Business Interruption Losses from Hurricane Harvey Have Started: Billions of Dollars of Insurance Claims Expected

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1 Business Interruption Losses from Hurricane Harvey Have Started: Billions of Dollars of Insurance Claims Expected BY SCOTT A. BARNES, CPA, CFF, CGMA specializes in assisting policyholders in developing and measuring their business interruption losses and building a defensible claim. The ongoing destruction and damage ongoing on the Texas Gulf Coast being inflicted by Hurricane Harvey will lead to billions in business interruption losses and the incurrence of extra expenses to get businesses back to normal operations. The path to normalcy will not be quick, considering the scale of the damage and flooding being experienced. The damage will impact every segment of a business supply chain, distribution capability and the ability to mitigate damages as required under a policy. Expert assistance in the measurement of these types of complex losses is required. Following a commercial property loss, policyholders, brokers, and insurers are often confused by the extent to which business interruption insurance will respond to their loss. Generally, there are three types of business interruption insurance typically encountered: Ø "Business interruption" insurance is intended to compensate the insured for the income lost during the period of restoration or the time necessary to repair or restore the physical damage to the covered property. Ø "Extended business interruption" provides coverage, typically limited by a period of time, for the income lost after the property is repaired but before the income returns to its pre-loss level. Ø "Contingent business interruption" provides coverage for the insured's loss of income resulting from physical damage, not to its property, but to the property of providers or suppliers on the one hand or consumers of its product or services on the other. The process to measuring the business interruption loss can be complex and time consuming and requires the insured and their advising brokers to maintain documentation and provide a defensible basis for the business interruption loss. The courts look to the language of the insurance policy in settling litigated

2 disputes over covered claims. The business interruption measurement process is generally a two-step process. Document Your Losses and Additional Costs Due to the Interruption First, the policyholder will need to document its casualty losses and the additional costs incurred due to the disruption from Hurricane Harvey. These losses include damage to facilities, equipment, inventories, materials and any other assets; possibly the cost of a temporary location and associated moving costs (both ways), and a detailed account of all actual and projected expenses, paying special attention to extraordinary expense items that were solely incurred as a result of the business interruption event. Establish Your Lost Income Attributable to the Interruption Second, the policyholder will need to provide a reasonable and credible estimate of what your lost profits from the business interruption were specifically due to the interruption caused by Hurricane Harvey and its aftermath. For this, the insured should engage an experienced expert witness consultant who can prepare a reasonable and credible projection, and who can provide testimony at deposition and trial if necessary. Generally, the business interruption insurance policy will provide for the recovery of third-party expert fees associated in building and measuring the claim. Business Interruption Losses Have Already Started on the Texas Gulf Coast A Checklist of Action Items Following is a general check list of issues that each policyholder and advising broker and legal counsel should start immediately: 1. Review Your Insurance Policy for the Types of Coverage Available and Contact Your Insurance Broker Business-interruption insurance includes a number of coverages, including the following: A. Business Income Coverage. Designed to replace income that would otherwise have been earned by the business had no loss occurred. Business income is generally defined as the net profit or loss before taxes, plus continuing normal operating expenses, including payroll. This insurance definition contrasts with the accounting definition of net profit (or loss), which is the net profit after taxes. 2

3 B. Extra Expense Coverage. Designed to pay for necessary expenses incurred during the period of restoration of the property because of the loss or damage to property at its original location, or at a temporary replacement location. Extra expense coverage may also include expenses that minimize the time your business is unable to operate or those necessary to repair or replace damaged property or valuable papers and records. C. Contingent Business Interruption Coverage. Designed as an extension of coverage to cover loss of income incurred due to a property loss at key supplier or customer location. D. Civil Authority Coverage. Covers loss of business income and extra expense for a short time due to government s denial of access to property, due to a covered loss at a location owned by others. A waiting period may apply. E. Ingress/Egress Coverage. Coverage may be provided for loss of business income and extra expense when you cannot gain access to your property for a reason other than government action. F. Miscellaneous Related Coverages. May include dust and debris removal coverage, event-cancellation coverage, valuable-papers coverage, and service-interruption coverage. 2. Give Notice of Loss Immediately A. An alleged delay in giving notice may void coverage. Give notice as soon as possible to avoid notice as a defense to coverage. B. Other documentation can be submitted as soon as feasible to do so. 3. Engage an Expert Accountant Experienced in Measurement of Business Interruption Losses A. Insurance coverage is intended to compensate the insured for the full loss available under the policy. Expert fees are generally a recoverable expense. Insurance companies will critically attack and attempt to deny a claim that is not properly documented. 3

