Damian Glynn with Sue Taylor and Steven Nock THE BASIC BUSINESSINTERRUPTION BOOK 60 CILA - The Basic Business Interruption Book 3. How does the cover work? 3.4 Declaration Linked Policies Traditional policies (written on the ‘difference basis’) are subject to proportionate reduction (average). It is possible to purchase BI cover without any proportionate reduction clause. These are referred to as Declaration Linked policies and they may be written on a Gross Revenue or a Gross Pro?t basis. Typically, the word ‘Estimated’ will appear before Gross Pro?t or Gross Revenue (or an ‘e’ inserted after the amount) if this is the case. These policies were introduced in the 1980s when in?ation was high and P may have found it dif?cult to assess the right level of cover. P was invited to estimate Gross Pro?t at the start of the policy year and to then con?rm the actual amount at the end of it, with additional (or a rebate of) premium. Additionally, average was waived and P could claim 133.33% (some policies offer other uplifts) of the declared amount in respect of unforeseen growth. It should be stressed that the 33.33% is not a margin of error available to P. The declared amount should not be less than the amount at risk (P can declare a higher amount if growth is expected). The 33% uplift is only relevant at the time of a claim for unanticipated growth subsequent to the start of a policy period. It is not relevant to assessment of the adequacy of the declaration. There is a practical problem in that declarations are not made in the majority of cases and potentially signi?cant underdeclarations might only be identi?ed when a claim is made. There may be no average clause and no policy sanction available to insurers. However, in extreme cases, signi?cant underdeclarations may be deemed to constitute a breach of the Duty of Fair Presentation, described in the Insurance Act 2015. At the time of writing, no cases have come before the courts to test this issue. It is unique to Declaration Linked covers - a Sum Insured subject to average already has a contractual remedy written into the policy contract to deal with it. Declaration Linked policies do not. CILA - The Basic Business Interruption Book 61 3. How does the cover work? In other words, the problem of underdeclaration is a signi?cant one and the adequacy of the declaration is best established at an early stage (preferably before liability is con?rmed). Discrepancies should be referred to insurers, to avoid surprises later in a claim. For small claims, it may be impractical to assess the overall adequacy of a declaration for a large group of companies. That just needs to be communicated to insurers to avoid any misunderstanding. Three ?nal observations need to be made. Firstly, an underdeclaration may require scrutiny even if it is accidental rather than deliberate, particularly if a misunderstanding arises due to P not having read their policy properly (or at all). Secondly, when considering the adequacy of a declaration, care should be taken in respect of indemnity periods longer than 12 months. For a 24-month period, the amount should be doubled, tripled for 36 months etc. MIPs shorter than 12 months retain the need for a 12-month declaration, i.e. it is not halved for a 6-month MIP, for example. Thirdly, declarations may be made for premium adjustment purposes for policies that are not declaration linked. Just because a declaration is made, that does not necessarily mean that there is no proportionate reduction clause. The scope of underdeclaration is evidenced by a number of surveys conducted by CILA over the last 12 years: Declarations understated When understated, degree of adequacy 2008 37% 50% 2009 52% 63% 2012 40% 45% 2017 44% 44% 62 CILA - The Basic Business Interruption Book 3. How does the cover work? Calculation of the Overall BI Loss: A Recap The policy speci?es the arithmetical steps to be taken in words (rather than numbers): • Standard Turnover • Trend • Adjusted Standard Turnover • Actual Turnover • Reduction in Turnover • Calculation of the Rate of Gross Pro?t • Loss of Gross Pro?t (applying the Rate of Gross Pro?t to the Reduction in Turnover) • Add: Increased Costs of Working • Deduct: savings • BI settlement • Less any applicable proportionate reduction. 