Over the past decade, a series of natural disasters have shaken countries across the world: the tsunami in Japan, earthquakes in Chile and Haiti in 2010 as well as in China in 2008, and widespread flooding in Thailand and the Philippines have, in addition to causing huge loss of life, rocked infrastructures. In 2013, even closer to home, the UK saw severe storms in July and December, causing widespread damage. So as a business, how do you cope with these types of disaster? These risks can be insured against, but the protection measures don’t end there.

Disasters usually require immediate attention and resources, which can strain cashflow in the short term. While insurance is an important protection against the worst of the effects of sudden shocks, it doesn’t remove the need for adequate planning. Being unaware of the procedures and having no proper plan in place will affect the claims process, which can threaten the existence of the business as a whole.

Earthquakes and floods such as those mentioned above are risks that can severely affect a business. However, other claim situations can cause business interruptions too:

• fires and explosions (for example the Buncefield explosion in 2005, and the fire at a Leeds chemical storage facility in April 2014);
• machinery breakdowns;
• subrogated claims – where the insurer, after indemnifying the insured, has a right to recover the loss from the third party that caused the loss (for example in case of a cleaning company using a faulty solvent and consequently damaging one of your machines and causing an interruption to business). In this case, you, the insured, have an obligation to help the insurer achieve that. If subrogation is successful, your previously unrecoverable excess, also known as a deductible, will become recoverable. After the recent floodings in the UK and the increase in global disasters, this area has become more important for businesses, as deductibles have increased significantly and more firms have become, in effect, self-insured; and
• commercial disputes – for example product liability issues, patents/rights issues or design faults, which result in a loss of profits to your business. In these cases insurers may not be involved. It is up to you to appoint experts with the right technical and interpersonal skills to help you win your case. One example is the product liability and recall at Toyota in 2010

Business interruption claims can be complicated. The essence of business interruption insurance is the attempt to indemnify the insured for losses sustained over a particular length of time relating to an insured event. The quantification of such losses must, by definition, project what would have been earned had the event not occurred. Of course, this can often be subjective, as there may be little direct evidence to indicate the measure of the loss. Outlined below are some procedural aspects and technical principles, which may be of help when facing a business interruption claim.

When faced with a disaster and consequent interruption to the business, it is wise to contact the broker as soon as possible: they are your contact with the insurance company and they will ensure that your business provides the necessary paperwork to start the claim process, including, ultimately, the submission of a claim.

After the submission, your claim will be analysed. Invariably, this will involve a range of professionals, including loss adjusters, forensic accountants and engineers. They will all provide their individual expert opinions to the insurer, who then makes a judgement as to whether your claim is reasonable. Contrary to common belief, insurers like to pay their insured a fair and reasonable settlement. It is in their best interest to do so, as their reputation in the market depends, to a large degree, on the fairness and speed of their claim pay-outs. They will often make advance payments, or payments-on-account, to cover large out-of-pocket expenses, which can be essential for staying in business during times of crisis.

To ensure that the levels of claim or advance payments are reasonable, forensic accountants can be asked to review the losses and measure the effect the incident has had on the business. They will request to see financial data to get a feel for how your business is performing and they will talk through with you any questions raised by the figures, so that they can better understand your business. Based on the data provided, the forensic accountant will provide the adjuster or insurer with an opinion as to what level of losses you have sustained and/or will sustain in the future.

It is important to be open with anyone reviewing your losses and to answer their questions completely and truthfully. It’s not unusual for insured parties to be reticent, only giving certain documentation, claiming that it is ‘irrelevant to the case’ or ‘commercially sensitive’. But if you are not open about the business in general and the impact of the incident in particular, the insurer may assume that you have no business case for that part of the claim and assume its lowest estimate of loss.

Also, as insurers often reinsure part of the risk and therefore report to other companies in the insurance market, insurance companies can only pay out claims if they can support that payment with underlying documentation. Consequently, refusal by the insured to provide documentation can severely hinder the claims process and will delay or minimise any pay-outs.

Generally, the more open you are with documentation, the higher your payment-on-account will be, as long as your insurance policy covers your losses, of course

Although in times of crisis you may pay less attention to paper trails of transactions and decisions, keeping good records will speed up the claims process and provide you with a better chance of recovering your losses. The records that can support your claim for loss of turnover are:

• management accounts;
• budgets and forecasts;
• sales and production data;
• stock records; and
• invoices and customer correspondence.

