Loss of Business Income Claims: Beyond the Numbers
"Loss of Business Income Claims: Beyond the Numbers" by Ethan A. Gross, JD, public adjuster and CEO of Globe Midwest Adjusters International, the leading public adjusting firm in the Michigan, Illinois, Wisconsin, and the Midwest.
This video provides useful public adjuster insight on loss of business income insurance claims so trusted advisors can help their policyholder clients after disaster.
- Good morning, everybody. Welcome to business income claims beyond the numbers. That is the part of the closely held business forum that will be discussing loss of income claims and how to assist your clients in the event that they have a fire or water damage or other disaster to their business.
My name is Ethan Gross, I'm the CEO of Globe Midwest/Adjusters International. We are a public adjusting firm. By education, I'm also an attorney, but I work as a public adjuster. For those of you who are not familiar with what public adjusters are, we represent property owners, business owners, after they've suffered an insurance claim some type of loss like a fire, in helping them prepare their claims and present them to the insurance company. As part of our services, when this loss has happened, we prepare loss of income claims in addition to building estimates. And so we've been negotiating insurance claims, loss of income claims and insurance claims for nearly a century. Personally, I'm not that old, I'm old enough that I've been doing this for almost 30 years.
So I wanna share some of our insights into these loss of income claims with you. As trusted advisors, you are going to have clients that will suffer some type of loss, and when they do, they're gonna come to you. As CPA's you understand the numbers better than I do for sure as far as profit and loss statements, reviewing tax returns and all of their sort of financial documents. However, when you put together an insurance claim, there's an entirely separate set of rules that you need to be familiar with, in order to properly prepare these claims. For example, if you were to try and prepare a tax return and you didn't have a copy of the tax code, and you didn't have any of the actual tax forms that you're supposed to be using, you'd be very limited in how you can do this. So you can be left to your own devices of trying to come up with some method that makes sense to you. However, when you file that tax return, the IRS would say, nice try, but this isn't what we're looking for.
So we're gonna go over is those rules that exist within the insurance policy, which is really the governing body for the entire loss of income claim. And so we're gonna walk through that and we're gonna spend more time on policy and other techniques in preparing a loss of income claim than just the numbers, because again, you guys understand the numbers. So we're gonna tie those together. I wanna give you a little understanding of how the loss of income policy works. And even before that, just insurance in general.
Most commercial insurance policies are gonna follow a similar format, though in current times, a lot of companies will have their own manuscript versions or they'll change the language. But when you get a policy for a business, it's usually gonna be on what's called an ISO form or an Insurance Service Office form. If you look at the screen, you'll see there's these numbers references. CP 00 30 10 12, and then the Insurance Service Office. That is a designation of a loss of income form. The Insurance Service Office puts out two types of forms for businesses. One is called the CP form or the commercial property form. And if you look at the top box on your screen, it says CP 00 30. There's another form at the, in the bottom box, which is a business owners form, which is a BP 00 02. So the language that governs loss of income claims is very similar in both of these forms.
The difference really is that, in the business income and extra expense form under the CP policy, what you most often have is a Alec Hart type of a policy. So you'll have in the middle box, it says business, or it says building in personal property coverage form. So your CP form will be made up of numerous endorsements. It'll have this building form, it'll have business income forms and all sorts of other forms attached. That BP form, the business owner policy is more of a combined package policy and all that information is in one bag. When you're looking at an insurance policy, it's very important to understand that these policies change and subtle differences can be very important. So the form that we're gonna use today, and you should have all received a packet prior to this webinar, and it includes a loss of income form. And we're using the most current version, which is a CP 00 30 10 12. What does that mean? That just means this issue date was October 12th of 2012. If you look at the box below, the issue date was in June of 2007, and there are some subtle differences and you may get a policy from one of your clients that could even go back to the 90s. And so you have to be able to know which form and to be able to look at that form. When you're following along in this policy, what I'd like you to do is keep your policy handy. And we're gonna walk through some of the relevant information. We don't have time to go through everything in this policy, but I've picked certain things that'll be most pertinent to you, and what you'll likely be doing.
