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Q: I have been asked by my managing director to review our current insurance levels, following the recent fires in Dubai. He is concerned we don't have sufficient insurance. My question is, how much is enough? How is it calculated and how can we make sure we're covered in the event of an accident or fire?
A: Not enough people realise that under-insurance is as big a problem in this market as no insurance. Recent fires in Dubai have reminded people of the importance of having insurance in place, but there's still a tendency for companies to significantly undervalue their requirements.
Obviously, insurance is initially an expense, and all businesses look to minimise expenses. However, companies who look to keep the size of the premium to a minimum often find themselves facing significant problems down the road.
One of the big problems is that people tend to look at the "book value" of their assets alone when determining how much insurance they need. If a fire destroys a piece of machinery, what is the cost of the machine? Adding the original cost of each asset together is used as the rough equation to cover the total insurance required.
Losses
This ensures a cheaper premium, but the problem is that prices rise, so that the cost of replacing an essential part is much higher in real terms than you've accounted for. A machine you've had since 1997 is likely to be significantly more expensive in 2008.
In addition, the process of replacing the machine will require technical support and expertise - again, an additional expense. Finally, the cost of business interruption - the time spent when you physically can't sell to customers, the overall disruption to your company - is likely to be a higher overall cost than the cost of replacing the assets.
So, as well as calculating the real value of the assets and the support you will need to replace them, you should also factor in the cost of lost earnings over time. Typically, this is calculated as the reduction in "gross earnings," less "expenses which do not necessarily continue." In other words, how much money would you have taken in under normal circumstances, factoring in costs you are not incurring while your business is not operational?
There are now policies available which provide cover in these instances. The so-called "Property All Risks" cover provides for loss or accidental damage to your premises and property under a single limit, including stock, machinery, furniture and fixtures. In addition, policies which include Business Interruption cover will provide for any loss of profits, additional costs and even lost rental income.
Policies
Insurance companies providing business interruption cover typically provide companies with policies based on sales that would have occurred, not sales that could have occurred, so you will need to have realistic sales and profit projections.
Rather than trying to work all these figures out on the back on an envelope, it is worth bringing in a trained insurance professional to discuss how much insurance you need. As well as helping you determine what a sensible premium and level of insurance will be, their advice will also help you analyse risks, look at your current safety policies, and help determine whether you need additional security equipment.
In truth, you should see this as an important opportunity to have a full review of your safety processes - particularly while you have the full attention of your managing director. Too few firms take the time to discuss what their level of exposure is, and how well they are protected. Too many have to have the more difficult discussion, once they've been through an accident or fire.
- The writer is director of general insurance at Nexus, a leading regional financial adviser. The opinions expressed above are the writer's and don't necessarily represent the views of Gulf News.
Please send your questions to: advice@gulfnews.com.
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