When preparing a business interruption calculation for an insurance claim, one of the most common statistical tools I use when evaluating continuing and non-continuing business expenses is the correlation coefficient. The correlation coefficient can be found using analysis tools found in spreadsheet software, using specialized statistics software, or by calculating the values with a pencil and calculator (Yuck!).

The correlation coefficient is significant because it tells whether or not two variables move in relation to one another and it also describes the relative strength of any potential relationship. In this post, I want to address positive correlations. The correlation coefficient is always expressed as a value between 0 and 1 for a positive correlation. If the correlation is 1, a perfect positive correlation, then every time X increases or decreases then Y does the same proportionally. There are no hard and fast rules, but I apply the following general cut offs when reviewing expenses:

0.75 – 1.00 Strong positive correlation
0.40 – 0.75 Weak positive correlation
0.00 – 0.40 Inconclusive or no correlation

For example, if variable X is the number of widgets produced and variable Y is direct production labor hours, I would expect to see both numbers moving up or down in relative tandem. If I calculated the correlation coefficient at 0.92 I would say that if production of widgets was reduced, I would expect to see a closely proportional savings in direct labor hours.

Alternatively, if the coefficient is 0.35, the expense may be saved, but I would suggest that it be evaluated on a basis other than being tied to widget production because there is no identifiable relationship between the two variables.

Every February 24th, without exception, my phone rings, and without fail the phone call catches me by surprise. This year, I was in the middle of sorting through a pile of debris on my desk, when the voice on the other end of the phone said, “No matter how bad things in your life may seem right now, I remember the day when it was worse.”

The voice belongs to Mike Toconita, my former roommate in the Marine Corps. The day he’s referring to is February 24th, 1991, which is the day that ground combat began in Operation Desert Storm. The night before, on February 23rd, the guys in my fire team huddled around our platoon sergeant and we were told: “Look at the guy on your left, now look at the guy on your right. One of those guys won’t be here this time, tomorrow.” In fact, we were told to expect 50% casualties the first day. Talk about a bad night of sleep.

As dawn broke on the morning of February 24th, I was packed into the back of an AmTrac (amphibious tractor), sitting knee to knee with guys, friends, that I’d known for years, and I felt the armored vehicle grind to a halt. Then a really strange thing happened. Everything went silent. The guys I was sitting next to, the ones you could never get to shut up–totally silent. You could hear the pins release on the AmTrac door, and then it dropped down. Out the back door of the vehicle, you could see dirt flying from the bullets that were sprayed at us–but I couldn’t hear anything. Time slowed down. Then, suddenly, our first guy bailed out, and all you could hear was the rat-tat-tat-tat of his machine gun firing. And then everything sped up to hyper-speed, racing, racing, including my heart! Every single one of those guys jumped out and did what they were supposed to do. And every single one of them came back.

This annual call from my friend Toconita is a reminder that 1) I can endure anything and 2) things that are “bad” in my life are relative. I need this type of reality-check in my daily life and I am grateful for my good friend who reminds me, without fail, every year.

If you’re in the middle of experiencing a business interruption loss, I know that it’s been tough. “If you’re going through hell, keep going,” says Winston Churchill. There just may come a day when you’re grateful for what life has dealt you…or have you already had that happen to you in your life? Leave me a comment, below.

There are many ways to format a business interruption calculation for an insurance claim. Each method is unique and there isn’t a “one size fits all” method that works for every business income loss.  However, there is one method that I use repeatedly,  which is referred to as the “Three Column Approach.”  In the graphic below, I’ve included a simplified example of what this type of business interruption calculation looks like.  Being the accounting geek that I am, it’s my pleasure to walk you through this simplified version of a “Three Column Approach” calculation.  Let’s get started.

The first column contains the projected, “without incident” values. These are the revenue and expenses that the business would have expected if the interruption had not occurred. The second column contains the actual values that were recorded. The third column is calculated by subtracting the actual values from the projected values.

In this example, you can see that sales were down by $200,000. Correspondingly, variable expenses were down $120,000. These values are what would normally be referred to as saved, or non-continuing, expenses and are deducted from the lost revenue.  The fixed expenses were not affected and the end result was an $80,000 loss of net income. Again, this example is overly simplified for illustration purposes and a real set of loss schedules would contain many sub-schedules and detailed calculations that are not shown here.

