Actual Loss Sustained in Your Business Income Policy

Definition of Actual Loss Sustained

Actual loss sustained—speaks to the difference between the net profit and continuing expenses, including ordinary payroll that normally would have been earned or incurred but for the direct damage to property or the suspension of business operations as a result of damage to property. The "actual loss sustained" is the point where actual income is lost , but before you get to where the business would have been had no Covered Cause of Loss occurred. For insured businesses, actual loss sustained can mean the difference between survival and bankruptcy. Understand what you purchased and what you need to recover after a business interruption and the difference between actual loss sustained and the business income form.

How Does Actual Loss Sustained Apply?

When a business ends up with a covered loss, the business income portion of their insurance coverage can provide a lot of much needed funds to the business as they begin rebuilding. The whole idea behind business income coverage is to get the business back to where they would have been if the loss never occurred. This should be done in a timely manner to put the insured business back on a normal track.
Properly worded and forms business income coverage is designed to get the downstream effects of the loss eliminated. Restore damaged property. Replace lost property. Put the business back in the position to earn their previous income in a timely manner. Every hour a business is non-operational, they are losing income. In turn, the business may be unable to pay employees and bills. It may not be able to satisfy preexisting contracts or live up to its obligations. Once the business cannot satisfy those obligation, it may be too late to recover. The term "actual loss sustained" is key to the insurance industry because it is the language commonly used to limit the insurance company’s obligation to restoration of income over the shortest period of time and "the period of restoration",
Most modern policies have added the "period of restoration" clause. It states that when the interruption occurs, if the insured has a "shortage of income", the insurance company will only pay the insured for a "shorter length of time." A shorter length of time is gauging the time it should take to have the property and earn income back to a pre-loss condition. For example, if the insured needs one year after the loss to get back to condition, but only takes four (4) months to get all their other property repaired and not any new income coming in, then the shorter length of time would last for four (4) months leaving the other 8 months unpaid by the insurance company, even though the loss was sustained for the one year. Take for example a business that earns $200,000 a year, and has eight (8) months left in the calendar year until they can reopen. The insured business would expect to receive $133,333 after the loss. The Business income policy for the same business would allow coverage only for the 4 months unless the insured business can show that "but for" the loss, they would have made the other amount after the total 12 months. If the business shows that they had a pre-loss contract where they would have earned an additional 20% ($40,000), the insurance company would have to pay the remainder of the $40,000.

Calculating Actual Loss Sustained

In general, there are two types of methodologies to calculate actual loss sustained. The first, and the one with which we deal most often, is the "Historical Performance Model". Under this model we look at the company’s past performance to determine its profitability, and our estimated range of profitability over the period of loss. To derive this range, we need to find the company’s "Normal Historical Net Profit", which is then used to determine a "Delay Period" over which the damages are calculated. Let’s use Widget Co. as an example. Widget Co. has been in business for 5 years and has been profitable every year. This year Widget Co. had a product failure problem with their new product. This caused them to suffer a major loss, which forced them to hire us to help them. We reviewed their historical financials and noted that Widget had profits the last four years of ranging from $150,000 to $250,000. The catastrophe in question has severely caused Widget Co. to shut down production for 9 months, incurring a loss of $112,500 per month in profit. Based on these numbers, our estimates ranged from the lower end of the losses ($112,500) to the higher end ($228,750). That is a span of $116,250 (or 117%) that may or may not be covered under the policy. Widget Co. is a distributor of widgets. They have contracts with four distributors in Australia to sell Widget Co. products. These distributors are an important part of Widget Co.’s business, approximately 30% of their business. We estimate the losses in cash flow will be: $112,500 (12’08) + $112,500 (01’09) + $112,500 (02’09) + $112,500 (03’09) + $112,500 (04’09) + $112,500 (05’09), for a total of $675,000. If we take the average profit over the years and multiply by 75%, we arrive at $126,562.50 per month profit. We see that 75% is the point at which the profit year over year is roughly equal to the estimate of loss over the loss period. Since the claim amount is based an estimate of profit, we need to determine when the delay has ended. Widget Co. has a six month backlog of products at $250,000 per month. Based on these numbers, we estimate that we need to divide $675,000 by 6 months. This gives us an estimate of $112,500 per month for a 6 month period. Subtracting $675,000 from $750,000 gives us an estimate of $75,000 excess of the amount that is going to be covered. Another portion of the loss to consider is the cost of goods sold. These are a percentage of Widget’s sales. During the loss period, Widget’s sales were reduced but its overhead continued, thus Widget had to absorb more fixed costs that were not covered by sales. Widget Co. figures their cost of goods sold represent approximately 25% of the gross sales. In this case, Widget Co. loses an additional $94,375 at 25% of 375,000, the amount of their sales during the nine-month loss period. This was a basic calculation, one in which we could make recommendations to their current accountant as to where their losses should go and how to explain/prove these losses to their insurance carrier. This does not include an analysis of what looms in the future, nor is it an insurance explanation, simply an analysis of a business loss over time. Widget Co. still has to "argue" with their carrier the resulting amount of the loss and its payment.

