​As a novice SCUBA convert diving in the pristine Celebes Sea east of Borneo and just off of Sipidan Island; one quickly appreciates that still waters not only run deep but can also be ambiguous. For a calm aqua blue surface may belie strong currents which can un-expectantly carry you away from your party after descending 20 metres. A situation which does not make for happy travel tales.

Fortunately for me, I was diving with some experienced and patient buddies who were there to assist with any difficulty and internal anxieties that may have otherwise become overwhelming.

​Whilst I am sure a more appropriate metaphor can be found, a loss of gross profits wording can similarly hide ambiguities which may only come to light after we have descended deep into the loss assessment process.

The standard UK Gross Profits wording (also adopted in Australian and other markets) provides a formula for calculating the indemnity under the policy. However, a strict application of the wording may not necessarily provide the outcome which the contracting parties had intended. The Rate of Gross Profit (ROGP) is defined as the rate earned "during the financial year immediately before the...Incident" to which the Other Circumstances clause is applied in order to adjust for any variations such that the resulting rate is reflective of what would have been achieved by the Business but for the loss event.

The indemnity under the policy is determined by applying the ROGP to the Reduction in Turnover (ignoring other elements such as increased costs, savings, average etc). However, following this wording to the letter may; in some instances result in the Insured being over or under indemnified. As an example consider a manufacturer of products A and B in equal quantities, which upon sale achieve a margin of 10% and 20% respectively. The financial statements would report an average ROGP of 15% for the Business.

Following a fire which resulted in restricted capacity and a loss of sales, the Insured decided to produce only the higher margin product resulting in all sales maintained through the Indemnity Period achieving a margin of 20% (let us assume no stock at the time of loss).

By strictly following the policy formula and applying the ROGP to the Reduction in Turnover; the Insured would be over indemnified as not only would it receive a payment under the policy (ROGP of 15% x the Reduction in Turnover) but it would also achieve an additional 5% of margin (20% less the average of 15%) on each dollar of sales maintained (as the sales mix has changed from what would have been the case but for the interruption).

Conversely, the Insured would be under indemnified had it been restricted to manufacturing the lower margin product, as on each sale maintained it would have achieved a margin of only 10% (in comparison to an average of 15% but for the loss).

An insurance policy is a promise of indemnity and the intent of the contracting parties would be (in most cases) to place the Insured back in the position but for the insured Peril with no gain or loss. However, the policy is also a legal contract which stipulates that “...the amount payable as an indemnity shall be…” in accordance with the policy formula.

When assessing the loss, should an adjustment be made such that the final measure is reflective of the actual loss sustained? Or is the correct approach to apply the formula as set out in the policy document with any subsequent windfall or shortfall lying where it falls? After all; the benefit of having a tried and tested formula, as set out in the contract, is that it reduces uncertainty and the number of disputes that would otherwise arise from parties arguing over how to value the indemnity to be paid.

In Elock v Thomas [1949], a property fire policy it was said: “When parties have agreed upon a valuation…they have made arrangements by which for better or for worse, they are bound…When losses occur after the parties to contracts have agreed upon valuations, then in some cases advantages may occur to the Insured while in other cases advantage may occur to the Insurer.”

Forensic Accountants are neither Underwriters nor Solicitors and thankfully it is not our role to adjudicate on matters of policy response. However, an appreciation of insurance concepts and the workings of the policy document will help to highlight these types of issues, which in some cases may result in a material adjustment to the settlement otherwise determined on the basis of a strict adherence to wording.

My experience in the more significant cases involving the above conundrum has been that after the matter was discussed with relevant parties the settlement was based upon the actual loss sustained. In these cases, we would tailor our calculations such that an over or under indemnification of the policy holder is avoided. I should however, point out that any departure from the policy wording when measuring the loss would need to be authorised by our acting principal.

Notes for any fellow divers:
For those wanting to dive well-renowned Sipidan Island, I can recommend Seaventures [http://seaventuresdive.com/]. Accommodation on a converted oil rig just off Mabul Island was a fun and novel experience. The operation was well run and the food surprisingly good.
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For diving closer to home (UK and Euro residents) the Maltese Islands provide excellent diving in addition to being a stand-alone destination. I can personally highly recommend Ms Charlotte Fenech of Cresta Dive Centre for any of your diving needs [http://www.crestadivecentre.com/].