Tag Archives: extra expense

What Is an Extra Expense? (in English)

I am not sure why policy language has to be so confusing. Truly, there are some complicated risks that insurance covers, but even the simple ones seem to be made complicated by the language used. One example is extra expense. The words themselves seem pretty self-explanatory; a policyholder spends extra money due to an occurrence and submits the expenses as part of the claim. Though it sounds straight forward, within a property claim these expenses require different types of measurement, documentation and coverage. To ensure you are buying the right coverage for your risks, it’s important to understand the details and the differences.

Per the International Risk Management Institute (IRMI), extra expenses are defined as:

“…additional costs in excess of normal operating expenses that an organization incurs to continue operations while its property is being repaired or replaced after having been damaged by a covered cause of loss. Extra expense coverage can be purchased in addition to or instead of business income coverage, depending on the needs of the organization.”

This is true, but there is another kind of “extra expense” that is included as part of your business income – this is commonly known as “expense to reduce loss.” These expenses meet the definition of extra expense, but they are incurred to reduce the duration or magnitude of the business income loss.

See also: The Most Effective Insurance Policy

Consider this scenario: A manufacturer is shut down because of a covered cause of loss. Despite damaged machinery, they manage to resume operations in the facility by performing work manually with more than normal labor. The extra labor costs enables the insured to maintain some production that reduces lost sales. Is this a business income loss, extra expense loss or both?

In this case, extra expense coverage in excess of the business income would not be necessary since the extra expenses reduced the business income loss. Any sales that were lost could still be recovered as well. If only extra expense coverage was purchased, the manufacturer could recover the extra expenses but not any lost sales.

The distinction between “extra expense” and “expense to reduce loss” is important when you are placing coverage. Quantification and documentation of extra expense exposures depends on the types of expenses and the scenarios envisioned. If the only extra expenses that are foreseen would be to reduce a greater business income loss, then it might not be necessary to purchase the additional coverage. If business income is not at risk or can be avoided entirely with extra expenses, extra expense coverage may be the way to go.

Another category of coverage that gets confused with extra expense is expediting expense. Per the International Risk Management Institute (IRMI) expediting expenses are defined as:

“…expenses of temporary repairs and costs incurred to speed up the permanent repair or replacement of covered property or equipment.”

The need for expediting expense coverage came from a time when boiler and machinery coverage applied to specific objects written on separate policies. Modern all risk policies will include expediting expense as a part of expense to reduce loss or extra expense coverage.

See also: Shouldn’t Your Insurance Coverage Become More Than An Expense?

Again it is important to understand how you might incur these loss related expenses when placing coverage. To the extent that you can save the insurance company money by expediting, you are less likely to meet resistance. If you will need to expedite repairs for other reasons, regardless of cost or time savings, you may need to get coverage that provides full reimbursement.

Understanding the different types of expense coverage and how they apply to your business is critical when buying insurance. You don’t want to find out how your coverage works during a claim or that you’ve been paying for coverage you don’t need. Think through your potential scenarios, consult your broker and a forensic accountant to explore what coverages and limits are best for your risks. Then, share your conclusions with your underwriter to make sure everyone is speaking the same language.

7 Common Issues on Property Claims

When a property claim occurs, with or without business interruption, it is very common to assume that it will be straightforward. Just submit your invoices, and your insurer sends you a check. You may think, “We can do it ourselves,” or, “We have it under control.” If this has been your approach, you need to read on.

There are many potential issues when preparing a property claim that are commonly overlooked or misunderstood. The challenge is even greater if there is a business interruption component to your claim.

From experience, my partners and I have identified the most common property claim issues that can slow down the claim process and have an adverse affect on recovery.

  1. Repair vs. Replacement

Repair vs. replacement comes up in almost every significant property claim. The issue arises when it becomes a battle of opinions and assumptions. We all know the humor on opinions and assumptions — but your property damage claim is no laughing matter, so let’s explore what can happen.

If you have a replacement policy, you have the option to repair or replace. If it makes more sense to replace with a new and improved item, then you should do what’s best for your business. However, if repairs are possible and at a lower cost, the adjuster will undoubtedly dispute the claim, and you’ll be debating a matter of opinion. When the adjuster’s experts recommend repairs that you know are not guaranteed to work, especially long-term, you face a challenge. As a business, you cannot afford to risk a failed repair, so you elect to go with new equipment with a warranty. The repair option will now be a theoretical scenario that your insurer can leverage to adjust your claim payment. Regardless of the adjuster’s position, you did what was best for your business, but there’s a way to neutralize this potential adjustment.

