Risk Managers' Forum
The business behind business interruption
A forensic accountant's approach to BI claims
By Scott E. Bushnell, CPA, CFF
One of the most challenging aspects of commercial property and
casualty insurance is preparing claims when disaster strikes. Most P-C policies
contain straightforward property damage coverage language. Generally, property
damage claims are simple in nature, and risk managers often handle many of
these claims in-house with some support from their accounting department.
However, business interruption (BI) claims often pose a daunting task to risk
managers and accounting personnel alike.
Preparing business interruption claims takes thoughtful planning
and insightful analysis, clearly communicated to all of the parties involved in
the claims process. One of the most important factors is the breadth and depth
of analyzing relevant financial information related to interrupted business
operations. Although this may seem like an intuitive step, there is often a gap
between the internally prepared financial information and the analysis to
determine lost profits. Application of due diligence results in a smooth claim
process, quicker payment from the insurer and a fair and equitable recovery.
Role of the forensic accountant
Policyholders often hire forensic accountants to prepare BI
claims and, in many cases, this makes good business sense. Their work requires
a unique mixture of analytics, statistics and accounting. Analysis of this type
of economic damage also requires an application of due diligence. Most business
professionals recognize due diligence as it applies to business acquisition or
combination of companies. An idea of due diligence that likely comes to mind is
a detailed verification of accounting information. However, in the context of
BI claims, due diligence considers verification of the affected business's
historical information as well as analysis of prospective operations and
challenging the veracity of information.
Preparing BI claims requires calculating damages on a perspective
beyond the empirical analysis of accounting data. This requires understanding
the market environment of the industry, business drivers for sales, inputs and
outputs of raw materials and finished goods, as well as operational data such
as units of production or plant operating rates. Due diligence brings into
focus the underlying components of commercial damages and lends veracity to a
Business interruption coverage
Business interruption insurance is a very common coverage
designed to protect a company's income stream. Most commercial property and
casualty policies include some form of this coverage. Although specific policy
language will vary from policy to policy, BI generally covers the loss of
profits due to damage of a physical asset by a covered cause resulting in an
interruption of the operations of a business.
A policyholder should conduct a thorough review of its insurance
policy as the first step in any claim situation. Furthermore, many
policyholders will consult legal counsel for coverage advice and forensic
accountants for quantifying losses during the claim process. Applying due
diligence at this stage of the process will reveal deductibles, exclusions and
limitations of coverage in relation to the loss, which are necessary elements
of any BI claim.
Had no loss occurred
The standard applied to determining lost profits incurred due to
an insured event is: expected earnings had no loss occurred, minus the actual
earnings incurred during the period of indemnity. Generally, analysis of these
types of claims applies the "but for" theory of damages. This assumes the
business would have earned profits (or reduced losses) but for the incident
interrupting normal operation of the affected business.
Furthermore, a complete cessation of operations due to the event
is not necessary as a policyholder has an obligation to take reasonable means
to mitigate its damages (including partial production, if possible).
Significant analysis is performed to understand the operational
and financial aspects of the business to prepare a reasonable forecast of the
results of operations had no loss occurred. This analysis includes lost sales
due to the event, fixed/variable costs and the ensuing BI losses.
Determining "but for"
The first step in BI analysis is to develop a strong foundation
in the operations business. This will often include site visits, not only to
affected locations, but also to unaffected locations as well. Risk managers
should conduct interviews with employees and managers at the affected location
and with accounting department personnel. Beyond getting a good perspective of
the loss incident and plant operations, they can address the following
• How are operations planned or scheduled at the plant?
• Is this schedule based on customer (internal or external)
demand or some other factor (such as maintaining inventory)?
• Are plant budgets available? If so, how are they used in
evaluating current or future performance?
• Do the budgets tend to be accurate when compared to actual or
are they inaccurate?
• How are costs of sales/manufacturing identified, collected and
reported in the income statement of the company?
• Are there any unusual characteristics to the costs individually
or in a pool of costs?
• What did the marketplace look like for products? And were there
any upcoming significant orders or sales that might have had a greater impact
to normal operations?
