Understanding Business Interruption Insurance for Professional Services

J.C. TUTHILL: Hello, and welcome to the Professional Services Industry Podcast. I am J.C. Tuthill, Managing Director with Cherry Bekaert and its Forensic & Dispute Advisory Services team. Today we will address the importance of business interruption insurance coverage, how it works, and whether your business has adequate business interruption coverage and the process that should be followed in the event of a loss.

J.C. TUTHILL: I'm joined by Lori Smith, partner in the FDAS practice, and John Collier, Managing Director. Lori and John are both CPAs with combined experience in the forensic field of over 50 years, during which time they have assisted over 1,000 clients in calculating business interruption losses. Let me begin by welcoming Lori and John.

LORI SMITH: Glad to be with you, J.C.

JOHN COLLIER: Thanks for having us.

J.C. TUTHILL: John, please share with our listeners the most significant business interruption issue facing businesses resulting from natural disasters and other casualty losses like hurricanes.

JOHN COLLIER: Business interruption insurance is extremely complicated, and business leaders often misunderstand it. Among the most significant issues are either the lack of business interruption coverage or inadequate business interruption coverage, which can result in a company going out of business because it is underinsured and significantly impaired financially.

JOHN COLLIER: We therefore recommend that business leaders understand how business interruption coverage works.

J.C. TUTHILL: Lori, how does business interruption insurance define what insurance companies will pay claimants for their lost profits associated with a covered event?

LORI SMITH: Typical business interruption policies state that the insurance company will pay for the actual loss of business income that the business sustains due to the necessary suspension of its operations during the period of restoration.

LORI SMITH: Business interruption coverage is part of a business's property insurance. It is not triggered until there is a covered cause of loss, meaning a suspension of business operations caused by direct physical loss of or damage to the property at the premises described in the insurance policy where the suspension occurred.

LORI SMITH: Before a business can claim a business interruption loss, it must have experienced an insured loss, such as damage to an insured property under its insurance policy. If there is no claim for property damage or another provision of the policy that provides coverage, the business interruption coverage does not kick in.

J.C. TUTHILL: John, how can business leaders understand the business interruption insurance coverage that they have in place?

JOHN COLLIER: The first place they should look is the declarations page, generally in the front of an insurance policy. There they will find a summary of the business insurance coverage, including the types and dollar limits of the coverages.

JOHN COLLIER: The declarations page also lists the amounts of deductibles and waiting periods that may apply before the business interruption loss calculation can begin. Other important coverages and limitations that you may find include whether there is a coinsurance clause, which could limit the amount of a claim if the property covered under the policy is underinsured.

J.C. TUTHILL: Lori, who calculates the claimant's business interruption loss?

LORI SMITH: The insurance company will typically hire a forensic accounting firm to calculate a claim. The insurance company's forensic accounting firm does not represent the insured, so you should hire your own forensic accountant with experience in calculating business interruption losses to represent your interests and calculate your loss independently.

LORI SMITH: This process should begin prior to the insurance company's forensic accountants beginning their work to ensure that all facts and circumstances are identified to provide you with the maximum coverage offered within the insurance policy and that all attributable losses are considered in the calculation of the claim.

LORI SMITH: Collaborate closely with your forensic accountant to ensure that both of you are aware of all applicable provisions of the relevant insurance policy or policies and the facts in support of the claim to maximize the amount recoverable under the policy.

LORI SMITH: An important coverage that you may have is claims data coverage, which pays for the cost of your forensic accountants to compile your claim. Not all policies offer this coverage, and where possible it should be negotiated up front by your insurance agent before your policy is issued. Where claims data coverage is not available, your forensic accountant may seek and recover certain forensic accounting fees as part of what is known as extra expense coverage.

J.C. TUTHILL: John, can you explain what types of losses are generally covered by a business interruption insurance policy?

JOHN COLLIER: Lost profits are the types of losses typically covered. Lost profits are often defined in business interruption policies as the net profit or loss before income taxes that would have been earned but for the impact of the insured event, plus continuing normal operating expenses, including or excluding ordinary payroll depending on whether ordinary payroll is provided for in your policy.

JOHN COLLIER: These lost profits should not include revenues that would likely have been earned as a result of an increase in the volume of business due to favorable business conditions caused by the covered cause of loss.

JOHN COLLIER: Another method insurance companies use to calculate lost profits entails calculating lost revenues during the period of loss minus the non-recurring expenses, i.e., saved expenses, that do not continue during the period of loss.

J.C. TUTHILL: Do these two methods result in the same amount of lost profits?

JOHN COLLIER: If done properly, they should be the same.

