Consequential Loss (Fire Loss of Profits)

What it covers

A fire damages more than property. While a factory is being rebuilt, sales fall, yet rent, loan interest and salaries still have to be paid. The fire policy, whether SFSP or IAR, pays for the physical (material) damage. Consequential Loss insurance, also known as Fire Loss of Profits (FLOP) or business interruption insurance, pays for the financial impact of the interruption.

The cover has two parts. The first is loss of gross profit, which in effect is the net profit plus the insured standing charges that continue during the interruption. Variable costs such as raw materials are not part of gross profit to begin with, so they are never claimed. The second is the increased cost of working (ICOW): extra expenditure, such as temporary premises or overtime, incurred to keep the business going.

The link with the material-damage policy

FLOP is not sold alone. It is issued only where a material-damage policy, such as the SFSP or IAR, covers the same property. The two are tied together by the Material Damage Proviso: FLOP responds only if the material-damage claim is admitted, or would have been admitted but for a deductible. If that claim fails, for example because the damage was caused by an excluded peril, the loss-of-profits claim fails with it, however large the interruption.

Indemnity period and sum insured

The indemnity period is the maximum time for which loss of profit is paid. It is chosen on the worst case: how long it would take to rebuild and fully restore the business, plus a reasonable buffer. If the period chosen is too short, the months beyond it are uninsured.

The sum insured follows from it. For an indemnity period of 12 months or less, the sum insured is the full annual gross profit. For a longer period it is scaled up in proportion: annual gross profit × indemnity period in months ÷ 12.

How a claim is adjusted

ICOW is payable only to the extent that it avoids or reduces the loss of turnover, and only up to the amount of gross profit it saves. This is called the economic limit. Spending ₹10 lakh to protect ₹6 lakh of gross profit recovers ₹6 lakh.

Savings are deducted. An insured standing charge that stops or reduces because of the interruption is a cost the business did not bear, so it comes off the claim.

The claim is also adjusted for trend, under what the policy calls the other circumstances provision. The aim is to reflect what turnover would have been had the fire not happened: a business that was already declining has its claim adjusted downward, a growing one upward. Finally, the Accountants Clause covers the cost of engaging a Chartered Accountant to prepare, quantify and certify the claim.

Rules at a glance

Key points

• FLOP pays for loss of gross profit and increased cost of working after insured damage; the fire policy pays for the damage itself.
• Gross profit is in effect net profit plus the insured standing charges that continue.
• Under the Material Damage Proviso, FLOP responds only if the material-damage claim is admitted, or would be but for a deductible.
• Sum insured is annual gross profit for periods up to 12 months, and scaled up proportionately beyond.
• ICOW is limited to the gross profit it saves; savings in standing charges are deducted.

Common misunderstandings

• FLOP is not a standalone policy: it is issued only alongside a material-damage policy on the same property.
• An interruption alone does not trigger FLOP: if the material-damage claim fails, the loss-of-profits claim fails with it.
• Increased cost of working is not paid in full whatever its amount: it is limited to the gross profit it saves.
• The claim is not based on last year's figures alone: the trend adjustment moves it up or down to reflect what turnover would have been.

Questions people ask