These are just a few of the questions that will begin to open up
fruitful conversation with local personnel.
The next step in the process is collecting the financial
information necessary for preparing the claim. As one can imagine, the list of
information that may be necessary will differ from company to company and from
claim to claim. Operational income statements and balance sheets as well as
supporting details provide the basic components for preparing the BI claim.
Additionally, the adjuster will likely request sales ledgers, forecasts, and
analyses. Cost and expense information will be useful in the BI analysis as
Beyond the financial information listed above, several different
categories of documents may be requested for preparing a BI claim. These would
• Copies of the past three- to five-year financial statements,
both audited and operational
• Sales ledgers for specific affected products or plants/stores
• Fixed asset ledgers and schedules for equipment maintenance or
• Details of expenses including depreciation, SG&A (selling,
general, and administrative), and out-of-pocket expenses incurred due to the
• Industry data and economic analysis performed independently of
This information will serve as the foundation of the BI claim,
but it is important to keep in mind that this list is not all-inclusive of the
population of documents needed in any particular case to prepare a claim.
Connecting the dots from event to lost sales
A connection must be made from the initiating event to damaged
covered property to the interruption of operations and lost sales. At its base
level, lost sales drive lost profits, even if there is only a partial cessation
of operations. However, there is still a causational link from the event to a
reduction in operations. A substantial amount of analysis will be directed to
Determination of lost sales begins with an analysis of
anticipated sales for the period of indemnity, the time from the date of loss
to restoration of operations. Several factors should be considered to forecast
sales during the interruption such as historical performance of the business,
economic environment of the industry, and anticipated movement of the industry
as a whole. Additionally, considerations such as strategic business
initiatives, sales campaigns, and new product development are other factors to
consider as analysis of damages progresses.
There are generally no hard-and-fast rules about how many months
of historical data should be reviewed to forecast sales in BI cases. However,
there should be enough information analyzed to determine trends, cyclicality
and seasonality of sales. This analysis is generally performed on a monthly
basis using a company's preceding three- to five-years monthly sales figures.
Similar analysis should be considered for units of production and costs of
sales as well. This form of analysis may lead to other areas for review such as
price volume or sales margin analysis.
Putting the pieces together
This is where due diligence comes to the forefront of preparing
the BI claim. After interviews are conducted and basic analysis is performed,
additional investigation into historical market and industry trends is
performed. The chief aim of this analysis is to test the reasonableness of
forecasted sales, gross margin, and profits and their interaction with BI
Economic indicators are available for every standard industry
code in the SIC system. As the nation has seen over the last three years, many
U.S. companies have had year-over-year decreases in sales due to the slowdown
in the economy. Relevant market and economic indicators should be considered
and applied when forecasting sales. For example, in the U.S. steel industry
over time, steel mills have generally become less profitable due to competition
from overseas and reduction of margins due to manufacturing costs. However, one
segment of the steel industry that has maintained profitability, and in some
cases, increased profitability, is the mini-mill. This is an excellent example
of economies of scale. Investing time into this analysis can pay off handsomely
when the claim is settled.
Due diligence involves testing out what part of lost sales can be
explained solely as an effect of the incident. Not all losses may be explained
in the mathematical difference between last year's sales and this year's sales.
Additionally, changes in the market conditions may affect costs and expenses.
The rising and falling price of oil will directly influence shipping costs.
This increase could be seen in freight costs on raw materials or expenses for
shipping out finished goods. Year-over-year increases or decreases in costs and
expenses need to be investigated enough to provide a realistic picture of what
forecasted profits would likely be had no loss occurred.
Scott E. Bushnell, CPA, CFF, is a Certified Public Accountant
practicing in forensic accounting for more than 16 years. He assists corporate
clients recovering from catastrophic events through claim investigation and
quantification of damages. He has testified as an economic damages (business
interruption) expert in federal and state court and has prepared numerous
contingent BI claims for policyholders. Additionally, he routinely prepares BI,
extra expense and property damage claims for corporate clients. He regularly
lectures and teaches CPAs and other professionals through continuing education
programs. For risk management education, attend the Certified Risk
Managers (CRM) program: www.TheNationalAlliance.com.