When I work with clients who suffer a business interruption loss, one of the questions I often encounter is, “What is a coinsurance penalty and why am I not getting paid for my entire loss?”

In short, if a policy has a coinsurance clause it means that the business must maintain a minimum amount of insurance, in relation to their actual value at risk, in order to recover 100% of their losses. For example, if the insured value at risk is $1 million and there is an 80% coinsurance clause, then the insured must carry $800,000 worth of coverage to recover 100% of their losses up to $800,000. If they are insured for only $600,000, or 75% of the required value of $800,000, then they would recover only 75% of each dollar of actual loss. The 25% not recovered is a penalty for being underinsured.

The previous example illustrates why it’s so important for a business to have accurately stated business interruption values at risk. Business owners and corporate officers need to understand that it’s critical that values at risk be updated, at a minimum, on an annual basis.

If a business is in a period of growth and its insurance is based upon values from one, two, three, or more years ago, then the business may be inadvertently underinsured for a business interruption.

The best way for a business to avoid this situation is to work closely with a broker and with a forensic accountant who specializes in business interruption valuations. Together this team can come up with the right coverage for business interruption values at risk.

Employees often incur expenses on behalf of their employer and then submit expense reports for reimbursement at a later date.  This common business practice is very useful because it allows businesses to operate efficiently without unnecessary delays related to petty cash disbursements.  Unfortunately, expense reports are one area that can allow easy pickings for employee theft.  According to the Association of Certified Fraud Examiners, as reported in their most recent study, approximately 15% of all asset misappropriation cases were related to expense reimbursement schemes.  The median loss for these schemes was $33,000 and the median duration was 24 months before the fraud was detected.

Last winter CNN reported on an employee reimbursement theft at NYU.  The scheme was carried out by collecting discarded liquor store receipts and submitting them for reimbursement.  It wasn’t an elaborate scheme, but just another example of ineffective controls and inadequate review policies.  To minimize the chance something like this from happening at your company, I propose the following:

• Any purchases made on credit cards must include a copy of the credit card statement, the original purchase receipt, and a signature on the receipt of the supervisor responsible for approving the purchase.
• Any purchases made with cash should be subject to a daily, weekly, or monthly limit.
• Purchases should be submitted under predefined categories (office supplies, party supplies, client gifts, etc.) and trends should be reviewed.
• Comparable level employees should have their reports compared with one another to look for outliers.
• Any high level supervisors or executives should have their expense reports reviewed by an outside Certified Fraud Examiner.

While there is no way to “prevent” employee expense reimbursement fraud, there are steps that can be taken to assist in early detection and to let the potential fraudster know that they will get caught quickly.  A Certified Fraud Examiner can work with management to establish a comprehensive fraud program related to internal controls, policies and procedures, and training at all levels.

When quantifying a business interruption for an insurance claim, many expenses are easily identified as variable or fixed.  When I use the term variable, I mean that the expense changes with sales or production.  As a general rule, variable expenses are usually (but not always) saved and fixed expenses are usually (but not always) continuing.  Given this rule of thumb, utilities can be a unique expense in terms of a business interruption analysis.

First, utilities may be partially fixed and partially variable.  There may be a monthly connection fee that is a flat rate for any amount of service provided to the property.  Then there may be a variable component based upon usage.

Second, the variable portion may be at different rates for different levels of consumption.  It is common to see decreasing rates for each increasing incremental level of usage.  This type of expense is referred to as a “step variable” expense.

Third, utilities may vary based on seasonality.  Depending on the nature of the business, utilities may be higher in the summer or winter for climate control reasons and not just vary due to production.  A historical seasonality analysis, the same as would be performed for a sales analysis, should identify whether or not this is the case.  If the expenses are determined to be seasonal this should be considered when projecting the expense assuming the loss had not occurred.

Finally, utilities are almost always considered as saved for preliminary business interruption calculations, but they can also ultimately be found to contain extra expense that should be allocated to the restoration portion of the claim.  During reconstruction the workers may be using the outlets for tools, the buildings HVAC may be operating at two to three times its normal hours for drying of drywall and paint, or the lighting may be on around the clock for repair work.  These reconstruction activities may lead to utility expenses that match, or exceed, normal utility usage in operations.

Because of the above four factors, utilities should be reviewed as a unique type of expense when performing a business interruption calculation.  The expense may be saved, equal to pre-loss levels, or there may be extra expense.

John was recently interviewed by CNNMoney.com reporter Catherine Clifford. In her article Florida: BP’s next big mess, John comments about business interruption issues and the impact that the BP oil spill will have on tourism dollars to the hotel and resort industries in Florida and all along the Gulf coast.

The Importance of Proper Record Keeping

As a follow up to that article, John wants corporate officers, risk managers, and business owners to understand that the most important thing to do, starting right now, is to keep detailed financial records. The records you keep right now can affect the outcome of your settlement, even if that settlement occurs months or years from now.

