Business Interruption Losses in Economic Downturn

A reasonable and supportable projection of lost revenues is a key to developing a solid business interruption claim. Recent economic conditions have highlighted the need to pay close attention to the economy and its impact on the insured's business.

Business interruption claims, by their very nature, present a basic challenge: How does the insured determine the "actual" loss sustained? Simply stated, the actual loss sustained is most often defined as what the company would have earned had the loss not occurred, less what it actually did earn.

The amount the company "would have earned had the loss not occurred" is essentially retroactively forecasted. This requires a methodology that looks at what would have happened in normal times and conditions during the period of loss. The methodology may incorporate many factors, including, but not limited to, the following:

• Facts surrounding the loss and its impact on the insured's business
• Company forecasts
• Historical trends
• Recent changes in capacity and product or service sales mix
• Significant contracts
• Marketing initiatives and plans
• New product or service launches
• Changes in the competitive landscape
• Changes in the economy

Developing a reasonable and supportable projection of lost revenues is a key to developing a solid business interruption claim. Organizations that have experienced losses in recent times did so in the midst of one of most significant recessions in decades. In many of these situations, it was not sufficient to simply project lost earnings based on trends of the past. It became increasingly important to factor in the impact of the economy on the both insured's business and the market in which it operates.

Projecting revenues "had a loss not occurred" can be challenging even in normal times, let alone during times of significant changes in the economy. While there are no magic fixes or formulas for this issue, here are some questions that an insured and its advisers should consider in preparing a business interruption claim occurring in times of economic downturn:

1. Has the specific market for the insured's products or services changed? While the company's trends may have been going in a particular direction prior to the loss, current market conditions could have materially changed that trend.
2. Does the insured have any contracts that help to support the forecasted level of sales despite changes in the economy? For example, a distributor that can document purchase commitments from customers prior to the date of loss could support a forecast of increased sales, even in a market where the competitors' sales were decreasing.
3. What makes the insured's product or service unique so that sales would have been less affected by (or even benefitted from) a downturn in the economy in contrast to the rest of the market? This might be supported by looking at how the sales of the insured's products or services compared to its competitors prior to the loss. An example might be an electronics component that possesses specifications and reliability that far outweigh its competition. In this example, a decline in the rest of the market could have less of an impact on the insured.
4. Has the insured recently introduced any new products or services for which no significant sales history exists? This may require looking at how similar products or services are performing in the current market and building a forecast around that, taking into account any unique advantages, including marketing, promotion, contracts, and advance orders that can be documented and supported.
5. Did the insured make any recent changes to operations or facilities that would have supported increased sales, despite the economic downturn? The recent addition of a new machine or process at a manufacturer, for example, could well support a forecast of increased revenue, given a strong demand for that product, even with a decline in the economy.
6. Have there been any significant changes in the competitive landscape as a result of the economy? For example, challenging economic conditions may have caused a major competitor to go out business, thereby creating a positive impact on the insured's business.
7. Have there been significant changes in the supply chain or commodity prices due to economic conditions that could have impacted the insured's price structure, necessitating an increase in sales prices, which in turn creates an impact on sales volume? For instance, let's say that economic conditions caused the closure of a metal fabricator that provided key components to a manufacturing company that recently experienced a loss. Had the loss not occurred, the manufacturer would have needed to find an alternate supplier, which as it happens, would have increased the cost of materials by 20 percent. The manufacturer would have in turn needed to increase the product's sales price in order to maintain a normal profit margin. It is projected that, in the insured's specific market, the resultant increase in sales price would have created a decrease in the volume of units sold.

These are just a few examples of key questions we typically ask our clients when preparing a business interruption claim. In the final analysis, the goal is to present the claim in a manner that is fair, reasonable, and well supported and reflects the reality of the insured's business, market, and the economy.