Getting Back to Business: Business Interruption Insurance For The Professional Service Firm
As our professional service firm clientele begin to return to some semblance of normalcy, we are being asked for advice as to the protocols for submitting a business interruption insurance claim. Whether our client be a law firm, engineering firm, architectural firm, or other professional service firm, the methodology used in quantifying lost profits is similar.
In our recent article, Gettry Marcus described the hurdles that the policyholder will certainly face regarding the consideration of a business interruption claim due to COVID-19. Insurance carriers are quick to point out that business losses arising from COVID-19 are not due to a “direct physical loss” to the business property, hence no coverage. The insurance carrier will also point to certain bacteria and virus exclusion language contained within the business interruption policy.
The frustrated policyholder may have to litigate in order to receive ultimate satisfaction. The authors do acknowledge that many states, New York included, have pending legislation that if constitutional would void this exclusion language.
Looking past these issues, the professional service firm will have to submit a lost profits computation to support its alleged business interruption loss suffered as the result of the COVID-19 pandemic.
The most common method used in computing this type of lost profits claim is the “before-and-after” method. Simply stated, the affected COVID-19 period is compared with a prior period, known as the “benchmark” or “base” period to determine the extent of the lost profits due to the pandemic.
Good record keeping becomes paramount when quantifying the amount of such a business interruption claim. In computing lost revenues for a professional service firm simply comparing revenues during the loss period (let’s say March 15, 2020 through June 30, 2020) against prior similar period(s) is not enough. Perhaps these revenues are not “lost”, instead they may only be “deferred” to a date sometime later in 2020. This can best be demonstrated using the plight of many tax preparation orientated CPA firms. These firms have seen large revenue decreases through April 30, 2020 and even well into May. However, a large portion of this work may not have been permanently lost. Instead, it is more likely that the work has been pushed to a future date. These CPA firms are now seeing a busy June that will certainly lead into a robust July and August.
The preparation of a well thought out financial projection that tracks the future revenue stream is an important tool in quantifying any revenue sources that may have been deferred to a future date. In performing the analysis, the damage expert would certainly account for these deferments of revenues as an offset to the preliminary conclusion of lost profits.
Lost revenues are not the sole factor in determining lost profits. Expenses represent another piece of the puzzle. There are two categories of expenses that should be addressed in this type of analysis. The first are “saved expenses”. To the extent that the professional service firm has lost revenues, there are in most instances traditional expenses that were avoided due to the situation at hand. These items may include reduced payroll, utilities, rent abatements, and other saved costs or expenses. These saved expenses serve to reduce the amount of net profit lost by the damaged business.
The other type of expenses that must be considered in a COVID-19 related business interruption lost profit claim are “extra expenses”. These extra expenses are items that go beyond a business’s normal operating costs and are often needed to mitigate damages. These expenses may include the costs incurred related to the cleaning of the work premises and even the professional fees paid to help compute the lost profits for submission to the insurance carrier.
Lastly, many professional service firms received PPP loan proceeds. Forgiveness applications will be forthcoming after the coverage period ends. The portion of the PPP loan that is ultimately forgiven may have to be included as an offset to the business interruption claim.
Business interruption insurance coverage is a binding contract between the policyholder and the insurance carrier. The policy itself will contain governing definitions and loss calculation methodology. A careful analysis of the business interruption policy by a qualified professional is a must for every professional service business and its advisors.
Gettry Marcus is actively looking for ways to assist our professional service firm clients during these difficult times. If you would like additional information please contact your Gettry Marcus Advisor or Andrew Ross, or Howard Fine the authors of this article.