Understanding business interruption and property insurance values

Understanding that every loss situation is unique, management must consider the facets of the industry in which they operate, and that the identified operational and financial risks are addressed within the organization's strategic planning process. Depending on the company's internal experience in preparing such analyses and the availability of internal personnel to perform such valuations and calculations, professional insurance claim specialists can provide modeling techniques to analyze an organization's interdependencies and provide insight into valuing time element exposures.

Here are five recommendation to preparing business interruption values:

• Communication – meet with management to identify existing business risk assessments, previous loss history, business plans, financial projections and potential mitigation strategies;
• Diagnosis – identify contingent and extended exposures, as well as other exposures that may not be triggered from first-party property damage;
• Analysis – review and analyze documentation to calculate time element exposures;
• Technology – integrate technological solutions to create an efficient and timely valuation process; and
• Documentation – create schedules with calculations and underlying assumptions to support values by operation and location.

Companies should also consider preparing a Maximum Probable Loss Scenario ("MPL) analysis. An MPL is the process of simulating an occurrence or occurrences in which the organization experiences a catastrophic loss event. The financial impact is quantified to provide a sophisticated analysis and report to management relating to the entities' "true risk."

The MPL should include detailed analyses on potential extra expense in addition to business interruption losses. The MPL is helpful to underwriters in their better understanding of the risk they are evaluating and underwriting. Senior management appreciates the MPL analysis because it may identify critical path weaknesses in the organization and be used in updating strategic plans.

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There are a number of factors that must be carefully balanced when determining the actual losses attributed to a business interruption loss. (Photo: iStock) 

Differences between values and an actual loss

There are significant differences between business interruption values and an actual business interruption loss, including:

• Values need to consider all locations (multiple calculations) vs. actual loss location.
• Values need to consider changes since prior year calculation.
• Values consider policy period (typically 12 months) vs. actual loss calculation which would be based on the period of indemnity.
• Methods to project revenues and cost of sales are typically similar for actual loss and values.
• An actual loss will consider continuing versus discontinuing operating expenses following the loss primarily based on actual operating results whereas a values analysis is based on estimates assuming a 12-month closure of operations.
• Customary BI values are predicated on prior year calculations with minor known financial adjustments.
• In many instances, reported annual business interruption values can be significantly greater than the projected MPL.
• Prepare an MPL calculation as part of the process to provide detailed information to underwriters as to "true risk" which will allow underwriters to properly price BI exposure, since such information may result in premium savings and can provide third-party confirmation as to values and maximum probable BI loss.
• Ensure that professional fees language is included within the insurance policy to cover assistance of accountants, engineers, architects, etc. These costs are not typically included in the BI values.

Many insurance policies cover buildings, inventory, machinery and equipment at replacement cost or actual cash value, which often differs from book values. It is important not only in the underwriting process, but when evaluating premiums versus values to have a clear understanding of the most appropriate value for assets as they relate to their insurance requirements.

Robert Glasser, CPA, CFE (bob.glasser@FTIconsulting.com) is a managing director in FTI Consulting's business insurance claims practice in New York, and has more than 35 years of diverse financial management, insurance claims, and accounting and forensic fraud investigation experience at public and private companies. Opinions expressed in this article are the author's own.

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