The devastation caused by the COVID-19 pandemic has been heartbreaking and unforgettable; however, the recovery and rebuilding is a story of strength and resiliency.
COVID-19 affected nearly every business and nonprofit, life and livelihood, process and procedure, and bottom line.
From a business perspective, many, if not all, experienced new and changing regulations, including mandatory closures, operating restrictions and modifications, employee safety and remote work challenges, customer demand fluctuations, and supply chain
disruptions. The impact on financial performance was significant and varied. It was a time unlike any that most of us have ever experienced.
When it comes to business interruption insurance claims, COVID-19 has brought on a host of challenges.
“Business interruption” may be a familiar term since it has been in the news often during the pandemic. There have been many questions surrounding business interruption coverage as a result of COVID-19. In the few cases where a business has
been paid for a COVID-19-related claim, that payment often has been limited to a specific coverage grant (e.g., event cancellation) or subject to a sublimit. Due to this narrow scope, COVID-19 losses experienced by a business generally are significantly
greater than the limit available per the carrier. In one example, a specific coverage grant had a sublimit of $250,000, but the business’s loss far exceeded that amount. The analyses performed to support
COVID-19 losses in many cases have been focused on the specific coverage being afforded. For the most part, though, carriers have rejected COVID-19 claims, and this rejection has been the source of litigation across the county.
This feature does not look at business interruption claims as a result of COVID, but rather how business interruption claims were analyzed and evaluated in the past and what impact COVID-19 has had on this process to date and going forward. The world
is adjusting to a new normal, and how business interruption claims are evaluated is evolving as well.
Business Interruption Coverage
Generally speaking, business interruption insurance replaces business income lost because of a covered event. Covered events may include damage resulting from floods, fires, or other causes. From an accounting perspective, business interruption claims
are generally calculated under two approaches: “top-down” or “bottom-up.” In top-down, the calculation is based on revenues (i.e., starting at the top of the profit and loss statement) less noncontinuing (saved) expenses. In
a bottom-up approach, the calculation is based on net income (i.e., starting at the bottom of the profit and loss statement) plus continuing expenses. A noncontinuing expense is saved if there is a business interruption. Also called a “saved
expense,” these include items such as rent, repairs and maintenance, utilities, or other expenses that stop or slow down as a result of the covered event. A continuing expense cannot be avoided if there is a business interruption. These may
include loan interest, insurance coverages, and payroll expense if employees were continually paid. These terms are frequently referenced when calculating a business interruption claim.
Complexities in calculating business interruption losses are not new and were an issue prior to the pandemic. While the methodology described above may seem straightforward, business interruption claims have long been complicated and time-consuming. The
way a loss affects a business is unique and each situation is different. There is no one-size-fits-all approach for calculating or evaluating a claim. The circumstances of the loss and its effects on the business must be considered and evaluated.
Forensic CPAs use accounting and investigative skills to analyze financial information and identify the financial impacts caused by an event. Gathering financial documentation and conducting in-depth financial analyses and modeling to understand the financial
impact of the event is also imperative. The forensic CPA works closely with the team presenting this information to relevant parties.
Many factors are analyzed and evaluated when preparing a business interruption loss, including the financial performance of the company, the market it operates in, the industry and the overall economy, among other information. There are also other nonbusiness
considerations, such as the period of restoration, the extended period of indemnity, waiting periods, and deductibles:
- The period of restoration begins when the covered damage forces a business to suspend operations and ends when the covered damages are, or reasonably could have been, repaired.
- An extended period of indemnity provides additional coverage beyond the period of restoration for a business to ramp up their sales, production, etc., and return to normal preloss operations.
- A waiting period is the time an insured must wait before some or all of their coverage is effective.
All these factors can affect a business interruption calculation.
Business Interruption Then
Preparing a business interruption claim can be an overwhelming process, particularly for the insured. For a business already dealing with a major crisis, this process can seem insurmountable. However, the work is not limited to the insured; the process
for the insured and the carrier involves a significant level of analysis, documentation, and time.