There are some definite advantages to using this type of presentation. First, it clearly defines projected and actual values, side by side, and easily allows the reader to see the specific areas of impact. Second, this method identifies every category from the profit and loss statement. No elements of the loss can fall through the cracks by simply showing either the saved expenses or just the continuing expenses, which is common in many claim presentations. Finally, the “Three Column Approach” provides a mechanism to potentially identify extra expenses that were not captured elsewhere.

For example, if fixed expenses had been projected at $60,000 and they were actually $75,000, there may be extra expenses that were captured in these accounts. If not, then perhaps the projected value is inaccurate and needs to be modified. Regardless, all revenues and expenses will be considered when using the “Three Column Approach.”

There is no one “right” method to prepare a business interruption calculation. An experienced and credentialed forensic accountant can guide you to the method that will work best for your specific situation.

I am often asked by potential clients if my forensic accounting fees to prepare a business interruption insurance claim will be reimbursed by the insurance company.

This question is completely valid because professionals who are experts in business interruption claims are not cheap, and risk managers, corporate officers, and business owners want to clearly understand what they’re getting into before hiring a forensic accountant to prepare their business income claim.

For me, the question is frustrating because it implies that if my fees are not reimbursable, then the insured should not retain me or any other forensic accounting expert. I know, from experience, that this is a false assumption for insureds to make. Here’s an example of why: I just closed a file two weeks ago. My total fees were approximately $27,000. What did the client get for that money? The insurance company, and the insurance company’s forensic accountant, valued the loss at $890,000. The final settlement, based on my calculations and critique of the insurance company’s report, was $1,650,000.

Was it a good investment of $27,000 for a return of $760,000, whether or not my fees were reimbursed by the insurance company? I know from experience that insured parties recover, on average, five times my fees in additional claim dollars. Yep, you read that right. On average, 500% ROI. Check out our results page for more real-world examples.

So, is it worth it to hire a forensic accountant to prepare your business interruption insurance claim, regardless of the professional fee coverage in your insurance policy?  I guess the burning question is: Do you trust the insurance company’s expert to come up with the right number to settle your claim, or your own expert?

In the wake of a major accident or delay on a construction project, don’t start pinching pennies when it comes to the graphics needed to submit a soft cost insurance claim. Every soft cost insurance claim should contain two critical graphics.

The first is the “Extent of Damage” graphic.  This graphic is a general schematic of the project, for example a building with several floors, that is color coded to visually show the extent and cause of damage.  A normal color coding example would be red = severe fire damage, yellow = moderate fire damage, gray = smoke damage, dark blue = severe water damage, light blue = moderate water damage, and so on.  An “Extent of Damage” graphic provides a powerful visual tool to help the adjuster, who may not be a construction expert, understand the extent and causes of damage. If this graphic is provided to the adjuster as soon as possible after the event, the graphic can help to prevent future disputes regarding the scope of damage and associated repairs.

The second necessary graphic is a timeline of the events.  The timeline should show the anticipated completion date, the date of the event that triggered the loss, and the actual completion date of the project.  If there are other factors that affected the completion date, a hypothetical date of when the project would have been completed “but for” these additional events should be shown.

Graphics like these can help the claims process go more smoothly and help you achieve winning results when submitting a construction soft cost or delay in completion insurance claim.

Criminologist Donald R. Cressey identified three traits that are commonly present when people perpetrate fraud. Cressey created an hypothesis known as the ‘fraud triangle.’ The three sides of the fraud triangle are:

1. Rationalization – Since the majority of individuals who commit serious occupation fraud are not career criminals, they feel a strong need to justify their actions.
2. Opportunity – Access to company assets and a lack of internal controls that will prevent immediate detection of the fraud.
3. Pressure – This is a financial need (real or perceived) that the individual cannot share with others due to potential shame or loss of social status.

When these three sides of the triangle are present, there is a much higher than normal chance of an individual committing a fraud.

In this post, I want to write more about one of the three sides of the fraud triangle, rationalization. Rationalization is the process of justifying actions that the individual knows to be wrong.  In the case of employee theft, most perpetrators are not habitual offenders. They are not career criminals.  They have a strong internal need to justify their actions.

I have seen two common rationalizations. The first is, “I was only borrowing the money.”  A person who uses this rationalization has convinced himself that this is a temporary situation and that, as soon as their finances turn around, they will repay the money in full. They haven’t “stolen” anything.  This was simply an unauthorized “loan.”

The second rationalization is that the money is owed to the fraudster. In the current economy, people are often asked to do more work, as their coworkers are laid off, and there is also no money for raises or bonuses. In some cases, workers are actually forced to take less just to keep their job. The employee feels they are being treated unfairly and they are simply helping themselves to something that is truly owed to them.

