Thabo Twalo, Chief Underwriting Officer at Santam Broker Solutions

In an increasingly tough risk environment, businesses must ensure they have adequate commercial insurance cover to be sustainable. According to the 2022/2023 Santam Insurance Barometer report, rioting and looting caused an estimated R50 billion in economic losses in July 2021, with climate change-related extreme weather events dominating the insurance industry’s claim statistics in 2022 and 2023.

Thabo Twalo, Chief Underwriting Officer at Santam Broker Solutions, explains that the South African commercial sector is traditionally underinsured. This is particularly true in cases where businesses find themselves under mounting financial pressure.

“Many businesses are facing undue financial strain due to the state of the economy. The solution, however, is not to forgo commercial insurance or reduce the level of cover. Instead, business owners need to work closely with their insurance intermediaries to develop a solution that falls within the parameters of their budget, and one that ensures that risks from every angle are accounted for. Doing this may well be the deciding factor of whether a business is able to survive a financial setback or whether it is forced to close its doors,” Twalo adds.

Financial gross profit versus insurance gross profit

Another factor that commonly contributes to businesses being underinsured is a lack of understanding of the difference between financial and insurance gross profit. Financial gross profit may be calculated by subtracting a business’s expenses from its monthly total revenue. Some of these expenses could include manufacturing costs, employee wages, factory overheads and utilities.

On the other hand, insurance gross profit considers the business’s uninsured costs, these uninsured costs should be outlined on the policy schedule as standard procedure. Typically, these uninsured costs vary according to changes in turnover.

The importance of calculating Insurance gross profit correctly

As Twalo asserts, while no two businesses are the same and will respond differently to untimely catastrophes, there are three common pitfalls that lead to businesses being underinsured. The first of these is the miscalculation of insurance gross profit.

For insurance policies, gross profit is the difference between turnover and variable expenses, or it may be the sum of the net profit plus fixed costs of the business. The rate of gross profit is essentially the percentage of profit earned on each unit of revenue.

What this means in essence, is that if the business experiences a reduction in turnover (total revenue) due to an event for which they are covered, their policy will provide cover for the loss of gross profit resulting from that decrease in turnover. However, in these cases, the client will not necessarily be covered against the total reduction in turnover.

The distinction here is important. The insurance coverage is specific to the loss of gross profit, which is the profit earned after accounting for the cost of goods sold. It doesn’t necessarily cover the entire reduction in turnover, which might include other underinsured costs beyond the cost of goods sold.

“For this reason, business owners should speak with their intermediary about choosing insurance cover based on a holistic view of their gross profit, the calculation should reflect a period of indemnity, which the client and intermediary will determine. Here, ‘indemnity period’ relates to the duration for which the policyholder can claim compensation for the financial losses suffered due to a covered event. It represents the worst-case scenario time it will take for the business to recover and return to a similar financial position as if the loss had not occurred” says Twalo.

Choosing a reasonable indemnity period

When businesses take out insurance cover, they will need to specify an adequate indemnity period, which is the forecasted period it would take to resume operations after business has been unexpectedly disrupted.

The indemnity period chosen needs to be sufficient to allow for the reinstatement or repair of the building, the sourcing/ordering and commissioning of a new plant, the replacement of equipment and machinery, as well as a return to the pre-loss production and turnover levels.

This is the maximum time that the policy would respond for, and should it take a longer period than the specified maximum indemnity period, then the policy holder will become their own insurer for the remaining period.

Accessing the support of an insurance broker

As Twalo concludes: “With the wide spectrum of insurance products available, clients need the guidance of an intermediary who knows which insurance products are best suited to mitigate the risks that are specific to a business and its industry.

Business owners should consult with their intermediary as regularly as possible and check-in on the level of cover they have in relation to how their business is growing and changing.”

ENDS