A close up view of: -
Machinery loss of profit
Despite
all the precautions taken by managers, companies may suddenly find
itself in a situation that threaten its survival, e.g. as a result of
natural disasters, accidents, fire, industrial espionage, sabotage,
damage to their reputation, or the failure of a supplier, the power
supply or a telecommunications network.
It is well accepted fact
that risks can never be entirely eliminated. However, while corporate
managements cannot guarantee that losses will be precluded, they are at
least expected to deal with loss events and the attendant aftermath in a
satisfactory manner.
In addition to the traditional tasks of risk
management - identifying, analyzing, reducing and transferring risks
companies are thus increasingly being expected to prepare systematically
to deal with loss events. A step for this purpose is machinery loss of
profit.
Introduction
Under both machinery and fire
insurance, indemnity is provided, in respect of damaged or destroyed
machinery, solely for the material loss sustained by the insured. These
types of insurance do thus not protect the insured against all the
losses which arise in connection with a fire or the breakdown of
machinery, since in most cases a material loss also causes an
interruption or interference of the insured's business operations. The
result is a financial loss in the form of lost profit and unearned
standing charges. In many cases the loss sustained as a result of an
interruption or interference of business operations by far exceeds the
mere material loss.
An awareness of the need for insurance protection against the
financial consequences of material damage arose at the beginning of this
century, and the result was the introduction of the two variants, loss
of profits following fire insurance and loss of profits following
machinery breakdown insurance - also called machinery loss of profits
(MLOP) insurance. As the size of modern production facilities increases,
MLOP insurance is becoming more and more important. The individual
production stages in modern processes are often accomplished by just one
machine, the failure of which leads to substantial interruption losses.
Machinery
loss of profit policy is just a replica of fire loss of profit policy.
Like fire loss of profit is require standard fire policy same with MLOP.
It requires machinery break down policy or boiler and pressure plant
policy or eclectic equipment policy. In US it is known as Business
interruption insurance. Sometimes it is also called as business income
coverage or loss of profit insurance, is typically a rider or
endorsement added to a business's property/casualty policy. As such,
what's covered under the main property/casualty policy will determine
what is and is not covered for business interruption. For example, P/C
policies typically cover fire, but not floods or earthquakes, so if an
earthquake damages the business, your business interruption coverage
won't kick in unless insured have obtained additional coverage for
earthquakes.
Need for MLOP
Business expert Ms.Meenakshi
Gupta said this policy is must for every business organization as the
market competitions is so tight that one minor loss can ruin the whole
business.
The incident of machinery breaks down not only cause
loss of property to industry but result in stoppage of work, resulting
in loss of production and loss of fixed charges which ultimately results
in loss of profit. To cover loss of profit because of machinery breaks
down it requires a specific policy given with machinery break down
policy or boiler and pressure plant policy or eclectic equipment policy.
The basic features of MLOP insurance will be dealt with.
1 Subject matter insured
MLOP
insurance provides cover for the actual loss of profits sustained as a
result of a business interruption caused by material damage
indemnifiable under machinery insurance. MLOP insurance provides
indemnity also in cases where the material loss amount falls below the
deductible to be borne by the insured under the machinery cover.
Basically speaking, a loss due to an interruption or interference of
business operations is made up of the following factors:
1. The
reduction in operating profit, i.e. the profit from selling the goods
produced and traded by the insured and from rendering services.
2.
The standing charges, i.e. the costs incurred entirely or in part if
operations are interrupted or impaired. These comprise wages and
salaries, including social security contributions if they continue to
become due during the interruption; interest, economic depreciations,
basic rates for third-party energy, expenses for the current upkeep of
buildings and machines, rent, taxes and other non-specified working
expenses, expenses for the preservation of vested rights, insurance
premiums and other business expenses, e.g. guaranteed commissions.
3.
Not included in standing charges, however, are turnover taxes and
expenses for raw or auxiliary materials, fuels and goods purchased
unless they serve to continue operations; excise taxes, freight charges,
specified license and inventor's fees and similar expenses. Loss
minimization costs are also covered if they lower the insurer's
obligation to indemnify. These include expenses that avoid, minimize or
terminate an interruption loss soon after the occurrence of material
damage.
Loss minimization is of great importance in MLOP insurance. The following are examples.
1. Purchase/sale of semi-finished goods
2. Provisional repairs
3. Early overhauls
4. Purchase of non-identical (but compatible) machinery
5. Express, airfreight
6. Overtime work, additional shifts, work on Sundays
7. To accelerate repairs on undamaged machines to reduce the interruption loss
8. Rent of machinery (e.g. transformers, boilers, compressors)
9. Shifting of operations to alternative plants
10. Making up for the production loss after reopening
Coverage
Machinery
loss of profit policy gives cover against consequential losses
following loss or damage to the property insured under machinery
breakdown and/or boiler and pressure plant insurance. This policy covers
actual financial losses suffered by the insured due to business
interruption arising from:
a) Reduction in turnover and
b) Increase in cost of working
The
standard policy thus insures the loss of gross profits in the business
because of accident to the machinery, boiler and pressure plant,
electric equipment covered under respective policy.
What Can Be Insured?
Continuing
Overhead Expenses: - which have to be met out of reduced earnings such
as rent, taxes, interest on debentures, mortgages and loans.
Increase in Cost of Working: - necessarily incurred to overcome or
to minimize the effects of damage upon the business such as renting of
temporary premises, hiring of machinery or extra labour costs.
Loss of Profit: - which would be earned by industry if there was no damage to machinery.
