November 2007

Question
I believe that in a manufacturing BI loss – that expenses directly consumed in the manufacturing process – including manufacturing labor, utilities of manufacturing, etc. – should be counted as a cost of goods, and not put below the line with the SG&A expenses.  Do you agree?

Answer
Gross Earnings is defined in most policies as net sales value of production less materials and supplies directly consumed in the manufacturing operation. In the days when co-insurance was still in vogue, Gross Earnings used to be referred to as “the line”.  Expenses included “above the line” were deducted to get to Gross Earnings, while all other non-continuing expenses were deducted “below the line”.  Co-insurance was measured “at the line”.

Ordinary payroll, to the extent it is not insured, would be deducted from Gross Earnings to arrive at Gross Earnings Less Ordinary Payroll.  This point would become the co-insurance measurement line when payroll is not insured.

With regard to utilities, they are generally deducted below the line since they are usually not “directly consumed”.  Electricity used in the manufacturing process to run machinery (but not changing the chemical composition of the product) would not be “consumed”.  Likewise, natural gas used for running the boiler is not consumed in the product.

Natural gas acting as a raw material, such as in the manufacture of ammonia, would be deducted above the line.  Similarly, electric used to power electrodes in an electric arc furnace would be deducted above the line.  Demand charges would be a below the line deduction.

In summary, expenses deducted above the line are:

1. Sales Deductions to get to Net Sales Value of Production
2. Raw Materials
3. Supplied “directly” consumed
4. Purchased Services
5. Ordinary Payroll, if it is not insured