One thing to always remember though, is this is not a standalone policy when we're looking at the CP form. So if that's all you have, and you're asked to prepare a claim, you need to look at the other parts of the policy because there are duties and obligations in there that you must comply with. And if you fail to comply with those, the whole claim... The nice thing about the CP form is right at the top page, it tells you read the entire policy carefully to determine rights, duties and what is, and is not covered. So I'm glad they give that advice up there. It is sound advice, you do need to look at the whole policy. And even if you have the BP form, the business owner's form, where it's a package policy, you can't just read the loss of income section, you have to read the whole policy. When we're looking at insurance policies, words are very critical, and as we walk through, you're gonna see a lot of words in quotation. Those are defined terms and other terms are defined within the policy other than the definition sections. As CPAs, you hang on the number. The numbers are very critical to you. You look through those as an attorney and a public adjuster, I also hang on the numbers, but I also hang on the words.
The words in these policies make even the subtlest difference can be the huge difference in the claim. So this slide that says the power of words, I want to just demonstrate an example of the power words can have, particularly if you don't know the meaning of the words. So there's a story told of two young boys, they're brothers and they share a room. One's 10 and one's 12. And at night they go to bed and before going to sleep, the older brother says to the younger brother, "You know, I'm almost an adult now. I think I should be able to swear in the house in front of our parents. They do it sometimes and I should be able to as well." The younger brother thinks that's a fantastic idea. And he says, "Yeah, you know, that's a great idea, and even though I'm only 10, I'm gonna do it too. Let's do this tomorrow morning." Next morning, the boys get up. They sit down for breakfast and mom says to the older boy, "So what would you like for breakfast son?" And he looks at his mom and he says, "Hey, what the hell mom, how about some fruit loops?" The mom's shocked, she says, "What, how dare you? Go to your room." The younger brothers seeing this, takes it all in. Mother says to him, "So what would you like for breakfast?" And he says, "I don't know mom, but you can bet your ass it's not gonna be fruit loops."
So the point of this story, is that if you don't know what the words mean or how they're being applied, you can get yourself into a lot of trouble. In an insurance claims, we see that every day where people look at a policy and language in a policy and they assume they know what it means, but without looking further in the policy, they don't. As you get a policy and you start to review it, it is important to take a look at what we refer to as the declarations page.
So on this screen, you don't have to be able to read it all, but it just shows all the forms that are listed. You wanna cross check that list with the policies themselves. One thing you would see here is it does have a business income and extra expense form, but it has a strange number, that's not what I just showed you. What that is, is it's a form that follows some information from the standard ISO form, but they've changed themselves. So on that policy it says, includes copyrighted material from the ISO. So those you have to look extra close at to see what are they doing different, that's not in the standard policy that you might be familiar with when doing this.
Now throughout this, I'm gonna have these little practice alert things drop in because those are things that are important to highlight. This first one is extremely important. It's not important to calculating the loss of income claim per se, but it's important to you as the CPA, because this is how you get paid. So many policies will have in their primary coverage, not within the business income form that you have, but in the primary coverage, they may have additional coverage, for what we referred to as claim data expense, or professional fees coverage, different policies call it something different. And that will typically say that if you need to pay somebody to help you gather documentation or for requested information, we will cover that and it might have a limit. Could be 25,000 could be 50,000. And that often, and most often applies to your fees as CPAs. Interestingly, they always exclude public adjuster fees, so I can't get paid or at least not by the insurance company, but you can. And what I find a lot is public, I'm sorry, is CPAs, oftentimes they're very, you know, have very good relationships with the client. So your client has a fire, they call you up and they say, oh, I need to get all this documentation together. I need, you know, three or four years tax returns, PNLs, whatever else they need. And you go and dig through it, you get it all up and you give it to them and you're like, I'm not gonna charge them, poor guy just had a fire, they're a good client, here you go. But if you find out, if they have this coverage, you should track your time and you can bill it and your client can recover these dollars to pay. So always good to know that you can get paid.
As we continue on, we start by looking at the form itself. And the very first thing under the coverage on page one is it says, business income, because this form is paying you for business income, lost business income. So the policy defines what that is. Business income under this policy might not be what you think it means pursuant to your normal experiences, but it is your net income, meaning net profit or loss before income tax, that would have been earned or incurred and continuing normal operating expenses incurred including payroll. So in the insurance world, we typically refer to this as net income plus continuing expenses. This is what we also refer to as a bottom up formula, meaning that we're starting at the bottom of that profit loss statement. We're looking and saying, okay, our net profit and loss from the financials is X dollars, and we're gonna add in any of these continuing expenses that you have during the loss period, meaning after this fire or hurricane or whatever the loss was. You can also get to the same number by doing a top down method, which is saying gross income less saved expenses. And oftentimes that is a better way to prepare the formula because it'll allow for more flexibility. It comes up with the same number and we're gonna do a sample of these claims towards the end. So you'll see what I mean, where you have a little more room to identify details and more complex claims.
