First and foremost, it is critical that every consultant involved in estimating the repair period — the contractor, the engineer, and the architect — has the same scope of work in mind following the loss event. It is far easier to compare estimates when the information on which they are based is the same. A clearly defined scope of repairs will help establish when the property should be repaired or replaced.

Additionally, the insured will often choose to make improvements or expand facilities while the business is closed for repairs. This can cause a delay in the resumption of operations and is typically excluded from the insured period of restoration. Before finalizing improvement plans, the insured should understand that the additional time to complete any expansion is excluded from the period of restoration. If the insured decides to move forward with improvements, then it is imperative that the adjuster frequently check with the contractor and ascertain whether the project is progressing as originally planned. Any variances in the original time estimates should be investigated and resolved as soon as possible. This will limit potential problems during the final settlement process.

Next, careful planning not only can mitigate the insured's business income loss but also minimize the suspension of operations. For example, certain situations may allow for replacement and installation of critical equipment well before the building is completely repaired or rebuilt. Even a partial resumption of operations can dramatically reduce the insured's business income loss.

Lastly, many standard commercial insurance policies include an extended period of indemnity beyond the period of restoration. Extended periods are typically limited to 30 days and begin immediately after the period of restoration ends. However, occasionally a gap may exist between the end of the period of restoration and the beginning of the extended period. For example, if an insured decides to make improvements that delay the commencement of operations, then the extended period of coverage would not begin until the date when the property was actually repaired or replaced and operations resumed. This means that the actual date could be weeks or even months after the period of restoration.

Fair Forecasting

The sales projection is often an area of disagreement and spirited debate between policyholders and insurance companies. Two key considerations that impact the sales projection are seasonality and trend analysis. To support a projection, it is crucial to present a forecast that falls within a reasonable range. This forecast would reflect what the business would have done, as opposed to what the business could have done. The former has a basis in fact, while the latter is merely possible.

It is also important to review the insured's sales history. The amount of data needed to project sales is contingent upon the length of the loss period and other situational factors. One common method is to determine either the increase or the decrease in sales (expressed as a percentage) prior to the loss. This will be based on a comparison of the same months from the prior year. For example, consider the sales trend analysis shown in Figure 1 (see figure links provided at end of article).

After a base period is established, the next step is to apply either the percentage increase or the decrease to the loss period. Continuing with our example and assuming a four-month loss period, the projected sales might look something like those listed in Figure 2.

At first glance, this appears to be a straightforward calculation. However, a credible sales projection is one that can be explained in real terms, not just in terms of the math. It should also be consistent with the experience of the business and changes in market conditions. For instance, the applicability of the 10 percent sales growth explained to forecast sales in 2007 depends on what you might find during your investigation. The projected increase might not be appropriate if, at the end of 2006, the business lost its largest customer, new competition appeared, it closed or sold an unprofitable segment, or its employees went on strike. It is critical to exercise good judgment in formulating sales projections. In short, without common sense, sales projections are merely mathematical computations.

Another method employed to project sales is a pre-loss monthly or daily average. When a business is stable — exhibiting no growth or declining trends — and is not seasonally dependent, a pre-loss monthly or daily average can be used to anticipate sales. An example of a business where this methodology would be appropriate is an established dental practice that is closed for one week. Note that this method tends to work best when the loss period is short.

Budget numbers can be a useful source to project sales as long as the reliability of the budgeted sales has been confirmed. Compare pre-loss budgeted monthly sales for a period of time to the actual sales for the same period. If the ratio between actual and budgeted sales is consistent over a span of several months, then using the budget for the loss period may be a reliable approach. To project sales, you would apply the computed ratio to the budgeted sales for the suspension period.

Duty Calls

Mitigation involves efforts on the part of the insured to reduce the business income loss. When considering mitigation, you must address several questions:

• What measures (if any) were taken to reduce the loss?
• Could anything have been done to mitigate the loss?
• What is the financial impact of the mitigation?
• Is it possible to make up the loss during the post-loss period either through normal or stepped-up operations?

Often, the insured's actions to reduce the loss are centered on protecting long-term business interests rather than reducing the claim to the insurance company. Even though most policies have a duty-to-mitigate clause, many insureds will do everything they can to resume operations, even partially, as soon as possible. Occasionally, however, an insured will not attempt to mitigate the loss when clear alternatives exist. In the early stages of the claim, it is wise to reference the specific policy language, which explains the obligation to mitigate and the consequences if this requirement is not met. Furthermore, most business income policies allow for extra expenses that serve to reduce the business income loss that would otherwise be payable.

Projecting Expenses

Based primarily on historical information, the process of projecting expenses involves identifying both fixed and variable expenses. Projected expenses are subtracted from projected sales to determine the likely net income or loss of the business had the loss event not occurred.

The main records used to anticipate expenses include federal income tax returns and monthly income statements. If these documents are not available, other records may be helpful, such as monthly profit-and-loss statements; trial balances; general ledgers; and budgets/business plans. Records for the two years preceding the loss event are typically reviewed. However, there are certain circumstances in which two years of history proves to be insufficient. Without an adequate history, it can be difficult to ascertain if the pre-loss period being analyzed provides a reasonable basis for projecting expenses.

To compute the business income losses, the continuing normal operating expenses are added to the projected net income (or loss). Calculating continuing expenses appears to be relatively straightforward endeavor. In reality, however, this can involve a variety of complex matters, including cash/accrual accounting issues as well as identifying and extracting expenses that have been submitted as property damage claims or other claims.

Before you get too far along in your analysis of continuing expenses, you may want to spend some time with the insured discussing the nature of their business expenses and how the loss might impact them. A valuable tool to use in your discussion is the insured's last income statement or a similar document that was prepared prior to the loss incident. Carefully examine each expense listed on the income statement and think of pertinent considerations. Your questions to the insured might resemble the following:

• What would you normally expect this expense to be, a monthly average for fixed expenses or a percentage of sales for variable expenses?
• How do you think this expense will be impacted by the loss?
• What type of documents can you provide to support continuing normal operating expenses?

Make sure you understand what specific documents are available to support the insured's claim. Not only will this question clue you in to the possible limitations of the insured's accounting system, but it will also point you in the direction of possible solutions early in the loss evaluation.

Russ Matheson, CPA, CFE, is a director in the Seattle office of RGL – Forensic Accountants & Consultants. He may be reached at [email protected].