Business Interruption Insurance: A Lifeline When Disaster Strikes

Despite a relatively quiet hurricane season, 2014 had its fair share of other natural as well as manmade disasters, including blizzards in upstate New York, wildfires and winter storms in California, mudslides in Washington and riots in Ferguson, Mo., and Berkeley, Calif. As we get ready to ring in the New Year, these tragedies serve as sobering reminders to always expect the unexpected.

Your business could become a victim of Mother Nature or other external forces without warning. After a disaster, an estimated 25 percent of businesses are unable to reopen. Depending on the type of business and its financial stability, a few weeks of lost income can be enough to close your doors indefinitely.

Proactive Disaster Planning

Commercial property insurance doesn’t typically pay the costs of this type of disruption. What can help you survive is business interruption coverage that allows you to relocate or temporarily close so you can make the necessary repairs — and still be provided with cash flow to cover revenues lost and expenses incurred while your normal operations are suspended.

To determine the proper amount of coverage, your financial adviser can help forecast a worst-case scenario and ask “what-if” questions to cover all the possibilities. Of course, you don’t want to over insure, but you also don’t want to overlook critical risks, such as prolonged or multiple power outages.

Business interruption insurance isn’t sold as a separate policy. Instead, it’s added to your existing property insurance policy. There are two basic types of business interruption coverage:

Named perils policies. These cover only specific occurrences that are listed in the policy, such as fire, water damage and vandalism.

All-risk policies. These cover all disasters unless they are specifically excluded. Most all-risk policies specifically exclude damage from earthquakes and floods, but such coverage can generally be added for an additional fee.

Business interruption insurance usually pays for income that’s lost while operations are suspended. It also covers continuing expenses, including salaries, related payroll costs and other costs required to restart a business. A lot of people struggle to meet payroll needs, so using modern payroll system might be a good option. Depending on the policy, additional expenses might include:

  • Relocation to a temporary building (or permanent relocation if necessary)
  • Replacement of inventory, machinery and parts
  • Overtime wages to make up for lost production time
  • Advertising stating that your business is still operating

Business interruption coverage that insures you against 100 percent of losses can be costly. More often, policies cover 80 percent of losses while you shoulder the remaining 20 percent.

Once you’ve selected business interruption coverage to suit your company’s needs, secure business documents offsite so you can access them quickly if a disaster occurs.

Disaster Control

The key to business continuity after a disaster is to file the proper claims against your business interruption insurance as soon as possible. But be warned: This type of insurance is arguably one of the most complicated on the market today; submitting a claim can be time-consuming and requires careful consideration.

Follow these steps as soon as it is feasible:

1. Notification. Tell your insurer about the damage. If your policy has been water-damaged or destroyed, ask the company to send you another copy.

2. Policy review. Read your policy in its entirety to determine how to best present your claim. It’s important to understand the policy’s limits and deductibles before spending time documenting losses that may not be covered.

3. Minimize losses. Make temporary repairs if possible and hire security guards if necessary to protect the property. Then:

  • Reopen as soon as practical, even if it is only for a limited number of hours.
  • Block off unusable parts of the building and operate from less-damaged areas.
  • Take out newspaper, radio or television ads announcing when you will reopen.
  • Consider laying off nonessential support staff to limit continuing operating expenses.

4. Record losses. Maintain accurate records to support your claim. Reorganize your bookkeeping to segregate costs related to the business interruption and keep supporting invoices. Among the necessary documents are:

  • Pre-disaster financial statements and income tax returns
  • Post-disaster business records
  • Copies of current utility bills, employee wage and benefit statements, and other records showing continuing operating expenses
  • Receipts for building materials, a portable generator and other supplies needed for immediate repairs
  • Paid invoices from contractors, security personnel, media outlets and other service providers
  • Receipts for rental payments, if you move your business to a temporary location

Be as precise as possible — or your claim may be delayed or denied. Your accountant can review the records you plan to submit and organize them in anticipation of litigation if the insurer is reluctant to pay your claim. Taking the time to prepare for that possibility — even if it is remote — can save a great deal of effort later.

Professional Assistance

The calculation of losses is one of the most important, complex and potentially contentious issues involved in making business interruption insurance claims. Depending on the scope of your loss, the insurance company may enlist its own specialists to audit your claim. So you also may want to consult an accountant who is experienced in business valuation and litigation support to help prepare your claim, quantify business interruption losses and anticipate questions from your insurer.

Here are the major roles your accountant can play in managing the claims process:

  • Point-person. The accountant can be the primary contact with the insurer, dealing with the typical onslaught of document requests. That leaves you free to run the business and bring it back up to speed. He or she can also keep the claims process on track by informing the insurer about your actions and dealing with requests to inspect the damaged property. It’s possible that your accountant may already have an established relationship with your insurer and knows how its claims department works.
  • Damage estimator. Most policies define losses based on the earnings a company would have made if the interruption hadn’t occurred. To project lost profits, the accountant will analyze, identify and segregate revenues and expenses. The insurer will cover only losses that are directly attributable to the damage, as opposed to macroeconomic or other external causes, such as an economic downturn.

Your company also will be required to detail the steps it took to mitigate losses during the business interruption period, which is the time it took your business to resume normal operations. The steps may involve having to move to a temporary location. The interruption period is critical and one of the determining factors the insurer will use when examining the total amount of your company’s claim.

Be a Survivor

No one knows what natural and manmade disasters will strike in 2015. Business interruption insurance obviously won’t solve all your problems when the next disaster strikes, but it can improve your odds of survival. Working with an attorney who can aid in the legal interpretation of the policy, your accountant can quickly and efficiently assemble the information and calculations needed for a viable business interruption claim. Filing a well-crafted business interruption claim can result in a quick and easy resolution with the insurance company — and provide much-needed cash flow to get your business back up and running again.

Are Business Interruption Proceeds Taxable?

Insurance proceeds received for the loss of property generally aren’t taxable if you use the money to purchase replacement property. But business interruption proceeds are fully taxable to the extent that they’re used to replace lost income.

When are they taxable? Cash basis entities that file an undisputed claim with the insurance carrier must pay tax when they receive payment. For accrual basis taxpayers, the general rule of thumb is: Where liability is undisputed by the insurer and the amount of the recovery can be reasonably approximated, income accrues in the year of the loss, despite the fact that the amount of the recovery may not be known at the time of accrual.

For accrual basis entities, the timing of the tax liability is less straightforward when a business interruption claim is in dispute. To determine whether the proceeds should be recognized in the year that the claim is filed, the IRS considers two main issues:

1. Whether the insurer has recognized a liability for your claim

2. Whether your proceeds can be reasonably approximated

The timing of tax liability hinges on the facts and circumstances . Sometimes, claims aren’t includible in taxable income until the litigation between the parties is settled and the amount is set. Consult with your tax adviser when you file a business interruption claim to make sure the timing is right.