Introduction
Advance loss of profits” refers to a particular class of consequential loss insurance and covers financial consequences of a project being delayed because of accidental damage to the project materials. it follows in principle the characteristics of an annual consequential loss insurance (Machinery Loss Of Profit Insurance) policy, but is issued in advance of the commencement of business.
With liberalized economies in indifferent parts of the world a good number of plants/production facilities are privately funded by banks and financial institutions. it is only with the compulsion of the financers of the project that the need for this insurance is on the rise, especially in countries like India.
A wide variety of causes – both internal and external to an organization lead to delays in commissioning of a new project. Such causes can be broadly classified into two groups viz.
Speculative or trade risks which relate to political, social or economic reasons or shortcomings in the management and errors in judgment. Such risks are not insurable.
Occurrences related to natural perils, inherent defects and human failure that lead to material damage of an accidental nature. These are the ones that concern the underwriters and as a basic principle ALOP policy is issued only in conjunction with a material damage CAR/EAR policy.
An ALOP coverage is normally incorporated as an additional section to the material damage CAR/EAR policy, e.g. it is section 3 of an EAR policy after the first two sections- the first relating to material damage & the second third party liability.
Object:
The object of ALOP insurance is to indemnify the principal or the project owner for the actual loss sustained due to a delay in commencement of commercial operations of a new project under installation/ construction. This delay must be caused by direct physical loss or damage admissible under the material damage CAR/EAR insurance covering the contract works. Whether the delay may be insured or not will mainly depend upon the following factors:
Defining and estimating the sum insured.
Segregating the insured incident from others which may contribute to project delays.
Computing the financial impact of the delay.
Critical Differences – Operational LOP VS. ALOP
Before going into the details ALOP insurance coverage, it would be desirable to have a look at the following comparison between typical features of an operating plant & a new venture, with specific reference to some important factors that affect business.
a) Market: an established market for an operating plant. No experience but only projections for new venture.
b) Product: proven in quality & accepted in the market for an operating plant if new venture product, demand & market acceptance uncertain.
c) Experience: technology/weaknesses well known; staff well trained no experience, newness of machinery & inexperienced staff
e) Machinery/ process: Tested & time proven for an operating plant Largely unknown & prototype for a new venture.
f) Revenue/ cost structure: Trading figures available for an operating plant. only projected figures for a new venture
g) infrastructure/ legal framework: Established for an operating plant. only assumptions for new venture.
Keeping the above points in mind, the following paragraphs touch upon certain important factors that relate to the ALOP insurance.
Basic Elements of Cover
The insured can only be the principal / owner of the project i.e. the party who stands to lose estimated revenue EARnings if the project gets delayed. Quite often the interests of the project financiers to be noted on the policy. Generally, they are included as ”additional insured”. The contractor/sub-contractor/engineers etc. are joint insured’s with the owner only under the CAR/EAR policy. Since they have no insurable interest, they cannot be accepted as insured under the ALOP policy.
Sum Insured:
By and large the definitions of sum insured closely follow the ones found in the standard loss of profits policies. However, the basic difference arises from the fact that, in the case of ALOP insurance, there are virtually no previous trading accounts available to arrive at a realistic amount as sum insured. The sum insured must be based on assumptions and its definition is on “would have been” basis. Normally, the budgeting and costing calculation on which the financial model of the project is based, are used in computing the sum insured.
The Sum Insured Can Be on The Following Bases:
Annual Gross Profits:
The annual gross profits would mean net profits plus standing charges (variable costs are not included) or turnover minus variable cost.
Debt Service Charges (Principal & Interest):
Sometimes the project financiers require the owner to take out insurance of amortization plus interest. This will require only a portion of the gross profit.
Fixed Overhead Charges:
They are generally accepted since the daily values on such charge can be easily known. however, the loss settlement will be on an actual loss sustained basis.
Interest Charges:
The additional interest burden that may be faced by the project owner during the period of project delay can be insured.
Loss of Rental:
This mainly applies to residential and office buildings for loss of rental due to the premises not being let due to insured delays.
Scope of Cover/Basis of Indemnity:
Basis of the scope of cover is normally detailed in the endorsement which is attached to the basic material damage CAR/EAR policy as separate additional section and relates to the actual financial loss sustained by the insured including increased cost of working, less any sum saved during the period of delay.
Object of Insurance:
The insurers hereby agree to indemnity the insured (principal or owner) for the actual loss sustained due to a delay in completion of the insured works caused by direct physical loss or damage (hereinafter referred to as “accident”) covered under the policy to which this endorsement is attached and occurring within the stated period of insurance, as defined below.
The cover provided under this endorsement shall be for the actual loss of gross profit due to the reduction in turnover and increased cost of working, and the amount payable as indemnity hereunder shall be:
In Respect of Loss of Gross profit:
The sum obtained by applying the rate of gross profit to the amount by which the actual turnover during the indemnity period falls short of the turnover which would have been achieved had the delay not occurred.
