Among the challenges posed by globalization and the continued expansion of operations outside of the U.S., multinational corporations face heightened risks of business interruption losses and elongated supply chains.
Meanwhile, the adjusting process for these types of international claims has become increasingly complex.
Today, it's fairly common for businesses with property claims involving business interruption issues to obtain a "negotiated settlement." These outcomes often result from the differing views of loss valuation and related coverage interpretations by the policyholder and representatives of the insurer.
For example, consider an international facility that manufactures a product 24/7 where a safe level of inventory is maintained to account for seasonal and other variances in customer orders throughout its geographic region. Should an incident disrupt production, the policyholder may submit a business interruption claim calculated on the basis of net sales value of lost production (less non-continuing expenses).
In reviewing such a claim, the insurer's adjusting team may ask: "Did the loss in production actually equate to lost sales or did the policyholder meet customer demand through utilization of inventory?"
To substantiate the loss, the insurance adjuster may also require the policyholder to prove its lost sales through evidence of customer communications and/or cancelled orders.
Business valuation in the policy will address either gross earnings or gross profits for applying coverage. (Photo: iStock)
Establishing valuations
These issues create a significant loss valuation hurdle as both sides may not agree on the proper methodology for adjusting the business interruption loss. Given the potentially large differences in loss quantum of differing methodologies, it could stall the entire claims adjusting process and delay any potential recovery by the insured.
The business interruption wording in an insurance policy is likely to include language that either states "gross earnings" or "gross profits" coverage. Although the policy language technically is intended to provide the same coverage under either wording, in practice, "gross profits" coverage is more likely to limit recovery to lost sales that can be proven through financial statements or actual cancelled orders.
On the other hand, the "gross earnings" coverage may provide the insured with some flexibility through its "net sales value of lost production" definition.
Understanding ops and market conditions
For the insured, a key to an equitable resolution is the understanding by the insurer's adjusting team of the policyholder's operations and market conditions at the time of the loss.
Here is an example of an exchange between a policyholder and insurer:
Policyholder: "I sell everything I make: If I didn't make it, I can't sell it. Pay me my production loss."
Insurer: "Prove the actual loss sustained. Provide evidence to support lost sales or cancelled orders. The policy responds to lost sales."
Tracking the sales impact and effect on inventory can provide anecdotal evidence to support a claim. (Photo: Shutterstock)
Keys to keeping claims negotiations from stalling
What steps can insureds take to keep the adjusting process moving forward? Regardless of which type of coverage they have, policyholders might consider taking the following four measures prior to and immediately after the loss to support their business interruption claim:
1. Track individual customer sales. Have the sales/marketing team take notes and track the sales impact to individual customers immediately following the loss. This type of information doesn't have to be exhaustive, but proves helpful as anecdotal support for a claim.
2. Show sales and inventory turnover. Provide evidence to insurers demonstrating that historically all product manufactured is sold (sales and inventory turnover).
3. Be prepared to discuss management of finished goods inventory levels. Most insurance adjusters and consultants will regard any level of inventory as an indication of the policyholder's ability to mitigate its sales loss. In a just-in-time inventory system, used by most businesses today, there is little flexibility to mitigate extended production downtime. Keep in mind, however, that inventory levels may be deceptive due to product mix. So, although there may appear to be several months of stock, in fact there may only be limited inventory at the key SKU levels.
4. Understand and explain the market dynamics affecting your product. In the event of an extended loss of production, you should be able to demonstrate how any downtime will potentially affect the company's overall market share. With respect to this point, a policyholder must be able to tell its story, which requires a comprehensive projection of production, inventory usage and ultimately what would have been converted into sales.
The policy will also identify what is considered a "triggering" event for coverage. (Photo: iStock)
Policy wording affects recovery
Another key distinction between the coverage under "gross earnings" and "gross profits" forms involves the duration of a business interruption loss following a triggering event. Under the gross profit form this period may be limited to 365 days; thus, in effect, there is no business interruption insurance recovery beyond that time.
On the other hand, under gross earnings coverage, the business interruption period of liability is defined as the time it takes to repair or replace damaged property, which can extend for more than a year depending on circumstances.
For example, a large international manufacturing operation may take multiple years to truly rebuild its facility to its state prior to the loss event. Under the gross profit form and its corresponding liability period limitation, the operation's business interruption recovery would be significantly limited.
Avoid any surprises
To avoid any surprises in the event of loss with respect to business interruption recovery, ensure the differences in each form are taken into account. The gross earnings form has advantages in loss scenarios that involve extended downtime; meanwhile, the gross profit form is advantageous where the sales loss extends beyond the time it takes to repair or replace damaged property.
Be aware that some insurance carriers allow policyholders to choose their optimal business interruption coverage after a loss, rather than at policy inception.
Carlos R. Moran, CPA, is a director in the Property Claims Preparation, Advocacy and Valuation Group of Aon Global Risk Consulting. Contact him via LinkedIn.
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