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Are You Prepared?

Please note: We are not in the business of providing risk analysis or brokering insurance. This article is intended to assist our clients improve the value of their businesses.  The focus of this article will be on casualty insurance (business interruption, inventory and property coverage).

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by Patrick DeLangis, Senior Project Analyst.

·        Advance Payments:  Immediately after a loss, most businesses need access to cash to replenish the damaged stock, relocate to another facility, or cover payroll and payroll taxes.  Just because you had a disaster does not mean your customers will wait for the product they ordered, or require a new landlord to forgo typical deposits or first and last month’s rent, or for your vendors on C.O.D. to change their terms.  The IRS will not look kindly on a business using the employee withholdings to save the company from going out of business.  (Note: Employee withholdings are trust funds that allow the IRS to collect the bill from the owners of the business when the business is in default). 

Does your insurance company advance monies in a loss situation?  Insurance companies have their own policies relating to this sticky subject.  Some of the insurance companies leave this to the discretion of the adjuster.  However, insurance companies do not typically move quickly to give you money.  You can equate them to the cumbersome bureaucracy in our government.  As a general rule, do not anticipate receiving any money from the insurance company within three months of a large loss.

 

·        Business Interruption Insurance:  This coverage allows a business to insure its operations.  When a covered loss occurs, business interruption insurance will typically cover the loss of income as a result of the interruption.  Your policy will state how a business interruption loss is to be calculated.  There are two basic methodologies in use: net income plus continuing expenses and gross profit less non-continuing expenses, both should result in the same loss calculation.  Despite your insurance contract stating the method to be used, it is not “black and white.”  Identifying continuing expenses, projecting what your sales would have been had the loss not occurred and taking any unusual circumstances into account are only a few of the subjective issues in an insurance claim.

There are medium-sized certified public accounting firms that offer their services only to insurance companies for the calculation of insurance claims.  In all likelihood, if you have a large business interruption claim, the insurance company will bring in an accountant to assist in the calculation of your claim due to all the accounting and complex financial issues that can arise.

The basic process to a business interruption claim is as follows: An insurance adjuster is typically required to set a “reserve” for every loss.  This reserve identifies approximately how much the adjuster estimates the loss to be, because, by law, insurance companies are required to set aside an appropriate amount of money to pay for your loss.  To set this reserve, the adjuster will need some preliminary financial information from you fairly soon after the loss.  If the loss is expected to be several months, the adjuster and his or her experts will attempt to project the loss over the estimated “period of restoration.”  The period of restoration is the time period to reasonably replace or repair the damaged property to return to business.  The insurance company will typically not pay beyond their period of restoration due to construction delays on the part of the landlord or other issues outside their control (see your policy).  Some insurance companies will negotiate with you using their projected loss calculation to be able to close their files before the restoration is completed or to have most issues agreed upon early on in the claims process.

If there is disagreement between you and the insurance company as to the value calculated, usually the adjuster attempts to work with you as best possible.  If the two of you cannot agree, then arbitration or litigation are options.  Be sure to document everything clearly in an insurance matter in case you end up in litigation.  Typically large insurance claims take several months, longer when in litigation, and the adjuster is required to maintain a log of all contact and decisions on your file.  To have a strong case, you should also maintain a log.  Take care with what you write in the log, as they are typically discoverable (meaning the insurance company can request a copy when in litigation that can later be shown to a judge, jury or arbitrator).

 

·        Inventory:  Sometimes an inventory loss is very straightforward, but sometimes the damage creating the inventory loss creates a loss of records, such as a fire, turning a straightforward inventory loss into your worst nightmare.  Do you maintain any records offsite?  Do you back up your computer data regularly and maintain a copy offsite?  When you have a loss, your insurance contract says you have to provide documentation to help prove the loss.

When you have an inventory loss in which most of your records are destroyed, the insurance company will attempt an inventory roll-forward.  This means they will use the last documented physical inventory available, add all purchases since that date and subtract all sales since that same date, to arrive at the inventory that would be expected to be on site at the date of the loss.  Other adjustments might be necessary for theft and other factors depending on the industry.  For the insurance company to perform this calculation, at a minimum, they will need total purchases of inventory during this time period and total sales of inventory during the same time period.  Can you imagine contacting all your vendors and customers requesting copies of any of your sales or purchase invoices they may have for an entire year, or longer?

Also, the insurance company may hire outside experts to attempt to identify the quantity of items that may have existed at the loss date.  You would be amazed at the ways they can do this, depending on the circumstances.  This count can be compared to the inventory roll-forward for verification.

Don’t think that the obsolete inventory you had sitting in the corner will be overlooked.  Obsolete and slow moving inventory is something the adjuster and other experts are trained to look for.

 

·        Employee Wages:  What happens to your employees when a disaster strikes and shuts down your business?  Do you have to continue to pay them? Will the insurance company pay this bill?  Most policies will consider reimbursing you for the salaries of “key employees.”  You may need to justify to the insurance adjuster why employees other than the top executive group are key employees to obtain reimbursement for them.  In today’s tight labor market, this will leave you vulnerable to employees looking for other employment.  Additional coverage may be available to reimburse your company for all your payroll expense.  (Please note: the term “Reimburse” is used here because the insurance company does not technically owe you money before you incur the debt.  So, typically, you must first pay the bill, then the insurance company will reimburse your company).

Another aspect of employee wages is whether or not the insurance company will pay for their time while your employees clean up after the disaster.  This area of insurance is not a “black and white” issue.  If you have appropriate coverage, almost all insurance companies will pay for a third party to come in and clean up but they may not pay for your employees to do the clean up.  Before having your employees clean up after a disaster, talk with your adjuster to be sure you will be reimbursed.

 

·        Coinsurance:  Coinsurance is a condition used in many policies that penalizes you if you do not insure your property to 100% of its value.  Coinsurance may apply to business interruption losses, inventory losses and property of others.  You can determine if you have coinsurance by reviewing your Declarations page of your policy or contacting your broker.

If you have 100% coinsurance clause on your inventory and you have a covered loss, regardless of size, the insurance company may determine the total value of your inventory immediately preceding the loss.  They will then compare that amount to the amount reported on your insurance policy.  If the total value before the loss exceeds the amount reported on the policy, you will only collect a portion of your loss.  In this example, the collectible portion of your loss is calculated by dividing the amount on your policy by the amount immediately preceding the loss.

Many policies for small to medium sized business contain coinsurance clauses.  This allows the company to obtain a lower premium.  If your policy contains coinsurance, be aware of it and constantly evaluate whether the limits on your policy are enough coverage.

 

·        Rent Expense Coverage:  Does your lease contract have a rent abatement clause?  A rent abatement clause typically says that if the premises are destroyed or left inhabitable, then you do not have to continue paying rent.  Typically your landlord has insurance on the facility you are renting and she or he is responsible for rebuilding the facility.  If your lease does not contain this clause your landlord has no incentive to rebuild, as he is still guaranteed rent while you are left out in the rain.  Your business interruption insurance will typically pay your rent expense, but only during the period of restoration.  If your landlord does not rebuild in a reasonable period of time, you may have to continue paying rent on an unusable facility.

 

·        Property of Others:  Do you store any goods on consignment? Do you own or lease everything on your premises? If not, you may want to check into insurance to cover property that does not belong to you.  Most standard commercial policies will cover a nominal amount for property of others, such as $2,000.  If you sell goods on consignment or repair customers’ equipment at your facility, this will not likely be enough.  Property of others requires an additional premium to obtain appropriate coverage.  Talk with your broker to see if you have sufficient coverage.  Keep an eye out for coinsurance on this policy.