  • First, the worst thing you can do is proceed on a plan without sharing your logic with the adjuster. Include the adjuster in the initial assessment and decision-making process. While you have the right to do what is best for your business, the adjuster’s involvement and buy-in early on will make her part of the decision and can help to avoid an issue down the road.
  • Next, get several (at least three) independent quotes to repair or replace the equipment — these quotes should include the time, expense and predicted reliability of the repair. If you only get a quote from the original manufacturer, there could be a perception that it has an ulterior motive. Armed with data, you will have an easier time justifying your decision. For example, the repair option may be cheaper, but if it takes longer to complete, it will add to your business interruption claim and ultimately cost more.
  • Finally, perform a realistic analysis of various failed repairs scenarios and the potential impact on timing and costs. Discuss your findings with the adjuster to ensure any subsequent repairs and resulting business interruption would be covered as part of this claim and not a separate occurrence. After all, everything is technically repairable — it is just a matter of determining the most practical solution given all the circumstances.
  1. Betterments

Losses often present opportunities to make useful changes and improvements to operations. Adjusters anticipate this and will be prepared with reasons to limit recovery by labeling certain repairs, reconfigurations, and replacements as betterments. Most of the time, newer is better, and that is why you pay for a replacement policy. However, just because something is better does not mean you should not get full replacement value.

Let’s say you are replacing a piece of production equipment that was damaged as part of your loss. In searching for a replacement, you find that the as-was capacity replacement for your equipment is no longer available and that the alternative equipment has a 10% greater production capacity than the damaged property. In this case, the adjuster may argue for a credit for the increased capacity. Though the new equipment is clearly a benefit to your business, because the exact model that is being replaced is no longer available, you don’t have an equivalent alternative. If required to justify and validate your decision, simply compare the cost/time differential between your decision and a custom order built to spec. In cases like this, you should not be penalized for the betterment.

There are valid adjustments for betterments, but it’s important to understand the difference between a betterment and your rights to a replacement of like kind and quality.

  1. Property Damage vs. Extra Expense

From a policyholder perspective, the types of expenses related to the claim do not really matter because they are necessary to get back in business. The insurance company, however, needs to see expenses segregated into their proper insurance claim buckets. To ensure a smooth claim process, knowing how best to account for expenses is critical to the outcome of your claim. Let’s say you have payroll expenses for cleanup and remediation. If you consider that property and extra expense are subject to different limits and deductibles, it makes good sense to claim them according to your coverage limits. As a rule of thumb, look at the property bucket first for expenses related to cleanup and repair of the property because the extra-expense bucket will offset business interruption, thus allowing you to operate as normally as possible during the indemnity period.

As an example, assume you have production labor working overtime to keep production going and to clean up and repair damage from the loss. This time should be separated as normal labor, property damage cleanup and repair and extra expense. To complicate things further, both normal rates and overtime rates need to be factored into each calculation. Finally, you have to keep detailed records that document the who, what, when and where that is involved in the work being done.

Remember, when appropriate, it’s best to claim expenses as property damage, provided the costs can be documented. It is a more tangible approach and will avoid conflicting with the business interruption calculations for extra expense and inefficiencies, which are based on assumptions and subject to debate.

  1. Actual Cash Value

Immediately after a loss, you are entitled to recover the documented actual cash value (ACV) of your damaged property. You may claim ACV as the amount you are due before exploring replacement options. This is a good tactic if you want to get the cash flowing early in the process while the replacement values are being determined and decisions on replacement are made. However, accurately determining ACV can be challenging.

Typically, the starting point is the asset ledger that shows a depreciated value of the asset. However, this number is usually used for tax purposes and may not represent the actual value of the asset. Other options to value the asset include pricing based on what a willing buyer would pay or replacement less physical depreciation based on the actual life of the asset. These methods vary state by state. Do your research to value the asset appropriately under the circumstances and know that there is not one right answer.

Additionally, some policies allow you to recover full replacement value for assets even if you do not replace them. The policies usually require that you spend the money on a capital project that was not approved at the time of the loss. The capital improvement does not necessarily have to replace capability of the lost assets. If this is of interest, check with your broker about adding this option to your program.

  1. Period of Indemnity Impact

In general, the period of indemnity is the length of time it takes (or should take) to make property repairs. Once repairs are complete or should have been complete, the period of indemnity terminates. While you can, and should, attempt to settle portions of the property claim as you go, any agreements related to the property side of your claim can have a costly impact on the indemnity period for the time-element portion of the claim. It is critically important to address property issues in tandem with time element, to avoid unnecessary recovery issues.

