Business Interruption—Is It Time for a Checkup?
November 2009
It may be time for a checkup on your business
interruption insurance coverage. As corporations focus on operational changes
needed to survive one of the worst recessions in decades, it is important to
recognize changes in the business landscape.
by Michael C. Speer, CPA and
Paul
D. Haynes, CPA/ABV, CFF
SMART Business Advisory and Consulting, LLC
These changes have affected virtually every business in every segment of
the economy, and often in unanticipated ways. As a result, the decisions and
judgments you made when you secured your business interruption coverage may
need to be revisited.
The question is, if your business suffered a catastrophic loss today, would
you have adequate coverage to compensate you for your loss (taking into account
any amount of risk you have chosen to retain)? Conversely, are you paying for
more coverage than you really need due to recent declines in economic conditions?
Unfortunately, many organizations do not discover that they are underinsured
until it's too late—after a loss has occurred. The business interruption worksheet
that you and your insurance agent prepared even just a year ago may no longer
accurately represent your business in today's economy.
The assumptions you used in determining the necessary level of coverage were
undoubtedly based on your best anticipation of future conditions—at that point
in time. They probably also took into account past performance and trends. But
given today's economic conditions, those assumptions may no longer be valid.
As a result, it is more important than ever to take a proactive approach
in reviewing your existing business interruption coverage. Clearly, there is
no way to anticipate every possible scenario that could occur in the future.
But in light of recent experience in your business and the market you serve,
you can probably make some enlightened decisions that can strengthen your overall
position in terms of mitigating risk while managing budget.
Business interruption insurance is intended to help a company get back to
the position it would have been in had the loss not occurred, by indemnifying
the company for the actual loss sustained. The actual
loss sustained is most often defined as what the company
would have earned had the loss not occurred,
minus what it actually did earn.
This means that in determining the proper amount of coverage, a company needs
to forecast anticipated revenues during the period of coverage as accurately
as possible, taking into account not only past and current trends, but also
the anticipated future impact of economic conditions. A review of existing coverage
might disclose that:
- The current business interruption coverage was based on a previous trend
of increasing sales which has now declined due to the economy. As a result,
the company may now be overinsured and paying an unnecessary premium.
- Due to economic conditions, the company's sales have actually increased
and the company is underinsured. An example might be in an industry where
a number of competitors have gone out of business placing the company in
an enhanced market position—with increased
revenues.
The forecast of revenues is clearly a key component in determining the amount
of business interruption coverage required by your organization. Yet, the development
of this forecast can be challenging, especially during times of changing economic
conditions. The following areas may be helpful to examine closely as you take
a fresh look at your existing coverage.
-
Has there been a significant change in the
specific market for your company's products or services? While the
company's trends may have been going in a particular direction over the
past few years, current market conditions may have changed that trend, or
at least the percentage of growth or decline.
-
What makes your company's products or services
unique so that revenues are less likely to be affected by (or even benefit
from) the recession, in contrast to the rest of the market? This
might be determined by looking at how sales of your company's products or
services presently compare to your competitors. An example might be an electronics
component manufacturer with a product that possesses specifications and
reliability that far outweighs its competition. In this example, a decline
in the rest of the market could have less of an impact on the manufacturer's
business even in the midst of a recession.
-
Have you recently introduced any new products
or services for which no significant sales history exists? This may
require looking at how similar products or services are performing in the
current market and building a forecast around that, taking into account
any unique advantages, including marketing, promotion, contracts, and advance
orders.
-
Do you have any contracts or advance orders
that support a forecasted level of sales that varies from industry trends?
For example, a distributor with purchase commitments from customers could
support a forecast of increased sales, even in a market where the competitors'
sales were decreasing.
-
Did your company make any recent changes to
operations or facilities that support increased sales, despite the recession?
The recent addition of a new machine or process at a manufacturer, for example,
could well support a forecast of increased revenue, given a strong demand
for that product, even with a decline in the economy.
-
Have there been any significant changes in
the competitive landscape as a result of the economy? For example,
challenging economic conditions may have caused a major competitor to go
out of business, thereby creating a positive impact on your company's business.
-
Have there been significant changes in the
supply chain or commodity prices due to economic conditions which have impacted
your cost structure, necessitating an increase in sales prices, and as a
result, creating an impact on sales volume? For instance, let's say
that economic conditions have caused the closure of a metal fabricator that
provided key components to a manufacturing company. The manufacturer needed
to find an alternate supplier, which as it happens, increased the cost of
materials by 20 percent. The manufacturer, in turn, needed to increase the
product's sales price in order to maintain a normal profit margin, and in
so doing, realized a decrease in sales volume.
Conclusion
Remember, forecasting future conditions can be challenging even during normal
times, let alone during times of a recession. Even the savviest of forecasters
during this recession would like to have a crystal ball at their disposal.
While it is impossible to predict all the various scenarios that may affect
your future earnings, a well-structured and methodical process with an accountant
experienced in this area can really pay off. By reviewing your business interruption
coverage now, you can increase the likelihood of minimizing your company's level
of risk, while keeping an eye on the budget. When it comes to business interruption
coverage, a fresh look with an open mind pays off every time.
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