Records that are often not retained, but can be vital to support a loss of orders, include (but aren’t limited to): order forms, notes of phone conversations of orders cancelled or prospective orders turned away. It is precisely these records that can fully illustrate the impact of a disaster on your business and need to be kept up to date.

As explained, being open and truthful about the impact of the incident on your business will speed up the claims process with external parties. Apart from external reasons, there are also internal reasons for not overstating your claim upfront.

An inflated initial claim may be presented for a number of reasons, and these may be innocent. Nevertheless, expectations are raised and it becomes difficult for the insured to move from the position initially adopted, whatever the reason. This situation is aggravated if the claim has had wide distribution within the organisation, particularly if it has been presented to the board of directors. If the claim has been provided for in the accounts at an optimistic level, then any reduction becomes extremely difficult to absorb, as it may have to be explained to the company’s auditors and shareholders.

In addition, in large organisations there can be difficulties in communication between the people involved in the claim process. If several departments are affected by one incident, often the first thought is that each department manager makes a separate claim for their own department. However, there may be overlap from a claims point of view and costs may be double-counted by departments, which can cause undue delays in review of the submitted claims. As most insurance policies cover the entire business, forensic accountants and other claim reviewers will look at the business as a whole. As a result, the review can become unmanageable unless there is one person with authority who is prepared to take responsibility for the claim as a whole.

Finally, it is also important for one person in the organisation to have authority to settle the claim. This may appear self-evident, but it is surprising how often there is no one to do this. It can occur in particularly large organisations that have a complicated multi-layered structure. In business interruption claims there are often areas which are subjective, and the claim may have to be settled by discussion and negotiation; for example the level of sales that would have occurred had the incident not taken place.

Many of the difficulties in settling business interruption claims arise from the lack of understanding of what the policy is designed to cover, or from a disagreement about the financial effects of the loss on the business. More often than not, the broker or adjuster will interpret the policy for you. However, misunderstandings and disagreements can be minimised by ensuring that you, as the insured, have an understanding of the terms of the business interruption policy and the calculations that flow from it. Areas that often cause misunderstandings are:

• Loss of profits: a business interruption calculation is intended to indemnify your business for a loss of gross profit arising from a loss of sales. The gross profit is usually derived by deducting purchases and other variable costs from sales. It should be noted that invariably this figure differs from the gross profit figure shown in the company’s accounts as these often include expenses that are not variable by nature. Generally, loss of profit insurance seeks to pay your continuing fixed costs and profit lost through sales.
• Loss of sales: in quantifying a business interruption loss, often the most complex area is identifying sales or income lost specifically as a result of the claim event. Sales can be affected by many factors, such as availability of raw materials, production capacity, level of inventories, technology, legislation, competition, and the economy. In projecting sales, it is essential to differentiate between what could have happened and what would have happened had the event not taken place.

The projection of sales lost should take account of past performance, although this cannot always be used as a reliable indicator of what would have happened had the loss not occurred. Account should also be taken of the levels of orders, cancellations of orders, and lead times required by customers.

Business interruption claims are often based on a company’s budgets and forecasts. However, these are often inaccurate and an unsound base on which to build a claim. This lack of reliability of budgets in the claims process can cause difficulties. For example, the accountants who prepared the budgets often defend them, as there is an implication that they have not done their jobs properly if the budget is not accepted without modification. This indicates a lack of understanding of the purpose for which budgets are prepared. They may be perfectly adequate in a management accounting context, but have not been designed for claim purposes.

Insured parties often assume that an interruption to production will automatically result in a loss of sales. This is not always the case. It is usually necessary to consider the entire business in order to understand the impact of the insured event on the business as a whole. There could be financial effects both upstream and downstream from an affected production facility. For example, if the damage occurred in a factory producing computer monitors, there may be a sister factory that can supply the same monitors instead, to avoid a loss of sales to the end customer.

The message with all this is simple: delays can occur when businesses are not open with documentation and information, or refuse to co-operate with the experts reviewing the claim. A good understanding of the policy avoids disagreements between you and the insurance experts, which will speed up the process. The shorter the process, the quicker you receive your money, which can be vital to the cash flow of your business.

Download pdf article:

• Stake your claim
  Finance & Management Magazine, Issue 223, July/August 2014

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