This can be a little confusing. As an example, let’s assume you have a total loss to a piece of equipment, and the replacement cost is known. It would be reasonable to settle for the replacement cost of that equipment. However, the adjuster assumes an aggressive timeline to order and install the equipment, not considering how installation might affect continuing production. When this happens, make sure the timeline and assumptions for installation are clear and acceptable before settling on the cost to replace the equipment. Otherwise, you might get what you want on the property settlement and then lose on the time element.

If you have a separate team working on the property and time-element claims, collaboration is essential to avoid assumption-based adjustments, This becomes especially important when repairs are theoretical, as this will be the basis for the time-element recovery. Always remember to consider all assumptions needed for time-element claims as part of any property settlement.

  1. Residual Value Adjustment

If you have a significant property claim, you may need to purchase equipment or supplies on a temporary basis. The validity of these purchases is not in question, but their use once permanent repairs are made is. For items such as this, the adjuster may look to take a residual value credit. Essentially, the adjuster agrees that you needed that item, but when the permanent repairs are made (and paid for), you will no longer need it. This may be true, but this does not always mean you should not get full value for the item.

For example, you have an electrical loss that will keep you out of business for an extended period. You purchase a generator to provide basic power to areas of your business. When repairs are complete and power is restored, you no longer need the generator but still have the unit. Because you still have it, the adjuster takes a residual value credit. Is that fair?

The first question you need to ask is whether you want to keep the generator. If there is some value to you, a fair credit can be negotiated with the insurance company. If you do not want to keep the item or do not feel the credit is reasonable, you can have the insurance company take possession — after all, the insurer paid for it. If the insurance company thinks it can get value from the generator by taking possession and selling it, the company will probably take you up on this. More often than not, this is not cost-effective, and you can minimize or eliminate the residual value credit.

  1. Documentation

If you have never been through a significant property claim, you might not appreciate the level of detail that is required to document your claim. The general perception is that you gather some invoices and quotes on a sample basis, and that should be enough. Unfortunately, the requirements for an insurance claim are more detailed than most capital projects and audits. Quotes and estimates need to be extremely detailed, and proof of payment needs to be documented almost entirely — if you cannot properly document a claim, it will likely not be paid. It may not be acceptable to the insurance company to use a dollar threshold for charges because the company will insist on auditing 100% of the charges.

To demonstrate the level of scrutiny that claims come under, I refer to an experience I had on one of the largest claims I worked on. The property portion of the claim was close to $200 million. Months of work and tons (literally) of paper were presented to support this claim. During a meeting between the accountants and engineers, one of the engineers made copies for everyone of one invoice presented for payment. He adamantly pointed out that the invoice had been duplicated in our claim submission. It was for one $5 roll of duct tape.

The point is that handling and organizing all the documentation required to support your claim can be daunting. To avoid mistakes, it is advisable to assign a dedicated person or team to locate, scan, print and manage all the support documentation. Bringing in an expert forensic accountant is always a good option to consider, especially for larger, complicated claims or just to relieve your team from these tedious and burdensome tasks. Forensic accountants that specialize in claim preparation may be covered in your policy to work on your behalf. Though you will still have some work to do, your claim will go more smoothly, with fewer pitfalls.

Now you know why property claims are not as easy and straightforward as you might expect. After decades of preparing claims for policyholders, we can attest that what you don’t know comes at a cost in both time and money. We hope the information above can help you prepare for at least some of the issues you might encounter should you have a future property damage claim.

Checklist to Prepare for Business Interruption

Business interruption (BI) losses are among the most confusing types of claims in the insurance industry. As claim specialists, we are often asked for a “checklist” filled with action items for when a loss occurs. A “checklist” isn’t practical because there are too many variables and “if/then” scenarios to map out. When you have a significant property damage and business interruption claim, only experience can guide the way to a fair recovery.

However, there are actions that can be taken ahead of a loss to ensure you are prepared. The following seven items represent such a “checklist.” It will not only help with your next loss but can have an immediate benefit to your risk management program.

1. Prepare accurate ratable business interruption values

The annual ritual of preparing the business interruption worksheet is often treated as an administrative nuisance.  It should be looked at as an opportunity to accurately account for the insurable risk for which you pay your premium and to accumulate annual values for future trending.

