The Benefits of Managed IT Services

HOST: Welcome to The Drawdown, a podcast by Cherry Bekaert's Private Equity Practice. In each episode, we explore the latest trends in the private equity sector as well as challenges and opportunities in the ever-changing investment environment.

J.C. TUTHILL: Hello and welcome to The Drawdown. I am J.C. Tuthill, managing director with Cherry Bekaert in its Forensic & Dispute Advisory Services team.

J.C. TUTHILL: Today we will address the importance of business interruption insurance coverage, how it works, whether your portfolio companies have adequate business interruption coverage, and the process that should be followed in the event of a loss.

J.C. TUTHILL: Business interruption coverage can cover losses resulting from weather events such as hurricanes, tornadoes, fires, and earthquakes, as well as other types of business interruption such as power outages or actions by civil authority. There are other specific coverages that may include cyber attacks or pandemics, but those are the subject of another Drawdown.

J.C. TUTHILL: I'm joined today by Lori Smith, partner in the FD practice, and John Collier, managing director. Lori and John are both CPAs with combined experience in the forensic field of over 50 years. Lori and John, welcome.

LORI SMITH: It's good to be with you, JC. Thank you for having us.

J.C. TUTHILL: John, let me start with you. 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 and portfolio managers often misunderstand it. Among the most significant issues are either the lack of business interruption coverage or inadequate coverage, which can result in a company going out of business because they're underinsured and financially impaired.

JOHN COLLIER: We recommend that business leaders, including private equity portfolio managers, understand how business interruption insurance coverage works.

J.C. TUTHILL: Lori, can you share with our listeners how business interruption insurance defines what insurance companies will pay claimants for, for their lost profits associated with a covered event?

LORI SMITH: Typically a business interruption policy states 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: It's important to understand that business interruption coverage is part of a business's property insurance policy and is not triggered until there's a covered cause of loss. A covered cause of loss is a suspension of business operations caused by direct physical loss of or damage to property at the premises described in the policy.

LORI SMITH: What this means is that a business cannot claim a business interruption loss unless it has experienced an insured loss, such as damage to its insured property under its policy. If there is no claim for property damage or another policy provision that provides coverage, the business interruption coverage does not kick in.

J.C. TUTHILL: John, how can business leaders and portfolio managers understand the business interruption insurance coverage they have in place, either at the fund level or within their portfolio companies?

JOHN COLLIER: The first place to look is the declaration page, which is generally in the front of an insurance policy. It contains a summary of the business insurance coverage, including the types and dollar limits of coverages.

JOHN COLLIER: You also find the amounts of deductibles and waiting periods that may apply before the business interruption loss calculation can begin. Other important coverages and limitations on the declaration page include whether there is a co-insurance clause, which could limit the amount of a claim if the property is underinsured.

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

LORI SMITH: The insurance company will typically hire a forensic accounting firm to calculate a claim. Be sure to keep in mind that the insurance company's forensic accountant does not represent your fund or your portfolio company as the insured.

LORI SMITH: You should hire your own forensic accountant with experience in calculating business interruption losses to represent your interest and calculate your loss independently. This process should begin before the insurance company's forensic accountant begins work to ensure all facts and circumstances are identified and that all attributable losses are considered in the calculation.

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

LORI SMITH: An important coverage you may have is claims data coverage, which pays for the cost of your forensic accountant to compile your claim. Not all policies offer this, and where possible it should be negotiated upfront by your insurance agent before the policy is issued.

LORI SMITH: Where claims data coverage is not available, your forensic accountant may seek and recover certain 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 often defined in business interruption policies as the net profit or loss before income taxes that would have been earned except for the impact of the insured event, plus continued normal operating expenses. This may include or exclude ordinary payroll, depending on the policy.

JOHN COLLIER: These lost profits should not include revenues that would have been earned as a result of an increase in the business caused by the covered loss. Another method used by insurers calculates lost profit as lost revenues during the period of loss minus nonrecurring expenses, which are called saved expenses.

