Loss Of Profit Insurance

Loss of Profit

Loss of Profit Insurance

Fire Insurance is concerned with Capital loss through the destruction of buildings, machinery, and stock. Consequential loss insurance (Loss of Profit insurance) is concerned with the loss of earning power Consequent upon the capital loss. Only with, Fire consequential loss insurance, full protection is obtained.

To understand the coverage, under fire material damage policy and LOP policy, consider the following diagram.

Before Fire After Fire
Capital Building, P&M, Stock SFSP policy pay for this.
Variable expenses(V.E) Raw material cost, unskilled labour charge These diminish in proportion to the stoppage in production (These charges are proportional to Turnover)
Fixed Expenses/Standing Charges (S.C) Overheads or continuing standing charges such as salaries, interest, rent etc., Consequential Loss Insurance pay for these
Earnings Net profit Consequential Loss Insurance pay for these

Hence Loss of Profits policy covers :

  1. Loss of Anticipated profit (Net Profit)
  2. Continuing trading expenses (Standing Charges)
  3. Increased trading expenditure (increase in the cost of working)

It provides compensation for Loss of Earning Power, While Material Damage (Fire) policy covers capital losses.

Increase in cost of working is the additional expenditure necessarily and reasonably incurred for the sole purpose of avoiding or diminishing the reduction in turn over.

Consider an example:-

Before Fire % After Fire %
Turn over 50,00,000 25,00,000
Production cost (V.E) 35,00,000 70 17,50,000 70
Standing Charges (S.E) 10,00,000 20 10,00,000 40
Net Profit 5,00,000 20
Net Loss 2,50,000 10

As variable expenses directly proportional to T/O, this expenses constitutes 70% before and after Fire.
As standing charges are fixed, the % on T/O is increased from 20 to 40. Whereas the sum standing charges and Net profit/Net Loss constitutes the same 30% on T/O. This sum is known as Gross Profit (G.P). Hence the rate of G.P (Ratio of G.P) on T/O is the same before and after the loss.

The Consequential Loss policy sets out to make good the shortage in G.P (Loss of G.P) which can be arrived at by multiplying the reduction in T/O with the rate of G.P.

Therefore the Sum Insured in a LOP policy is the “Annual gross profit “


Sales 500 loaves @ Rs. 30 /- per loaf per day            Rs.15000/-

Expenditure (V.E)

Wheat flour 20 Kg @ Rs.40 / Kg / day                         Rs. 800/-

Sales per month 15000 X 30 days                               Rs.4,50,000/-

Less flour for 30 days                                                   Rs. 24,000 /-

Less monthly expenses                                                Rs .1,20,000/-

Net Profit                                                                       Rs.3.06,000/-

Monthly Expenditure (Fixed Expenses/Standing Charges):

Rent                                     Rs.50,000

Salary                                  Rs.50,000

Electricity                             Rs.15,000

Other Expenses                  Rs. 5,000

.                                          ——————-

Total                                    Rs.1, 20,000

.                                          ——————-
What will be the loss to the bakery, if it is closed for 30 days.

Net Profit                             Rs.3, 06,000

Monthly expenditure            Rs.1, 20,000

Gross profit                          Rs.4, 26,000

This is called “ADDITION BASIS”.

From another perspective, He has lost The Value Addition.

Sales                                    Rs.4,50,000

Cost of wheat flour               Rs.24,000

Hence Gross Profit               Rs.4,26,000

This is known as “DIFFERENCE BASIS”

Standing charges = All Fixed Expenses like:

Salaries & Wages, Rental Rates & Taxes, Repairs & Maintenance, Administrative Overheads, Factory Overheads, Selling Overheads, Interest & Depreciation.

Working Expenses are:

Raw material cost, Power & fuel, GST, Wages of Piece rated workers, Sales commission, stores and spares.

These are “VARIABLE EXPENSES“ which decrease proportionately with production/sales. These are called “SPECIFIED WORKING EXPENSES” under a LOP Policy.

“VARIABLE COSTS “are called “WORKING EXPENSES” by Insurers.

“FIXED COSTS” are called “STANDING CHARGES“ by Insurers.


  1. TURN OVER: The money paid or payable to the insured for goods sold and delivered and for services rendered in course of the business at the premises.
  2. INDEMNITY PERIOD: The period commences from the date of Fire/Peril and ends when the business ceases to be affected thereby subject to maximum PERIOD specified in the policy.

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