Filed Under:Claims, Catastrophe & Restoration

A Forensic Accountant’s View of Business Interruption

Catastrophes and Expeditious Claims Evaluation

The Association of Certified Fraud Examiners (ACFE) explains that, “forensic accounting is the use of professional accounting skills in matters involving potential or actual civil litigation.” The word “forensic” is defined by Black’s Law Dictionary as “used in or suitable to courts of law or public debate.”

In the insurance claims world, a forensic accountant is typically engaged by an adjuster, or an attorney, to provide an understanding of an insured’s books and records, and to determine through an analysis of those books and records whether the policyholder has sustained a loss, as defined in the insurance policy.

The Forensic Accountant’s Role
Depending on the size and complexity of the policyholder’s business operation and claim, a team of adjusters and consultants may be assembled to analyze many of the issues that arise during the claims process, including (but not limited to): building and construction, production, sales and marketing, advertising, and accounting. Both the policyholder and the insurer will assemble a “team” to support their respective position. The insurer’s “team” may include a field adjuster, claims manager, underwriting department, in-house legal staff, and other experts such as engineers, salvors, outside legal resources, and forensic accountants. The policyholder’s “team” may include a public adjuster, in-house accounting department, external CPA/accounting firm, production managers, sales and marketing departments, and in-house legal department. It may also employ outside consultants, including engineers, salvors, outside legal counsel, and forensic accountants.

Many adjusters do not have the time or expertise to both properly and expeditiously evaluate a business interruption (BI) claim, especially in a catastrophic environment. A competent forensic accountant will provide an adjuster, policyholder, or legal counsel with his or her knowledge and experience in matters including (but not limited to): technical aspects of accounting rules and procedures and other related data; and, the ability to translate accounting data to conform to insurance policy coverage language. (Please note, a forensic accountant does not provide coverage interpretation, as this is the responsibility of an adjuster and or legal counsel.)

A Look At Loss Occurrence
Once engaged, a forensic accountant will review the applicable BI coverage, and familiarize himself/herself with both macro and micro-economic trends of the insured’s industry. The forensic accountant will then contact the appropriate representative to discuss the loss occurrence and how the damage affected business operations, business/accounting records maintained in the normal course of business, and may possibly suggest integrating additional accounting procedures to expedite the claim process.

In medium- to large-sized businesses, there may be a person or persons that have expertise in accounting—for example, the CFO or controller. However, in many smaller businesses, the owner of the business, who may have no formal accounting training, is also the “accountant.” Be it a small “mom and pop” operation or a large complex business, a forensic accountant will expedite the claims process by having the ability to translate the policyholder’s operating results, as reflected in its financial records, to its BI coverage.

The Time Element Component
One of the critical factors in determining the value of a BI loss is the “time element,” or duration of time the BI loss will be measured over. A claims adjuster may make a determination of the measurement period by melding his or her knowledge of BI coverage with assistance from knowledgeable consultants (construction, electrical, engineering, legal, and so forth).

Once the time element is established, it is then forwarded to the forensic accountant to include in his/her computation. The time element is typically referred to as the Period of Restoration, and may include an Extended Period of Indemnity. ISO coverage form CP00 32 04 02 - Business Income (Without Extra Expense) Cover Form, defines the Period of Restoration as the period of time that: (a) Begins 72 hours after the direct physical loss or damage caused by or resulting from a Covered Cause of Loss at the described premises; and (b) Ends on the earlier of: (1) The date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality; or (2) The date when business is resumed at a new permanent location…” The extended period of indemnity is defined as: (1a.) Begins on the date property (except finished stock) is actually repaired rebuilt or replaced and “operations” are resumed; and (1b.) Ended on the earlier of: The date operations could be restored with reasonable speed to the level which would generate the business income amount that would have existed if no direct loss or damage had occurred; or (ii) 30 days after the date determined in (1a.) above. Even with this succinct measurement period language, the time element component of the claim calculation is one of the most disputed areas of business interruption claims.

BI Claim Calculation
A BI loss can be calculated using two separate methods, as they will end up with the same value: net income plus continuing expense or gross earnings less non-continuing expenses.

Once the loss measurement period is determined and coverage is confirmed, a forensic accountant will prepare a list of relevant financial and other related documents needed to calculate the actual loss sustained, if any, during the measurement period. The documents requested may include but are not limited to: income tax returns, income statements (profit & loss statements), budget to actual variance reports, sales tax returns, equipment and office leases, general ledgers, and payroll ledgers.

Under both methods of calculating the BI value, analyses of sales, costs, and expenses are necessary. Regarding sales, a forensic accountant will project what the sales level should have been during the loss measurement period “but for” the loss incident. Some potential factors to consider when projecting sales are outlined in the sidebar.

Expenses and costs can be segregated into general categories: fixed, variable, and a combination of fixed and variable. Fixed costs are considered continuing expenses in the business interruption calculation. Examples of fixed/continuing expenses include: rent (unless the rent is abated in accordance with the insured’s lease terms), insurance, property taxes, interest expense, and other contractual obligations. Variable costs are considered non-continuing expenses. Variable/non-continuing expenses include: bad debt, sales discounts, merchant credit card fees, shipping and freight, raw materials, ordinary payroll expense and supplies. An example of an expense that has both a fixed and variable component is a telephone expense, where there is a base/fixed monthly charge with additional charges based on usage.

Once the period of restoration is determined, the sales trend established, and pre- and post-loss costs and expenses analyzed, a business interruption calculation is prepared. In a simple scenario, the difference between the insured’s expected revenue and expenses and its actual revenue earned and expenses incurred during the measurement period, results in the BI loss.

Now What?
A BI calculation is the sum of many components. Some of the components are objective while others are more “grey” in nature. The “grey” components may result in a difference of business interruption value between the “teams.” If the differences can be resolved, then the claim will be paid and closed. If not, then a forensic accountant may be engaged to take on a new role as an appraiser in the Appraisal process found in many insurance policies, or as a consultant or expert witness if the claim ends up in litigation.

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