What is Gross Profits Insurance
Gross profits insurance is a type of business interruption insurance that provides funds in the amount of profit lost if an insurable event, such as property damage, occurs. Gross profits insurance is most commonly used in the United Kingdom and Canada. This type of insurance differs from gross earnings insurance, which is more commonly found in the United States.
BREAKING DOWN Gross Profits Insurance
Gross profit insurance is designed to “bring back” the insured to where it would have been financially assuming the insurable event had not occurred. The amount of loss that a business experiences is calculated based on a pre-defined formula, and typically relies on historical rates of turnover to determine the amount a business is losing. Gross profit is calculated as turnover less purchases and variable costs. The loss formula looks at turnover over a specific period of time, such as twelve months, though extenuating circumstances that have affected turnover during the examination period may need to be smoothed out.
Policy coverage extends through the period of time in which the insured is rebuilding or repairing its business property. The policy covers the losses that the business experiences while not being able to function as it normally would have, though a pre-defined indemnification period is usually set at a maximum of three years. If the business is still rebuilding at this point, any losses would fall outside of the indemnification period and thus, would no longer be covered.
Challenges of Gross Profit Insurance
One of the primary difficulties in establishing coverage levels for gross profit insurance is defining what constitutes "gross profit," as standards can vary among accountants and business people. Turnover, work-in-progress and opening and closing stock are easily determined in accordance with normal accountancy methods. Meanwhile, "uninsured working expenses" refers to costs, sometimes called "specified working expenses," which vary in direct proportion to turnover. So, if turnover is reduced by 30 percent, the costs will also be reduced by 30 percent. An accountant’s gross profit calculation will subtract any cost that varies in proportion to production; but for insurance purposes, they must vary in direct proportion. This is a key distinction and the source of much underinsurance.
Gross profit insurance coverage does not apply in all situations. In most cases, proximate cause is used to determine whether or not an event caused the insured party to experience a loss. The policy covers the increased costs of working, which are additional expenses incurred in order to keep sales from falling. The policy will also cover the loss of any finished goods that could have been sold had they not been damaged.