When Catastrophe Hits, Are You Covered?

How to Calculate Loss of Income

I recently assisted a client with reviewing their claim for insurance due to business interruption. Their facility’s main roof collapsed due to the weight of an excessive ice and snow storm, causing damage to a substantial amount of equipment and making the facility unusable for approximately eight months until it was rebuilt.

Luckily, the client had enough insurance coverage to rebuild the facility better than it was before, replace certain equipment, repair other equipment and replace lost income. The most important coverage they had was the replacement of lost income.

Do you even have loss of income coverage? If so, how is it calculated? What restrictions are there, if any? What are the limits in dollars and/or length of time for the coverage? Will the limits be high enough to cover the length of time needed to rebuild or even move the facility?

Determining your normal selling volume and gross profit generated is a matter of history from prior years and an estimation of the future. You would normally look back at the last two to three years for each month to average out the volume. When looking at this, carefully review extraordinary events which may have occurred. One of the most recent is the Cash For Clunkers program. This generated increased sales and gross profits for a one-time gain. Something else to consider is the depressed economy, which caused the number of new vehicle sales to decrease substantially in the past year or so.

You will need to be ready to calculate and explain what your sales and gross profits would have been, emphasizing the sales increases and minimizing what possible decreases there could have been. You may have to consult national and regional sales statistics, 20 group data and other local franchises near you to gather enough information to help support your claim. This will be an ongoing process for the length of time your facility is being rebuilt.

During a business interruption from a covered event some of your operations may be able to continue. Additional expenses in excess of normal expenses may be incurred to keep the operations going. The problem is trying to track all the additional expenses in excess of what you would have normally incurred with the same sales and also what additional selling gross you would have as income if you were in full operation and at your normal selling volume.

You will need to account for these additional expenses separately from all of your other expenses. I would recommend these be posted to a prepaid general ledger account. I would control it by the vendor and or type of expense. You will need to keep these bills separated from your normal bills so they can always be reconciled easily to your prepaid schedule. Some bills will have both normal and additional expenses. You will need to make additional copies of and mark on these bills the allocation of how you separated and recorded the expense.

An additional expense commonly not accounted for is the time your employees spend doing things they would not normally have to do if your facility was not damaged. Your employees’ time is an expense you need to also keep track of and record. An easy way to do this is with the use of time cards, even for your salaried personnel. Look at it as if you would have had to hire someone to do those extra jobs while your normal personnel continued with their own jobs. Now add the employee benefits and payroll taxes to the hourly rate and/or salary paid for the additional time spent. You will need to not only document on the time cards the time spent, but also what they were doing which incurred additional time.

Once you have recorded all of the additional expenses, you will need to prepare a recap to submit to the insurance company. Having detailed records and copies of bills will increase your chances of getting those expenses paid.

Loss of income coverage will not normally reimburse you for your fixed expenses. The insurance company, by reimbursing you for the lost selling gross profit, in effect has made you “whole” enough to pay for these fixed expenses. Review your fixed expenses to determine they are really fixed and not tied to sales volume. If any of them are, prepare a summary of why they are tied to sales and why they should be covered. During a catastrophe, one of the things you can do is try to decrease your fixed expenses and/or your semi-fixed expenses to help you through the tough times.

You will also need to consult with your accountant to help recap the information to provide to the insurance company. Chances are they have helped other clients through the same process and know how to present the information in an orderly fashion along with explanations for the expenses. They will also need to recap and explain tax-related expenses, such as LIFO, section 179 expense on the write-off of various assets for tax purposes only, accruals and reserves for tax purposes but not for your financial statement purposes, and other items.

Sit down with your insurance agent today and walk through what your insurance company would pay for under various catastrophe scenarios. It is always better to find out ahead of time if you have the proper coverage based on your existing sales volume and profit potential. Ask what they won’t pay for that is hidden in all the fine print in your policy. Have them walk through the coverages, and make notes accordingly. If you find you don’t have a certain coverage you think you may need, ask them if they provide it. If not, look elsewhere for the coverage.

Vol. 7, Issue 5