Business insurance coverage can vary widely, so it can be challenging for owners and operators to decide how much or what is appropriate and necessary to protect their company from exposure to risk. Factors like coverage scope, type and cost are certainly important, but a key component of business insurance is a full understanding of what is covered and what is not. Far too often, however, this clarity around coverage is reached only after an insurance payout is less than expected or a claim is denied.
From coverage assumptions on the part of the business owner to confusion over policy terminology to fine print that is hard to read and harder to understand, there are many reasons why a business owner may ultimately feel disappointed by the final outcome of an insurance claim. Let’s take a look at one type of insurance in particular that often results in a disputed claim to help illustrate the challenges of managing business insurance coverage.
Disputed Claim Example: Business Interruption or Loss of Profits Coverage
Whether the insurance company refers to it as business interruption or loss of profits, this type of coverage is intended to provide financial support during a time when a business cannot operate as normal due to a covered incident like fire or water damage.
The tangible damage to the business, like ruined inventory, broken equipment or building damage, is covered under the property insurance policy. The business interruption or loss of profits claim, however, is calculated using the fixed costs incurred and profits lost while the business operation was out of commission. There are several factors that make this claim difficult to quantify:
- Measurement of lost profit: The method by which lost profit is calculated is often times not clearly spelled out in the policy or is presented too simplistically. Many businesses see monthly net profits fluctuate, particularly when seasonal revenues are involved, so basing the lost profit calculation on historical earning trends will produce different results than a current snapshot of the profits at the time of the business interruption. The difference in these measurements is subjective and can be controversial.
- Fixed vs. variable costs: In general, business interruption coverage applies to fixed costs but not variable, or avoidable, costs. This can create differences of opinion when the overall cost structure is reviewed line by line as to whether certain costs, like payroll or employee benefits, are fixed and therefore eligible to be included in the damage claim.
- End date of the interruption period: Both the business owner and insurance company usually have a clear and agreed upon date on which the business interruption started. What is often less clear, however, is the date when that period ends. Standard policy language typically defines the interruption ending when “the damaged property is physically repaired and returned to operations under the same condition that existed prior to the disaster,” which is also a subjective matter.
Business Insurance Analysis Can Help Create Clarity
Given all the subjectivity and complexity involved with insurance coverage, what is a business owner to do? One surefire way to get a more comprehensive grasp on coverage is to conduct regular, periodic reviews of the overall business insurance program. Business owners should be sure to ask the following questions during their reviews:
- What types of policies are in-force?
- How much coverage does the business have?
- When do the polices expire?
- What premiums are being paid?
- Is there a clear understanding of what each policy actually covers?
- How would the insurance company quantify a covered claim?
- Does the business have the necessary supporting documentation for claims?
- Are coverages and policy limits adequate based on current and future business plans?
- Based on our current and future business plans, are our coverages and policy limits adequate?
- Are there any identified coverage gaps to consider filling?
The importance of conducting a routine and thorough business insurance analysis cannot be understated. It helps business owners ensure their companies are adequately protected against the unexpected. Business owners don’t have to go it alone, however; a trusted business advisor like RKL can help with the review process. Contact your RKL professional or one of our local offices today for more information on this topic or for assistance reviewing your business insurance coverage.
Contributed by John S. Stoner, CPA, CVA, partner and leader of RKL’s Business Consulting Services Group in the Lancaster office. John provides a wide range of business consulting services, including business valuation, financial analysis, litigation support, merger/acquisition assistance and business succession planning to business clients.