Successful Business Interruption Claims by Daniel Hughes
Posted on February 21, 2013
Companies usually buy business-interruption insurance as part of a broader property-casualty insurance policy. But treating this type of coverage as an afterthought can be costly. Give thought to how your business may be impacted by a fire, flood, or in the case of South Florida, a hurricane. It’s important to pay close attention to the fine print.
I have helped companies prepare insurance claims for property destruction and business interruption that arose from on-site damages due to fires, floods, hurricanes, even the devastating tsunami that struck Japan in March 2011.
But off-site interruptions can also cripple a company, even if no on-site property damage occurs. Smart companies have business-interruption insurance with coverage triggers such as utility service stoppages, the inability to access your place of business due to physical constraints or actions by civil authorities, and disruptions affecting key suppliers and/or customers.
Consider the case of a commercial client, a manufacturer of fiberglass Jacuzzi bathtubs. The Jacuzzi manufacturer made a business-interruption insurance claim after a factory flood disabled a critical supplier. For at least 30 days, the supplier was unable to deliver a key chemical for fiberglass fabrication to the Jacuzzi manufacturer. The manufacturer responded by delaying delivery to consumers who had placed orders, and as a result, some cancelled orders. In other cases, the manufacturer lost new orders because of the inability to commit to a delivery date. The order cancellations and the lost orders became the basis of the manufacturer’s business-interruption insurance claim, which proved successful.
In other situations, you may be unable to access to your place of business for physical reasons, such as flooding or because civil authorities sometimes temporarily close public access to certain areas. Both scenarios can become a trigger for business-interruption insurance claims.
For example, after Hurricane Wilma hit South Florida in 2005, broken glass and other debris on Brickell Avenue in Miami led authorities to temporarily close public access to sections of the street, blocking employees’ ability to enter into office towers.
Utility service stoppages such as electric power outages also can serve as the basis of successful claims. A supermarket with no physical damage still may face large losses from food spoilage if the electricity goes off. Similarly, companies that rely on call-center operations or online websites to drive sales could make a successful business-interruption claim if their phone service or computer systems stopped working.
But remember, timing is everything. Insurers routinely include a waiting period or “time deductible” in their business-interruption coverage terms. Coverage for an electric power outage, for example, usually doesn’t begin until after the first 24 hours to 48 hours after the outage begins.
How much business-interruption coverage is enough? The right answer varies from company to company.
Everyone is required to use the same basic formula for calculating claims based on lost net profits. Companies should estimate potential lost net profits, not potential lost sales, in determining the dollar limits of business-interruption insurance that are best for them.
Hypothetically, if a company sells a product for $100 and spends $70 to assemble or acquire it, its business-interruption insurance will cover $30 per lost sale.
Premium levels depend on factors that include the amount or limit of insurance the company wishes to purchase, the amount of the deductible or how much risk the company is willing to accept internally, as well as the company’s history of insured losses and its exposure to hazard.
A law firm is inherently less hazardous than a chemical manufacturer that handles flammable materials. Companies with geographically diverse facilities may appear less risky to insurers than those with geographically concentrated facilities (two facilities in the Florida Keys, for example, instead of one in the Keys and one outside the Atlantic hurricane zone).
Property damage doesn’t necessarily mean a company is entitled to compensation for business interruption. Imagine a pizza parlor owner who replaces shattered windows with wooden boards due to a tornado but continues to serve customers because the business retained electrical power and telephone service. The owner can make a property-damage claim based on window damage, but it may be more difficult to prove a business-interruption claim because for all practical purposes the business operations continued.
A successful business-interruption insurance claim unfolds in four phases. It starts with a review of coverage, notification of the insurer, and the assembly of the internal recovery task force, typically staff representing operations, sales, finance, information technology and risk management.
Second, gather data to prepare damage estimates and document claims. Establish proper accounting procedures to recognize, record, categorize and track loss amounts and recovery expenses. Avoid commingling insurance-related expenses with everyday expenses.
Third, prepare and submit claims, and fourth, negotiate a recovery. Aim to collect 100 percent of a defensible claim, not 50 percent of an inflated claim. Document everything. The insurer won’t take anyone’s word for it.
Companies that experience long-term business interruptions should file a series of interim claims as losses occur, rather than waiting until a year or two after the interruption to file a single claim covering all losses.
Interrupted companies should negotiate with their insurers as they progress through the various stages of the recovery process. Claims that companies calculate unilaterally rarely get a warm reception from insurers because nobody likes surprises. The best approach is continuous collaboration. Insurers aren’t exactly partners of their commercial policyholders, of course, but treating them in that fashion can smooth the path to full recovery.