But to move forward with the business income claim, we have to know a few things. How do we project this net income and what are normal operating expenses and how do we even go about calculating the entire loss? So to do this, we move through the policy a little bit more. When it says business income means the net profit or loss before income taxes that would have been earned or incurred, there's a couple things to think about. One is the net income, meaning net profit or loss. You can actually start with a negative number.
So for example, if a business is losing money and they have a loss, a fire, and now they wanna make an insurance claim, you can't just dismiss it and say, "Hey, wait a minute, I looked at your profit and loss statements, you're losing a thousand dollars a month, so don't come to me insurance company and ask for money." The way the formulas starts, it says, what is that number? So if my net profit or loss is actually a net loss of a thousand dollars a month, but I have continued normally operating expenses of $2,000 a month, then I can make claim for a thousand dollars a month. The whole purpose of insurance is to make the insured whole, put them back into the position they were prior to the loss. So prior to the loss, that's where they were at. Now, if it starts off when they're profitable, then it moves from there as well.
The other thing is, it goes to, that would have been earned or incurred, had no loss occurred. So we're trying to figure out using this crystal ball, which is what I have there. What would our projected net income be? And that is a whole discussion in itself that we'll get to. So insurance policies, they're a little complicated. They're not always in the best order and they kind of move around. So under this policy, the determination of the loss and the identification of how to identify what the projected net income would have been, is in section three, which is on page six. And we'll get to that shortly. The policy continues with and continuing normal operating expense. So what's interesting about this is, we start with our net profit or loss, and we add our continuing normal operating expenses. And under this policy it includes payroll. Need to read policies carefully, not all of them will include ordinary payroll, but at the end really means plus, and the distinction I mentioned earlier as attorneys, we hang on words.
There was a case in California where a very creative attorney argued that the formula says net profit or loss and continuing expenses. So that client was losing money. And even if you took their net loss and added their continuing expenses, they were still losing money. So they didn't have a claim. The argument was the policy doesn't say net profit or loss plus continuing expenses, it says and so they said, we're just gonna ignore the net profit or loss and make a claim for all of our continuing normal operating expenses. It's been tried a few places, it fails everywhere, but California does have one case where they let it go and they did collect for it. In the meantime in Michigan or most other states, you should always just look at this as net income plus continuing expenses, even though it says 'and'.
I want to talk for a minute about the continuing expenses. So I have a billboard and it's separated by continuing expenses on one side and saved expenses on the other. And there is a distinction here. Oftentimes when you're looking at a summary of somebody's expenses following a fire or water loss or whatever other damage they had, it can be a little counter intuitive as to what's going to continue and what isn't. And they need to start thinking about this early on after a claim. And this is a great area where discussions with a professional in the insurance industry can be very helpful to understand how to do these, because they have to decide what they're gonna spend money on and what they're not. And the claim might be for a business that's totally shut down after a fire or they could be partially.
So if we look on the, on both sides of the ledger, so to speak here and the continuing expense side, my first one is advertising. You may be thinking if, if I own a business, I'm a manufacturer of auto parts and I have a fire and I'm completely shut down, why am I gonna continue advertising? It's an expense that I don't need until I get up and running. But in the real world, sometimes there's expenses that have already been paid.