When these situations are combined with the financial hardships many families are facing, it is a recipe for disaster. This is why it is critical for employers to do things to maintain a positive atmosphere. It is much harder for happy and satisfied employees to rationalize theft from their employer.  Business owners should review the current satisfaction level of employees, pay heed to their complaints, and address them if appropriate. This is one area of business where is doesn’t pay to be penny wise and pound foolish.

In the 1960 movie The Magnificent Seven, Steve McQueen and Yul Brynner were hired to protect a small Mexican town from outlaw Banditos.  The Mexican villagers realized they needed to fight fire with fire by employing their own hired guns.

When adjusting a business interruption loss the insurance company often hires an outside forensic accountant to assist in determining the value of the claim based on the expected loss of revenue.  I see the hiring of this consultant as the insurance company’s hired gun.  In contrast, with a third party liability claim the insurer will hire outside counsel to represent the insured.  This attorney has the legal obligation to defend the claim to the best interest of the policyholder, even if it is to the detriment of the insurer.  This is why in liability claims if there is any dispute as to coverage terms or their application, the insurer is obligated to secure separate coverage counsel independent from the legal defense of the claim.

The hiring of a business interruption forensic accountant by the insurer is not done with the intent to find the best possible recovery for the policyholder.  Their charge is to minimize the loss payment for the insurance company. Right about now you are starting to see that the insurance company plays the role of Eli Wallach (the Bandito) in the movie.  Many policyholders think they can self-represent against these accountants, since they have a sound understanding of finance and an acute knowledge of their own business.  These insurance company consultants specialize in the particular industry of the insured and know all of the ways to structure the analysis to minimize loss payment.  John Hutson points out that the adjuster and accountant will not always share with the policyholder the entire analysis and worksheets that go into their claim summary.

This all leads to the need for the insured to also secure a hired gun forensic accountant.  It will be important to find one who regularly represents policyholders and does not work exclusively for insurance companies.  You want to make sure that your consultant has the right perspective to view your situation.  This can be a costly expense at times, but I believe that you will easily recover the cost of the consulting expense through the higher loss settlement that will be achieved.

Now, back to the movie.  The Mexican peasants never paid for the hired guns since Steve and Yul found satisfaction in their efforts as sufficient reward.  You, too, can avoid paying for your hired gun.  Many of the comprehensive property policies today have broad coverage grants and provisions.  One that should be considered is Professional Fees.   This extension pays for the expenses incurred by the insured to hire auditors, accountants, appraisers and engineers in order to certify the particulars and details of the loss.  Normally, the limit that is provided is anywhere from $50,000 up to $250,000.  This means the insurance company will now be responsible for paying both forensic accountants as expenses under the loss.

If your policy does not currently have this feature, have your broker try to negotiate this coverage extension at your next renewal.  This will ensure that you are on equal footing with the insurance company when it comes time to determine the business interruption loss value.

Bob Trompeter

Mr. Trompeter is a principal  owner in Risk Resources, an independent risk management and insurance consulting firm. He has been consulting for over 25 years and has developed particularly strong expertise in the analysis of sophisticated casualty insurance programs.  He has concentrated much of his efforts in the area of alternate funding techniques and cash flow analysis. He also has acquired a broad knowledge of large property insurance programs and has been involved in the adjustment of many larger property claims, both on  property damage and business interruption. You may read more of his posts on his blog, Risk & Insurance Chalkboard.

The forensic accountant is a strange animal. Did you know that there are no ‘official’ credentials required for an individual to claim he is an ‘expert’ in the field of preparing a business interruption insurance claim?  I have seen some experts with undergraduate degrees in accounting, economics, finance, engineering, computer science, mathematics, even philosophy.  I have seen some who carry some of the following alphabet soup after their name such as MBA, CPA, CMC, CFF,CVA, AVA, CFFA, CFE, and CPCU.  I have even seen some with nothing after their name.

While I am the first person to advocate that the MOST important criteria to be an expert at preparing a business interruption insurance claim is experience, I believe that credentials are as important as street creds.  Well, let me say that they MAY be important.  For example, I have an enormous amount of respect for a credential that requires a rigorous exam or exams.  I respect this type of credential because its holder had to learn a body of knowledge, information specific to the credential that other experts in the field believe is appropriate.