It doesn’t matter if your business will recover financial damages from the BP oil spill fund being administered by Kenneth Feinberg, an Oil Pollution Act claim through the National Pollution Funds Center, or by filing suit against BP.  You must have the correct records to support your claim and define your business interruption loss.

Many times, business owners and corporate officers don’t understand which records to keep in order to maximize the settlement of a business interruption claim.  It matters.  The good news is that we can help.  For more information, visit our Oil Spill Services page.

For more information about business interruption issues related to the BP oil spill, visit our blog here:  BP Oil Spill.

One word: policy. For BP oil spill claims, there is no policy.

For almost two decades, the vast majority of my experience has been in calculating business interruption losses for insurance claim purposes.  Because the amount that a business recovers for a business interruption loss is limited by the provisions within the insurance policy, a business may experience damages beyond what is actually covered in the policy.  When this situation occurs, it can be very frustrating to the business owner or corporate officers.

What makes the BP oil spill claim process different is that there is no policy that limits the damages that can be claimed against BP.  All damages that can be supported, with a reasonable degree of accounting/valuation certainty, should be presented and considered for reimbursement by BP and Mr. Feinberg’s team. 

As a matter of fact, until very recently, it has been the position of both BP and Mr. Feinberg that all “legitimate claims” would be paid.  This sounds very reasonable to me as a damage valuation expert.  Businesses should have to quantify, support, and defend their damage measurements.  However, in recent public statements, Mr. Feinberg has revised his position.  He now states that not everyone will be paid and that physical damage, in other words, oil on the beach, is a prerequisite for recovering damages.  My question is, “Why did this change in his thinking occur?”

I’ve recently learned that BP has engaged ESIS to administer the claims related to the $20 billion fund for BP claims.  ESIS is a third party administrator with the technical abilities to handle a large volume of damage claims. Sounds like a good idea, right? It does, until you look a little closer at who’s really involved. 

ESIS is owned by ACE.  ACE is a property insurance company.  A company well versed in both limiting their liability by verbiage in their insurance contract and then hiring teams of experts to minimize payments on claims made against them. 

In other words, a property insurance company has now become involved and all of a sudden businesses must prove “physical damage” in order to be reimbursed for financial damages.  It’s not hard to connect the dots. 

Here’s my prediction: at some point, you will hear Mr. Feinberg talk about limiting the damages to a specific time frame following the actual oil cleanup.  The insurance term for limiting a time frame related to damages is the “extended period of indemnity.” 

The powers that be are trying to, and will continue to, apply insurance policy theory to a situation where no insurance policy exists, in order to limit the amount of damages BP will have to pay. The situation is supremely unfair to Gulf coast residents, who never entered into a contractual agreement with BP, but are now seemingly subject to rules they never agreed to.

Does anyone really know how long the damage due to the oil spill in the Gulf of Mexico will be around? How long will business owners and residents be affected–months, years, or decades?  Hopefully, Mr. Feinberg will have compassion for the people of the Gulf coast when evaluating these claims, rather than listening to only his new insurance company friends.

I recently watched the following video on CNN.  While I have a lot of empathy for the business owner in the story, I think that the angle that the reporter takes in the story shows the reporter’s lack of research into the subject matter by attempting to equate the term “forensic accounting” with “death” for Gulf coast business owners.

The term “forensic” means that which is subject to public debate (think legal setting).  The definition of a debate is  a “discussion, involving opposing viewpoints.”  In other words, there are always two sides to a debate. It’s true that forensic accounting is adversarial in nature because the numbers generated by a forensic accountant are used to support a specific position in a debate.  The problem with the BP oil spill claims process is that right now, many business owners are experiencing only one side of the debate–BP’s side.  Businesses need to understand the most basic rules of the claims process, including:

1. These claims are a debate and therefore they’re subject to negotiation.  Businesses do not have to simply accept what BP’s forensic accountants tell them.
2. Businesses need to hire their own forensic accountants, to get the tools they need to identify, quantify, present, support, and defend their oil spill claim.

While business owners or corporate officers are the definitive subject matter experts of their business, they are not economic damage valuation experts. They do not know how to identify, quantify, present, support, and defend their damage measurements. By hiring a forensic accountant who is an expert in business interruption claim preparation, businesses can get paid both fairly and faster.

Some business owners are choosing to trust BP to “do the right thing” later on and are not immediately hiring a forensic accountant to calculate preliminary estimates of a business interruption loss related to the Gulf coast oil spill.  A business owner or corporate officer could be rationalizing that:  a) BP will pay these losses because they said they would; b) If BP doesn’t pay, we can get reimbursed through the federal fund; or c) Our attorney will have us hire someone to quantify our damages before a trial, in the event we sue BP for our business interruption. The mistake in this logic is omitting the urgency of the business interruption claims process.

All of the forecasters are predicting an active 2010 hurricane season.  While the ultimate effect of a hurricane on the spill situation is unknown, one thing is certain.  A business that has not effectively supported its damages from the oil spill, prior to a hurricane, will have serious issues in presenting loss estimates after a hurricane.

