1. Small Firm Value. Big Firm Benefits.
Business Interruption 101: Measurement and Calculation Methodologies and Claim Preparation Issues Prepared for Northeast Ohio RIMS Regional Conference October 6, 2017
Small Firm Value. Big Firm Benefits.

2. Course Outline » Introduction to BI Claims (5 Minutes)
» Policy Terms (10 Minutes)
» Period of Restoration (10 Minutes)
» Proper Calculation of Values
» But-For Revenue (10 Minutes)
» Saved Expenses (10 Minutes)
» Specific Claim Facts (5 Minutes)
» Q&A (10 Minutes)

3. Section 1 – Business Interruption Claims
Introduction to BI Claims

4. Business Interruption – Introduction
Relevant Policy Language (e.g.):
“We will pay for the actual loss of Business Income you sustain due to the necessary suspension of your operations during the Period or Restoration.”
Business Income means the “Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred, and continuing normal operating expenses [including payroll]”
Therefore, Business Interruption (BI) Loss is the difference between:
what the insured “would have earned” (referred to as “BUT-FOR INCOME”);
less what they “actually earned”;
during the loss period.
Mathematically, this can be expressed as:
Lost Income (BI Loss) = But-for Income – Actual Income

5. Business Interruption – Introduction
Lost Income (BI Loss) = But-for Income – Actual Income
If:
Net Income = Revenue (Sales) – Expenses
 Then:
[“But-for” Sales – Actual Sales] = Lost Sales
– [But-For Expenses–Actual Expenses] = Saved (Increased) Expenses
= Lost Income
For the less mathematically inclined, standard BI loss is often depicted graphically as follows:

6. Business Interruption – Introduction

7. Business Interruption – Introduction
This “three-column” approach is standard for “bean counters”. So, given the same set of facts, why might two parties come to different results on measurement?
Potential Measurement Issues fall into four (4) Common Areas:
Policy conditions (deductibles, limits, exclusions) impact the calculation.
Defining the Period of Restoration (aka Period of Indemnity).
Assumptions/approaches for measuring/calculating values:
But-For Revenue
“Saved” (or Increased) Expenses
Specific Claim Facts and Circumstances
Market Conditions
“Make up” Sales
We will demonstrate/review each of these using a hypothetical claim scenario:
Bob’s Pizza Parlor suffers a loss caused by a Hurricane that tore off the roof and blew rain into the interior. A subsequent flood swept into the building. Bob intends to rebuild and re-open. He has a property policy with Fire and Storm Turnaround (FAST) Insurance Company, and has retained us to assist in preparing the claim.

8. Section 1 – Business Interruption Claims
I. Policy Terms

9. Deductibles, Limits/Sub-Limits, BI/PD/Extra Expenses
Policy Terms:
Deductibles, Limits/Sub-Limits, BI/PD/Extra Expenses
Claim Example: Deductibles
Bob’s policy deductible for Property Repair is $10,000;
Bob’s deductible for “Time Element” is 3% of the total (BI and Extra Expense);
During restoration, theft/vandalism lead Bob to incur $30,000 for security and fencing.
Does it matter which “bucket” these costs are placed -- Property Repair or Extra Expense ?
Answer:
The property deductible is a fixed amount regardless of the loss amount.
The BI deductible applies to each incremental dollar of the BI claim.
Therefore, deductible is lower, and claim is higher, if these expenses are categorized as “property repair” as opposed to “Extra Expense”.
Alternative Claim Scenario (#2):
Instead of a 3% deductible, there is a 24-hour “Waiting Period”? Does this affect the calculation?
Answer: BI deductible is now also fixed. Therefore, result could be the same or reverse of #1.

10. Deductibles, Limits/Sub-Limits, BI/PD/Extra Expenses
Policy Terms:
Deductibles, Limits/Sub-Limits, BI/PD/Extra Expenses
Claim Example 3: Limits
The FAST policy has a $500,000 per occurrence limit, except for flood and earthquake, which have a sub-limit of $200,000.
What is Bob’s covered cause of loss? Would FAST agree with that conclusion?
Answer: Because the flood limit is lower than the “wind” limit, there is more coverage for the insured to make a “wind damage” claim. FAST liability may be lower if the loss is caused by flood, not wind, damage.
Other potential deductible/limits issues:
Multiple Deductibles -- If more than 1 deductible applies (e.g. Property and BI), policy may indicate that only the larger of the two applies.
Carrier may take the position that a “Waiting Period” is not a deductible, nullifying the above clause.
Average Daily Value (“ADV”) – deductible may be a factor times the insured’s actual average daily gross margin for the prior year (e.g. “2x ADV”), requiring a review of financial statements to calculate deductible.
Co-Insurance – coverage limits are based on insured’s BI worksheets or financial statements provided during underwriting.

