A loss of profits policy is necessary because coverage for material damage is usually insufficient. There are two important factors to take into account for loss of profits policies:
- The timeframe the insurance claim process can last some time. This is known as the “compensation period” or “eligibility period”.
- The financial aspect: an assessment is carried out of the loss to be covered, which forms the basis for calculating the ‘annual amount’. This is also known as the “insured revenue”. It is made up of the sum of the fixed costs plus the net profit or loss, or the revenue minus all variable costs.
Of course, a well-insured revenue and a 30% increase/decrease-clause are important, but above all having a long enough eligibility period is paramount.
In practice, we can observe that the eligibility periods currently on offer are frequently too constrained, causing problems which can be avoided.
The insurance policyholder and insurance provider need to seek the answer to this question together, and work jointly to determine an appropriate eligibility period.
The damages incurred by a company are mainly determined by the length of the interruption period or recovery period.
Often, it is assumed that a company will start running at full capacity again as soon as its property and production materials have been repaired. Unfortunately, nothing is further from the truth. It takes a lot longer to restore the trust of your clients, and the damage to your image can also take time to repair.
We have analysed the factors which play a role in determining an appropriate eligibility period.
The eligibility period is the period during which the company sustaining the loss can receive compensation from its insurance provider in order to absorb the costs incurred after submitting an insurance claim. This compensation period commences on the day of the insurance claim, and is limited to a maximum duration set out in the contract. This period is usually set at 12, 18 or 24 months. In practice, most insurance policies limit these compensation periods to 12 months.
Therein lies the problem: for most insurance claims, a 12-month eligibility period is far too short.
In order to ensure optimal coverage, it is vital to try to assess the insured period as accurately as possible.
To make sure you are well-informed, it is important to work together with your insurer to identify critical processes and production lines.
• the timeframe for carrying out appraisals and soliciting expert assistance;
• the demolition and reconstruction period;
• the timeframes for acquiring construction and operating licences;
• potential notice period of the rental agreement;
• time needed for other administrative procedures.
For equipment and installations:
• timeframe for conducting repairs; timeframe for replacements, installation and testing;
• transportation time, export or import issues, customs issues;
• time to reconfigure plans, drawings, archives, models, data carriers etc.
For raw materials and goods:
• timeframe for rearranging stock according to nature or origin of the products used.
• transportation or supply issues;
• storage issues.
For loss of market share and clients:
• timeframe for winning clients back;
• potential fallback positions (internal or external).
For fallback positions:
You will have to weigh up the options for proceeding either partially or fully with processes following an insurance claim. Options include fallback agreements with similar companies, or (partially) transferring production to a nearby branch.
However, these are not ideal solutions: transferring activities elsewhere often generates considerable extra costs, lower gross margins and market loss. You also need to bear these issues in mind when determining an appropriate eligibility period.
Do not underestimate the importance of issues that might appear trivial at first sight. Take time to clear up and prepare the damaged property for reconstruction: asbestos removal can lead to delays of several weeks compared to a “normal” situation.
Your loss of profits insurance policy needs to be appropriate for your company’s situation, to give your company a chance to recover from a major disaster. When the amount of insured revenue is too low and/or the eligibility period is too short, you may be under-insured.
Your situation is changing constantly. That’s why it is important to review your company’s insured revenue on a regular (preferably annual) basis. Otherwise, you may have a nasty surprise the next time you make an insurance claim.
We recommend that you base your annual policy review on the “worst case scenario”. Account for demolition, design, permits, the actual timeframe required for construction, plant layout, entry into service, stock development etc. Don’t forget the ensuing revenue recovery period, either. Prioritise the length of the time period over making a saving on your premium. Because accidents are waiting to happen!
Want us to help you determine the appropriate eligibility period for your company? Interested in discussing this topic further? Get in touch with us!