So a billboard, for example, you might have an annual contract. So if you're paying $12,000 a year to have this billboard up and you've paid it upfront, and now you have a fire two months into it, you still have that technically as a continuing expense, at least for your insurance claim purposes, because we're gonna prorate it all out and look at what your monthly expenses are. So a monthly continuing expense would be this thousand dollars a month for the billboard, even though you paid it all at one time. There's other advertising that might fall into the saved expense category or non-continuing. And that might be if you're having, you know, stuff placed on the internet, or you're sending out flyers or other type of advertising that you can pay as you go, TV commercials, any of those where you might just pay per spot or on a monthly basis, if you don't wanna continue those, they stop and they become a saved expense. Property tax typically continues if you own your property, be it the building, you're gonna pay that property tax, whether the damage, so the building exists or not. Now, if the building is gonna be shut down for a long time, I have had clients who have gone and got the property tax adjusted downward. Insurance will typically continue because you still have to protect yourself, particularly on the liability side, if you've got a burnt out building and somebody goes in there and gets hurt. And the saved expense, some other common ones would be rent. If it's a rental building, and most policies are much, are most leases are gonna have a provision that says, if this building is destroyed or your space is destroyed and you can't operate, there's an abatement of rent clause. So if rent stops, that's a saved expense. And that's all part of the loss of income formula that goes away. Auto oftentimes will go away. Utility sometimes will be a mix, and again, this is where knowing what's going on and speaking with the insurance professionals like myself, can help guide you on that part of it. With utilities, it may be that you're completely shut down and you're incurring nothing. But if you repair the building and you start rebuilding, the contractors once they get in there, are gonna have water, they're gonna have power, they're gonna have heat, there's gonna be stuff going on. And oftentimes the utilities at that point will go up because all the construction. So these numbers may change throughout the claim in different months and there's ways to prorate those.
You'll also see, I have depreciation on the bottom of both of these for continuing and saved expense. So if you look at depreciation as a continuing expense, it puts money in the insurance pocket as part of the claim. If you look at it as non-continuing, it takes money away. There has been a great debate since the beginning of depreciation, amongst insureds and insurers as to whether or not it should continue or not continue, you could wallpaper the entire sky with the case law and the articles that have been written, and it's way beyond the scope of this. Just know that's an issue that's out there. Oftentimes we resolve that through compromise and we split it 50/50 in the claim. Once we know a little bit about how a claim or what the insurance policy says in regard to a claim, we have to figure out what triggers coverage and how much money is actually available for a claim. So we're gonna go over some key questions that are answered by the insurance policy. These are what is owed, what's owed is actual loss incurred. How much money did they owe, even though it's a theoretical calculation.
There are times that an insured may not actually use anything even though they were shut down or they might lose much more for various reasons. When is it owed? When there is a suspension of operations. And you'll see both those words are in quote because they're defined in the policy so we'll discuss those. How long does the insurance company owe for? They owe for the entire period of restoration. What's the period of restoration? So another term that's in quotes, it's defined by the policy and so we'll have to discuss that. What triggers coverage is direct physical loss or damage. And even that can have some question as to what it is. And then what is the limit? Is there a dollar limit or a time limit on how much the insurance company will pay? So we're gonna answer all those questions. We're gonna start with what is owed actual loss incurred, and when is it owed?
The actual loss is fairly stumbled, but you have to sustain this loss. If an insured, for some reason is not actually losing money, then they don't get anything. You may have an insured that was planning on shutting the doors in two weeks and they have a fire and it destroys the business. So their actual loss might only be for two weeks because they were gonna close the business down. Even though the period of restoration, you know, would technically be, could be a year. The other part is when is it owed? So we have these two terms, suspension and operations. Suspension means, and I've pulled this it's on your sheet from the definition section in the back of the policy. Suspension means a slowdown or cessation of your business activities, or that a part of all or of the described premises is rendered untenable, if coverage is for business income due to rental value. So in simple terms, there has to be some, either slow down or complete stoppage of your business.
Business activities is very broad term. And so while this, you know, in most cases, it's simple, you have a fire you're completely shut down. Yes, there's been a suspension of your operations, nobody's gonna ask questions. There are times when you have, for example, in manufacturing where some stuff is repaired, but maybe you're not operating at full capacity, so you still have a suspension. And those can be quite tricky issues that get battled out between myself as the insurance professional and the insurance company's adjuster. Operation similarly, can become an adjusting issue because operations is broadly defined here too, as your business activities. So you see a little bit of the circular language in the policy. The suspension means that you had a slowdown or cessation of business activities. Operations is a science, is defined as business activities occurring at the premises, but nobody tells us what business activities are. So we can look at a broad definition. And then you most often won't deal with that as a big issue, but it certainly does come up for us from time to time, particularly in manufacturing.
So now we get to really, a real big issue in insurance claims. And that is how long does the insurance company owe for? And what they owe for is the period of restoration. And the period of restoration is defined in the policy. And there's a lot that can impact it. So we're gonna spend a little extra time on period of restoration. If we look at the definition and actually this isn't the full definition, there's some more in there that isn't so relevant for our conversation today, but when you read the policy, which I'm sure you'll all do it for fun, because they're really exciting. That's a joke. I don't know if CPAS have the same humor as insurance kids, but yes, that's what it was.