The worksheet provided by the insurance company is woefully inadequate to explain the nuances of most businesses. Go beyond the worksheet and explain your business more completely to underwriters. For an effective BI values methodology, solicit help from the specialists, such as an experienced forensic accountant. The results will be appreciated by underwriters and should translate into more appropriate coverage and possibly a more favorable rate. Once a system is in place, accuracy, consistency and efficiency should be improved.

2.    Analyze exposure scenarios and calculate MFL and PML

Once the ratable BI values are calculated, policyholders should explore realistic loss scenarios. The BI value is an annual number that does not factor in real-life responses that would generally mitigate a claim. To get to the actual exposure to risk, companies should determine the maximum foreseeable loss (MFL) and probable maximum loss (PML) measurements. The MFL measures a “worst case scenario” in which all of the loss-control protections fail. The PML is the more realistic loss scenario, in which mitigation systems work and contingency plans are executed properly. In both cases, the property damage and business interruption effects would be calculated as if they had occurred.

Loss scenarios should be postulated in detail, e.g. by location and by occurrence, considering all factors. These numbers should not be measured by simply applying a daily “BI rate” to an engineered loss period. It is more realistic to prepare as if presenting a claim, exploring all “what if” possibilities. Insurers may offer some assistance in this process, but remember, their version will be from their perspective. As with any claim, you should always prepare your own scenarios and your own calculations according to your understanding of your operations. An independent forensic accountant will have prepared claims just like your scenarios and would be able to accurately value the losses.

3.   Analyze contingent risks

Concurrent with the MFL and PML analysis, you should work to understand contingent risks to your business. Knowing what your suppliers’ and customers’ exposures are is important. Policyholders should involve leaders in operations, procurement and sales to help identify contingent exposures. If you have a sole supplier, your contingent exposure may be greater than anticipated and should be examined.

It is important to understand how your current policy language would respond to the contingent loss scenarios you’ve identified. For example, if suppliers in your policy are referred to as direct supplier,” make sure you understand how this would be interpreted in a claim. If “direct” means only those suppliers with whom you have a direct contract, and an indirect supplier, i.e. a second-tier supplier, has a loss that affects you, would you be covered? These scenarios should be discussed with your broker and underwriter to ensure your policy will respond as expected.

Once the values and scenarios are updated, you will be better able to make informed decisions about your insurance coverage, limits and terms.

4.    Business interruption vs. extra expense

Another common discovery from performing an exposure analysis is which type of time element coverage is the best risk transfer solution. Considering each location, if the risk is a lost of sales, BI would cover the lost earnings. If sales are not the risk or they can be sustained at an extra expense, extra expense coverage would be more appropriate. If sales are at risk but can be mitigated to the degree contingency measures are enacted at an additional expense, it’s a combination loss exposure.

It’s of value to risk managers to know what the exposure truly is because, if an exposure can be covered by extra expense coverage, it may eliminate or reduce the need for BI insurance. For example, if you are a distributor with multiple warehouses whose inventory is insured at selling price, what’s at risk? If you have alternative space or can quickly secure temporary space, the likelihood of experiencing a sales loss that exceeds the sales value of your lost inventory is remote. How much BI coverage should you buy vs. extra expense? Exploring your loss scenarios and subsequent contingency plans would allow you to better quantify your risks and select the option best suited to your needs. Extra expense is a more “tangible” risk than BI, making it easier for underwriters to rate, and it generally will cost less.

5.   Gross earnings, gross profit and business income

The names are different, but the intent is the same – to protect earnings lost because of damage or loss of use of insured property. The history of each of these forms would take a separate paper to detail, but, in a nutshell, gross earnings is a form commonly used in the U.S. with a basis in manufacturing risks, while gross profit is used throughout the world and has its basis in mercantile operations. Business income is the term used for the current ISO forms. Today, all forms have been modified to accommodate almost any business — however, there are some situations where one form may be preferable. The terminology and the mechanics of calculating business interruption loss varies among the forms, but the answer should be the same, regardless.

The exception to this has to do with the period of indemnity — the gross profit form is usually limited to a specific time, while gross earnings will continue until repairs are (or should be) completed with “due diligence and dispatch”; there is the ability to add an extended period to recover sales. It is important to make sure the form you have would cover your potential loss period. For example, if you have a manufacturing company with specialized production equipment that have long lead times to replace — longer than the period that a gross profit form would cover — you should probably have a gross earnings form. If you do not see a scenario that would exceed the gross profit period and you cannot accurately predict an extended period required to add to gross earnings, the gross profit might be a better option. If there isn’t any scenario that would create a loss that exceeds the gross profit period of indemnity and you are comfortable that you can cover that time to recover sales, than either form would work. There are new options that allow you to pick which form you would like to use up until the closure of a claim — these forms eliminate the need to determine which form is right for your business. Just make sure you have a form that will cover your worst-case scenario.

