advance loss of profites policy
introduction :

Advance profits insurance follows the general principles and conditions of “ ordinary” profits insurance. In simple terms “ Ordinary “ profits deals with the future earnings of a present business, where as advance profits deals with the future earnings of a future business.

Where as claim of loss of future earnings in an existing business can be based to an extent on past trading experience, claims for future earnings where there is no past or even current experience must be based largely on what might have been anticipated.

If the damage or an accident occurs during this period having the effect of delaying the commencement of trading or production beyond the projected start – up date, claims may be made in respect of:

  • Loss of net profit ,
  • Standing charges payable despite the lack of income,
  • Increase in expenditure to reduce or avoid the delay, to start-up.

Protection is provided for anticipated earnings where no earnings have existed previously. The period of insurance starts before the date when the business goes into commercial operation and ends on the date. Usually it will correspond with the associated contract works period, but it may encompass also the period of supply and manufacture prior to the delivery of the contract material to the site

The indemnity period starts from the anticipated commencement date of the business :

insured property

On machinery and industrial installations, interest in advance profits is most likely to be proposed in connection with the large and complex projects, not only because the potential loss exposure is greater but also accident incidence is likely to be high. Power plants, Oil refineries, readily spring to mind in fact any industry or process where single production lines are common or where a key item of plant occupies a critical interruption position may be viewed as a prime candidate for advance profits cover.

The underlying material damage cover is normally the contract works form, be it E.A.R (machinery installation C.A.R. (buildings or civil engineering construction). An important feature of the EAR forms is the testing or commissioning period. Indemnifiable contract works material damage occurring during this phase contains the potential to produce substantial material damage losses in addition to delaying severally the projected handover and start-update of the completed plant.

Consequently advance profits proposals often-lay emphasis on the testing / Commissioning risk where:

  • the plant or much of it is probably in operation for the first time because full-scale tests at the manufacture’s works were impractical ;
  • by the very nature of the plant, teething troubles and minor breakdowns are inevitable;
  • the plant may not be fully within the control of the purchaser as regards both the operation and care of the plant and the method of undertaking and expediting repairs;
  • under tight time schedules there is unlikely to be at this late stage any time margin to cushion the effects of a stoppage..

On the C.A.R. side advance profits is particularly relevant for building construction works for example, office and commercial developments, hotels and retail outlets, where delay in completion result in loss of anticipated earnings in the form of rental income, sales revenue, hotel bookings etc.

The possibility of inadequate cover is reduced if the insurance period corresponds to the construction / erection period. However, as there may be instances where there is no interruption exposure during the very early stages, adequate cover will be provided if the insurance commences as soon as there exists an exposure from damage by an insured peril at the contract site.

insured interests

During the contract works, erection and commissioning periods, various parties’ financial interests are at stake

  • Principal : A delayed commencement of operation would deprive him temporally of anticipated earnings earmarked to pay interest on capital, wages etc.
  • main contractor :A delay in handing over the plant to the principal would lead to a disruption in the schedule of payments and consequently to unexpected expenses for loans, increase in the cost of completing the project, delays in taking on or commencing new work, and liquidated damages.
  • sub contractor They might be affected similarly to the Main contractor.
  • suppliersPurchase price installments payable on satisfactory performance test could be delayed.
  • financial institutions :They might see their client’s earnings power and thus loan security diminish.

The financial interests at risk are those which depend upon the satisfactory and timely handover of the plant or project to the principal .

Unlike the approach adopted on the material damage side where the contract works policy may embrace all the project participants, Advance profits insurance covers the interests of the principal only.

Forms of cover may be devised to protect the interests of contractors above but they do not form the subject matter of the profile

Advance profits insurance deals essentially with the new business. To illustrate the some what limited scope of interests insured: if a businessman or a entrepreneur decides to establish a business that has not existed previously on a new site, with new management, work force,suppliers, customers etc. then he himself will seek a “classic” Advance profits cover.If an advance profits policy is issued it will,on expiry,be replaced by “permanent “ to safeguard the trading income of the on-going business. The business clause because either the business is genuinely new or on the other hand, the new capacity represents a significant increase in the productive capacity of an existing plant.

sum insured

Definitions of sums insured follow closely those found in the orthodox machinery profits form. The essential difference stems from the fact that for Advance profits insurance, there are virtually no previous trading accounts upon which to refer.

