1. Overview of Business Interruption Coverage. 2. Key Financial Information and Terms. 3. Calculating Business Interruption Losses

Transcription

1 Pennock Acheson Nielsen Devaney

2 Presentation Outline 1. Overview of Business Interruption Coverage 2. Key Financial Information and Terms 3. Calculating Business Interruption Losses 4. Summary / Questions

3 Overview of Business Interruption Coverage What is Business Interruption Insurance? Business interruption ( BI ) insurance is a type of coverage that is intended to restore a business to the same financial position as if a loss event had not occurred Typically triggered by physical damage to property or forced shutdown of business operations E.g. Fire, flood, theft, vandalism, accident, etc. Loss of profits as an insurable risk was first implemented in 1797 Purchased by the insured as an add-on to an existing insurance policy

4 Overview of Business Interruption Coverage Key Principles of BI Insurance Insured must prove damage sustained to insured property and that damage caused suspension of business operations. Coverage should restore insured business for profits it would have otherwise earned. Cannot put insured in a better position. Must be an ongoing business with track record of profits. Anticipated i t profits, without historical evidence, typically too speculative to claim. Insured has duty to mitigate losses in a business interruption by taking reasonable actions to minimize impact of shutdown.

5 Overview of Business Interruption Coverage Types of BI Coverage Business interruption Extended business interruption Contingent business interruption Extra Expense insurance

6 Overview of Business Interruption Coverage Role of the Valuator / Accountant May act for the insurer or the insured Key activities include: Detailed review of insured s historical operational and financial records; Interview key management, suppliers and customers as appropriate; Analyze industry data to assess impact on profits and market share; Compare budget vs. actual results during interruption and prior periods; Consider non-loss related events/conditions that may impact business; Consider loss mitigation actions taken/ignored & extra expenses incurred; Calculate damages attributable to incident and present in report form; Meet with adjuster, broker, legal counsel and company management to review claim status and loss calculations throughout project; and Act as Expert Witness in the event that claim is litigated.

7 Key Financial Information and Terms Gross Profit vs. Net Profit Gross profit (Gross earnings) Calculated as: Revenue minus Cost of Goods Sold ( COGS ) COGS - refers to direct costs attributable to the production of goods sold by a company including direct materials and direct labour, Excludes indirect or fixed expenses such as facility costs, administration, insurance, etc. Net profit (Net income) Calculated as: Gross profit minus fixed/indirect expenses For BI loss calculations: pre-tax BI Coverage typically based on either: Gross profit minus discontinuing expenses ; or Net profit plus continuing expenses Discontinuing expenses fixed/indirect expenses which the insured does not have to incur during the period of business interruption Continuing i expenses ( insured standing charges ) fixed/indirect expenses which the insured must still incur during the period of business interruption

8 Key Financial Information and Terms Example Gross profit vs. Net Profit Valve manufacturing business sustains a fire to their main production facility. The facility must be completely closed for one month for repairs. During a typical month, the company would generate a 35% gross profit on sales of $1 million. The company s typical monthly fixed expenses are $250,000. During period of restoring the facility, the company generated no revenue and incurred $150,000 of fixed expenses ($100,000 of normal fixed expenses were not tincurred ddue to suspension of operations). Assume nil Extra Expenses for purposes of this example.

9 Key Financial Information and Terms Example Gross profit vs. Net Profit Expected Actual Results for Normal Results during Operations Restoration Period Difference Revenue $ 1,000,000 $ - $ 1,000,000 Cost of goods sold 650, ,000 Gross profit 350, ,000 Fixed operating expenses 250, , ,000 Nt Net profit fitbf before tax $ 100, $ (150,000) 000) $ 250, Loss calculation pursuant to Gross Profits less discontinued expenses Normal gross profit $ 350,000 Less: discontinued fixed expenses (100,000) Business loss $ 250,000 Loss calculation pursuant to Net Profits plus continuing expenses Normal net profit $ 100,000 Add: continuing fixed expenses 150,000 Business loss $ 250,000