11. Section 1 – Business Interruption Claims
II. Period of Restoration/
Extended Period of Indemnity

12. II. Definition of Terms –”POR” and “EPI”
Policy Language Example:
“Period of Restoration begins with the date of direct physical loss or damage caused by or resulting from any covered Cause of Loss at the described premises, and ends on the date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality”
However, insureds are not “made whole” until business reaches pre-loss income levels.
Period between the date the property is placed back into service and date business reaches pre-loss income levels is often referred to as the “ramp-up” period.
Extended Period of Indemnity (Extended Business Income) is intended to cover this “ramp-up” period.
“Begins on the date property is actually repaired, rebuilt or replaced and ‘operations’ are resumed and ends on the earlier of the day insured could restore ‘operations’ with reasonable speed to the condition that would have existed if no direct physical loss or damage occurred or [30, 90, 180, 365] consecutive days after the date on which repair, replacement or rebuilding of such part of the property as has been damaged is actually completed.

13. II. Definition of Terms: Extended Period of Indemnity (EPI)

14. II. Measurement Issue: Extended Period of Indemnity (EPI)
When does the insured reach pre-loss income levels?
Bob’s Pre-Loss Experience:
The day before the loss, Bob sold 123 pizzas.
In the 30 days prior to the loss, Bob sold an average of 121 pizzas per day.
For the 12 months prior to the loss, Bob sold an average of 117 pizzas per day.
This ranged from 111 pizzas per day 12 months ago to 121 pizzas the month prior.
Bob’s Post-Loss Experience:
After reopening 60 days ago, Bob’s pizza output for days is summarized below:
Has Bob reached pre-loss income levels?

15. II. Definition of Terms: Extended Period of Indemnity (EPI)

16. Section 1 – Business Interruption Claims
III. Proper Calculation of Values

17. BUT-FOR SALES
- ACTUAL SALES
= LOST SALES
- SAVED EXPENSES
= LOST INCOME

18. III. Proper Calculation of Values –
Projection of “But-for” Sales -- New or growing business
Claim Example:
Bob opened his store seven (7) months before the loss. There is no operating data available from the prior owner. Bob’s P&L shows revenue as indicated to the right. The POR lasts seven (7) months.
“Standard” Approach:
Calculate average revenue over the pre-loss operating history: $120 per month
Projects that figure across the 7 month POR.
Calculate “But-for” Revenue of $840

19. III. Proper Calculation of Values –
Projection of “But-for” Revenue -- New or growing business
A closer look reveals very clear trends:
Business has consistently increasing revenue of 6% per month, a total of 42% over the 7 months.
Average revenue of $120 is virtual equivalent of revenue in month 4 and below actual results for Months 5-7, significantly understating insured’s actual pre-loss revenue.
What is another approach for projecting revenue?
Project the growth trend across the POR.
Assuming month-over-month growth of 6% for the 7-month POR, total But-for revenue is $1,264.
This is $424 dollars, or approx. 50%, higher than the “standard” approach.

20. III. Proper Calculation of Values – Projection of “But-for” Revenue -- Trends versus Averages – Conclusion

21. III. Proper Calculation of Values – Calculation of Saved Expenses
Bob’s Per Unit Profit and Loss:

22. III. Proper Calculation of Values – Application of Saved Expenses
Percent (%) to Revenue Approach:
Apply saved expense as a percentage of Revenue to calculate saved expenses and BI Loss
Is this the only approach?
Note: But For Sales Units assumes 123 pizzas for 3 months, 30 days per month

23. III. Proper Calculation of Values –
Calculation of Saved Expenses

24. Section 1 – Business Interruption Claims
IV. Specific Claim Facts and Circumstances

25. Specific Facts and Circumstances – Changes in Market Condition
Most policies contain language indicating it does not insure against “changes in market or economic conditions.”
Policy covers insured for loss of income they would have achieved but-for the peril, but post-loss drop in income may have occurred even absent the loss.
POR and/or EPI have a fixed end date regardless of insured’s post-loss results.
Claim Example: Hurricane Ike -- Changes in economic condition (unrelated to the loss)
Strikes Texas in September 2008, severely damaging apartment complex. The insured:
Immediately cleaned up property and began repairs, including upgrades to units
Secured an advance from very cooperative carrier.
Completed repairs months ahead of schedule and ahead of other properties in the area.
Undertook significant advertising efforts for re-opening
After six month EPI, insured was still well below pre-loss occupancy at lower average rents.
Repairs begin during one of worst economic recessions in U.S. history – daily drops in stock prices, home values and employment figures.

26. Specific Facts and Circumstances –
Changes in Market Condition

27. Specific Facts and Circumstances – “Make-up Sales”
Make-up sales: When negotiating claims, carriers might advance the argument that the insured partially benefits after the loss by achieving higher levels of revenue than before the loss. The theory is that customers hold purchases of the insured’s products or services until they resume operations, creating a “pent-up” demand such that the insured “makes-up” for sales lost during the POR in the months immediately after.
Generally rare, as it assumes:
Strict customer loyalty
Inelastic demand
Lack of competition in the marketplace
Short POR before real “pent-up” demand finds alternatives
Katrina/Sandy – occasions where it could be real as businesses that survived or quickly re-opened saw large demand.
Claim Example: After Hurricane Katrina, a clothing retailer in New Orleans suffered losses at over 30 locations, and projected significant losses during the POR and the EPI. After quickly reopening stores, demand far exceeded claim forecasts and pre-loss levels.
Insurer: BI loss during POR should be reduced by increase in post-loss income
Insured: Policy doesn’t cover market conditions, can’t apply it to make-up sales

28. Specific Facts and Circumstances –
Changes in Market Condition – “Make-up Sales”