Anyways, after my failed attempted humor, we're gonna look through this. It says, period of restoration means the period of time that begins 72 hours after the time of direct physical loss or damage for business income coverage. And then also talks about immediately after the time of direct physical loss for extra expense. Extra expense is a whole issue we're gonna talk a little bit about in this webinar, but it really is a webinar in itself. The period of restoration ends the earlier of when the property at the described premises should be repaired, rebuilt, or replaced with reasonable speed and similar quality, or when the date, the business's resumed at a new permanent location. So there's actually a lot in here.
The first thing that it mentions, is it begins 72 hours after direct physical loss or damage. For loss of income it doesn't start when the fire happens or when the water pipe broke or whatever the loss was caused by. It starts 72 hours later, why? The reason for that is this is what we referred to as a time deductible. So if you have a fire to a building and you make a building claim, there's usually a dollar limit for a deductible. It says your deductible is $10,000. So if you have $100,000 claim, the insurance company is gonna pay you $90,000 because they're gonna use the $10,000 deductible and loss of income claims, that is a three day time deductible. There's a lot of reasons for that.
One is a lot of businesses might have some occurrence and they're shut down for two, three, four days. It's not that long, and so insurance company doesn't wanna be handling a bunch of small claims and paying out these smaller business interruption claims. So what they do is they have this three-day deductible. The three-day deductible is also something that's the practice alert here is to think about how that should work. Oftentimes someone will look at it and say, okay, well, it's pretty simple. If I have a hundred thousand dollar claim, and my loss is over a period of a hundred days, I can simply prorate it and say that my deductible should be $3,000. And that's what often happens. And oftentimes that is in everybody's best interest. It's a reasonable thought. However, in some cases, that is a very unfair result for the insured. And let me give you an example.
Let's say our insured has a bar in a college town and they have a fire right after they close up and clean up on a Sunday morning. They closed at two in the morning and by three o'clock in the morning, everybody's out of the building and they have a fire. 72 hours following that 3:00 AM Sunday morning fire, that bar isn't doing a lot of business. Sunday, Monday, Tuesday is not the biggest day in a bar business. So if you were to put together a claim and prorate it, you might be hitting them with a large penalty. On the other hand, if you were to look at this same business and say, well, what happened if the fire was at five o'clock on a Thursday and they lost Thursday night, Friday night and Saturday night, that would be a much larger dollar amount. So the point is when you're putting together a loss of income claim, you need to be aware of how the policy works and think about these things a little bit deeper and know, for example what the time deductible that you should look at what happened right after, because depending on the business, it could really hurt the insured, or it could be helpful to them.
As we move through this, we have some additional language in here that talks about the time that it should have taken. And I wanna just hit on that, and then we're gonna go through our next practice alert. So why does it say should and should is for how long should it take in order to perform these repairs? But when you're repairing a property, there is a reasonable amount of time to make all of these repairs. But you don't have to make the repairs and you can still make a loss of income claim. The small business administration has a statistic out there. And that statistic is that I think it's 40 to 60% of all small businesses never reopened after a disaster. So if they have a substantial fire or get hit by a tornado hurricane, whatever it is, they just don't have the ability to reopen. That doesn't mean they're not entitled to make a loss of income claim. And the reason for that is that if they tell everybody, the insurance company, my business is destroyed, I can't reopen, I'm not reopening, what the period of restoration gives them is the reasonable amount of time that it should take to do this. So if we determine that it would have taken 10 months to get their business rebuilt and operational, they can still collect for loss of income for 10 months. An issue that's been coming up more recently, and you know, I've been doing this for a long time, I didn't see this 20 years ago, 10 years ago, it's really just been in, in the last five or so years. And that is insurance companies trying to limit this period of restoration and what I think is an unfair method. But you should understand this and be aware of it in case one of your clients runs into this issue. And what is this? So what we look at for period of restoration is how long should it take to repair or rebuild the property? And this could be business personal property, or it could be the building.