Wages:
- of employees not gainfully employed during the interruption period
and payments to employees whose services are no longer required.
Indemnity Period
In
contrast to a material loss, the loss of profits following a business
interruption depends on the time factor involved. In other words, the
longer the period for which operation is interrupted or impaired, the
greater the loss of profits. For this reason it is essential to set a
certain limit for the period during which the insurer is obliged to
provide indemnity for an interruption loss. This is done by the insured
specifying an indemnity period limit which represents the maximum time
for which an insurer is liable for loss of profits. The period of
indemnity begins on the date on which material damage could first be
said to have occurred, as judged according to the recognized principles
of engineering, at the latest, however, on the date when the loss of
profits commenced. Generally the indemnity period limit is three, six,
nine or twelve months. The basic rule is that the indemnity period limit
should relate to the amount of time required for removing the
interruption loss, i.e. for repairing the machinery damaged or for the
delivery of new machinery in cases of a total loss, assembly and trial
run. Higher premiums are, of course, charged for long indemnity period
limits.
In other words the indemnity period commences with the
date of damage and lasts till such a time as the business is restored to
its pre damaged level or the period stipulated policy which ever comes
first. The policy insures earnings of the business lost during the
indemnity period. But in any case indemnity period will not exceed 12
months.
Graph showing relation of indemnity period with damage
Sum Insured
Sum
insured is net profit plus standing charges. For calculating profit
past years data are taken. It is difficult to calculate gross profit for
future so it is allowed to increase gross profit by 50%.
Refund
of premium is allowed if estimated figure is more then the actual figure
but subject to that refund does not exceed 50% of premium collected.
Premium
Premium
rates depend on the critical nature of the machinery covered by the
breakdown or explosion policies; their relative importance and
contribution to final output; the repairs, maintenance and stand by
facilities available and the indemnity period opted.
Exclusions
1.
Loss or damage to machinery or other items which are not listed in the
list of machinery insured even if the consequence of material damage to
an item indicated in the list of machinery insured is involved
2. Any restriction on reconstruction or operation imposed by any public authority
3.
Shortage, destruction, deterioration and spoilage of or damage to raw
materials, semi-finished or finished products or catalyst or operating
media even if the consequence of material damage to an item indicated in
the list of machinery insured is involved
4. Alterations
improvements or overhauls being made while repairs or replacements of
damaged or destroyed property are being carried out
5. Extension of repair period beyond 4 weeks on account of
a. Inability to carry or delays in carrying out repairs
b. Prohibition to operate the machinery due to import and/or export customs & other restrictions or by statutory regulations
c. Inability to secure or delays in securing replacement parts, machines or technical services
d. Transport of parts to and from the insured premises
6. Willful acts or Gross Negligence on the part of Insured &/or his employees
7. War or warlike operations, Civil Commotion, Strike & Locked-out workers
8. Nuclear reaction, nuclear radiation or radioactive contamination
9.
Loss or damage caused by any faults or defects existing at the time of
commencement of this insurance within the knowledge of the insured or
his responsible representatives whether such faults or defects were
known to Company or not
Time exclusion
Explosive factory, petrochemical, power plant and fertilizers 14 days exclusion where as in other industry it is 7 days.
Underwriting consideration
- Risk inspection report.
- Description of plant
- Date of make
- Work performed
- Alternative means of working
- Repair time
- Spare parts held
- Unattended plant
- Percentage of daily loss. Incase production is halted.
- Any alternative means of working available.
- Stand by machine.
- Breakdown experience.
The possibilities of loss minimization
The
results of MLOP insurance depend to a great extent on the loss
minimization measures taken. It is therefore quite obvious that this
topic deserves special attention. Such measures for loss minimization
are, for example, the hiring of substitute motors, generators,
transformers, boilers, small turbines, etc. or the speeding up of repair
work by carrying out complex welding operations even on high-alloy
materials or using metalock and other special repair methods on the
damaged components.
Terms used in policy:
The following terms used in this policy will be defined as follows:
a.
Gross Profit is defined as the sum produced by adding to the Net Profit
the amount of all insured fixed charges. If there is no Net Profit the
amount of all insured fixed charges less that proportion of any loss
from business operations as the amount of the insured fixed charges
bears to all fixed charges.
b. Net Profit is defined as the net operating profit exclusive of all:
1) Capital receipts and accruals; and
2) Outlay properly chargeable to capital;
Resulting
from the business of the Insured at the described location after due
provision has been made for all fixed charges and any other expenses,
including depreciation, but before deduction of any taxes on Profits.
c. Insured Fixed Charges are defined as all fixed charges unless specifically excluded in the declarations.
d. Sales are defined as the money paid or payable to the Insured for:
1) Goods sold and delivered; and
2) Services rendered;
e.
Rate of Gross Profit is defined as the rate of Gross Profit earned on
the sales during the twelve (12) full calendar months immediately before
the date of physical loss or damage to the insured property.
f.
Standard Sales are defined as the sales during that period in the twelve
(12) months immediately before the date of the loss or damage to the
insured property which corresponds with the period of indemnity.
Marketing aspect for betterment of MLOP policy in India
Capered
to other products of engineering insurance, MLOP is very less in
number. This product requires proper advertisement and making the small
business owner aware of this policy. This policy is more suitable for
small industrial sector of India which facing many difficulties. Agents
are required to train about coverage and usages of policy, so that they
will be in position to explain other. Special advertisement campaign is
required.
Vishnu Ramdeo
MBA (Insurance)
National Law University
Jodhpur.
India
