What it means
When a fire closes a factory, the physical damage is only part of the loss. The business still pays rent, salaries, loan interest and insurance while producing nothing, and it loses the profit it would otherwise have earned during the months it takes to recover.
Gross profits insurance is designed to fill exactly that hole, putting the business back in the financial position it would have occupied had the incident never happened. The insurance definition of gross profit is the source of most disputes at claim time.
It is turnover minus the variable costs that genuinely stop when trading stops, typically raw materials, goods for resale, carriage and packaging. Fixed costs such as rent, management salaries and interest stay in the insured figure precisely because they continue to be payable while the shutters are down.
Two settings drive the size of the cover. The rate of gross profit is the insured gross profit expressed as a percentage of turnover, and it converts a shortfall in sales into a loss of profit.
The indemnity period is the maximum length of time the policy will pay for, chosen by the business to reflect how long a full recovery would realistically take. Getting the indemnity period right matters more than most buyers expect.
Rebuilding a specialised production facility, re-obtaining regulatory approvals and winning back customers who switched to a competitor can easily take longer than a year, yet many businesses default to a twelve-month period because it sounds standard. If recovery takes eighteen months on a twelve-month policy, the last six months are uninsured.
Most policies also cover increased cost of working, meaning the extra money spent to keep trading, such as renting temporary premises or paying overtime, provided it costs less than the loss it avoids. Policies usually apply the principle of average too, so if the sum insured falls short of what it should have been, the settlement is scaled down by the same proportion.
Reviewing the sum insured annually against a growing turnover is therefore essential rather than optional.
In practice
Real-world examples.
Example
A bakery loses its ovens to an electrical fire and cannot trade for four months. Its property policy pays to replace the ovens, while its gross profits policy covers the lost earnings and the wages of staff it chose to keep on so they would still be there when it reopened.
Example
A distribution business is flooded and rents a temporary warehouse across town at a cost of $40,000 to keep serving its main accounts. The increased cost of working clause pays that $40,000 because the alternative, losing those accounts entirely, would have cost the insurer considerably more.
Example
A precision engineering firm chooses a twenty-four-month indemnity period rather than the standard twelve, because its machine tools have long lead times and its customers require re-approval of the production line before orders resume.
Formula
Calculation
Insured Gross Profit = Turnover - Uninsured Working Expenses. Rate of Gross Profit = Insured Gross Profit / Turnover. Claim = (Turnover Shortfall x Rate of Gross Profit) + Increased Cost of Working - Savings in Insured Standing Charges.
A furniture manufacturer has annual turnover of $6,000,000 and uninsured working expenses, being timber, fittings and outbound carriage, of $2,400,000.
Insured Gross Profit = $6,000,000 - $2,400,000 = $3,600,000. Rate of Gross Profit = $3,600,000 / $6,000,000 = 60%.
The business selects an eighteen-month indemnity period, so the sum insured should be $3,600,000 x 1.5 = $5,400,000.
A fire then closes the main workshop. Over the indemnity period turnover falls $1,500,000 short of what it would have been. Loss of gross profit = $1,500,000 x 60% = $900,000. The company spends $60,000 renting temporary premises and saves $15,000 on insured standing charges it did not incur. Claim = $900,000 + $60,000 - $15,000 = $945,000.
If the business had insured only $4,320,000 instead of the required $5,400,000, average would apply at $4,320,000 / $5,400,000 = 80%, cutting the settlement to $945,000 x 80% = $756,000.Case study
Seen in the real world.
Ashcombe Ceramics is a fictional manufacturer used to illustrate how this cover works in practice. It set its gross profits sum insured at $2,000,000 when turnover was $3,200,000, and then grew steadily for four years without revisiting the figure.
By the time a kiln fire closed the plant, turnover had reached $5,000,000 and the correct sum insured on a twelve-month indemnity period would have been about $3,000,000. The loss adjuster calculated a full loss of roughly $1,400,000, then applied average because the business was insured for about two thirds of what it should have been. The cheque that arrived was around $930,000, leaving the owners to fund the rest from their own reserves.
The illustrative point is straightforward. Nothing about the policy wording was unfair or hidden, but the sum insured had been treated as a fixed annual line item rather than a number that must move with the business, and a growing company had quietly become badly underinsured.
Watch out
Common mistakes.
- Using the accounting definition of gross profit to set the sum insured. Accountants deduct wages and other costs the insurance definition deliberately keeps in, which typically leaves the business insured for far too little.
- Choosing a twelve-month indemnity period by default. Recovery frequently takes longer once rebuilding, re-equipping and winning back customers are counted, and cover simply stops when the period ends.
- Leaving the sum insured unchanged as turnover grows. Average clauses scale the payout down in proportion to the shortfall, so a growing business can find its settlement cut by a third or more.
Questions
People also ask.
Does gross profits insurance cover the damaged building?
No, physical damage is covered by the property policy; this cover deals only with lost earnings and extra costs during the disruption.
What triggers a claim?
An insured physical event such as fire, flood or impact damage, so a downturn in demand or the loss of a large customer is not covered.
Should the indemnity period match the policy year?
No, the two are separate; the policy runs for a year, but the indemnity period sets how long a single claim can be paid for and can be eighteen, twenty-four or thirty-six months.
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