3.5 Interim Payments Following a loss. P may not only be suffering a reduction in turnover but also incurring increased costs resulting in pressure on their cash ?ow. Cash ?ow per se is not covered under the policy but, as solvency post loss is desirable for all, interim payments/ payments on account are usually made. While many policies have a payment on account clause, they generally offer no speci?c guidance as to how interim payments should be calculated. It is sensible to try to forecast any payments in advance, considering major plant reinstatement and also allowing for operational overheads in order to keep P in a cash neutral position, regardless of whether there is a clause addressing payments on account. The Enterprise Act 2016 gives P an opportunity to claim damages in the event of late payments after sums are due. Some payment on account clauses are very speci?c, but many are vague and do no more than signal a willingness to consider interim payments. As noted in the Introduction, it is good practice to recommend interim payments where settlement cannot be achieved quickly. This empowers P to mitigate loss, for the bene?t of all. 3.6 BI/PD Overlap BI and PD are distinct areas, but they can overlap. CILA - The Basic Business Interruption Book 63 3. How does the cover work? To calculate Gross Pro?t, variable costs that reduce in direct proportion with any reduction in turnover are deducted from that turnover. So, the Gross Pro?t amount is insuring all of the costs that have not been deducted, along with the net pro?t: The BI claim and the Stock claim together can never add up to more than the selling price (‘SP’). That would amount to an over-indemnity. Policies are simply apportioning the SP between the stock and business interruption covers. Some (typically marine or stock throughput) policies value ?nished stock at SP. When that is the case, the turnover paid in the stock claim should be deducted from Adjusted Standard Turnover in the BI claim. In the example above, if the stock valuation includes only purchases, there is no overlap with the business interruption cover. However, if P had included administrative or distribution costs in their stock claim, then there would be double counting, as those same overheads are also covered under the BI cover. Insurers will not pay for the same overheads twice. £000 £000 Turnover 100,397 Opening Stock 4,299 Purchases 52,499 Closing Stock (5,317) Cost of Sales (51,481) Gross Pro?t 48,916 Administrative 33,772 Expenses Distribution Costs 8,643 Interest Payable 1,232 Pro?t before Tax 5,269 This part of the pro?t and loss account is insured as PD (Stock), or assumed to reduce directly in line with turnover. This part of the pro?t and loss account is insured as BI. 64 CILA - The Basic Business Interruption Book 3. How does the cover work? Assume that (a different) P values their stock as follows: £ Raw material purchases 50 Wages 10 Power 5 General overheads 15 Total cost of stock 80 P sells stock for £120. A ?re occurs, destroying the stock and also causing a loss of turnover. The stock claim is resolved ?rst, as is usually the case, at £80 per unit. A BI claim is then submitted at £70 per unit (SP £120 less raw material purchases of £50). The PD and BI claims total £150, whereas P would only have received £120 (the initially anticipated SP) had the Damage not occurred. The reason that the policy at ?rst sight appears to offer overpayment of £30 is that the wages, power and general overheads in the table above total that amount. They have been included in the stock claim. Because they are not deducted from turnover to calculate Gross Pro?t, they are also included in the BI claim. Most policies do not de?ne how stock should be valued for settlement in the PD section. If P claims for stock loss at material cost only, there will be no overlap (assuming that purchases have been uninsured in the BI cover). As a matter of indemnity, costs can only be claimed once, and as a matter of pragmatism, they will usually be deducted from the business interruption claim. If the stock sum insured is subject to average, P may prefer to claim only on a raw material basis to reduce the impact of any stock underinsurance. It should be observed that P may have a stock loss without any BI claim (they may have suf?cient buffer stock to meet orders) and it may be sensible to insure overheads under both policy captions for this reason. The overlap issue is not con?ned to stock. Use of P’s staff to carry out restoration work will produce the same result. Assuming that wages have not been uninsured (i.e. have not been deducted from turnover to calculate Gross Pro?t), payment for P’s employees to carry out cleaning/repairs of plant and machinery as part of a PD claim represents an over-indemnity as the wages are also being paid as part of any Gross Pro?t loss. The wage cost is not additional - it is a redeployment. Subject to agreement in advance, insurers sometimes allow the admission of these costs as a matter of pragmatism, where the costs are lower than third party external costs and where the involvement of the employees keeps them engaged and retained.