When a fire happens, for example, there's usually a few weeks and sometimes months where the entire scene is locked up because there is investigators there doing cause and origin investigations. These investigations aren't always just to see if the insured's an arsonist and not pay the claim, but they're oftentimes what we refer to as subrogation. So if a restaurant burns down, they're gonna have an investigator in there. And if they can identify that, hey, this GE oven malfunctioned and caused this damage, the insurance company is gonna sue GE and say, "Hey, I paid out a million dollars, I want my money back, this was your fault." So the building at the time though is locked up and it's hard for the insured to go in there and put together their claim and certainly they can't start repairs. There's also an adjustment period that when I'm handling a claim, my team will put together an estimate. I write maybe a million dollars to repair a building, and the insurance company might write 400,000. It takes us several months when we go through a negotiation and ultimately we settle the claim and they get paid, but they couldn't start repairs until the claim was settled because they don't know how much money they're getting. We don't have an agreed scope of repairs of what needs to be done, so there's no way that this insured could reasonably be expected to start repairs. Also in the policy, on the building policy, it says, we're not gonna pay you if you don't give us a chance to inspect this property. So if the insured starts repairs before the insurance company gets out there, insurance company can't agree with the loss because they haven't had a chance to see it.
So let's say an average claim that we have a three month period of time to reach an agreement. And we have six months that we all agree it takes to repair. So the total period of restoration in that claim should be nine months. Some carriers are saying, no, the period of restoration is six months. The contractors agree it should be six months, and so we're only gonna pay you for six months. Problem with that is it's not reasonable. It's not what the policy says, and it's not possible for the insured to have done those repairs. It doesn't happen all the time, but I have been seeing it more frequently. And I've had several cases that have gone to litigation. Now, every time that I have seen a insurance company make this argument, they have lost pretty quickly in court because it's such an egregious position and just defies all logic. But I want you to be aware of it because period of restoration is a key component to the loss of income claim. Whether you're collecting for three months or for 18 months is gonna make a huge difference on how much money the insurer's collecting. The end date of the period of restoration, which skip to the next slide, but the end date for the period of restoration is when that work is completed or when that time that it should take is completed, which means all loss of income stops on that day. It also is the same date, that all extra expense.
So now we wanna look at what triggers coverage. So the trigger of coverage is direct physical loss or damage, and that damage must be at the insured premises, but it doesn't have to be to insured property, which is a little bit of an interesting twist here, that's important to know. But I will tell you that there are times where even direct physical loss or damage, everything in insurance can become an issue. So of course, if there's a fire to the widget manufacturer, everybody agrees, there's direct physical loss or damage. But what if there was a release of a chemical in the widget manufacturing company, everybody evacuated, and they were shut down for 10 days, but nothing was damaged that eventually this chemical dissipated and everything was fine. So there's arguments that of course it's direct physical damage. There was contamination on equipment, it had to be wiped off, or it eventually went away and we were shut down. The opposite argument is nothing was damaged. You couldn't be in there 'cause the air wasn't safe, but your equipment is just fine. Your building is just fine. And we're seeing that today as part of the arguments with COVID-19.
The insurance companies are saying, look, COVID-19 is not direct physical loss or damage. Now there's other exclusions as well. There's exclusion for viruses. It's a tough argument on the COVID-19. But one of the arguments, if there is no virus exclusion that the insurance companies make is where's the direct physical loss or damage? Yeah, okay, you maybe you have this contaminant in your building, but if you leave for a week, it's gonna be gone or if you spray it or wipe it, but your desk isn't gonna break, there's no other problem. So arguments go both ways.
In my opinion, I think that if you have something there that can physically be, you know, identified and then ultimately could be clean, then you do have physical damage. But I wanna move a little more into something that's a more common issue, which is it must be at the insured premises. But it doesn't mean that it has to be to insured property, the actual language, which is in the box to the right, says be caused by direct physical loss or damage to property at premises, which are described in the declarations of your policy and for which a business income limit of insurance is shown.
So what does that mean? And how would I have a situation where my insured property isn't damaged, but I'm losing income. So what you have there is a great example is a claim I just had was at a car dealership. So the car dealership, the building and all of the equipment and everything inside of it was all insured under one policy. But the cars are insured under a separate policy. They're under a floor plan policy with a different company in a completely different set of circumstances. The cars were all out in the lot and they were damaged by hail. The business itself really didn't sustain any damage that would have shut them down, but they were entitled to make a loss of income claim because there was damage to property at the premises, which was insured. So this lot, this building, all of that was insured. It's just that insurance company didn't insure the cars. So what's the period of restoration? The period of restoration is how long will it take to repair or replace those cars so I can sell them. And while that's going on, I'm still entitled to make a loss of income claim because of the way the words are written out here. So it's a nuance that does come up from time to time. And if you represent auto dealerships, it's a fairly common problem where hail or some other event will damage cars, but the building itself is in good shape.