Business owners or officers may wonder, “Why?  What’s the difference?”  Here’s what they need to realize: once a hurricane hits, businesses may be further damaged, and it may be very difficult to segregate damages from the economics of the oil spill and damages from the hurricane. Businesses will be in the unenviable position of trying to be reimbursed by either BP or the insurance company, as both BP and the insurance company point their fingers at one another, fight over who should have to pay what proportion of the losses, and the entire process grinds to a halt, negatively affecting the cash flow of the very business they should be helping.

Alternatively, if a business immediately hires a forensic accountant who specializes in business interruption calculations, the business can provide BP with strong and defensible business interruption models before the hurricane hits. In other words, a business will be “on record,” having properly quantified and documented their damages related to the oil spill. Then, incremental damages that occur in the event of a hurricane will be easier to segregate and will have more merit than business interruption damages that are arbitrarily allocated after the fact.

Now is the time to calculate a business interruption loss due to the oil spill and document these losses, before the waters get muddied as well as oiled.

From the time you notify your insurer about  business interruption loss, and you have your first conversation with the insurance adjuster or their consultants, you are being deposed. Of course no one has sworn you in and no one told you that “everything you say can be used against you.” But this is the essence of all communications between you and the insurance company from this point forward.

Please understand that I am not saying that you shouldn’t talk to your insurance company, but I am suggesting that you be guarded in your conversations. Every estimate, guess, maybe, and possibility that comes out of your mouth is being recorded in someone’s notebook. For example, you may have said that a competitor, with whom you have a friendly relationship, may be able to produce products for you to offset your losses. If this “deal” between you and your competitor doesn’t work out for whatever reason, you may have to explain to the adjuster who you contacted, what was said, what were the potential terms, why the deal wasn’t struck, what is the contact information for the person from the other company, can the insurance company call and question them, etc. You will be treated as if you did something wrong when you just tried to mitigate your loss.

My advice on this issue is simple. Answer questions truthfully, directly, and as succinctly as possible. Do not elaborate on your answers and do not guess or estimate. If someone is asking questions you do not feel comfortable answering immediately, ask them to put the questions in writing and tell them you will respond after researching the issue. You will need to answer their questions, but I think you should do submit an answer on your own terms, with time to think about it.

Putting your answers in writing also helps you with the documentation burden you’re tasked with throughout the business interruption claim process.

The trust and optimism of business owners and managers never ceases to amaze me. No matter who I approach regarding fraud deterrence services they will tell me that fraud “doesn’t go on around here,” and “I trust my staff implicitly.”

These are the same people who, once a fraud is uncovered, will say, “I never would have suspected (insert name).” Because the employee is trusted, and therefore above suspicion, they are able to get away with stealing for an average of 18 months before anything is detected. I have not, in 16 years of forensic accounting, met the business owner who says, “You know, I figured they had been stealing from me for the past few years.”

Here is the rub. No one thinks fraud is going on in their organization, but according to the Association of Certified Fraud Examiners in their 2010 Global Fraud Study, fraud costs businesses approximately $2.9 Trillion (Yes! with a “T”) per year throughout the world. The truth is that fraud exists, on some level, at virtually every single business. The only real question is, “How much?”

Businesses should recognize that fraud does exist and owners should decide what’s okay–for example, is it okay for an employee to take home a box of pens from the supply room? Owners should also clearly define what’s unacceptable. For example, it’s okay to drink a can of pop from the fridge at work–but it’s not okay to take home cans of it.

Clearly defining the rules and expectations for everyone helps to create a culture of openness and integrity in the workplace. When employers blindly trust their employees, or are too busy or lazy to clearly define policies, owners inadvertently create an atmosphere that is conducive to fraud.

A Certified Fraud Examiner can help to put positive procedures in place to help create a healthy atmosphere in the workplace. A CFE can objectively review policies, procedures, and controls to reduce the probability of a large-scale fraud going undetected.

I contacted the Bristish Petroleum claims hotline today and asked them the following question: If a business retains a forensic accountant to quantify, support, and create a claim for their economic damages related to the oil spill, will the forensic accountant’s fees be reimbursed?

I think this is a reasonable question given that this is an expense that the business owner would not have incurred but for the oil spill. In typical corporate fashion, the response from the BP representative was that the business owner should file their claim and then an adjuster would decide whether or not these fees could be recovered. I asked if there was any objective basis in the adjuster’s determination and I was told “no.” The adjuster has the authority to make a subjective decision on whether or not a professional fees incurred by the business will be reimbursed.

It’s interesting that BP has said publicly that it wants legitimate and supported claims, but won’t commit to reimburse businesses for professional help until after they incur the cost.

So, how will Mr. Feinberg’s involvement change the claim practices related to this loss? I guess we’ll all find out together in the coming weeks. If you have some insights to the situation, please let me a comment below.