Not So Fast With Coverage for Business Interruption

Even dirt cheap, why buy something when the value can't properly be ascertained?

By DAN REYNOLDS, senior editor of Risk & Insurance®

No one disputes the value in theory of business interruption coverage. The devil comes in how to calculate what a business would have earned had life not been so rudely interrupted. As is so often the case, working out these details isn't easy.

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Take the gross earnings form, for example. Gross earnings are not to be confused with gross profit, although the terms sound familiar. "Gross earnings deductions," an insurance concept that includes only raw materials and consumable supplies, isn't the same as the accounting concept of cost of goods manufactured, according to Hans-Dieter Sprohge, writing in the Journal of Accountancy.

Or, take this concept of noncontinuing expenses, which represents the difference between projected normal expenses and the actual expenses that would have occurred during the loss period. Insurance companies treat noncontinuing expenses as a reduction in gross earnings and take a credit against gross earnings for expenses that have ceased.

Noncontinuing expenses should not be confused with "variable expenses," and continuing expenses should not be confused with "fixed expenses," Sprohge writes.

But here's my point: If accountants and insurance adjusters can't agree on the meaning of terms used to describe values that would have been spared had a business continued to operate, it's not going to be easy figuring out how much a business would have earned had it not fallen victim to interruption.

When we went about trying to ascertain the impact of the 2007 wildfires that scorched so much of Southern California, we specifically asked policyholders about whether they planned to file business interruption claims in cases in which those policies weren't automatically triggered by the property policy. And in many cases, they just weren't sure what they would do or whether they had any hope of collecting.

One reason was that in the case of mandatory civil evacuations because of a wildfire, the policyholder seeking to collect on a business interruption claim might have to provide insurers with the physical proof of an evacuation, that is, the notice itself.

In addition, in California, employers facing an advancing wall of flames who thought they were being proactive in sending their employees home before an official evacuation notice might have found themselves without coverage. Same goes if your employees live in an evacuation area and your business isn't located there.

Business interruption coverage in theory has value. But in practice you better be very good at understanding it, and that is not an inherent benefit.

(Read Managing Editor Cyril Tuohy's Point, "Pile on the Coverage With Your Next Renewal.")

April 1, 2011

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