The other question now is, is there a limit on how much will be paid? And of course the answer is yes, insurance companies are not big fans of giving unlimited money, but you can have somewhat unlimited. Typically with business interruption, you have two ways of insuring it. One is what we refer to as actual loss sustained. And in an actual loss sustained policy, you're gonna have coverage for a specified period of time. It might be 12 months. It might be 24 months. So in that case, if your business is shut down for 12 months, it doesn't matter how much income is lost. It could be a hundred thousand dollars. It could be a hundred million dollars. They will pay all of it during that insured period, 12 months, 24 months, whatever it is. If it's a 12 month period and your loss is 14 months, they'll pay unlimited amounts of money up through 12 months, but month 13th, month 14, even if everybody agrees, that's a period of restoration. there is no coverage for it. The dollar limit is just that you, will have a policy that says we will insure you for a million dollars. So everybody might agree it's an 18 month period of restoration. And if you had a million dollars on that loss within the first two months, you've maxed out, that's all you get. If you go for 18 months and your losses are only $400,000, that's all you get, you don't get the full million.
So those are a couple of ways of making sure you understand what's going on. And particularly when you're preparing the claim, it's important to understand what time you have available, if it's actual loss sustained, because that may change how the insured proceeds. If they know they only have 12 months coverage, they might wanna move a little quicker and reopening.
There's a couple more provisions that I wanna go over that follow through in the policy. Some we're gonna just discuss briefly, some a little bit detail, and then we're gonna get into some real nuts and bolts of how to project the lost income. Extra expense is critical. It's more than we're gonna be able to get into enough detail to really do justice, but I want you to be aware of it and how it relates at least for this webinar. Extra expense means the necessary expenses you incur during the period of restoration that you would not have incurred, if there had been no direct physical loss or damage to property caused by a resulting from a covered cost of loss. So the overlap here is we know that our loss of income formula is net income plus continuing normal operating expenses. So we have to understand the distinction between normal operating expenses and extra expenses.
If you look back on this form, it says, this is business income and extra expense. Some forms are just business income, your client may not even have extra expense coverage. If you look at payroll, for example, if in order to keep the business operating to some degree, you have overtime, that overtime would be an extra expense. So the normal 40 hour week would be under the business interruption claim for normal operating expense. And then the overtime would be extra expense and they have to be separated. And there's a lot of reasons where that becomes critical. One is do they have the coverage also, if you run out of money on loss of income and you realize you were including a bunch of extra expenses as normal operating expenses, then you need to move those over.
Again there's a lot there we don't have time to get into, but that's another reason to work closely with an insurance professional. It also refers to covered cause of loss. It must be a result of that. And that just goes to the other part of the policy, not the business interruption. It says, what do we cover? Fire, when and there's exclusions, you could have a client who has a bad water loss, and that water may be excluded. So just because they have business interruption coverage, they still get nothing. There's additional limitations listed through the policy and you can go through those on your own if you need to. It's more than we have time to get into in this class. Some other ones are civil authority and I'll take a second on civil authority to say, when we talked about loss of income, only applying when you have damage at your premises, one exception is civil authority. If you have that coverage in the policy, then if the area is damaged, let's say for a hurricane and you can't access your business, there is some limited business interruption money available. There's also coverage for alterations and new buildings where it will apply there. I do wanna spend a minute on this extended business income, because this is very important to any claim that you're gonna work on with one of your clients.
So extended business income begins the day that the property is actually repaired or rebuilt or opened at a new place and ends when you restore your operations with reasonable speed and operations again is defined that's that same definition from earlier, but when your operations are restored to a level that would have existed had no loss occurred, or in this case 60 days after the date determined in 1A above, which is the date that the period of restoration ended. So what does this mean? This means that I know that I know that if I have an agreed period of restoration is six months, I can only collect lost income for six months. Let's say I have an apartment building and it's all fixed. And six months has gone by and now I open the doors and I try to lease it up. Well, if I have a hundred units available, I'm not gonna get back to normal occupancy in one day, let's say I'm normally at 80%, it could take me two, three, four months to get up there. So this extended business income, this will cover that gap in where you should have been 80% occupancy with where you are 10 or 20 as it slowly rebuilds. So this gives you some extra coverage to pay for the lease up or for whatever the business it is to try to get back to where you should have been had no loss occurred.
