Business interruption insurance must change with a business’s needs to avoid being underinsured

Businesses are advised to regularly review and revise business interruption (BI) insurance coverage or chance being underinsured should a loss occur, John-Paul Strasler, principal of independent forensic accounting firm Insignia Forensic Group Inc., cautioned during a presentation in downtown Toronto on Feb. 5.

Speaking about demystifying BI insurance at the Ontario Insurance Adjusters Association’s 2014 Professional Development & Claims Conference, Strasler said it is very important not to lose sight of co-insurance.

“It doesn’t apply in all policies, but in cases where it does, we see penalties all the time,” he told seminar attendees. For the policies that do have it – but do not specifically state the co-insurance percentage – “it’s equivalent to 100%,” explained Strasler, who has practiced exclusively in the area of investigative and forensic accounting since 1994.

“For the loss to be fully compensable, the amount of insurance carried must at least be equal to specified percentage of annual gross profit or earnings. If the insured has insufficient coverage, the insurer is only responsible for a portion of the BI loss,” Strasler explained. “That portion is the amount of coverage in force divided by the amount of coverage required,” he added.

“You really need to read the wordings and confirm whether or not co-insurance applies,” Strasler recommended, providing attendees with an example, one in which a 100% co-insurance requirement applies.

If the amount of coverage in force (numerator) is $500,000 and the annual insured gross profit (denominator) is $500,000 or less, he reported that there is no penalty. But if “the insured gross profit is $600,000, the insured is only going to collect 83% of their loss. If the profit is $700,000, they’re only going to collect 71% of losses. You can see how the loss recoverable goes down pretty quickly,” Strasler said.

“Quite often, we see in the case of growing businesses where the amount of coverage was sufficient initially, but it was never reviewed and revisited and after several years of growth, this is what happens. The business becomes dramatically underinsured,” he told seminar attendees.

There are some key questions that should be asked or considered on any claim, Strasler suggested. Those questions relate to, among other issues, the following:

• understanding the business – for example, what are the revenue streams, how is each revenue stream generated, how unique is the product or service provided by the insured, and how did the property loss impact the ability of the business to earn revenue;
• sales lost or deferred – quite often what looks to be a sales loss is not because sales that declined during the period of business interruption are recovered once operations resume;
• production capacity available – with manufacturers, for example, is there still capacity to produce while the damage is getting repaired.

“The key takeaway from this is that just because there’s been an interruption, it doesn’t necessarily mean there’s been a sales loss,” Strasler said.