Business Interruption Losses in Economic Downturn
August 2011
A reasonable and supportable
projection of lost revenues is a key to developing a solid
business interruption claim. Recent economic conditions have
highlighted the need to pay close attention to the economy and
its impact on the insured's business.
by
Michael C. Speer, CPA
Grant Thornton LLP
Business interruption claims, by their very nature, present a
basic challenge: How does the insured determine the "actual"
loss sustained? Simply stated, the actual loss sustained is most
often defined as what the company would have
earned had the loss not occurred, less what it actually
did earn.
The amount the company "would have earned had the loss not
occurred" is essentially retroactively forecasted. This requires
a methodology that looks at what
would have happened in normal times and conditions during the
period of loss. The methodology may incorporate many factors,
including, but not limited to, the following:
Facts surrounding
the loss and its impact on the insured's business
Company
forecasts
Historical trends
Recent changes in capacity and
product or service sales mix
Significant contracts
Marketing
initiatives and plans
New product or service launches
Changes in
the competitive landscape
Changes in the economy
Developing a
reasonable and supportable projection of lost revenues is a key
to developing a solid business interruption claim. Organizations
that have experienced losses in recent times did so in the midst
of one of most significant recessions in decades. In many of
these situations, it was not sufficient to simply project lost
earnings based on trends of the past. It became increasingly
important to factor in the impact of the economy on the both
insured's business and the market in which it operates.
Projecting revenues "had a loss not occurred" can be challenging
even in normal times, let alone during times of significant
changes in the economy. While there are no magic fixes or
formulas for this issue, here are some questions that an insured
and its advisers should consider in preparing a business
interruption claim occurring in times of economic downturn:
Has the specific market for the insured's products or
services changed? While the company's trends
may have been going in a particular direction prior to the loss,
current market conditions could have materially changed that
trend.
Does the insured have any contracts that help to
support the forecasted level of sales despite changes in the
economy? For example, a distributor that can
document purchase commitments from customers prior to the date
of loss could support a forecast of increased sales, even in a
market where the competitors' sales were decreasing.
What
makes the insured's product or service unique so that sales
would have been less affected by (or even benefitted from) a
downturn in the economy in contrast to the rest of the market? This might be supported by looking at how the
sales of the insured's products or services compared to its
competitors prior to the loss. An example might be an
electronics component that possesses specifications and
reliability that far outweigh its competition. In this example,
a decline in the rest of the market could have less of an impact
on the insured.
Has the insured 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 that can be documented and
supported.
Did the insured make any recent changes to
operations or facilities that would have supported increased
sales, despite the economic downturn? 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 business, thereby creating a
positive impact on the insured's business.
Have there
been significant changes in the supply chain or commodity prices
due to economic conditions that could have impacted the
insured's price structure, necessitating an increase in sales
prices, which in turn creates an impact on sales volume? For instance, let's say that economic
conditions caused the closure of a metal fabricator that
provided key components to a manufacturing company that recently
experienced a loss. Had the loss not occurred, the manufacturer
would have needed to find an alternate supplier, which as it
happens, would have increased the cost of materials by 20
percent. The manufacturer would have in turn needed to increase
the product's sales price in order to maintain a normal profit
margin. It is projected that, in the insured's specific market,
the resultant increase in sales price would have created a
decrease in the volume of units sold.
These are just a few
examples of key questions we typically ask our clients when
preparing a business interruption claim. In the final analysis,
the goal is to present the claim in a manner that is fair,
reasonable, and well supported and reflects the reality of the
insured's business, market, and the economy.
Conclusion
In
determining lost revenues, it is critical to pay attention to
current and projected future economic conditions. By considering
all of the relevant variables and asking the right questions,
you can develop a methodology and business interruption claim
that is both reasonable and supportable. Additionally, it can be
highly beneficial to secure assistance from a professional
services firm that has forensic accountants and
economists who specialize in business interruption claims.
Michael C. Speer, CPA (Illinois),
is an expert commentator for the www.IRMI.com
business interruption series, which provides articles on
practical and topical ideas on how a risk manager or insurance
professional can better understand the business interruption
claims process and the challenges faced with such claims. Mr.
Speer has more than 30 years of experience in public accounting
and consulting firms and has extensive experience with forensic
accounting, insurance claims, and litigation support. He is a
senior manager with the Chicago office of Grant Thornton LLP,
where he provides property, business interruption, and FEMA
claim support services to policyholders. He also provides
general forensic accounting and litigation support services. For
contact information, see Mr. Speer's full biography on
www.IRMI.com. He can be reached at (312) 602–9180 or by e-mail
at .
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