Business Interruption Insurance: Fire Loss of Profits
The fire policy rebuilds the factory. This one pays for the months it cannot trade.
A fire policy pays to rebuild the factory. It does not pay for the months the factory cannot sell anything. The standard fire wording says so directly: it excludes loss of earnings, loss of market and any consequential loss. Business interruption insurance, called fire loss of profits (FLOP) or consequential loss insurance in India, covers that second loss: the gross profit lost because turnover fell, plus the extra costs of keeping the business going.
Picture a Surat dyeing house that burns in March. The SFSP pays for the building and machines. For the next eight months, though, it has no sales while rent, salaries of key staff, loan interest and electricity minimum charges keep running. The FLOP policy pays for that gap until turnover returns to normal, within a time limit chosen at the start.
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The Terms the Policy Is Built On
- Gross profit
- Net profit plus the insured standing charges (costs that continue when trade stops: rent, salaries, interest, depreciation). It is usually worked out as turnover plus closing stock, minus opening stock and the specified working expenses that vary with output, such as raw material and power.
- Rate of gross profit
- Gross profit as a percentage of turnover in the last financial year before the damage.
- Standard turnover
- Turnover in the matching period of the twelve months before the damage. It is the benchmark the fall in turnover is measured against.
- Indemnity period
- The longest period after the damage for which the policy pays, chosen by the insured when buying the cover. It runs from the date of damage, not from the date of the claim, and should cover rebuilding, re-equipping and winning customers back.
- Material damage proviso
- A loss of profits claim is payable only if there was a material damage (fire) policy in force covering the property, and the insurer under it has paid or admitted liability for the damage. No admitted fire claim, no loss of profits claim.
How a Claim Is Worked Out
The dyeing house: rate of gross profit 25%, standard turnover for the eight months ₹12 crore, actual turnover ₹4 crore.
- 1
Reduction in turnover × rate of gross profit
(₹12 crore − ₹4 crore) × 25% = ₹2 crore.
- 2
Add increase in cost of working
Hiring outside processing to keep key customers cost ₹40 lakh. It is payable only up to the gross profit it saved (the economic limit): if it rescued ₹2 crore of turnover, that limit is 25% of ₹2 crore = ₹50 lakh, so all ₹40 lakh qualifies.
- 3
Deduct savings
Insured charges that stopped during the shutdown, such as a cancelled maintenance contract worth ₹10 lakh, come off.
- 4
Adjust for trends
If the business was growing or shrinking before the fire, standard turnover is adjusted so the claim reflects what would really have happened.
- 5
Apply average on gross profit
If the gross profit sum insured is less than the rate of gross profit applied to annual turnover (scaled up for an indemnity period longer than a year), the claim is reduced proportionately. Here, with adequate cover: ₹2 crore + ₹40 lakh − ₹10 lakh = ₹2.3 crore.
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Underwriting Points
The cover follows the fire policy: perils insured under the loss of profits policy are normally the same as those on the material damage policy, so a loss from an excluded peril (an earthquake not added back, say) fails both. Wages can be insured as a separate item, because a business may keep paying workers for a while after a fire. Insurers usually apply a time excess, so the first few days of interruption are borne by the insured.
Choosing the indemnity period is the insured's biggest decision. Imported machinery with a long delivery time, or a building needing fresh municipal approvals, can stretch recovery well beyond a year, and turnover lost after the indemnity period ends is not paid.
How IC-11 Tests This
Expect the material damage proviso ("a loss of profits claim is admissible only if..."), the definition of gross profit, what standard turnover means, and the economic limit on increase in cost of working. The trap is starting the indemnity period from the claim or the restart date: it starts on the date of the damage.
FAQs
What is a fire loss of profits policy?expand_more
Business interruption cover that pays the gross profit lost because a fire or other insured peril damaged the business premises, plus extra costs of keeping trade going, for up to the indemnity period chosen.
What is the material damage proviso?expand_more
The condition that a loss of profits claim is payable only if there was a material damage policy covering the property in force at the time and that insurer has paid or admitted liability for the damage.
What is the indemnity period in business interruption insurance?expand_more
The maximum period, starting from the date of damage, during which reduced results are covered. The insured chooses it when buying the policy, based on how long recovery could realistically take.
Does a fire policy cover business interruption?expand_more
No. The standard fire policy excludes loss of earnings and consequential loss, so a separate loss of profits policy is needed.
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