The sum insured is, therefore, based on assumptions and extrapolations. Its definition is phased on a “would –have-been” basis, taking advantage of the budgeting and costing calculations made before a new project is started. Consequently, indications should be available of what, had nothing gone wrong - the rate of Gross profit and the annual and standard turnovers were expected to be.

Each case should be examined on its own merits in order to determine:

  • an adequate period of indemnity.
  • the sum insured.

There are cases where, from the moment of commercial start up, full 100% efficient production is achieved from a new project, but normally a period of commercial build-up may extend over a period of months or even years.This becomes more in cases of relatively complex plants with long commissioning / testing periods, during which already marketable semifinished products are produced. Even if there should exist, from the moment of start-up, a market for all the goods, which the factory is designed to produce, it is unlikely that full 100% output will be achieved immediately. A reasonable period following the start-up will be necessary for the operators to become accustomed to operating the new plant to full capacity.

loss of gross profit: This is the “classic” coverage for continuing business expenses (standing charges) and net profit, preferably calculated on the “difference” basis. The insured amount is calculated in the same way as for Machinery or Fire Profits, but based upon anticipated sales, costs and prices.

loss of gross earnings: This can be compared to Gross profit calculated by the “difference” method (specified working expenses are deducted from turnover). It is however, based not on turnover but on sales value of production from which consumed raw stock, supplies, merchandise and services purchased are deduced.

principal and interest: This can be compared to Gross profit calculated by the “difference” method (specified working expenses are deducted from turnover). It is however, based not on turnover but on sales value of production from which consumed raw stock, supplies, merchandise and services purchased are deduced.

basis of indemnification

Reduction of Turnover during the Indemnity period is the index by which the loss is measure, but because the plant, factory or building will not previously have been in production or use, the measure must be reduction in anticipated Turnover.

The Rate of Gross Profit is that “which, but for the damage would have been earned on the Turnover during the Indemnity period”. The Standard Turnover is that “which, but for the damage would have been earned during the Indemnity Period” and the annual (or Comparative) Turnover is “the Turnover which, but for the damage would have been earned during the twelve months immediately following the date on which Turnover would have commenced to be earned”.

INCREASE IN COST OF WORKING : necessarily and reasonably incurred to diminish or avoid a reduction in turnover during the Indemnity Periods are covered similarly to an ordinary consequential loss specification. But because the insured peril must necessarily operate before the Commencement of the Indemnity Period under an Advance Profits policy, the additional expenditure can be incurred either prior to or during the Indemnity Period.

indemnity peroid

The maximum indemnity period does not commence from the date of accident as it does under a normal policy but on the projected starting date of operations the period commencing from the date on which but for the accident turnover would have commenced should the construction of the factory or the installation of the plant and machinery fall behind schedule through causes such as labour disputes not included in the insured contingencies the policy may be extended at an additional premium to expire on a revised date the commencement of the indemnity period being correspondingly deferred

Project delays will be determined by the length of repair or replacement period of damaged items or property and as with the normal machinery profits form, the insured is well advised to adopt this measure to determine his indemnity period.

In the event of delay the specific cause(s) must be closely investigated as the delay period may be lengthened by the factors, which are not indemnifiable, Some wordings therefore explicitly excluded prolongation of the repair or delay period resulting for example, from :

  • Strike or Labor disputes.
  • Lack of funds for repair ( due to an inadequate material damage sum insured or under insurance).
  • Alterations,extentions or improvements to affected items.
  • Restrictions on constructions or operation imposed by public authority.
  • Shortage of or damage to materials destined for the insureds business.
  • Weather conditions.

The selected indemnity period must take into account the special circumstances of the risk e.g. market timings, prolongation potential etc It is unwise to opt for a short indemnity period as a premium - saving device, but also account must be taken of cumulative delays from more accident.

time exclusion

The time exclusion begins with commencement of the maximum indemnity period. Theoretically it should be applied for each occurrence, but it is often difficult to investigate the effect of each occurrence on the works progress schedule and to allocate delays in the completion date to each and every loss. In practice the time exclusion will be applied just once; this may affect the underwriter’s judgement on the scale of rating discount for the selected time exclusion.