6.   Professional fees coverage

Most policies now include professional fees coverage. Insurers recognize the need for dedicated claim preparation experts and are willing to pay for it as part of the claim. Often, this coverage is subject to limits that can be negotiated. If you are not familiar with this coverage or do not have it, you should discuss with underwriters. For the most part, this coverage can be included at some level just by asking. The benefits of having specialized claim preparation experts available as a resource for a claim can make the difference between a successful claim and a headache.

7.  Organize your claim team

In addition to forensic accountants, a claim may include forensic engineers, attorneys and others. It is a good idea to know those you want to use before needing their services. Meet with the various providers beforehand and select those that fit best for your organization. Typically, paperwork associated with hiring someone can be completed before needing their assistance (i.e. non-disclosure, purchasing, W-9, etc.) so that if something happens they can begin work immediately. Additionally, there may be an opportunity for the provider to help with reporting issues on business interruption values.

While no business wants to suffer a loss of earnings, the more prepared you are the better the results will be. The steps shown above may take years to fully develop and should be evaluated annually to account for changes to your business.

If these recommendations are incorporated into your insurance program, there’s no need for a claim checklist. Your risk management team will be prepared for any worst-case situations with the best-case solutions.

Business Income And Dependent Property From A Secondary Location

There was a lot that changed with the Commercial Property Forms in the 2013 series. In fact, most forms underwent some sort of modification. One of the most interesting of the changes was the introduction of an optional coverage available on the Dependent Property Forms for Dependent Properties in the Supply Chain (Business Interruption).

By way of background, the Business Income and Extra Expense forms require that there is direct damage at the premises described by a covered cause of loss that gives rise to a loss of income or need to pay extra costs to operate during the period of restoration. In providing this form of coverage, we have been aware of the exposure to a loss of income due to a physical loss at a location that our insured depends on for various reasons. Recognizing that a loss to a dependent location could cause financial harm to our insured, ISO created Dependent Property Endorsements (CP 1508, CP 15 09, CP 1534) provided on a scheduled basis. What this means is that, for our insured, we identify what company(ies) they are dependent on and schedule those locations on the Dependent Property Form attached to their business income policy.

For example, we could be insuring a winery that is dependent on a single manufacturer to manufacture their distinct wine bottle and provide them with their customized cork. If that bottle manufacturer had a loss to their manufacturing facility by a peril insured against on the winery's policy and the winery now has no bottles and the winery can demonstrate they are losing money or incurring an Extra Expense by going to a more expensive alternate supplier then the Dependent Property Endorsement could respond.

What we learned, when losses such as this arise, is that oftentimes the physical loss did not occur at the dependent location we scheduled on the policy but rather to a “location” that the dependent property was dependent upon to supply them a product or service. So to expand on the winery example — the bottle manufacturer is dependent on a single cork manufacturer to supply them with the blank corks they customize and the cork manufacturer has a loss (covered peril) and cannot supply the wine bottle company with the product. We never identified the cork manufacturer on our insured's policy as there was no known or direct relationship.

The new language on the Dependent Property forms have an option for “secondary contributing locations” and “secondary recipient locations.” Secondary locations are limited to direct suppliers and recipients of the dependent property's materials or supplies.

On the form, secondary contributing location and recipient location are now defined terms. There are some important clarifications of the coverage:

  1. The secondary location is not identified in the schedule. However, there is a box on the schedule that has to be marked identifying that a secondary location has been included.
  2. The secondary location cannot be owned or operated by the “contributing” or “recipient” location that is identified in the schedule.
  3. There is clarity that a secondary location is not a road, bridge, tunnel, waterway, airfield, pipeline or any other similar area or structure.
  4. There is clarity that any source of “services” in the area of water, power, wastewater removal or communication supply cannot be a secondary dependent property. These would be covered under Utility Interruption endorsements.
  5. Lastly, there is clarity that the secondary dependent property coverage is subject to the territory of the policy and is not worldwide.

This additional coverage under the Dependent Property Endorsements is very important to consider, especially for manufacturing accounts. This all gets back to our identifying exposure and providing solution.

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