This type of credential proves that the individual has received a certain amount of training at one point in their career.  Most of the respected credentials require continuing professional education.  Continuing education helps to ensure that the practitioner stays up to date with current theories and trends in their area of expertise.  Finally, most respected credentials require a certain amount of experience to both obtain and to keep the credential, which further ensures that the professional’s skills are current.

Surprisingly, many so called “forensic accountants” have no professional credentials.  Many forensic accountants may, or may not, have ever received any formal training, which means that they may have never been tested on the body of knowledge in which they claim to have expertise.  Forensic accountants without credentials are not required to attend continuing education and have no minimum experience requirements.  Forensic accountants without credentials are not formally recognized by any professional peer group and have not been tested on demonstrated skills or training–although they may be very good salesmen.

Because risk managers, business owners, and corporate officers who are experiencing a business interruption loss are under a lot of stress, our advice is to beware of people who are good salesmen without the proper experience and credentials.  While experience is a very important factor, make sure your forensic accountant also has recognized and applicable credentials related to your type of project by asking for a CV or Bio–and then following up on that information.   Doing this simple check can help prevent a very expensive lesson.

I am often asked to assist professional services firms, such as attorneys, accountants, engineers, and doctors, with estimating their business income values at risk.  My advice to professional services firms is often the same:  assume you will collect nothing for your lost business income.  I know that this advice sounds harsh and may seem shocking. But professional services firms should be aware that proving lost business income to your insurance company after an event such as a fire or natural disaster is one of the most-difficult scenarios.  So, why is supporting a business interruption insurance claim for a professional services firm so difficult?  Because the insurance company will assume that you, the professional services firm, will make up the lost time.

When I started my career, I worked for one of the biggest forensic accounting firms that prepares insurance claim calculations for the insurance company.  In other words, I worked for the “other side,” and my client was the insurance company.  During this time, when a professional services firm (a group of attorneys) submitted a lost business income claim, I was trained to ask the following:

• Please provide the names of the clients that you had at the time of the loss.  Of these clients, which ones did you refer to another attorney? Which attorney did you refer them to?  Please provide the contact information for the attorneys who are now providing services to your clients.

• Please provide the contact information for all potential clients who contacted you following the incident, that you told you could not provide services because of the incident.

You get the picture.  The attorneys didn’t send any clients away and didn’t turn away any new clients.  They may have lost some incoming phone calls before the phones were forwarded to cell phones, but that type of communications loss is often extremely difficult to support with records kept in the normal course of business.

Professional services firms often lament, “We lost the billable hours and we can’t make it up!”  But the fact of the matter is that I have heard an adjuster respond, “Work late, work on the weekends, do whatever you have to do.  You are not insured for extreme inconvenience.”

So what can professional services firms do when determining their values at risk for a lost business income scenario?  My advice is simple.  Have a strong business continuity plan and make sure you work with your broker to have adequate extra expense limits.  While it is still prudent to have business income insurance, be aware that your loss will most likely be an extra expense issue and implement procedures to make sure any losses of new clients are minimal.

Following Hurricane Katrina, I was retained to help a private school quantify its business interruption loss.  I valued the business interruption loss related to the period of restoration as well as the extended period of indemnity.

The first hurdle was getting the adjuster to understand that a school doesn’t make widgets.  What I mean is that once five weeks of school were missed, due to the physical damage, that the entire quarter was a complete loss.  A school is not a widget factory that can just add another shift or work overtime.  The students can’t go to class for 22 hours a day once repairs are done.  Do I sound a little annoyed?  Check the header of my website and note the word “passion.”  Yes, I do get worked up over my clients’ situations.

Once we moved past that issue, the adjuster said the correct valuation of the loss for the extended period of indemnity was $0.  Yes, that’s right, zero dollars.  He said that the ongoing loss was not due to the physical damage caused to the insured, but was because of the personal damage sustained by the students, such as the homes of students were so destroyed that they moved from the area.  He further said that the personal damage sustained by students was excluded under the “Loss of Market” exclusion in the policy.

In this case, the only thing the adjuster was lacking was support, because there was no definition for “Loss of Market” in the policy.  He could not identify the school’s “Market,” he had no addresses for, or direct proof of damage to students’ homes.  It was one of those theoretical defenses.  The end result was that the broker and insured were able to use my observations to negotiate an equitable settlement.

My advice to schools and universities:  Work with your broker to see if your policy contains a “Loss of Market” exclusion.  If it does, make sure that it is clearly defined or remove it from the policy so you don’t have to figure out what it means in the middle of a business interruption insurance claim.