The devil’s in the detail – policy wording in business interruption claims
As you’d expect, we’ve seen a rise in insurance claims for business interruption losses over the past year with the majority of claims arising from the pandemic. Whilst most of the Court’s time at present is dealing with aggregation issues such as in the matters of Greggs v Zurich and Corbin & King v Axa, work can still proceed on loss quantification and, for entities without aggregation issues, settlement.
We have been involved both in quantifying losses suffered and in negotiations following the initial claim. You might expect it to be obvious from a company’s accounts whether, and how much, loss was suffered. Common sense would suggest deducting the profit in one year from the profit in the year before. However, this is often not the case and depends on how key terms have been defined in the policy wording.
It’s all in the small print
For starters, the definition of ‘loss’ may take into account income, specified costs and / or cost savings. Some policies do not require any consideration of overheads, meaning the ‘loss’ is similar to gross profit, being profit generated directly on sale of goods or provision of services. Other policies require deductions for saved overheads, most commonly rent and rates where concessions were given by landlords or local authorities. In these latter scenarios, the ‘loss’ more closely resembles net profit, being profit generated after deduction of all costs including overheads.
Classification is key
The definitions set out in an insurance policy often do not match up with the presentation of costs in the accounts. For example, a hospitality business may choose to report salary costs as a cost of sale, a cost deducted in calculating gross profit. This makes sense from an accounting perspective where the salary costs are directly incurred in the generation of sales income (unlike, for example, the salaries of head office staff). Categorisation in this way ensures the costs of making the sale are reported as a clear deduction from the income generated – the net figure of total income less total costs of sale is gross profit.
However, some policies state that the only cost to be included in the calculation of lost gross profit is the cost of goods supplied to customers. These costs may be significantly lower than direct staff costs reported in the accounts such that the lost profit for insurance purposes would be greater than reported gross profit.
A departure from the accounts
Insurance policies rarely factor in accounting adjustments required in the preparation of a company’s accounts, such as impairments to write down stock.
Impairments are accounting adjustments made to reflect the net realisable value of stock held, where that value has fallen below the purchase price. Impairments are treated as a cost of sale and deducted in calculating gross profit for the period. The impact of reversing impairments is to improve profitability in the period in question. Depending on whether this impacts the reference period, period in which losses are claimed, or both, this can have an unexpected impact on loss quantification.
A pragmatic approach from the start
In our experience, the difference between insurance policy definitions and accounting treatment can be very significant to the quantum of loss. The exclusion of specific cost categories (or otherwise) can be crucial in determining whether a ‘loss’ under the policy was actually made and careful consideration at the outset of a claim can be crucial when managing client expectations and in order to ensure the claim put forward is robust and not unduly limited.
Sometimes a claim based on the strict wording of the policy doesn’t compensate for losses suffered. Many policies include ‘catch all’ wording stating that, where losses calculated in accordance with the strict wording of the policy don’t put the claimant back into the position they would have been in but for the pandemic, the loss calculation will be adjusted in order to rectify the position.
It is never going to be easy to persuade an insurer that this clause should be invoked but it should be considered where necessary. Our experience to date is that insurers have been fair where a reasonable case has been put forward for a departure from the strict wording of the policy and have been willing to consider losses on an alternative basis where necessary.