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

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

J.C. TUTHILL: John, you mentioned ordinary payroll earlier. Please 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 for officers, executives, department managers, and contract employees. Ordinary payroll coverage pays the cost of employees other than those excluded if the company wants 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 a claimant's lost profits?

LORI SMITH: The period of loss is often stated in the policy declaration page and is based on policy provisions agreed upon between the business's insurance agent and the insurer when the policy was issued. It is typically comprised of two periods: the initial period of restoration and an extended period of indemnity.

LORI SMITH: The initial period of restoration is often limited to 12 months from the date of the physical loss or damage until the date the 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 for an additional number of days allowed by the policy. Its purpose is to allow the business to return to its pre-loss level of operations, to get its doors open, and to ramp up operations.

J.C. TUTHILL: John, in addition to lost profits, let's talk about extra expenses. Can you explain how that coverage works?

JOHN COLLIER: Most business interruption policies will reimburse the claimant for extra expenses, which are expenses incurred to avoid or minimize the suspension of business during the period of restoration. These are expenses that would not have been incurred but for the loss at the described premises or a temporary replacement premises.

JOHN COLLIER: Examples include renting generators to keep power on or other expenses to keep the business running and mitigate 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 government action or civil authority that prevents access?

LORI SMITH: This is an area we know well because our offices are in downtown New Orleans. During Hurricane Katrina, the city flooded, the government declared a state of emergency, and issued a civil authority order that prevented access to premises.

LORI SMITH: In cases like this, many policies provide civil authority coverage for a certain period, often 30 consecutive days.

J.C. TUTHILL: John, do business interruption policies cover lost profits due to utility failures?

JOHN COLLIER: In some cases, yes. Coverage may apply to on-premises or off-premises power failures. These are very technical and tricky coverages, so they must be carefully explored and defined in the policy to avoid post-loss coverage issues.

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. For example, a doctor's office may incur lost profits because a hospital where the doctor operates is closed due to a casualty.

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

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

JOHN COLLIER: It's important to read the defined terms and have the entire policy available, including all endorsements, riders, and exclusions. These are legally binding changes that can add, modify, or exclude coverage.

JOHN COLLIER: Identify and read these areas carefully, as the coverage you think you have may not be the coverage you actually have when riders, endorsements, and exclusions are considered.

J.C. TUTHILL: John, what steps should our listeners take when one of their companies has a business interruption, whether due to fire, hurricane, tornado, or earthquake?

JOHN COLLIER: First, take a proactive approach by working with your insurance agent and your forensic accountants to understand your insurance needs and seek the best coverage before a loss occurs.

JOHN COLLIER: When a loss occurs, immediately report it to your insurance agent so they can notify the insurance company. Mitigate your losses and minimize downtime and lost revenue.

JOHN COLLIER: Engage forensic accountants immediately to assess and calculate the claim, and authorize them to work with the insurance adjuster and the insurer's forensic accountants. Company management should cooperate with the insurer and provide necessary information in coordination with their forensic accountants.

JOHN COLLIER: Before management answers questions from the insurance company, they must understand the implications of their answers so they will be accurate and consistent with the insurance coverage. If in doubt, seek advice from your agent, forensic accountants, and counsel.

JOHN COLLIER: Finally, file a proof of loss with the assistance of this team. Your agent, forensic accountants, and attorney will help you through the process as necessary.

J.C. TUTHILL: Thank you, John. Those steps are helpful. This concludes our episode. Thank you, Lori and John, for joining us, and thank you all for listening.

J.C. TUTHILL: If you have questions about this episode, please feel free to reach out to us on our website, cb.com.

HOST: Thank you for listening to The Drawdown, Cherry Bekaert's Private Equity Podcast. The views presented by our guests do not necessarily represent the views of their respective firms. For more information on how Cherry Bekaert serves as a guide forward to private equity funds and their portfolio companies through accounting, tax, and advisory services, please visit cb.com.

[Music]