Final answer:
The main difference between the Earnings and Profits approaches in business interruption insurance is that the Earnings approach uses only explicit costs, analogous to accounting profit, while the Profits approach includes both explicit and implicit costs, akin to economic profit. These differences are fundamental in measuring a business's actual interruption loss and its economic performance.
Step-by-step explanation:
The two main types of business interruption insurance, using the Earnings approach and the Profits approach, have significant differences in how they calculate losses due to business interruption. The Earnings approach focuses on the actual loss of income, considering only explicit costs - these are the out-of-pocket expenses that a business pays, resembling the concept of accounting profit which is total revenue minus explicit costs. On the other hand, the Profits approach includes both explicit and implicit costs, taking into account the opportunity costs of what the business is not able to do because of the interruption, similar to the economic profit calculation, which is total revenue minus both explicit and implicit costs.
This distinction is essential since accounting profit reflects the cash flow and is used for income tax purposes, whereas economic profit reflects the actual economic performance of a company. Moreover, insurance companies need to manage their income, which comes from insurance premiums and investment income, by investing in liquid assets to ensure funds are available when needed to cover insurance claims.