The challenge for every business operator is deciding how much insurance coverage and what types of policies are needed to adequately mitigate risk exposure. To truly alleviate identified risks, though, it is important to have a clear understanding of what is covered in your policy and what is not. For many business operators, the realization of what isn’t covered is only understood after the fact, when a claim is denied or a settlement check is less than expected.
There are several common reasons why business operators are often disappointed in the final resolution of an insurance claim. Some of these are as follows:
The insured party assumes that anything bad that happens must be covered under one of the policies.
The wide variety of insurance policy types and terminology used in the insurance industry may leave gaps. Common types of business coverages include business interruption, business owners’ policy, commercial property, cyber, data breach, errors and omissions, general liability, loss-of-profits coverage, and umbrella.
Oversight due to the inherent difficulty of “hard to read” and “hard to understand” insurance policies that outline all of the terms and conditions, definitions, covered events, excluded events, limitations, disclaimers, and other technical details related to the policy.
- An insurance claim adjuster who represents the interests of the insurance company.
Examples of the types of insurance that often result in a disputed claim are business-interruption and loss-of-profits coverage. The purpose of this coverage is to provide financial relief in the event that a business is unable to conduct normal operations for a period of time due to a covered loss, such as water damage or a fire. Physical damage to business property (inventory, equipment, and other fixed assets) would be addressed under the property insurance policy, while business interruption or a loss-of-profits claim would be based on the fixed costs incurred and the profits lost during the period of time the business is unable to operate normally. Quantifying this type of claim is difficult for several reasons:
Profits that would have been earned can be based on historical trends, but many businesses experience fluctuation in the level of monthly net profit, especially those that have seasonal revenues. The method typically used to quantify “lost profit” is either not spelled out clearly in the policy language or is presented in an overly simplified format. The measurement of the lost profit during the business interruption period is subjective and can be controversial.
Generally speaking, “fixed costs” are covered but “variable or avoidable costs” are not. In reviewing the overall cost structure of a business line by line, there are often differences of opinion on whether particular costs (such as payroll and employee benefits) are “fixed” for purposes of the damage claim.
There is usually a clear understanding of the date in which the business interruption started, but it is often less clear when the interruption period ends. Policy language typically indicates that the interruption ends “when the damaged property is physically repaired and returned to operations under the same condition that existed prior to the disaster,” which can also be a subjective concept.
Business Insurance Analysis
Based on the complexity of insurance policies and the different forms of coverage, every business owner and operator should review his or her overall insurance program on a periodic basis and address the following questions:
What types of policies do we have in force, how much coverage do we have, when do those policies expire, and what premiums are we paying?
Do we understand what each policy actually covers?
- Do we understand how the insurance company would quantify a covered claim?
- Do we have the supporting documentation necessary to support a covered claim?
- Based on our current and future business plans, are our coverages and policy limits adequate?
Have we identified any gaps in coverage that we should explore filling?
Business owners and operators do not need to become insurance experts to effectively go through the business insurance analysis process. CPAs, as trusted business advisers, can assist in the analysis and other aspects of this undertaking along with an attorney and insurance broker. Each adviser brings a different expertise and perspective to the “insurance question” that collectively can be used to mitigate risk in a cost-effective manner. This analysis will also avoid the greatest risk: not knowing what is covered and what is not.
John S. Stoner, CPA, CVA, is department head of Reinsel Kuntz Lesher LLP’s business consulting group in the Lancaster office and a member of the
Pennsylvania CPA Journal Editorial Board. He can be reached at firstname.lastname@example.org.