A LOSS ADJSUTER’S PERSPECTIVE….
Business interruption losses are less tangible than direct physical losses. An adjuster must understand both the nature of the loss and the specifics of the business before determining how to document the loss. This article provides practical tips for examining a business interruption loss and seeking an equitable settlement.
Step 1: Understand the coverage
You’ll need a solid understanding of the coverage so you can determine the compensable period of loss (indemnity period), the insured charges and expenses, the appropriate treatment of payroll costs, and the application of coinsurance provisions.
Two forms of business interruption coverage are widely used in Canada, both as endorsements to the property policy: the Profits form and the Gross Earnings form. Both provide coverage for loss resulting from a reduction in sales and loss resulting from an increase in costs (to avoid a reduction in sales). Once you’re familiar with the standard wordings, variations are easy to spot.
Step 2: Understand the business
Business interruption loss calculations require a projection of the sales (the turnover or revenue) that would have been possible if the damage had not occurred. Questions to consider include:
• What is the legal form of the operation -sole proprietorship, partnership, joint venture, corporation?
• How is the business organized? One location or many? Segregated departments or linked?
• Are there key success factors, limitations, production bottlenecks, essential personnel or suppliers?
• What’s the impact of the overall business environment -regulation, competitors, other external events?
The insured is in the best position to educate you about both the business and the industry in general. At the same time, independent research can uncover information that will help you put the claim into context and evaluate representations made by the insured.
Step 3: Identify the cause of damage and expected impact
Business interruption coverage compensates the insured for business losses resulting from insured direct damage to property. To pinpoint which losses flow from the damage, you may need to call on independent experts to help review the cause of loss, estimate repair costs, or estimate the restoration period.
Step 4: Help the insured recover quickly
As an adjuster, you deal with disastrous events on a regular basis. Your experience can help the insured to minimize business interruption losses. Here’s how:
• Consider requests for interim payments against covered losses, to help finance restoration and encourage speedy recovery of operations.
• Offer advice to help the insured generate a recovery plan (you might propose rental of generators, a source of equipment, a temporary location, etc.).
• Keep track of contractors’ progress to prevent undue delays.
Step 5: Estimate the required reserve
The insurer may engage an investigative or forensic accountant to help calculate losses, but may also require a preliminary estimate of the losses in advance of the detailed work, in order to set an appropriate reserve.
Before establishing a reserve, gather as much information as possible from the insured to document the basis for the estimate. If the reserve needs to be increased later, it will be easier to justify the change if your notes and reports concerning the preliminary estimate are clear. In some cases, losses may not be evident until they are incurred and you may have to wait until the indemnity period has ended before accurate numbers are available.
Step 6: Gather financial records
Even if a forensic accountant is involved in dealing with the claim, you’ll need to understand the evidence gathered.
Basic documentation generally includes the following:
• Recent historical operating statements (referred to as profit and loss, statement of operations, or income statement)
• Forecasts (budgets) for future operating results
• Sales records and significant contracts with customers or suppliers
• Production records
• Details of equipment maintenance programs
• Payroll records
• Invoices for additional expenses
All parties in the claims process will need to cooperate to identify the most appropriate records in support of each item claimed.
Step 7: Examine the business outlook
The insured’s business outlook and environment also affect the operating results that would have been achieved. Assessing the business environment includes investigating the activities of competitors, regulatory bodies, suppliers, and customers. For example:
• Has a new competitor been eroding the insured’s market share?
• Have regulations been tightened or eased in ways that hamper or enhance productivity?
• Has a major supplier gone out of business, causing a shortage of raw materials?
• Have the insured’s customers been decreasing their orders in favour of internal production?
Step 8: Calculate the loss
Since your role as a loss adjuster is to make recommendations to the insurer, you must assess the loss calculations, whether they are presented by the insured, the insured’s expert, or an expert retained by the insurer. Here’s a basic framework for calculating losses under the standard Profits and Gross Earnings wordings.
- Calculate the insurable values using the profit and loss statement for the most recent financial year, adjusted to reflect the results that would have been obtained without the insured incident.
Determine the rate of contribution using the insurable values as a percentage of sales.
Calculate the rate of recovery by comparing the insurance in force with the minimum coverage required (determined by applying the specified coinsurance percentage to the insurable values).
Determine the loss of sales during the indemnity period as a direct result of the damage. The sales loss is the difference between the projected sales and the actual sales.
Calculate the lost contribution by applying the rate of contribution to the sales loss.
Accumulate the additional expenses necessarily incurred to mitigate the sales loss. Compare these expenses to the avoided loss by applying the rate of contribution to the avoided sales loss (economic test).
Deduct the savings in insured standing charges or non-continuing expenses.
Calculate the loss related to ordinary payroll if separate coverage applies.
Apply the rate of recovery to losses where a coinsurance clause applies.
Determine the amount recoverable subject to the policy limits and not in excess of the actual loss sustained. Consider any waiting periods and deductibles that may apply.
For an example of this calculation, see the upcoming October/November issue of Claims Canada.
Step 9: Examine related coverage
Since business interruption coverage is typically an endorsement to property coverage, the entire policy should be reviewed for related coverage to ensure appropriate classification of losses. Claims submitted under related coverages for the same loss event should be reviewed to ensure that items are not claimed twice under different coverages.
Extra expense coverage may be available for expenses incurred that do not meet the economic test associated with the additional expense coverage in the business interruption policy.
Step 10: Settle the claim
Business interruption loss calculations are estimated based on projected results in response to the question, "What if the damage had not occurred?" It is not possible to determine such losses with precision; they will almost always be subject to negotiated settlement. You’ll need to manage the competing interests during these negotiations and make every effort to ensure a timely and equitable settlement.
Every loss adjuster knows that no two claims are alike, and business interruption losses are no exception. However, these 10 steps can provide a framework for approaching the settlement process.
This article is based on excerpts from the study material in the Claims Professional Series of applied courses -a core of the CIP Program that helps adjusters learn the functional knowledge and skills required of their profession.