4 4. Start the Process to Calculate the Business Interruption Loss A. Identify the operation affected (office, store, restaurant, plant)? B. Is there interdependency with other operations? C. Is production or operations partially or totally down? D. Are sales affected? Partially? Totally? E. How long will the insured need to continue paying salaried employees until the business is restored? Can they assist with restoration of the premises and business operation? F. Is the supply chain of critical inputs disrupted and what is the estimated time frame of the supply chain disruption? G. Is there any seasonality associated with operations at the current time that need to be considered? H. Has there been destruction of critical computer facilities, networks and third-party providers limiting access to operation data and backups? I. Document everything and build the backup for every identified loss and impact of loss. J. Implement work orders or establish specific general ledger accounts in the accounting system to accumulate loss-related charges. Business interruption accounts should be established for: a Expediting costs on repairs, such as: i. Temporary repairs; ii. Incremental repair costs for fast track; and iii. Incremental freight for faster than normal delivery of repair items. b. Incremental costs for alternative production, such as: i. Temporary facilities; ii. Higher costs of production using alternative methods or facilities; iii. Extra freight; and iv. Premium paid for higher cost of material on subcontracted work. K. Obtain copies of company accounting records and documents related to the business interruption, including, but not limited to: a Production records for the base period, the period during the loss and the period after the loss; 4

5 5. Mitigation and Recovery b Sales records for the base period, the period during the loss and the period after the loss ; c Inventory records for the base period, the period during the loss and the period after the loss; d Tax returns; e Sales tax returns; f Budgets and short-term projections; g Production schedules; h Financial statements; i Cost accounting records j Other statistical or internal records; k Bank statements; and l Payroll records for the base period, the period during the loss and the period after the loss. A. Insurance policies generally require a policyholder to mitigate its losses. Some of the common questions related to the ability to mitigate are as follows: Ø Identify the operation affected (office, store, restaurant, plant)? Ø Is there interdependency with other operations? Ø Is production partially or totally down? Ø Can operations or production be transferred to a facility unaffected by the damage? Ø Are their expenses that can be avoided while operations are down? Ø Are sales affected? Partially? Totally? Ø How long will you need to continue paying salaried employees until the business is restored? Can they assist with restoration of the premises and business operation? B. Maintain thorough records of costs incurred to mitigate and reduce the loss. a. Expediting expenses: expenses that are necessarily incurred for the purpose of reducing the loss. They may shorten the indemnity period or be necessary to continue the business, but generally at higher costs, such as: 5

6 i. Premium portion of overtime (that is, the additional cost incurred for overtime worked to make up for lost production); ii. Price premiums and extra shipping charges to expedite delivery of replacement machinery; iii. Extra shipping charges for inventory (such as the difference between air freight and land freight to meet contract deadlines); and iv. Difference between the cost of buying the end product from a competitor and the insured s normal variable cost to manufacture. b Extra expenses: expenses required to continue business operation so that the business will not lose customers during a shutdown, such as: v. Relocation costs; vi. Overtime pay; vii. Added freight charges for quicker delivery of emergency supplies; and viii. Advertising costs in notifying customers of the relocation. Our thoughts and prayers go out to our fellow Texans suffering from this mega disaster. As professional advisors, we need to look after our colleagues and client s best interest while they focus on the immediacy of this disaster. The sun will soon come back out and the task of measuring the impact will need to start. * * * * * * * * * * 6

7 Scott A. Barnes, CPA, CFF, CGMA is the Chief Executive Officer of who during the past 25 years has assisted corporations, investors and attorneys in assessing the financial issues surrounding complex and sophisticated accounting issues, merger and acquisition transactions, business valuation and industry and competitor analyses. He has extensive experience providing sophisticated commercial damage analyses and expert testimony for clients in a diverse range of industries, especially with respect to forensic analyses, intellectual property infringement, antitrust, lost profits, business interruption, contract disputes, business valuation, fraud, accounting, accounting malpractice and other complex commercial damage issues. He has served on two editorial boards of national publications specializing in economic damages, business valuation and forensic accounting issues and published numerous articles on the subject of economic damages, business valuation and professional standards in the performance of litigation services. He can be reached at sbarnes@barnesco.com About is a boutique management consulting firm providing sophisticated financial and economic damage analyses and expert services related to commercial damages, business and intellectual property valuation and fraud investigations. ( 7