Business interruption – wageroll and adequate gross profit cover

At a glance

Employee wages represent a significant expense for most businesses and therefore have a major bearing on gross profit sum insured calculations

There is a common misunderstanding about the role that wage roll plays in calculating the correct sum insured

We explain how to determine what proportion of a customer’s wage roll is suitable to exclude from their gross profit sum insured so that you can help your customer determine the correct level of cover

When calculating gross profit sum insured, businesses need to decide whether or not to subtract employee wages – and if so, to what extent. Getting it wrong could have a substantial bearing on the adequacy of that business’s gross profit sum insured.

We consider the significance of wage roll and how your customers should approach it when calculating gross profit.

Tackling wage roll misunderstandings

When calculating gross profit, accountants will usually subtract employee wages to arrive at a final figure. However, for insurance purposes, the significance of wage roll needs to be determined before deciding whether or not to subtract it. This difference in approach is a regular source of underinsurance.

“Customers routinely declare incorrect figures, as they do not understand this important distinction,” explains Ian Dunbar, Risk Engineer at Zurich. “When we delve deeper into declarations, we also see that different sites are often calculating gross profit in their own way. So it is important that the correct method is communicated throughout a customer’s business and that brokers are checking that it has been understood.”

Where does wage roll fit in?

Depending on the nature of your customer’s business, a proportion of their wage roll might constitute an uninsured working expense (UWE).

By declaring a UWE, customers are stating that those wages will not continue following a loss, and therefore do not require insurance. If they do continue, customers could find themselves significantly underinsured.

UWEs are a crucial part of the gross profit sum insured calculation (see boxout) and must be approached with great care to avoid underinsurance.

Delving deeper into wage roll

Most customers will have a range of employees, each with varying degrees of importance to their on-going operations.

The question of whether to subtract wage roll is therefore not black and white, but requires customers to carefully consider what would happen to those different categories of employees immediately after a loss.

Some employees may be let go, but others may be crucial to the business’s recovery. Determining which fall under each category is an essential exercise for establishing an adequate gross profit sum insured and minimising underinsurance.

Consider partial losses

When considering which wages would cease in the event of a loss, customers need to consider both partial and total losses.

Partial losses are much more common, and neglecting to consider these scenarios is a common cause of underinsurance.

Which wages would cease?

A wage should only be considered a UWE if your customer is certain it is a cost that will cease in the event of a loss. There are a number of factors that will influence this, for example:

• How crucial these particular workers are to the business – Most customers will want to retain key personnel both during and after a loss
• Employee contractual terms – Can workers be released straight away and at no cost, or is the business obliged to give notice or issue redundancy payments? If so, these costs will need to remain covered
• How easy will it be to recruit staff of the same quality? Former employees may go to work for competitors or find other careers. Potential difficulties in future recruitment could make it more beneficial to retain staff in the short term
• A catastrophe may lead to adverse publicity particularly if employees are seen to be struggling financially due to inadequate wage roll cover
• Has the business invested significantly in training, so that it would be uneconomical to recruit and train new staff?
• Would letting workers go put a strain on future workplace relations that the business may wish to avoid?

“A business’s most valuable asset is usually its workforce, and you are unlikely to want to lay off the very people who will be crucial to your recovery,” says Graham Herridge, Major Loss Team at Zurich.

“When you think through all of these factors, I don’t think there are many circumstances where a business would not want to insure wage roll. I would always recommend a starting point of insuring full wage roll and then give careful consideration to deducting costs, only if the customer is certain they will cease in both partial and total loss situations.”

How to calculate gross profit sum insured

Business interruption is recognised as a particularly difficult area for brokers and customers alike, with an estimated 40% of policies thought to be underinsured, by up to 50%.

As a consequence we have introduced the Business Interruption Calculator (BI Calculator), a simple online tool that works through the gross profit calculation, offers detailed guidance on key areas and calculates an appropriate sum insured for your customer.

Customers who set their sum insured by using our BI Calculator will also benefit from a 10% discount on their BI premium.

http://insider.zurich.co.uk/risk-management/wages-included-gross-profit-sum-insured/