J.C. TUTHILL: You mentioned ordinary payroll earlier. Can you explain what ordinary payroll coverage is and how it can impact the amount of a claim?

JOHN COLLIER: Ordinary payroll means payroll expenses for employees except officers, executives, department managers, and contract employees. Ordinary payroll coverage will pay the cost of employees who are not officers, executives, department managers, or contract employees if you want to keep them employed and paid during the period of loss.

J.C. TUTHILL: Lori, how does the insurance company determine the period of loss during which they will calculate the claimant's lost profits?

LORI SMITH: The period of loss is often stated in the declarations page and is based upon the policy provisions agreed between the business, the insurance agent, and the insurance company when the policy was issued. It typically comprises two periods: the initial period of restoration and an extended period of indemnity.

LORI SMITH: The initial period of restoration is often limited to a 12-month period that extends from the date of the physical loss or damage until the date the damaged property is restored or a limited number of months allowed by the policy, whichever occurs first.

LORI SMITH: The extended period of indemnity follows the initial period of restoration for an additional number of days allowed by the policy. It is often limited to a number of consecutive days, such as 60, 90, or 180 days. The purpose of the extended period of indemnity is to allow the business to return to its level of operations prior to the event, to reopen, and to ramp up operations.

J.C. TUTHILL: John, in addition to lost profits, insurance companies will pay what they refer to as extra expense. How does this coverage work?

JOHN COLLIER: Most business interruption policies will reimburse the claimant for extra expenses, defined as expenses the claimant incurred that were necessary to avoid or minimize the suspension of business during the period of restoration.

JOHN COLLIER: These are expenses that would not have otherwise been incurred had there been no loss at the described premises or temporary replacement premises. Examples include generators to keep power on at the premises and other expenses to keep the business running and mitigate the amount of the loss.

J.C. TUTHILL: Lori, what happens if there's no damage to property at the insured premises and thus coverage is not triggered, but the business cannot resume operations because of an official governmental action or civil authority that prevents returning to the insured premises?

LORI SMITH: This is an area we know well from our offices in downtown New Orleans during Hurricane Katrina. The city flooded, the government declared a state of emergency, and issued an action of civil authority that prevented access to described premises. In cases like this, many insurance policies provide civil authority coverage for a certain period, like 30 consecutive days.

J.C. TUTHILL: Do business interruption insurance policies cover lost profits due to utility failures?

JOHN COLLIER: In some cases they do, where coverages may apply to either on- or off-premises power failures. These are very technical and tricky coverages, so they must be carefully explored and defined within your policy to avoid coverage issues after a loss.

J.C. TUTHILL: Lori, can you explain what dependent property coverage is?

LORI SMITH: Dependent property coverage applies when a business sustains lost profits because another property is damaged. An example is a doctor's office incurring lost profits because the hospital where its doctors operate is closed due to a casualty.

LORI SMITH: This important coverage is often overlooked by businesses and their agents, and as a result they can incur uninsured losses.

J.C. TUTHILL: John, insurance policies are extremely complicated and often not clear-cut. How should businesses deal with that?

JOHN COLLIER: Read the defined terms and have the entire policy available, including all endorsements, riders, and exclusions. Endorsements and riders are legally binding changes that can add, modify, or exclude coverage, so identify and read them carefully.

JOHN COLLIER: Insurance policy exclusions specify which events or risks are not covered and can vary by policy and carrier.

J.C. TUTHILL: What advice do you have for listeners when they experience a business interruption from a fire, hurricane, tornado, or earthquake?

JOHN COLLIER: Take a proactive approach by working with your insurance agent and forensic accountants to understand your insurance needs and seek the best possible coverage before a loss occurs. When a loss occurs, immediately report it to your insurance agent so they can report it to your insurance company on your behalf.

JOHN COLLIER: Mitigate your losses and try to reduce the amount of loss to the extent possible. Engage forensic accountants to immediately begin assessing and calculating your claim and authorize them to work with your insurance adjuster and the insurance company's forensic accountants.

JOHN COLLIER: Cooperate with the insurance company adjuster in providing necessary information for your claim in coordination with your forensic accountants. Before answering questions from the insurance company, ensure you understand the implications of your answers so they are accurate and consistent with your insurance coverage. If in doubt, seek the advice of your agent, forensic accountants, and attorney.

JOHN COLLIER: Finally, file a proof of loss with the assistance of your agent, forensic accountants, and attorney as necessary.

J.C. TUTHILL: Thank you, Lori and John, for joining us, and thank you all for listening. If you have any questions about this episode, please feel free to reach out to us on our website, cbh.com.