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August 1992

CPAs and business interruption loss claims. (includes related articles)

by Bruno J. Graizzaro, Jr. and Chris Campos

    Abstract- The adjustment of claims for business interruption insurance has become a lucrative service rendered by CPAs. Insurance accountants are differentiated from regular accountants by their greater familiarization with insurance policies rather than generally accepted accounting principles, the characteristically adversarial nature inherent in their work place, and a required ability to think in terms of hypothetical and alternative situations. The problems that insurance accountants are most likely to encounter arise froma misunderstanding of concepts surrounding insurance policies. These problems concern coverage of continuing operating expenses, period of indemnity as differentiated from period of interruption, the determination of the appropriate multiplier for measurement problems, and the insured's obligation to minimize loss.

The insurance industry's practice of hiring CPAs to assist adjusters and other claims persons to settle business interruption claims began after World War II and grew rapidly through the 1960s and 1970s. One author of this article worked on his first business interruption claim in 1955 and has observed the development of this area of practice from an obscure beginning to a prominent position in the CPA's scope of services.

This change came as part of a broader insurance industry trend of using outside experts trained in accounting, engineering, and building to handle specific aspects of claims. The underlying reason for the change has been the increase in the complexity and size of business insurance claims.



Accountants may be hired by the business or individual which files an insurance claim to help prepare it, or by insurance adjusters or other claims professionals to review it for reasonableness and accuracy. In those rare instances when a dispute arises that leads to litigation, accountants may be asked by either side's lawyers to prepare reports; to consult during discovery, depositions and other and other pretrial activities: and perhaps to serve as expert witnesses at the trial itself. The larger and more complex the claim, the more likely that one or both sides will feel an accountant's services are required. Business interruption and large property losses generate most such engagements, though liability and fidelity claims are increasing in importance.

The accounting issues that arise in the process of settling business insurance claims are not fundamentally dissimilar from those that conventional accountants deal with every day: What is the true value of inventory? What is the income generated by a business enterprise over a specified period of time?

However, there are three differences between insurance accounting and "normal" accounting.

First, insurance accountants must understand and be comfortable with concepts that are defined and inherent in insurance policies rather than GAAP. The sometimes arcane principles governing business interruption insurance claims are the subject of the accompanying article. There are other concepts with which the experienced insurance accountant is comfortable such as co-insurance valuations, reporting forms, blanket coverage, contingent coverage, etc. The basic difference in insurance claims accounting is that the principle of direct cost accounting is generally followed in business interruption claims and property claims rather than GAAP.

Second, insurance accountants must perform their work in a fundamentally adversarial environment. It is true that the great majority of claims on are settled amicably; insurance companies usually wish to retain claimants as customers, and both sides have a strong economic interest in avoiding litigation. Nevertheless, analyzing the books and business records of a firm which is not your client in order to discover possible inaccuracies or exaggerations in a claim against the firm that hired her or him is hardly the typical auditing situation.

The third thing that sets insurance accountants apart is their need to consider alternative scenarios and hypothetical results. This aspect is most pronounced in business interruption claims analyses. Here the question is not what the enterprise earned but how much it would have earned had the insured event not occurred. Clearly there is no one correct answer to such a question but a varying degree of plausibility among competing theories. The accountant must go beyond historical company data to tap additional industry and general information.

CPAs often ask about the training or skills required to perform this type of service. Aside from acquiring knowledge about specific insurance policies and, perhaps, attending the internal training programs of firms handling this type of practice, there are no special courses of study available. In fact, there is little written on the subject. There is even a paucity of court decisions, since most business insurance claims disputes are settled prior to litigation.

The skills needed are fairly general: an inquisitive mind and investigative instincts. The key activity is verifying data or theories presented in a claim; the resources available are claimant's records and business knowledge.

The ultimate product delivered to the client is the CPA's report, which is the basis for the adjuster's or claims person's subsequent negotiations and settlement with the insured.

As CPAs who are involved daily in the review and analysis of insurance claims based on business-interruption losses, we encounter a variety of challenges on the twisting - not necessarily rocky - road to settlement. This article presents a realistic view of several common problems that CPAs come up against when working with adjusters in dealing with claimants, the attorneys who sometimes represent the claimants, public adjusters, and other claims professionals.

Many problems are traced to the insured parties not understanding their coverage. Those involved for the first time in the settlement of a business interruption claim may naively assume that the insurance policy will make up the difference between a business's actual results after an interruption caused by an insured peril and its likely results had the incident not occurred. In some cases, that might be an accurate description, but very often insurance policies do not provide such coverage. The following paragraphs examine some of the insurance concepts that create the most confusion.



The most common business interruption insurance policy written in the U.S. today may be the business income form. Under this type of policy, an insured is entitled to recover for continuing operating expenses and profit. Many uninitiated insureds assume that the expression "operating expenses and profit" is going to be the same or very similar to the amount on which their insurance premium is based. It is not. The insured can only collect on continuing operating expenses plus profit, not for expenses which did not continue following the loss. Exhibit 1 illustrates two methods for making the appropriate calculations.