10 Key Financial Information and Terms Typical Information to be Reviewed for a BI Loss Calculation Business interruption insurance policy Historical year-end financial statements for the subject entity/division Annual budgets and forecasts for the business Historical monthly profit & loss statements including actual vs. budget Profit & loss statement for interruption period including actual vs. budget Monthly and daily production and/or inventory reports Details of loss mitigation efforts and extra expenses incurred by the insured and the company s rationale for such Market research reports relevant to the subject business and its industry Any preliminary loss estimates prepared by the insured and its advisors

11 Key Financial Information and Terms Key Considerations When Reviewing Financial Information Internal vs. externally prepared financial statements Audited vs. unaudited financial statements Interim vs. year-end financial statements Private company financial statements Historical vs. forecast financial information Seasonality/cyclicality of the business Historical trends in revenues, margins and profitability Divisional i i vs. entity-wide id financial i statements t t

12 Calculating Business Interruption Losses Does BI Coverage Apply to an Event? Does company have BI coverage added to their property insurance policy? Is the loss event in question a qualifying event for purposes of the existing BI coverage? Review Excluded Perils. Is the BI coverage a regular or extended form of coverage? Are Extra Expenses included in the coverage? What BI coverage limits (time/amounts) are specified in the policy? Are professional fees covered in the policy?

13 Calculating Business Interruption Losses WEM Mindbender Case June 14, 1986 Mindbender rollercoaster at West Edmonton Mall derails just three months after opening Three riders were killed, 19 people were seriously injured Accident resulted in significant impact to WEM s revenues in Fantasyland 3 month period prior to accident - Mindbender generated $1.0 million in revenues ($2.3 million for all Fantasyland rides) Ride closed 14 months for repair and redesign, re-opened in August 1987 WEM had Gross Earnings BI coverage and sought a claim for losses Insurer and insured disagreed on the BI claim and the matter was litigated

14 Calculating Business Interruption Losses 3 Essential Variables in a BI Loss Calculation Time Period of interruption / Indemnity Regular vs. extended Theoretical BI period WEM/Mindbender 14 month BI period Revenue Nature/type of revenues lost Internal and external risk factors Permanent loss vs. postponement Relevant historical Base Period vs. pure forecast WEM/Mindbender Base Period : Mar15-Jun14/86; lost revenues: ride and games/concession revenue; considered High/Med/Low revenue days Expense Nature/type of expenses saved (i.e. discontinued expenses) Expediting and Extra Expenses incurred to mitigate losses WEM/Mindbender Saved expenses: labour, oil/grease/tires, electricity and direct costs of gaming and concessions; No Extra Expenses noted.

15 Calculating Business Interruption Losses Mindbender BI Loss WEM s Valuator WEM MINDBENDER - REDUCTION IN "GROSS EARNINGS" REVENUE DEFICIENCIES Fantasyland rides $ 8,900,000 Games and concessions 400,000 9,300,000 LESS: NON-CONTINUING EXPENSES (250,000) BUSINESS INTERRUPTION LOSS $ 9,050,000 Source: "Thrills, Spills and Business Interruption Loss", Business Valuation Review, September 2001.

16 Calculating Business Interruption Losses Mindbender BI Loss The Court s Conclusion 1994 Alberta Court of Queen s Bench Triple Five Corporation Ltd. and West Edmonton Mall v. Simcoe & Erie Group et al, Alberta Court of Queen s Bench, Trial judge - malfunction was an excluded peril Alberta Court of Appeal Triple Five Corp. v. Simcoe & Erie Group, Alberta Court of Appeal, Agreed with the trial judge s conclusion Faulty Design exclusion

17 Summary Proper consideration of applicability of BI coverage is critical first step before undertaking a loss calculation l Three key variables in any BI loss calculation: Time, Revenue, Expense Determination of BI loss is not an exact science; many factors to consider and weigh into a given analysis Involvement of valuator or accountant important where significant financial information needs to be reviewed and complex analysis is required Don t ride a roller coaster in its first year of operation! QUESTIONS?

18 Contact Information Pennock Acheson Nielsen Devaney Chartered Accountants Trevor Philippon, CA, CBV Peter Blasetti, CA Director, Financial Advisory Services Senior Manager Phone: Phone: Allan Barwick, CMA Partner Phone: