The coronavirus (COVID-19) pandemic is wreaking havoc on world markets as businesses have faced forced closures or significant reductions in operations and customer demand. Many businesses are now bracing for more severe outcomes in the coming months. In addition to immediate concerns about how to manage liquidity, protect employees and maintain ongoing operations, companies may be identifying other sources of financial relief and loss mitigation. Whether seeking funding support from government agencies or deciding whether to submit claims for insurance recoveries, it is crucial for businesses to have an accurate assessment of the impact the pandemic has had on them. Precise, well-supported quantification of the business losses stemming from this event are necessary for a claim to be measured, validated and approved.
This article summarizes some of the key considerations in claiming business losses, both in claim preparation and claim review. Although our discussion principally uses the concepts associated with an insurance-related submission, these same guidelines can apply to other types of damage recovery for business losses, such as submissions for government relief or litigation proceedings.
Key questions and analysis
The development of a claim to recover business losses goes beyond a typical financial and accounting analysis; preparation of such a claim often requires a professional specialist who understands when a coverage applies and how a policy responds. A professional who understands the complexities and nuances of different businesses and who is accustomed to working with the specified requirements of properly measuring a claim can play a significant role. That professional can perform the financial and accounting analysis necessary to support and validate submissions or applications for recoveries of business losses.
Experienced professionals who have worked on behalf of policyholders, governmental agencies, insurance carriers and others should understand the issues faced by parties on both sides of the table. Those individuals can bring an appreciation of each party’s objectives, as well as a thoughtful, reasoned approach to determining the relevant types of analysis and information involved in making a balanced and objective analysis of the business losses.
In our experience, the following items comprise some important considerations and analysis that the claims expert should address:
- Reviewing the insurance policy form and coverage details to determine the appropriate type of policy (profits, earnings, business income) under which a claim is being prepared and the relevant definitions of insured events, exclusions, loss measures, etc.
- Determining the appropriate basis for measuring the loss such as ‘actual loss sustained’ or a ‘stated amount’ of insurance that has co-insurance application
- Determining and analyzing continuing versus non-continuing expenses and saved expenses
- Determining the appropriate rate of gross profit by analyzing fixed, semi-variable and variable expenses
- Reviewing the methods of calculating additional operating expenses that would not have occurred during normal operations and identifying extra expenses that may be insured by the policy
- Reviewing the historical financial performance, current business plans and forecasts to determine what the projected sales of the business would have been absent the incident.
- Identifying and quantifying any mitigation of the losses
While the initial framework of business loss calculations may be similar, or begin from a common reference point based upon the industry (e.g., manufacturing, services, nonprofit, etc.), understanding the nuances of measuring sales, production, expenses and profit in conformity to policy or coverage requirements will be important to validate an accurate, supportable claim. In a COVID-19 environment, many factors may cause business losses; for example, supply chain disruptions, employee availability and orders from civil authorities.
We recognize that many different policies and coverages may exist, and government recovery programs will have their own (yet to be determined) requirements. The unique facts and circumstances of each situation will determine what types of documentation, financial and accounting analysis, and measurement of losses are needed. All of this work requires a professional familiar with both the business itself and the business of recoveries.
Documentation and analysis
Regardless of the type of claim, businesses need to compile and analyze key information to document losses stemming from any situation, including COVID-19. The nature and extent of the documentation needed will depend on the type of claim filed and who it is filed against, e.g., an insurance company or a government fund. The goal is to analyze and validate claims on an objective, data-driven basis.
A skilled financial advisor can provide valuable assistance in determining what documents are needed, which questions must and should be addressed, and what data will be necessary to support a claim. This process will involve detailed analyses of:
- Insurance policy contracts, other coverage agreements or government program rules that are in force at the date of the loss, including all extensions, endorsements and declarations pages
- Financial statements for two to three years before the loss event, and ongoing for the loss period
- Audited financial statements, corporate tax returns (or personal returns for unincorporated businesses) and other external financial information for two to three years before the loss event, and ongoing for the duration of the loss period
- Other expert reports, opinions and/or loss claim calculations
- Relevant customer and vendor agreements/contracts in force at the date of the loss
- Payroll information for the two to three years before the loss, and roles and responsibilities of each staff member
- For manufacturers, production information and schedules as of the date of the loss
- For service companies or nonprofit entities, program information, staffing, expense and supply reports as of the date of loss
- Monthly customer sales data, margin reports and other revenue trend data
- Monthly expense data and detail for the business before and after the loss event
- Description of the loss event and how the business has been affected to date.
- Expense details, including supporting documentation, such as invoices for additional expenses incurred as a result of the loss
- Details of any mitigation efforts to reduce the loss of profit and associated costs incurred from the loss event, if any
In addition to the information compiled above, other items may be relevant, necessary and specific to the nuances of the business and the industry in which the business operates. Documentation of other such factors may be requested as the loss is quantified and supported.
Management by the loss claims professional team
Based on our experiences managing the claims process on behalf of claimants and on behalf of insureds, we suggest the following management items for consideration.
Frequent and informed communication (in any and all forms) is important to structure the analysis and to identify and obtain relevant information. The communication should be ongoing and consistent between all parties, including experts, counsel, brokers, carriers and insureds.
Use of interviews:
Firsthand knowledge via written reports is often supplemented with interviews and meetings to fully understand issues, develop an understanding of facts and timelines, and to gather documentation. In a COVID-19 environment, these interactions may happen over the phone or online rather than in person.
Client information should be treated confidentially and only be available to those who directly participate in the work, at the discretion of the clients and their professionals, as they may see considerable proprietary information in the preparation or analysis of a claim.
Professionals should understand how to guide and work through the clients’ processes to prepare or review claims, providing regular updates and seeking input into the analysis and supporting documentation as the parties proceed through the claims process.
Professionals can support their clients in identifying, compiling, and analyzing comprehensive documentation and the data necessary to support claims. Often the clients and their supporting professionals work together in a dynamic relationship to do this.
Professionals can bring their expertise to bear in identifying relevant analytical approaches and apply scenario testing as suitable for each situation to measure and quantify losses.
Understanding the differences between routine business accounting versus the nature of the accounting information used in computing claims, and applying that knowledge in analyzing and presenting financial information, are important to successfully validating claims. This often requires digging into supporting general ledgers and assessing the accounting postings and their underlying documentation.
Communicating findings in concise, yet comprehensive written and/or oral reports (as required for the type of claim or recovery sought) that focus on the relevant issues and include supporting analysis, opinions and recommendations will be an important component of each engagement.
There is little doubt that the current COVID-19 environment will have a significant economic impact on individuals, companies and entire industries. Clients across a wide range of markets, both domestic and international, are likely to experience significant business losses. While many insurance coverages or government programs may offer potential sources of recovery, the applicability and potential relief associated with those coverages and programs will depend on the situation and the findings of professionals, clients, the coverage providers or even the courts.
A proactive, ongoing dialogue between the client and its financial and legal advisors should facilitate management of the short- and long-term implications of the current challenges businesses face. The most important advice may simply be to approach this entire pandemic period proactively, seeking informed advice and assistance as losses are tracked, documented and submitted for potential recovery.