Business interruption claims are typically evaluated in two phases. Claim professionals will first determine the period of indemnity (a.k.a., period of restoration) and then measure the loss of income by reviewing the business’ income and expense trends and future projection charts.
For short periods of restoration or for very stable and non-seasonal industries (i.e., certain commodities or utility services), a basic trend analysis may be fair and sufficient, but in catastrophic losses or for businesses that are not simple or steady, the same basic approach will fall short or create a windfall, and therefore create disputes that delay and prolong the process.
Many insurers take the normal trends and data of a business to create a standardized measure of the income loss, but after they come up with a number they want offsets or credits if the performance of a business exceeds the normal trends after the restoration of operations. Interestingly, should the performance worsen after operations resume as a result of damage done to contracts or reputation during the interruption, insurers will never agree that coverage extends to those losses.
In the textbook Business Interruption: Coverage, Claims and Recovery, 2d ed., the concept of makeup, offsets and residual values are explained as follows:
Makeup (a term not often found in the text of an insurance policy) refers to a situation in which the performance of the business after restoration of operations exceeds the normal trended results. Adjusters and accounting experts use this excess performance to reduce the amount of the measured losses. In other words, the apparent losses during the period of interruption that are made up for after the restoration through excess performance are not considered losses at all, but rather deferred sales or earnings.
Offsets (which again is a term seldom, if ever, defined in the insurance policy) represents another means of reducing measured losses. While the makeup concept is most applied on a product-specific basis (i.e., the subsequent sales of the same product are evaluated against the claimed losses in that product), other offsets may include sales of substitute produces or alternative models from the same division or “price spikes” from other related companies within the policyholder’s portfolio.
Residual values represent a credit against claimed losses pertaining to the assumed ongoing value of temporary assets obtained during a period of restoration that will be retained permanently.
The authors point out that there is very little agreement on measuring makeup, offset or residual values, but that differences and disputes could be mitigated if the parties agree that any makeup or offsets should be attributed directly to the loss suffered and residual values should be determined using generally accepted valuation methodologies.
As a matter of good practice, claims professionals should spend a considerable amount of time in getting to know the intimate details of the affected enterprise. Are there any special trends, characteristics or events that had an impact on the representative period of data chosen to measure the business income loss? For example, would it be accurate to measure the loss with income or expense data during a period where an insured’s key customer or supplier went bankrupt? Similarly, would it be accurate to consider the surge in sales after a one-time promotion? These questions will not always have the same answer and proper consideration to company-specific or industry-specific factors should be given, instead of applying standardized formulas that can inadequately skew the numbers, to identify what part of the post-loss income trend is related to the loss (i.e., deferred sales) and what part is simply a boost that would have occurred anyway in the type of industry or sector.