Exclusions and Limitations of Actual Loss Sustained

Despite actual loss sustained being a complex coverage element, most business income coverages do not "expressly" include an actual loss sustained option. They simply include the phrase, "actual loss sustained." This cumbersome term can lead to the interpretation that there is some type of coverage for losses sustained as a result of the operation at that location. In order to be considered actual loss sustained, the loss must be an actual occurring event that causes a decline in income. Only direct damage to the insured structure, such as fire, water, or a storm, would cause an actual loss sustained. An important coverage limitation in the ISO 2011 edition of business income insurance plans is the "period of liability" limitation. The period of liability states "we will not pay for any resulting loss until the end of the 72 hours immediately following the direct physical loss or damage." This means that the 72 hour business income waiting period begins immediately when the direct physical loss or damage occurs as a result of the covered peril. Since an actual loss sustained clause cannot be triggered without direct physical damage, the 72 hour waiting period will almost always apply. Some other limitations found in the ISO 2011 edition of business income insurance includes "prescribed duties" and "extra expense." Prescribed duties limits coverage for actual loss sustained by stating "we will adjust your loss payable at the actual loss of income or extra expense level(s) specified in the declarations." This means that if the declarations of the policy specify a sublimit of what actual loss sustained is covered, this applies to the entire policy including additional damage, extra expense, and business income in the policy regardless of its location. Several types of coverage exclusions can limit or exclude coverage in a business income insurance plan. One of the most common exclusions is the "interruption by civil authority" exclusion. This exclusion only applies under specific circumstances. The first circumstance is when the premises are damaged by a covered peril and the property is inaccessible for 24 hours or more. The other circumstance is when the civil authority has issued an evacuation order to the premises and damage has occurred which has rendered the premises inaccessible for 24 hours or more. Neither of these exclusions apply if action by the civil authority is taken to avert a much greater loss. The ISO 2011 edition has excluded from coverage a "suspension of ‘operations’ due to any order of a civil authority that prohibits access to the described premises because of direct physical damage to property, other than at the described premises." In such a situation, the effects of the order must be more than just simply causing a delay. The order must suspend business due to damage to property. Therefore, damages only at nearby locations or even other states will not be considered. Coverage broadened significantly under the ISO 2000 version and it has expanded again with the most recent 2011 edition. Other common business income coverage exclusions include: Additional limitations may be found in an individual policy. A careful review should be made to ascertain the full extent of coverage limitations and exclusions in a business income policy.

Making a Claim for an Actual Loss Sustained

Business income insurance for actual loss sustained typically contains many of the common loss reporting conditions, which require timely and proper notice of loss. The specific conditions and timeframes will be outlined in the policy, and coverage may be jeopardized for failure to comply with such conditions.
Insurance policies also contain conditions requiring the insured to file a proof of loss. The proof of loss contains information that is solely within the knowledge of the insured. For example, the insured would be required to provide the gross earnings or net profit before applicable taxes, minus other specified items . Generally, the policy will specify that the insurer is to be placed in a position to settle with all reasonable promptness. If the insured fails to timely provide the necessary information, the insurer can likely argue that it has not been put in a position to settle promptly.
In addition to the foregoing, the amount of information and the timeframes in which it is required will vary. It is advisable that the insured closely follow all requirements in the insurance policy as a failure to do so can cause the claim to be rejected or improperly or unfairly delayed.

