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Understanding a Business Interruption Claim

By Robert Glasser, Managing Director, Berkeley Research Group LLC

Robert Glasser, Managing Director, Berkeley Research Group LLC

With hurricane season beginning on June 1st, it is time for businesses to prepare for the devastating damages that can result from these natural disasters. We discussed in Part 1 the necessity to have current and accurate values in your property policy. As hurricanes become an increasing threat, early preparation has never been a higher priority to understand how to prepare for a business interruption loss.

Most financial and risk managers are comfortable understanding and purchasing their property and liability insurance needs to protect their companies from a loss due to an insured peril. However, I have found that their comfort level drops dramatically when understanding how a business interruption claim is prepared. This discomfort and unsurety surrounding business interruption coverage, extensions of coverage and claim measurement methodology result in many organizations finding themselves uncomfortable with the claim preparation and settlement process.

Unexpected occurrences can happen to any business; whether the event is a hurricane, flood, earthquake, or fire, the disaster can be catastrophic. A catastrophic event can shut a business down for an extended period of time, dramatically affecting a company’s ability to generate future profits and pay employee wages.

Property Claims after a Disaster

The property loss aspect of a disaster is most likely where a company will incur an immediate outflow of cash. The restoration process for an impacted facility requires immediate attention, whether it is removing flooded property, or drying a building to avoid mold issues. Having an insurance company’s adjuster assess damage in the immediate days following a loss can help a business obtain estimates from restoration companies more quickly to begin remediation work and more importantly, consider providing an interim cash advance.

A business interruption claim for lost profits takes a fairly lengthy time to prepare and settle because lost profits cannot be determined until actual profits or losses during a period of interruption are quantified. Insureds can benefit from having an experienced forensic accountant included with their team of professionals during a loss to start calculating pro forma revenues and loss of profits as soon as possible. Pro forma revenues are projected revenues the company would have earned “but for” the loss. The forensic accountant will take the pro form revenue and subtract the actual revenue during the period of interruption to derive the “lost revenue”. Additional calculations are prepared to ultimately determine the estimated lost profits, which will be the amount of the business interruption claim submitted to the insurance company. This process, however, can be one of the most challenging and complex coverage areas for insureds.

Protection against a Business Interruption Loss

Business interruption insurance is a primary form of insurance that protects against disruption of operations and resulting lost profits, however, there are other extensions of coverage available. Extended Period of Interruption (“EPI”), is to protect a company against losses that extend past the actual period of interruption. EPI provides coverage for lost profits during the “ramp up period” following physical restoration and until a business is back to operating at pre-loss levels. Contingent Business Interruption (“CBI”) coverage can enable the business to recoup lost profits as a result of property damage at a supplier, customer or feeder property even though your property did not incur damage. If you have hourly skilled labor that you cannot afford to lose during a shutdown, Ordinary Payroll Coverage will allow you to pay workers while shutting down for a period of time you purchase coverage for, normally from 30, 60 to 365 days.

An important extension of coverage is claim preparation fee coverage which enables you to hire a forensic accountant to help prepare and present a claim to the insurance company. With this coverage, the fees incurred for the work preparing the claim can be included in the claim submitted.

Conclusion

It is important for management to understand the ramifications of a catastrophic event affecting their business now that we are in hurricane season. Management must develop and quickly effectuate alternative suppliers, manufacturing operations, warehousing, distribution, technology and other operational components to get back on their feet with minimal disruption to their operations.

Management should closely examine with their brokers how their coverage will react after a catastrophic loss in order to make them financially whole. The critical takeaway is that insurance may not make your company whole in every loss scenario; however, it can be one of your most valuable assets providing the critical working capital needed to survive during a catastrophic event

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