INFocus: When it rains, it pours: Insurance recovery for earnings loss

Date: August, 2013 road sign that says high water

This article was originally published in the Comments Summer ’13 Issue.

As I write this article, Toronto is recovering from its biggest rainfall since Hurricane Hazel. Two weeks ago, downtown Calgary was affected by days of heavy rains following which the Bow River burst its banks. And while the initial focus should always be on the personal safety of those affected, in short order this focus will give way to dealing with the financial consequences of the events which have occurred.

As “forensic accountants,” who specialize in insurance and litigation claims, our group knows the “financial” questions that may surface when natural disasters occur. The first question may be, “Are we covered by insurance?” This question is followed by, “What exactly are we covered for?” If you are unsure as to whether coverage applies, you should consult with your insurance counsel or insurance broker. If you determine that coverage is available, the next question may be, “How much can I claim?”

If your business has been affected by the recent flooding (or by any other insured event), and the business has or will suffer an earnings loss, you may wish to check with your insurance broker to determine if you have coverage for earnings loss. Often this is called coverage for “business interruption.” Whatever name is used, the coverage allows you to claim for the earnings loss resulting from the damage caused, subject to the policy terms and conditions.

Our firm has varied experience in the assessment of business interruption losses, where businesses have been affected by an insured peril.

Often an insurance adjuster will advise business owners that the insurer will retain an accountant to quantify the business interruption loss that can be claimed. Based on our experience, business owners would be wise to consider retaining their own accountants (with the necessary specialized knowledge) to develop business interruption loss calculations. In fact, your insurance coverage may include a provision (or endorsement), that will reimburse the cost of retaining your own “forensic” accountant. This, of course, is subject to the limits of any coverage provided, and is often referred to as “professional fees coverage.” Generally, an accountant that has been retained by the business will develop calculations, which subsequently (along with supporting documents and information) may be provided to the insurer’s accountant for review. While the insurer’s accountant may not always agree with the approaches adopted, areas of agreement may be identified and areas of disagreement can be further explored. Further, with this process, the business owner knows of the approach their accountant is considering for developing loss calculations, and is able to ensure that the business information provided is correctly understood and fairly used. Although forensic accountants should not become “advocates” for their clients, it is important to be aware that the persons who best understand the affected business are the business owners and employees, not the accountants!

There can be many pitfalls involved in developing business interruption loss calculations. Some of these relate to the actual coverage itself, and the specific wording will impact the calculation of recoverable loss. For example, what are relevant time limits for the “indemnity period?” Is the business covered for losses until damage is repaired (or could have been repaired), or until sales return to normal (normally, with a maximum of 12 months)? Is the business covered for continuing “ordinary payroll” – being the lower level employees who would normally be laid off during an interruption? Is there a “co-insurance” clause (“co-insurance” is a term which suggests that responsibility for compensating a loss may be shared between the insurer and the insured person or business)? If there is a co-insurance clause, this could mean that some of the loss will not be paid if insufficient insurance was purchased. This aspect is complicated and may give rise to a reduced payout even though the calculated loss is less than the actual limit of insurance.

Other pitfalls arise when dealing with the estimation of the financial results that would have been expected, without the damage. For example, usually, there will need to be a projection of the sales, which would have been made, had the damage not occurred. While it may be reasonable to simply project sales by reference to sales for the corresponding period in the prior year, this approach may overlook specific circumstances or recent trends that affected the business outlook. For example, were new markets or products being developed? In today’s changing world, it is easy to see how both external factors and business initiatives may be expected to affect sales or profit trends.

A question often arises under circumstances where a business is not covered for “ordinary payroll” (the lower level employees) but lower sales are achieved once business operations resume. Based on the policy wording, the lost “margin” on lost sales may be determined (on a percentage basis), after subtracting “ordinary payroll” costs. However, there may have been no saving in payroll during the “start-up” period following the interruption, even though below-normal sales were achieved.

Under the circumstances described above, it may be necessary to consider both: (a) lost profit on lost sales, and (b) the labour “inefficiency” during the “start-up” period (following resumption of operations). Our group usually takes the approach that labour “inefficiency” is an additional cost incurred (during the post-interruption start-up period) to achieve some (albeit below-normal) sales during this period. As such, the cost of the labour “inefficiency” may be claimable as an additional cost that reduces the loss that would otherwise have been incurred, had no sales been made at all during the start-up period.

Complicated? Without question. However, an experienced forensic accountant may be able to assist you when navigating the challenges of business interruption loss calculations.

Connect with the Author

Daniel M. Edwards, MA, CPA, CA • IFA, CBV, CFE, CFF, Daniel M. Edwards Professional Corporation – Partner, Valuations | Forensics | Litigation

Daniel Edwards is a partner in Crowe Soberman’s Valuations | Forensics | Litigation Group. Daniel is a chartered accountant who has been designated as a specialist in Investigative and Forensic Accounting and a Certified Fraud Examiner.

Connect with Daniel at: 416.963.7221 or

Crowe Soberman is a public accounting firm. Contact your insurance broker or agent for professional advice regarding coverage.

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