Examples of Actual Loss Sustained Claims

A large manufacturing facility suffered extensive damage to its processing and warehouse facilities as a consequence of a fire. Numerous building and contents items were damaged in the fire as were production and manufacturing equipment that severely impacted the company’s ability to produce its manufactured products. Amongst the damage was also a number of silos that contained raw materials such as resins; some of the resin chemicals had spilled into the area damaging the process and warehouse facilities. The insurance company paid and settled for all of the damage for building, contents and equipment in some €25m settlement. In addition and over the next couple of years, the insured claimed for actual loss sustained. The initial claim was for €5m – this claim arose as the company provided free product to meet their contractual obligations. The amounts were agreed. The company also claimed for loss of profits in the period after the business had recommenced but in this period there was no improvement in overall sales, though the business costs had been carefully controlled. The insurer did not agree to this claim as they felt that the business was selling its product in at an unduly low price. The insured was able to show that they were in the process of moving to increased prices. The company was increasing production and using process improvements to increase margins; as such they were well on their careful way to pricing their products at a more profitable level. In addition, the company had a cluster of contracts where the production and delivery of the products was not delayed due to the event. This contract relief was significant – the company got away with the fact that the event occurred in peak season so it would naturally have lost the sales anyway. After review by the liquidators, it was decided to pursue the claim against the insurer. The claims were re-evaluated and both the claim for free product and the claim for post-event loss of profit were recovered. The majority of reserved losses were recovered. The company in this case had focused on expanding their product portfolio mix with higher margin products in the first period. This feature together with the short delay in delivery of various contracts allowed the company to increase its pricing and get back to a normal sales position; as such they were able to recover against business interruption. However without these features, the insured may very well have been fighting an uphill battle.

Tips to Maximize an Actual Loss Sustained Claim

The Actual Loss Sustained period is a vital component of the general insurance coverage that will maximize your recovery from your insurance carrier in the event of a catastrophe.
So here are some tips for maximizing your income claim when dealing with an actual loss sustained provision:

Make sure that your General Agent submit to the Insurance Carrier a "Special Cause of Loss – Business Income-Actual Loss Sustained Form" after a catastrophe, even if you do not think that it will be necessary, because it will be too late once a loss occurs, and can only be submitted when prompted by the carrier.
In the event of a catastrophe, it is crucial that you stop or cut back all unnecessary expenses over the daily operating expenses, so that all receipts can be properly justified by you as necessary to mitigate the disaster and replace the loss of income. Complete documentation with invoices will be needed to complete your claim.
Remember to keep an accurate daily record of expenses such as payroll, rent, taxes, utilities, etc., that will be needed to prove lost income in the event of a catastrophe.
Make sure that your accountant or public adjuster has access to these daily records so that they can assess the losses against daily operating records and assist in preparing the claim, which may include specific forms for actual loss sustained loss of income claims.
It will be critical to translate the language of your actual loss sustained form into understandable terms that will allow you to understand the terms of your insurance policy, and to discuss with others.
Do not accept an insurance adjuster’s assessment of the ACTUAL "average" daily working operations of your business, unless you agree with the assessment. You know better than anyone, what your overhead operations are.
Be prepared to prove your actual daily operations.
Keep a log of each day of your operations with metrics that should be used to determine your proof of damages, including your normal income, payroll, taxes, and other expenses which will have to be submitted in support of your claim to the carrier’s forensic accounting.
Provide adequate documentation to your accountant or public adjuster for proof of your losses.
Sales records, time clock records, and other essential operating records should be preserved so that your business can produce them for an accurate assessment.
Premiums should be paid promptly so that your coverage cannot be contested, which some carriers do .
Take notes of all conversations with your carrier regarding your specific actual loss sustained demand.
Failure to comply with the aggregate actual loss sustained policy requirements can be found to be a breach of the contract.
The Insurance Carrier will want to know WHY you have to spend extra sums in comparing your expenses with past records, so keep records of ALL past expenses to discuss with your accountant so that he will be prepared to answer the carrier’s Accountant’s questions.
If the amount of net loss of business income is not quantifiable, it will complicate the claim and give the Carrier less incentive to settle your claim if your records are not adequate.
You will probably not hear about your lost business income until your insurance company has investigated the claim and sent the "loss of income" reports to it’s Claims Adjusters.
More than one expert opinion may be needed to properly assess your losses.
Be prepared for disputes over the proper application of the business interruption insurance clauses of your policy, especially in coverage disputes between "general policies" and "policies limiting claims to coverage in specific areas only."
Temporary storage of office equipment, records, supplies, and other files should be considered to mitigate losses.
File a written proof of claim with your insurance company as required before the policy expiration date, enclosing your signed proof of loss and any estimates of the damage.
Alert your insurance agent and the insurance adjuster of the fact that you have filed a Proof of Loss and will be submitting information from your forensic accountant to support the claim.
Be sure to provide a complete list of records that your forensic accountant would like to see so that it can be provided to the carrier promptly. Provide a list of all business hard copies and soft copies on your servers, written "on-screen-diskage-usage reports" and "hard copy" lists from your office so that the forensic accountant can cross-reference it for completeness.
A written explanation should be provided to your forensic accountant so that they will be able to spell out specifics about how to assess the damage properly implemented procedures, especially if they require additional help.
Be ready for a forensic accountant to be "told" by the carrier to stop working, even if you have another source of funding to continue.