Following a business interruption loss, you can expect many changes in the business to occur. Revenues may drop, expenses could increase or decrease, and for a period the business may even cease operating. Often when a business interruption loss occurs, the business is likely to experience a savings in certain expenses which would normally be a fixed monthly cost. The longer a business is unable to operate, the more likely it is for otherwise fixed expenses to cease. The degree to which expenses change is often dependent on the amount of damage which occurred.
This post is about the saved expenses which occur following a business interruption loss, and how they impact the resulting loss quantification.
Common Expense Changes
There are a few types of expenses which are commonly impacted in the event of a loss. It is important when assessing a claim, to review these expense categories to determine how they have been impacted by the loss.
- Rent – The changes to rent payments following damage to a rental space is typically specified in the lease agreement. In commercial leases we most commonly see three types of rent abatement:
- If the rented space is damaged in such a way that a portion of the space is still usable, then a portion of the rent will abate.
- If the rented space is entirely unusable but can be repaired within 120 days, then rent will cease until repairs are completed.
- If the rented space is entirely unusable and cannot be repaired within 120 days, the rent ceases and the lease is terminated.
It is important to understand which of these three rent abatements may be applied, as they would be considered a saved expense.
- Repairs and Maintenance – These expenses are typically incurred periodically rather than on an ongoing basis. During a period in which the business is being repaired as a result of a loss, the repair expenses are typically paid by the insurer and the insured will not incur any normal repair expenses relating to the damaged area. Accordingly, it is reasonable to treat this expense as a savings.
- Utilities – In the event the premises is entirely destroyed all utility costs would cease. However, in the event the premises is only partially damaged it is likely that utilities will continue, although possibly at a reduced rate. In the situation a business is closed for repairs, although the utilities normally consumed in operating the business may cease, the utilities consumed to perform the repairs may off-set any savings. Each situation must be assessed to determine what if any the saved expense would be from utilities.
- Advertising – Advertising expenses may cease or be reduced depending on the nature of the advertising done by the business, and the severity of the damage. While annual contracts may not change, costs associated with short-term advertising such as radio and newspaper ads may cease or be reduced. Further, depending on whether the entire business is closed for an extended period, or only a portion, will impact whether the business continues to draw clients to its premises.
- Amortization – The treatment of amortization as a saved expense is often the most controversial item. Many insured’s will argue that as it is a non-cash expense it really is not an expense and therefore the savings in amortization should not be considered. However, in determining the profit of a business, amortization is a very real expense and has direct implications on the amount of taxes paid by a business. When the assets is subsequently replaced the Insured will have the advantage of being able to fully depreciate a brand new asset, reducing future tax liability. If the savings in amortization is not considered following the destruction of an asset, and in the period in which the business is unable to operate, the insured would be over indemnified as the insured would recover both the insured value of the asset plus an allocation of the original cost.
There is no set amount to consider for saved expenses, and the expense categories listed above do not comprise all categories in which savings may be realized. Instead, it is important to understand the business operations before and after the incident, and the impact on each expense category.