Damage control

Many companies lose more than they should during a business interruption because they do not have sufficient or appropriate insurance coverage.

Loss due to fire, theft or flood, is something that can affect every company and is rarely seriously considered until it happens. As a result, insurance

Vancouver-based insurance claims specialist Paul McEwen says that many companies do not spend a great deal of time assessing their insurance needs. He adds that management often mistakenly thinks it can completely handle the claim preparation in-house. According to McEwen, a vice- president in PricewaterhouseCoopers' dispute analysis and investigations practice, these mistakes are costing companies a lot of money. "Insufficient insurance can cut a claim in half or even worse, making the payment a third or an eighth of the claimed amount," says McEwen.

When loss or a business interruption occurs, it's important for businesses to get their insurance claim processed as quickly as possible and resume their day-to-day business. There are some steps that companies can take to ensure this happens. McEwen says many companies purchase insurance when they start up but do not raise the insurance coverage sufficiently as the business grows. This creates a situation called under- insurance and may trigger "co-insurance" penalties.

"Companies are in a co-insurance situation in many of the business interruption claims that we see. It can be the result of significant growth by the company, before or after the interruption, or a lack of attention and understanding of the mechanics of how coverage needs should be calculated," says McEwen.

In the event of loss or business interruption, companies that are under- insured are only reimbursed pro-rata. This means that, subject to some technical adjustments, the company will only be reimbursed for the percentage of coverage it bought. As a simplified example, if your company needs insurance coverage for $1 million but you only bought coverage for $300,000, you will be reimbursed for 30% of your claim. This is because you only had 30% of the coverage you should have had.

"The pro-rata calculation is in place so that you and the insurance company share the risk. It is called co-insurance because the two of you are involved," says McEwen. "Co-insurance can often cut the claim in half or worse. I've seen it happen many times."

McEwen says it's important for businesses to spend time assessing their insurance needs long before loss occurs to ensure they have sufficient coverage. He says it's important to analyze the business and financial statements, paying particular attention to the industry and marketplace of the business. "One of the things companies need to consider when assessing their insurance needs is the length of the loss period that will be covered and how you want payroll costs to be treated."

According to McEwen, there are two basic types of business interruption insurance policies, and each covers a different basic loss period. With an "earnings" policy, your business interruption loss is covered only until the physical damage to your premises is repaired. With a "profits" policy, the loss period extends to the date when your sales return to the level that they would have been if a flood, fire or theft had not occurred.

"If your business is one where you might have to rebuild your customer base over a prolonged period after a fire, you should consider getting a "profits" policy. On the other hand, if your business is similar to a gas station, where most customers would quickly return once the business re-opened, an "earnings" policy might be better," says McEwen.

Another area of business interruption insurance that can cause confusion is the handling of payroll costs in an insurance claim. "The amount and type of coverage available for labour costs varies quite a bit so companies should know what they're getting," says McEwen. "Coverage options for payroll costs during an interruption vary from full coverage to limited coverage to no coverage at all."

After or during a business interruption, companies may have to decide whether to keep employees on the payroll while repairs are done. "In some industries or businesses, it may be critical to the long-term success of the business to retain skilled labourers," McEwen adds. "As a business operator, you need to consider how your insurance stacks up against those long-term needs."

In addition to ensuring your business has sufficient coverage before a loss, it's equally important to carefully prepare the claim after a loss. McEwen says the careful preparation of a claim can even result in an advance payment from the insurance company. According to McEwen, it's important to prepare the claim using the proper terminology and sufficient business analysis. The insurance company will have an easier time honouring the claim if the calculations of the loss include the same categories and sections of the insurance policy. "I find that many companies will say 'this is how much I've lost.' They may be right in terms of the economic reality, but if the loss is not expressed in the same sort of code language of the insurance policy, it can create delays and possibly impediments to settlement."

The second thing businesses should do in preparing their claim is to ensure a thorough business analysis is done. McEwen says claims preparation is often erroneously viewed as merely an accounting exercise. "Many insurance policy holders project the loss based on simple arithmetic additions and averages of the last three months. Rarely do owners go to the business drivers of the organization and pull together details of the nature and number of sales and product-specific information to support their case for why the last three months are reasonable."

Because of the need for analysis and a thorough understanding of insurance issues, it often makes sense for companies to hire an insurance claims accountant - especially when the fees for an insurance accountant are often covered in many insurance policies. "There's this perception that your company has a whole team of accountants and that accounting is just adding up the numbers," says McEwen. "Often people don't realize that the area of insurance claims accounting and business interruption insurance has lots of technical wording and requirements. It's a lot more than simply going to the ledger and doing an average of three months of sales and banging off a claim calculation."

An insurance claim accountant with a strong knowledge of insurance issues can piece together and analyze the available evidence and review all relevant information to establish the reasonableness of a claim. The type of evidence sought will depend on the nature of the claim, but may include the following:

- Financial, marketing and manufacturing data from before, during and after the claim period;

- Budgets and forecasts;

- Production data which will provide a means of establishing a claimant's capacity, productivity, stock and production costs; and

- Correspondence with suppliers, customers, banks and solicitors.

For overall guidance with the actual negotiations and resolution of any coverage questions, it is important to rely on your corporate insurance department.

Many companies lose more than they should during a business interruption because they do not have sufficient or appropriate insurance coverage.

One of the things companies need to consider when assessing their insurance needs is the length of the loss period that will be covered and how you want payroll costs to be treated.

Insufficient insurance can cut a claim in half or even worse, making the payment a third or an eighth of the claimed amount.