The significance of the example in Exhibit 1 is twofold: First, the amount of the calculated loss is identical when measuring lost sales less abated expenses versus profit plus continuing expenses. Second, the amount at which this loss should be settled is not the same amount on which the premium was based. The insured in this case would have paid premiums on rent expense and store salaries. After the loss however, the insured was not entitled to collect for them. Any reimbursement for expenses which did not exist during the loss period would have resulted in a windfall profit to the insured.

This concept has historical basis in the older gross earnings policy. Under this policy form, an insured's premium was based on gross earnings, yet it collected on gross earnings less discontinued expenses. The policy contained a clear definition of gross earnings but unfortunately, not of discontinued expenses. Those who have little experience with business interruption claims may understandably have trouble with this concept.

Theoretically, there could be situations where the collectible amount under the policy will be equal to the gross earnings - profit plus operating expenses. But only when the period of interruption is so short that there would be no effect on operating expenses - all expenses would have continued.

The rationale for these interpretations is the principle that business interruption insurance is meant to pay the amount of the loss, not reward the insured with reimbursement for phantom expenses.




The period of indemnity is the time during which the insurance policy covers the insured's loss. Under the business income form, the period of indemnity is defined as the period during which a loss of business income is sustained " ...due to the necessary suspension of your operations during the period of restoration." Often, this is different from an insured's perception of the period the business is interrupted.

The period of restoration is defined as beginning with the date of a direct physical loss or damage caused by or resulting from any covered cause of loss at the described premises and ending with the date when the property at the described premises should be repaired, rebuilt, or replaced with reasonable speed, toward premises of similar quality to what existed before the loss.

This is analogous to a principle of property insurance that is perhaps more generally understood: insurance covers the cost of repairing or replacing lost property, not of improving or modifying it. In the case of a business interruption, if the period of time taken to effect the improvement or modification exceeds the time it should have reasonably taken to return property to an "as was" condition, that additional time is not compensable. It falls outside the period of indemnity covered by the business interruption policy.

The period during which the damaged property should have been repaired is also subject to a reduction for those times when operations would normally have been suspended. Examples include vacations, Sundays, holidays, employee strikes, normal shutdowns, and time to repair uninsured damage events. No loss would be calculated for the days during which the insured would not have been operating had the loss not occurred.

The distinction between period of indemnity and period of interruption is also significant in regard to claims for the loss of an insured's market. Assume, for instance, that an insured's operations are physically shut down for only a few hours. As a result of the shutdown the insured's production falls behind and several major customers are lost. The insured would then submit a claim covering the entire period for restoring its business to its pre-loss-of-market level.

Although some policies may allow for a limited period of indemnity after physical restoration of the premises, there is no standard policy that allows for an indefinite period to restore business that was damaged by a covered cause of loss.

Non-standard Periods

of Indemnity

The business interruption insurance concepts discussed here are standard in the U.S. Non-standard policies do exist. The exceptions are the British loss-of-profit (LOP) or consequential profit forms and manuscript policies. Endorsements may be added to the standard policy to cover extended periods of indemnity, usually 30, 60, or 90 days. Consequential profit forms usually allow for periods of indemnity of one, two, or three years. The business income form is the only standard U.S. policy which automatically allows for an extended period of indemnity of 30 days.



To some extent, every business interruption claim has a speculative and therefore highly debatable element: What would have happened to the insured's business had an interruption not occurred? The business interruption claim settlement issues discussed in this article until now have related not to the measurement of the loss but to the extent of the policy's coverage. Measurement problems can be very sticky. A key question is always choice of the appropriate multiplier - the rate of increase or decrease in production or sales applied to the period following the loss.

Multipliers should have a solid rationale based on past experience of the business. Factors that may lead an insured to use excessively optimistic multipliers in its claim include newness of the business, introduction of new or modified products, or recent marketplace shifts. Occasionally the insured or, more often, overly aggressive outside advisors, see the business interruption loss as a potential windfall, particularly during periods of business contraction.

In manufacturing operations, for example, there are several typical areas where multiplier problems arise. Production projections may be based on rated capacity of machines rather than actual production history of the firm. Projections may be based on average production per hour multiplied by operating hours lost, but the projected hours lost may include time when the machinery would not have been operating.

We have seen some particularly egregious multiplier problems. In calculating its average daily production, on occasion, an insured has chosen to disregard bad days. The assumption is that every lost production day would have been a good one. This is akin to a resort community's Chamber of Commerce excluding cold and rainy days from its calculation of average weather conditions. Unrealistic multiplier assumptions can be large obstacles on the road to settlement.



Insurance policies do not provide coverage for losses that could have been prevented by good management and common sense. Quoting typical business interruption policy language, the insured is required to reduce the loss from interruption of business by "the extent you can resume your |operations' in whole or in part by using damaged or undamaged property (including merchandise or stock) at the described premises or elsewhere." In other words, in the event of a loss, the insured is expected to do exactly what it would do if it were not insured - take steps to minimize the loss. These might include utilizing other facilities that it owns or controls, temporarily leasing other facilities from competitors or elsewhere, subcontracting all or part of the production process, making temporary repairs to resume partial operations, making the most of existing inventory, and so forth.