As previously stated, business interruption calculations typically focus on the revenues or net income and expenses of a business. As part of the calculations, it is often necessary to determine the performance of the business “but for” the
event. In and of itself, the nature of projecting future performance is tricky. Projections require an understanding of the business’s financial data and trends. It can also involve obtaining an understanding of other factors, such as business
policies and procedures, business drivers, key metrics, competition, future business plans, as well as the market and industry the business operates in.
Projecting future performance can be further complicated by the business itself. Its structure may be complex, with multiple divisions, profit centers, or locations. The business may have new business lines or new products or could be planning an expansion.
Start-up businesses have their own nuances and challenges. Business systems and their level of sophistication can add complexity, as can the ability to obtain documentation and information. In short, how a business is structured and operates can affect
the process of analyzing and evaluating an interruption claim.
Historically, financial data and analytics played a key role in evaluating the impact a covered event had on the revenues and expenses of a business. As part of the process, a wide range of documentation is typically analyzed and reviewed, including profit
and loss statements, budgets, forecasts and projections, general and subsidiary ledgers, key metrics/reports, correspondence, among other data. Other supporting documentation may be reviewed, including details related to customers, suppliers, competition,
production, product history/life cycle, and business plans.
As discussed, the two prime components in calculating an interruption claim are revenues and expenses. Even in a bottom-up approach, revenues and expenses are the key considerations.
When evaluating revenues and expenses, traditionally there were a number of analyses that could be performed to identify trends and patterns. Data points often evaluated include trends related to historical performance (growth/decline during period),
seasonality, and cyclical events. Comparisons have also been part of the analytical process, including comparisons of actual results period-to-period, projections to actual performance, and, in some cases, market or industry data. These analyses are
typically done for a period relevant to the business and situation. They provide insight on how a business performed historically and where it was heading. Combined with other pertinent details, these analyses provide a state of the business and often
form the basis of a revenue projection for the loss period.
Expense analysis is focused on determining whether an expense was continuing or noncontinuing: did a certain expense specifically change disproportionately related to the covered event? This may sound simple, but it often is not. Expenses were generally
shown as a percentage of sales, with this percentage applied to lost revenue in calculating the business interruption claim. This is done to measure the proportionality of the expense to revenue and to further investigate any changes in the current
period with past periods. For example, salary expense may change because of the loss event.
Business Interruption Now
Business interruption claims in the post-pandemic world have become even more complex. The intricacies discussed have been exacerbated and new complexities have arisen. Many businesses are finding the analysis, effort, and time needed to support business
interruption claims have increased.
To understand the additional complications in calculations post-COVID-19, it is important to consider the impacts the pandemic had on businesses globally as well as the business for which you are measuring losses. Most, if not all, businesses experienced
changes to their financial performance because of COVID-19, and certainly these affected revenue and expenses. The challenge to the forensic CPA today is identifying the specific impact of COVID-19 on the business and appropriately addressing it.
The impact of the pandemic on business revenues varies, with companies experiencing both negative and positive revenue changes. For example, closures (full or partial), capacity restrictions, and other regulatory limitations had an effect on many businesses’
performance. But these factors changed over time as the pandemic evolved. Think of a restaurant that was closed for a period, and then was able to reopen at a restricted capacity. Then that capacity limit changed over subsequent months. The varied
financial results would likely be unique to the pandemic and may not be reflective of past or future performance.
It is important to remember that closures, restrictions, or added regulation may not be solely indicative of a decline in financial performance. Some businesses were able to pivot and adjust to the evolving environment. Think of a restaurant that was
able to create a large outside space and develop a robust take-out business: this business may have experienced an increase in capacity and revenue due to its specific circumstances. Many businesses have permanently changed their capacity model and
continue to offer outside seating in addition to being fully open inside.
Another factor affecting financial performance is consumer demand: demand increased for some products/services and decreased for others. For example, companies that manufactured toilet paper and cleaning products experienced an all-time-high in demand
during the pandemic, with many experiencing significant sales growth over prior years. While consumer demand may have varied depending on the business, consumer demand generally changed throughout the pandemic. The impacts on some – building
and home improvement, grocery, entertainment, and retail – varied greatly with the pandemic. Some had high demand initially, which then leveled out; some had continued high demand; others started with low demand and then saw an increase; while
some are still struggling to recover. Demand was further complicated by shortages and an increase in hoarding of high-demand products.
