
Summary



Are costs direct or indirect?
Are costs variable or fixed?
Is there a standard costing system?

Example - overlap with gross profit
Selling price
Materials
Power
Gross profit
Wages
Overheads
Net profit
100
(20)
(5)
75
(25)
(20)
30

Gross Profit - policy definition
The amount by which
The sum of the amount of the Turnover and the amounts of the closing stock and work in progress
Shall exceed
The sum of the amounts of the opening stock and work in progress and the amount of the Uninsured Working Expenses.

Gross Profit - policy definition
Turnover
Opening stock x
Uninsured Working Expenses x
Less Closing stock (x)
Gross Profit x
(x) x

Gross Profit - accountant
£
Sales
Opening Stock
Purchases
Wages
Maintenance
Closing Stock
5,000
20,000
7,000
6,000
38,000
(4,000)
Gross Profit
£
50,000
(34,000)
16,000
Rate of gross profit =16,000 x 100% = 32%
50,000

Gross Profit - policy
Sales
Opening Stock
Purchases
Closing Stock
Gross Profit
£
5,000
20,000
25,000
(4,000)
£
50,000
(21,000)
29,000
Rate of gross profit =29,000 x 100% = 58%
50,000

No definition of uninsured working expenses
£
Turnover
Opening stock
Raw materials
Packaging materials
Production wages
Salaries
Bad debts
Consumables
Depreciation
Closing stock
50,000
500,000
50,000
300,000
200,000
10,000
40,000
80,000
1,230,000
(55,000)
£
1,500,000
(1,175,000)
325,000

No definition of uninsured working expenses
£
Turnover
Opening stock
Raw materials
Packaging materials
Bad debts
Consumables
Closing stock
50,000
500,000
50,000
10,000
40,000
650,000
(55,000)
£
1,500,000
(595,000)
905,000
Rate of gross profit =905,000 x 100% = 60%
1,500,000

Rate of Gross Profit – common industries

If we have no definition of Uninsured
Working Expenses what should we deduct?

What rate of gross profit would we expect

Rate of Gross Profit – common industries
Hotel Rooms
Bar and restaurant
Garage
Clothing retailer
Sale of new cars
Sale of used cars
Servicing
Paint shop
Fuel
Designer wear
Department store
Budget chain

Two common types of policy

Sum Insured basis

Estimate Gross Profit or Declaration Linked basis

Sum insured basis
Sum Insured is the Gross Profit which would have been earned in Maximum Indemnity
Period but for the incident
If Sum Insured is not adequate then
Proportionate Reduction will apply

Estimated gross profit
Gross Profit is declared each financial year
Estimated Gross Profit is the Insured’s estimate of Gross Profit to be earned in the financial year most concurrent with the insurance period
Policy Limit is 133.3% of Estimated Gross Profit
If Estimated Gross Profit is an under or over estimate then must pay more premium or get a rebate

Sum insured basis
….provided that if the sum insured by this item be less than the sum produced by applying the Rate of
Gross Profit to the Annual Turnover (or to a proportionately increased multiple thereof when the Maximum Indemnity
Period exceeds 12 months) the amount payable shall be proportionately reduced.

Sum insured basis
To check adequacy of cover
Insurable Amount - estimate the Gross
Profit which would have been earned in the
Maximum Indemnity Period
Consider
Historic Turnover
Trend
Rate of Gross Profit

Turnover £500,000 Growth - +10%
FIRE
Maximum Indemnity Period - 24 Months

Sum insured basis
Example - 24 months Maximum Indemnity Period
Turnover Last 12 months 500,000
Turnover in first 12 months (+ 10%) 550,000
Turnover in second 12 months (+ 10%) 605,000
Turnover in next 24 months 1,155,000
Rate of Gross Profit 40%
Insurable Amount for 24 months 462,000

Sum insured basis
Example - 24 months Maximum Indemnity Period
Turnover Last 12 months
Turnover in first 12 months (+ 10%)
Turnover in second 12 months
Turnover in next 24 months
Rate of Gross Profit
500,000
550,000
550,000
1,100,000
40%
Insurable Amount for 24 months 440,000

Sum insured basis
Example - How do we apply Proportionate
Reduction ?
Sum Insured
Insurable Amount
200,000
250,000
Business Interruption Loss 100,000
Amount Payable = Sum Insured
Insurable Amount
X Loss
= 200,000 x100,000=80,000
250,000

Sum insured basis
How can underinsurance arise?
Sum Insured set on last available audited accounts
Rate of Gross Profit too low
Common misconceptions

Sum Insured perceived to be a limit

Maximum Indemnity Period is misunderstood

Estimated gross profit
How can underinsurance arise?
In theory if Estimated Gross Profit is calculated properly there cannot be underinsurance!
Common errors in calculation


Wrong Rate of Gross Profit used in declaration
Maximum Indemnity Period is misunderstood

Conclusion
If cover is properly set up there should never be underinsurance !
Estimated Gross Profit cover gives more flexibility for a growing business

Insurers
Returns to the DTI
Make funds available to make payments
Adjusters
Loss mitigation steps
Ensure involvement of appropriate staff
Manage EVERYONE’S expectations

Setting the reserve
It is imperative that we:

Understand the Insured’s business

Understand the potential effect of the loss on the business

Calculate the probable extent of the loss

Reserve conservatively and review regularly

The Insured’s business

What does the Insured do?

Financial data

Use of assets in the business

Software

Data back-up regime

Effect of the loss on the business

What has been lost and what did it do?

How quickly can the lost items be replaced?

Mitigation steps

Will business be lost?
Be realistic

CALCULATE the probable extent of the loss

Period of interruption

Reduction in Turnover

Insured Rate of Gross Profit

Increase in Cost of Working

Savings

Adequacy of cover

Common pitfalls

Not appreciating importance of equipment lost

Accepting the Insured’s optimism

Ignoring long term effects

Incorrect Rate of Gross Profit
Not understanding the business