In Respect of Increased Cost of Working:
The additional expenditure necessarily and reasonably incurred for the sole purpose of avoiding or diminishing the reduction in turnover which, without such expenditure, would have taken place during the indemnity period, but not exceeding the sum by which such loss amount otherwise payable under this endorsement is thereby reduced.
Less any Sum Saved:
During the indemnity period as may cease or be reduced in consequence of the accident (including any liquidated damages and penalties the insured is entitled to receive)
if the annual sum insured hereunder is less than the sum obtained by applying the rate of gross profit to the annual turnover, the amount payable shall be reduced proportionately.
(Note: the above clause closely follows the operative clause of MLOP policy)
Definitions :
Turnover: the amount of money (less discounts allowed) paid or payable to the insured for goods, products or services sold, delivered, or rendered in the course of the insured business conducted at the premises.
Annual Turnover:
The turnover which would have been achieved had the accident not occurred, during the 12months after the planned date of completion of the insured works.
Annual Gross Profit:
The amount by which the annual turnover exceeds the amount of the specified working expenses. specified working expenses are those costs which vary directly with turnover, such as those for the acquisition of goods, raw materials or auxiliaries, as well as for supplies (unless required for the upkeep of operations) and any costs for packaging, Carriage, freight, intermediate storage, turnover tax, purchase tax, license fees and royalties for inventors, etc.
Rate of Gross Profit:
The rate which would have been Earned, had the accident not occurred, on the turnover during the indemnity period.
Period of Insurance:
The period of insurance shall be stated in the schedule to this endorsement. it shall end Earlier if and when the entire works or parts thereof are taken over or taken into use by the insured. For the purpose of this endorsement, this shall be deemed to take place on completion of full operational testing (if applicable) or at the planned date of completion of the insured works stated in the schedule, whichever shall occur first.
Indemnity Period:
The indemnity period begins with the date upon which, had the accident not occurred,
The insured works would have been completed or
The full operational testing of the insured works would have been completed but not prior to the planned date of completion stated in the schedule. The indemnity period ends with the actual date upon which (a) the insured works are completed or (b) full operational testing of the insured works is completed.
The maximum indemnity period is stated in the schedule.
(Note: the period of indemnity is based on the longest replacement time required for items critical to the plant. such replacement time includes the elements of reordering, re-manufacturing, transportation to the site, re-erection/testing/commissioning.)
Deductible Period (Time Excess) :
The deductibles period runs from the date upon which, had the accident not occurred, the insured works would have been completed. when a delay exceeds the deductible period, the indemnity is reduced in the same proportion as the deductible period bears to the indemnity period.
Note: the time excess or the waiting period is the period within the period of delay for which the loss is borne by the insured. it starts along with the indemnity period and is normally stipulated to absorb the effects of delay due to minor events which are inherent to the project. the te period depends on the type of plant/ equipment, the replacement time for critical items, the location of site and other underwriting factors.)
Special Exclusions:
Insurers shall not be liable under this endorsement for delays due to
Loss or damage covered as an endorsement under the material damage section unless it has been specifically agreed in writing. Earthquake, volcanic eruption, tsunami, unless it has been specifically agreed in writing,
Loss of or damage to surrounding property, construction machinery, plant and equipment;
loss of or damage to operating media or feedstock, shortage, destruction, deterioration of or damage to any material necessary for the insured business;
Any restrictions imposed by a public authority, non-availability of funds;
Alternations, additions, improvements, rectification of defects or faults or elimination of any deficiencies Carried out after the occurrence;
or for any loss due to fines or damages for breach of contract for later or non-completion or orders, or for any penalties of whatever nature.
Special Conditions
Duties of the insured: the insured shall take all reasonable steps to complete the works as scheduled and shall fully observe all manufacturer’s instructions for construction, erection, commissioning/testing of the works, as well as any government, statutory, municipal and all other binding regulations in force concerning the installation and commissioning/testing operation of the works.
The insurers’ representatives shall at all reasonable times have the right to inspect and examine the works.
The insurers shall periodically furnish the insurers with updated works progress programs as stated in the schedule. In the event of a difference between the anticipated and the actual progress of the contract works necessitating a revision of the anticipated date of completion, the insurers and the insured shall agree to a revised anticipated date of completion, which will be amended to this endorsement.
Change in degree of risk: the insured shall immediately notify the insures in writing of any material change in the original risk, such as:
Changes of the envisaged works progress programed, testing procedure, etc;
Alteration, modification or addition to any item of machinery or work, etc.;
Departure from prescribed construction or operation conditions;
Changes in the insured’s interest (such as discontinuation or liquidation of the business or its being placed in receivership).
In such cases, continuance of cover under this endorsement is subject to the written consent of insurers.