Other factors that arose during COVID-19 – and continue during recovery – are supply chain disruptions and employment challenges, such as employee safety, work-from-home allowances, and recruitment and retention. These issues affect both revenues
and expenses and, again, the challenge is to understand how or if the pandemic affected the behavior of these items.
Consider this example: a business experienced a fire loss in September 2020. An analysis of revenues showed the business was seasonal, with higher revenues in the summer/fall. The 2020 revenue trend showed growth over the prior year for all months except
April and May. Further analysis identified the business experienced reduced capacity in the months of March and April due to closures and capacity restrictions but was able to transition to outside/hybrid service by May 2020, increasing capacity.
This was a factor in the revenue recovery/growth seen prior to the September loss. This data was critical in calculating the business interruption loss due to the September fire.
COVID-19 also affected business expense structures, with businesses seeing both increased and decreased expenditures. Examples of expenditure changes include higher costs for products due to limited supply and supply chain issues, increased and new expenditures
for cleaning and personal protective equipment, increased/saved expenditures resulting from a remote workforce, among other factors. As a result, historical comparisons and analytics related to expenses need to be carefully evaluated and considered
in calculating business interruption claims. Similar to revenues, the changes to expenses were not static and, as such, frequent adjustments may need to be analyzed and understood.
So, what does this mean for a business that has a business interruption claim post-COVID-19 (a covered claim that is not related to COVID-19)? It means more complications and likely added time. More importantly, though, it highlights how important it
is to understand the business that was impacted by the covered event. Understanding where the business was pre-COVID-19, how COVID-19 affected the business over time, and where it stands today are musts.
For example, when analyzing a business that had a post-pandemic loss, fluctuations in salary expense were noted in the financial statements. Further analyses identified that staffing was impacted by changes in capacity along with challenges in obtaining
workforce, resulting in higher wage rates. This information was important in calculating the business interruption loss – specifically in evaluating saved expenses.
Typical trend analyses may not be applicable in the post-pandemic world, as it will likely include COVID-19 impacts. Whether the impact is positive or negative, the issue is understanding what the impact is and how it affects the projection of revenues
and expenses. Depending on the circumstances, a shorter or longer period may need to be analyzed. Further, different approaches may need to be applied to different periods. These methods may not be consistent with what has historically been used in
business interruption calculations, but they are reflective of the impact COVID-19 had on businesses and the economy.
Businesses are experiencing other challenges in post-pandemic claims too, and more will likely arise as we move through recovery. As noted, a general complexity in business interruption claims has been period of restoration (when the damage reasonably
should have been repaired). In the post-pandemic world of supply chain issues, the reasonable time to repair may be very different than it would have been in years past. For example, the demand for qualified building contractors has recently been
very high, and trying to get a business back up and running may take more time and expense (consider the cost of lumber in early 2021) – all of which needs to be factored into a business interruption claim.
State of the Business
For at least the next several years, complexities and challenges will continue at a heightened level. The simple fact is COVID-19 was a unique event that had global impacts, and these impacts have become part of the financial fabric of businesses.
So, what can a business do now in the event of a loss to make the process easier? A brief proactive approach now could pay significant dividends in the event of a future loss. Get a good sense of the state of the business – understand how COVID-19
affected the business, the timelines and regulatory impacts the business experienced, and where it is going in the future. This insight will be invaluable in the post-pandemic world when calculating a business interruption claim.
To minimize the impact of the claims process, a business would be well-served by setting up a separate general ledger code to track loss-related expenses, preparing a timeline documenting changes to business operations, tracking key business metrics (e.g.,
occupancy, visits, etc.), and tracking specific event-related business activity (i.e., cancellations, modifications, customer complaints, etc.). A business would also be well-served by the early establishment of a team of experts, including CPAs and
industry professionals, to assist in the claims process.
Measuring business interruption losses in the normal course of business is challenging enough; doing so in a COVID-19 world is that much harder. Much attention needs to be focused on how the pandemic specifically affected business revenues and expenses
so you can understand the true impact a covered event had on the business and how that should be measured.
Colleen Vallen, CPA, is senior vice president of forensic services at J.A. Montgomery Consulting in Camden, N.J. She can be reached at firstname.lastname@example.org.