Machinery Breakdown Business Interruption (Gross Profit) Cover simplified

For a manufacturing or mining operation, machinery is at the heart of production. Crushers, mills, conveyors, pumps, compressors, processing equipment and other critical machinery can determine whether you are producing at full capacity, operating at reduced capacity, or not producing at all.

When one of these critical machines suffers a sudden and unforeseen breakdown, the immediate concern is usually the cost of repairing or replacing the damaged equipment. But the repair bill may only be the beginning of the financial loss. The bigger financial impact may arise because the damaged machinery is no longer available to support production. Production volumes may fall. Sales may decline. Employees and other fixed expenses may continue to be incurred. Specialist engineers and replacement parts may have to be brought in urgently. Production may take months to return to normal.

This is where Business Interruption / Loss of Gross Profit cover following Machinery Breakdown becomes particularly important.

In simple terms:

Machinery Breakdown Material Damage cover helps pay for the physical damage to the machine. Business Interruption (Gross Profit) cover helps protect against the financial consequences of the interruption caused by that insured breakdown.

1. What Does Business Interruption (Gross Profit) Cover Mean?

Business Interruption cover is sometimes referred to as Consequential Loss or Loss of Profits insurance. Its purpose is to put the insured business, as far as the policy permits, in approximately the same financial position it would have been in had the insured physical damage and resulting interruption not occurred.

For a manufacturing or mining operation, this can mean protecting the financial contribution that would have been generated from production during the period affected by the machinery breakdown.

The cover commonly responds to:

• Loss of gross profit resulting from a reduction in turnover;
• Increased Cost of Working incurred to minimise the loss;
• Standing charges that continue while production is interrupted;
• Other extensions specifically agreed under the policy.

2. How Does the Gross Profit Calculation Work?

This is one of the areas that often causes confusion. The term “Gross Profit” in an insurance policy is not necessarily the same as the accounting gross profit shown in the company’s financial statements.

The policy will define how Gross Profit is calculated and what expenses are treated as uninsured or variable expenses. A common structure is based on the loss arising from the reduction in turnover, multiplied by the applicable rate of gross profit.

In simplified terms: Loss of Gross Profit = Reduction in Turnover × Rate of Gross Profit

The policy may then consider other factors like Increased Cost of Working; Savings in expenses; Actual turnover achieved; Trends in the business; Production and market conditions; The applicable indemnity period and The time excess;

Suppose a company normally generates:

Annual turnover: US$120 million with a calculated rate of Gross Profit of 30%. The company therefore has an annual insured Gross Profit exposure of approximately:

US$120 million × 30% = US$36 million

Now suppose a covered machinery breakdown causes a major processing interruption. During the affected period, the company’s turnover is reduced by US$20 million. Using the simplified calculation:

US$20 million × 30% = US$6 million (the potential Gross Profit loss)

This is before considering applicable policy provisions such as savings, increased costs of working, deductibles/time excesses, limits and other adjustments.

Four Questions Every Business Should Ask About Its Cover

1. What machinery is insured? Do not assume that every machine on site is automatically covered. Review the schedule carefully.
2. What is the maximum Business Interruption exposure? Calculate the potential financial impact of the failure of your most critical machinery.
3. Is the Gross Profit sum insured adequate? Do not simply use last year’s accounting figure. Consider expected growth and the selected indemnity period.
4. Is the indemnity period long enough? Consider the entire recovery process not just the estimated repair time.

A properly structured Machinery Breakdown policy should therefore protect more than the machine. It should help protect the financial engine of the entire mining operation. Talk to the Firstlink team today on (0242) 744048/79, 0772392075, 0772434103 to secure cover for your business.