Conditions Relating to Claims
Should any occurrence giving rise or likely to give rise to a claim under this endorsement come to the knowledge of the insured, the insured shall:
give immediate notice thereof to the insurers by telephone, telex or telefax and send written confirmation thereof, within forty-eight hours of the event to the insurers;
Do and concur in doing and permit to be done all things which may be reasonably practicable to minimize or to avoid or diminish the claim amount or any delay in completion of the works;
discontinue the use of any damaged machinery, unless the insurers authorize otherwise (the insurers shall not be liable in respect of any delay in completion of the works arising out of the continued use of any damaged machinery or part of work without the prior authority of the insurers, until such parts has been repaired to the satisfaction of the insurers);
so far as may be reasonably practicable without causing any increase in period of interruption or interference, take precautions to preserve anything that might prove necessary or useful by way of evidence in connection with any claim;
allow the insurers and every person authorized by the insurers, without prejudice to any party insured by this policy, to have access to the construction site where such loss or damage has occurred for the purpose of direct negotiation with the responsible contractor or subcontractor in order to establish the possible cause and extent of the loss or damage, its effect on the items listed in the schedule, to examine the possibilities for minimizing any delay to the schedule date of completion of the insured works, and if necessary to make any reasonable recommendations for the avoidance or minimization of such delay.
if the insured or anyone acting on his behalf hinders or obstructs the insurers during any of the above mentioned acts or does not comply with such recommendations of the insurers, all benefits under this endorsement shall be forfeited.
In the event of a claim being made under this endorsement the insured shall:
deliver to the insurers in writing a statement noting particulars of the claim, together with details of all other insurances covering the accident or any part of it or consequential loss of any kind resulting therefrom;
also furnish to the insurers such books of account and other papers relating to the business such as invoices, balance sheets and other documents, proofs, information, explanation and other evidence as may reasonably be required declaration of the truth of the claim and of any matters connected therewith.
In the event of an accident, the insurer’s representatives shall have immediate access to the plant and the right to take over and to control all necessary repairs.
no claim under this endorsement shall be payable unless the terms of this condition have been complied with and, in the event of non-compliance, any payment of account already made shall be repaid to the insurers immediately.
Risk Categories for Insurance:
ALOP and similar forms of “delayed income insurance” have been requested for all types of projects. in so far as the Indian market is concerned the demand for this cover mainly comes from private owners of infrastructure projects, as most of these projects are financed by bank/financial institutions. power projects,
Being more in demand, form the single largest group of clients who require the ALOP insurance covers. Generally the demand from them relates to ALOP/DSU cover in conjunction with both:
The marine Cargo insurance for critical items of the project Cargo & The CAR/EAR insurance for construction phase of the project
Internationally the insurers have come across requests for ALOP insurance for the following classes:
Single machine installations for coverage during erection phase only. such requests generally being for smaller periods of time and the assessment for single machine installations being simpler, insurers have found such risks acceptable.
Expansions of existing plants in the manufacturing sector. in this category some underwriters prefer to restrict coverage only for “key” items.
New plants and production facilities.
buildings and civil engineering projects-either relating to works like road construction or relating to heavy foundations for industrial plants.
for residential or office building a special policy form has been devised to insure against loss of rent/interest
Underwriting information:
Questionnaire and Proposal:
Reproduced below is the proposal form recommended by a professional reinsurer for collecting information for the purpose of underwriting an ALOP risk.
insured:
insured project:
nature of business:
periods
construction/erection : from________to_______
commissioning/testing: from_________to_______
anticipated date of commencement of commercial operation:
period of indemnity:
time excess:
please enclose detailed works progress program indicating:
arrival of main items at site:
construction/erection phase of main items and allowance for delays:
commissioning/testing phase.
please enclose description of how the installation works, together with:
simplifies process flow diagram indicating bottlenecks:
list of major items indicating probable replacement time in the event of a total loss:
list of spares available on the site prior to commencement of commissioning/testing.
will the work involve any large scale manufacturing or fabrication on site?
if so, please state details.
will any second-hand machinery be installed? if so, please mark them on the list of machinery and details regarding age, condition, spares available, etc.
please give details of envisaged site protection and when this will be operative at the latest.
Sum insured:
please forward details of how the required sum insured was arrived at.
(refer to definitions in the policy wording)
if phased handing-over is envisaged, please indicate break-down of sum insured for each section to be handed over individually.
please give details in respects of availability of import license and foreign currency for material, spare parts, labour and technical assistance to be imported.
please give details of possibilities of minimizing loss in case of damage to the works: repair facilities on and nEAR site, transport facilities, etc.
does the sales contract provide for penalties in case of delay in completion?
if so, please state details:
please attach copy of envisaged underlying material damage policy with all endorsements, should this be other than sr standard wording.
the proposer declares that the above particulars are correct and given in good faith.
place and date proposer’s name & signature
rating:
Since no insurer has a sufficiently large portfolio statistically supported rating systems could not be developed to date. Obviously, in the Indian situation the insurers have to depend upon the international reinsurance market for guidance on a case to case basis. secondly, the critically of propos varying from project to project, no tariff can be formulated which can be used as standard.