The insurance carrier typically agrees to reimburse the insured for "any necessary expenses you incur, except the cost of extinguishing a fire, to reduce the amount of loss under this Coverage Form. We will pay for such expenses to the extent that they do not exceed the amount of loss that otherwise would have been payable under this Coverage Form." This means the insurer will finance the insured's successful efforts to reduce the amount of loss. The principle at work is that the insurer is not obliged to pay the insured any more than what would have been payable had no action been taken by the insured. Such initiatives are in the insured's best interest since, as noted above, the period of indemnity rarely, if ever, covers the full period of interruption, particularly when it extends into a loss of market. The sooner a business is back on its feet, the better for both insurer and insured.

Adjusters and claims people will usually play an active consulting role immediately after the loss occurs. They will ask, for instance, whether the insured has other plants or machinery that could make up for lost production, whether overtime work, added shifts, weekend and holiday operations, or recalling of laid-off workers are viable options. Sometimes other plants can increase capacity by rescheduling shutdowns for boiler maintenance or other procedures. An adjuster may recommend making up lost production through creative use of existing inventories. Marketplace recovery can sometimes be enhanced by stockpiling in-process goods during the period of interruption, for quick completion later.

In one case, involving a multimillion-dollar loss, the insured's facilities were divided into two departments corresponding to two stages in its manufacturing process. Department A had only half the capacity of Department B, which was responsible for completing products. Because of this bottleneck, Department B normally operated at only 50% capacity. When Department B's operations were interrupted, the insured was able to drastically minimize its loss by using existing finished goods inventories and stockpiling work-in-process inventories. This meant incurring additional expenses, which were reimbursed by the insurer. The insured however, was able to maintain sales and avoid losing customers, which would not have been recovered under a typical business interruption policy.



The final area of major misunderstanding in the settlement of business interruption loss claims is coinsurance. It is widely assumed that coinsurance is not a factor until a loss exceeds the limit of liability or a certain percentage of that limit. The reality is far different.

Coinsurance is the answer to an insurer's concerns that the insured reports business income accurately for a appropriate premium assessment. Coinsurance means that when business income values are under reported, the insured shoulders a corresponding share of the insurance burden.

Coinsurance attaches a new dimension of difficulty to the settlement of business interruption losses. It adds another step to the calculation of the actual payment from the insurer to the insured. Previous steps included resolution of the period of indemnity, the difference between continuing and discontinued expenses, and agreement on appropriate multipliers for the calculation of lost production and sales.

While many insureds use business interruption worksheets to determine the level of coverage to be purchased, the time and effort expended, necessary for making accurate calculations, is often insufficient. One loss in which the insured ends up as a surprise coinsurer is usually sufficient to make them realize the importance of monitoring coverage levels.


With all the grounds for misunderstanding, how do business interruption loss claims ever get settled amicably, as most do? The key is communication. Not all communication problems are between insurer and insured. Members of the adjuster's team may be uncertain of their role, creating problems in the process. The adjuster heads the team and must maintain control.

While the adjuster has probably been through every conceivable business interruption scenario more than once, the insured is usually going through a once-in-a-lifetime experience. Ideally, policyholder workshops will have prepared insureds by making them more aware of how their policy responds to particular loss situations.

After a loss has occurred, it is vital for the adjustment team to communicate with the insured fully, frankly, and immediately. The sooner misconceptions can be removed, the faster amicable settlement will be achieved.


A few years ago, our firm reviewed the business interruption loss claim of a company that suffered an explosion and fire. The insured decided not to restore the facility to its previous condition, but to improve it. Among other things, the insured wanted to reduce the risk of future explosions. Absent the current explosion, the insured would have made the changeover during a planned and orderly shutdown. Plans for upgrading equipment had already been started; the loss merely accelerated the changes. It look the insured several months to complete the design, production, and installation of the new equipment.

The insured submitted a claim for the entire period that its operations were stopped, from the day of the explosion to the commencement of production using the new, improved equipment. As consulting CPAs, we accompanied the adjuster on a visit to the insured's headquarters to discuss the claim.

From the insured's perspective, the purpose of the meeting was to discuss which expenses would be treated as discontinued by the adjuster in calculating the business interruption claim. The insured made a presentation of the various expenses incurred in their operation and sought guidance as to which expenses would be covered. Differences of opinion, whether certain expenses continued while others abated, are typically not hard to resolve between reasonable parties. A review of the insured's records and discussions with their personnel allowed for a mutually satisfactory conclusion.

The problem with this claim was the period of indemnity; the insured assumed it was equivalent to the period of interruption. It became necessary for the adjuster to educate the insured that coverage was only for the period of time previous state, not for the time taken to improve them.


The key phrase in business interruption insurance policies, repeated many times, is "actual loss sustained." The intention is to make clear that the insurance policy is meant to indemnify the insured only for actual losses sustained under the policy's provisions. Insurance is predicated on the concept that the insured should not profit from a loss.

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