Loss of Profit (Consequential Loss) Insurance Claim

Understand Loss of Profit (Consequential Loss) Claim

Key rules to remember

Insured gross profit (rate base)

Net profit + Insured standing charges

Use the figures of the last financial year before the fire. Add only standing charges that are insured.

Rate of gross profit

Rate = (Net profit + Insured standing charges) ÷ Turnover of the last year × 100

Adjust for trends if the question gives them.

Short sales

Short sales = Standard turnover − Actual turnover in indemnity period

Actual turnover is the sales achieved during the indemnity period after the fire.

Loss on short sales

Short sales × Rate of gross profit

Add only if actual sales fell short.

Increased cost of working (limit)

Lower of: actual additional expense, or Rate × turnover saved by that expense

Where the question gives a limit, apply it. Extra expense saved from standing charges ceasing is deducted.

Standing charges saved

Adjusted loss = Loss on short sales + Increased cost allowed − Insured standing charges saved

Deduct saved insured standing charges from the loss before applying the average clause. Uninsured charges are not part of the claim, so they are not deducted.

Average clause

Adjusted loss × Sum insured ÷ (Rate × Annual turnover)

Annual turnover is the turnover in the 12 months before the fire, adjusted for trend. Applies if sum insured is lower than the denominator.

How to solve Loss of Profit (Consequential Loss) Claim questions

1. 1Read the data: indemnity period, policy sum insured, which standing charges are insured, and the last financial year's sales, profit and expenses.
2. 2Compute the gross profit: net profit + insured standing charges. Find the rate of gross profit on the last year's turnover.
3. 3Find standard turnover: the turnover of the corresponding period in the previous year, adjusted for any stated increase or decrease in trend.
4. 4Find short sales: standard turnover − actual turnover in the indemnity period. If given, add turnover that was reduced by the fire but later made up inside the indemnity period only as the question directs.
5. 5Compute the loss: short sales × rate. Then add the admissible increased cost of working, limited to the profit it saves.
6. 6Deduct insured standing charges that were saved (not incurred) during the indemnity period. This gives the adjusted loss.
7. 7Apply the average clause to the adjusted loss: annual turnover × rate = required cover. If sum insured is lower, multiply the adjusted loss by sum insured ÷ required cover. State the final claim clearly.

Quickest way: Rate, short sales, average fraction

Common mistakes in Loss of Profit (Consequential Loss) Claim

• Using accounting gross profit as the rate

  Students link the word gross profit to the trading account.

  Fix: Always build the rate from net profit plus insured standing charges.

• Adding all standing charges to net profit

  Students ignore which charges the policy covers.

  Fix: Add only insured standing charges. The rest behave like variable costs.

• Applying the rate to total sales instead of short sales

  The word profit makes students think of total profit.

  Fix: The insurer pays only on the shortfall against standard turnover.

• Allowing increased cost of working in full

  Students treat any extra expense as claimable.

  Fix: Limit it to the rate × turnover saved by the expense.

• Using the wrong base for average clause

  Students use short sales or the standard turnover for the indemnity period.

  Fix: Use annual turnover (the last 12 months, adjusted) × rate as the required sum insured.

• Forgetting to deduct saved insured standing charges, or deducting them after the average clause

  The charges are assumed to continue, or the deduction is left to the last line.

  Fix: If the question says some insured charges stopped, deduct that amount from the loss (or reduce the gross profit as directed) before applying the average clause.

Worked examples