Reported business interruption values can have a significant impact on an organization when it comes time to submit an insurance claim. Policyholders need to correct inaccurate or out-of-date insurable values to avoid the following issues:
1. You May Not Have The Right Amount of Insurance
Ask yourself: Has your company simply taken the prior year’s reported business interruption values and added an inflationary factor to it? Do you know what inputs were used to develop the original values that have been carried forward each year? How many years has this methodology been used?
While simply adjusting the prior year’s values may seem like an efficient method for reporting purposes, the results will be incorrect if the values were not accurate in the first place. This could be due to incorrect assumptions, limited guidance from underwriters or the use of a one-size-fits-all model. Additionally, a company may not be considering the changes in market or business conditions, including profitability, capacity, inventory on hand, or other changes in the business that have occurred or are expected to occur. For example, if a company underwent a plant expansion in 2022, but the annual values had simply been carried forward from 2021, it may be underinsured.
Understanding the inputs used as the basis for reported business interruption values is vital to presenting an accurate assessment of the company’s risk, both to management and to insurance carriers. By not reviewing these factors on an annual basis, companies may purchase too little insurance, which could be catastrophic in the event of a loss. Alternatively, a business may purchase too much insurance for limits that will never be required, overpaying for unnecessary premiums and increasing the likelihood that insurers could be unwilling to take on the perceived risk of covering the business.
2. A Co-Insurance Penalty May Limit Your Financial Recovery
While generally less prevalent than in the past, it is not uncommon for some property or business interruption policies to include co-insurance penalties when the amount of insurance procured is materially less than the true values at risk. In simple terms, business interruption co-insurance imposes a penalty on an insured’s loss recovery if the limit of insurance purchased is not adequate for the value at risk. For this reason, it is important to understand your exposure, because if you are materially incorrect, it can result in a penalty that creates an unexpected gap in insurance coverage.
For example, imagine a business has 10 locations and reports business interruption values of $100,000 at each location for a total exposure of $1 million. In this example, the company purchases a global limit of $1 million. If a hurricane hits one location and the resulting business interruption loss equals $350,000, despite having adequate blanket limits, a co-insurance penalty may be triggered depending on the specific policy wording.
3. Deductibles May be Tied to Reported Values
There are many types of deductibles depending on variables like the insurer, the type of loss and the location of loss. Common deductibles for business interruption include dollar value deductibles per location, a waiting period in which losses incurred represent the deductible, and a percentage of business income.
Business income deductibles can be based on previously reported values. In this situation, under- or overreported values can impact your business interruption recovery. While underreporting values may result in a lower deductible, it may also trigger co-insurance penalties that will reduce the compensable recovery.
Business income deductibles can also be based on expected business income during the policy period or loss period. Following the loss event, insurers will analyze your expected business income during the policy period or loss period to calculate your deductible. If a company utilized previously reported values to estimate recovery, the actual deductible could be significantly different based on current factors. This could call into question how accurately values were disclosed during underwriting and may result in additional scrutiny.
4. Initial Estimates and Loss Reserves May Not be Accurate, Hampering The Claims Process
Following a loss event, insurers create a loss reserve in which funds are set aside for the purpose of meeting financial obligations as they become due. To this end, loss preparers and insurers immediately attempt to estimate the potential exposure of the event. An initial starting point is often to review the reported values on file, as receiving current financial information usually takes time. Loss exposure estimates factor in the loss particulars, such as whether it is a full or partial suspension, whether there are mitigation opportunities, the estimated period of interruption and so on. The preliminary estimate of loss often aids in the reserve setting process.
If the starting point of the preliminary estimate of loss is rooted in inaccurately reported values, the resulting loss estimate and insurance reserve may be materially incorrect. Managing expectations of both insurers and policyholders is critically important and claims may not go well when expectations are misaligned.
5. You Will Not Fully Understand Your Company’s Risk Exposure
It is important to remember that insurance is just one part of a successful global risk program. Performing an in-depth analysis of potential loss exposures will lead to a better understanding of potential issues and concerns, which may also lead to ways to mitigate the exposures. For example, if a company learned during the exposure analysis that an important piece of equipment is backordered for eight months, it may decide to procure a replacement to expedite a recovery from a potential loss. Or a company may seek out and pre-qualify a third-party manufacturer to assist in the event of a manufacturing disruption.
How to Accurately Report Values
An insured is obligated to understand their risks and communicate them accurately to insurers if they are to remain business partners. But how is a business to ensure that they are accurately reporting business interruption values?
It is critical for a business to understand not only financial factors, but also operational factors such as rebuild and replacement timelines and interdependencies within the company. A cross-functional team will allow risk management to better understand the risks and needs of a business. Often, experts such as forensic accountants familiar with business interruption claims and proper valuation techniques partner with policyholders and insurance brokers to analyze and calculate annual ratable values as well as perform exposure analyses to aid in the policy placement process.
At the completion of the business interruption values study, policyholders benefit from accurate values, often allocated by location or product, as needed. Further, working with the company’s cross-functional team provides for a true exposure analysis that considers factors such as existing risk mitigation plans, available capacity/utilization, mitigation opportunities, likely loss timelines and other factors that may come into play during a loss and resulting business interruption. Ultimately, the business interruption values model should provide a systematic, transparent and detailed report that reconciles with a company’s reported financial statements, which underwriters can rely on when evaluating the risk profile.