Now the time period is important. Again, this policy is 60 days. Some are 30, some are 120, I've even had manufacturing where they're unlimited. And I will tell you that becomes a big fight because insurance companies don't like to pay unlimited. So I don't know why they put it in there, but they should honor it. Anyways, there's one more thing that this addresses and what that is, is it says, however, extended business income does not apply to loss of income incurred as a result of unfavorable business conditions caused by the impact of the covered cause of loss.
So what does that mean? Let's say I have a hurricane, we talked about this a little bit with, earlier in the opposite end. This is sort of the flip side to the unfavorable business conditions. But here let's say I have a hotel in Panama city and then a hurricane comes and it gets damaged and everything around me is completely shut down. And I take the position that you want me to make a claim and project what business I would have done had no loss occurred. Well, if my building wasn't damaged and I was the only hotel open in Panama city and every other hotel is closed, and now you've got contractors and insurance people flocking to the area to do work, I would be at a hundred percent occupancy every night. But the policy here is saying is, no, you can't do that. You can't say, excuse me, you can't say that, you know, when you have a normal occupancy of let's say 50%, that it would have gone up to a hundred percent because of this hurricane, if miraculously you were the only hotel left standing. So here they take out whatever caused that loss and the impact from it. You wanna go back in time and say, if no hurricane happened at all, what would you have got? So it's a, it's an important distinction because it really does prevent an insured from trying to overreach, so to speak, by taking advantage of that situation. And in the other end is the insurance company can't look at it and say, well, there's a hurricane. You shouldn't be, you know, there's nobody around to give you any business anyways, so too bad for you.
So in here, that's how we're looking at that extended business income. There's several other provisions in this policy that are very important that need to be addressed and looked at including duties in the event of loss, which are time for filing proofs of loss and such. But again, that's beyond what we're gonna have time to get into. I just wanna make sure you're aware of it. All right, now, this is a critical or a critical, there's a lot of critical parts to it. But the policy, when we were first starting to talk about the business income formula, and I said, how do we pull out that crystal ball? How do we project a loss? What do we look at? That was all under section three, loss determination.
So that's where we're at now. We need to spend some time on this. Within the loss determination, there's four key components that an insurance company looks at to determine what your loss is, what you can claim. And this is the guidelines that you have to stay with them. So we're gonna go through all these in a bit of detail, but very briefly right now, number one, the net income of the business before the direct physical loss or damage occurred. So that's what, what your history is. Then they're gonna want to look at the likely net income of the business, if no physical loss or damage had occurred, including any net income that would have likely been earned as a result of an increase in the volume of business. I'm sorry, but not including the increase based on the, the favorable business condition.
So we just talked about that under the extended period. Again, they're saying here, we're not gonna let you look at favorable business conditions. The operating expense, including payroll expenses necessary to resume operations. Remember our formula is net profit or loss plus continuing normal operating expenses. So they wanna look at all of those and see how they were in comparison before and after, and then other relevant sources, financials, et cetera. So we need to go through each of these in a little bit more detail because they are so important to the claim. So the net income of the business before the direct physical loss or damage occurred, that's to say, I wanna see your history. 'Cause I don't know what your history was and how do I know what you're telling me would happen has any, any credence, but I will caution you as we hear on all these commercials for stocks and businesses, past performance is no guarantee of future results.
So while looking at my history as a business is critical, it is also extremely important that I know what was my future going to be and I can't rely solely on that. Then the likely net income, if no physical damage had occurred, but not including increase due to favorable business conditions. That is where we get into this whole crystal ball of trying to determine. Again, the favorable business condition here is, you know, I can't just say, well, I'm the only building left after hurricane, and so my business would have gone up. Similarly, I couldn't say in my extended period that hey, you know, because of the hurricane, nobody's coming back to my business, and so I wanna have extended business income. The next one is the operating expenses including payroll expenses necessary to resume operations with the same quality as before. So they really do look closely at these operating expenses to make sure that they are necessary to continue your operations. Because if there's things that you could avoid paying, they don't wanna pay for it, and again, this includes payroll.
And something that's pretty important to know is a lot of times after there's a loss, the business owner does not have a whole lot of money or they have nothing. And so they might want to continue to pay all their employees, but until they get some money from the insurance company, they don't have money to give to them. So what we tell them is, look, if this is a continuing expense and you can't pay it now, book it as a payable. So when we go back to the insurance company, we can say, yes, these are payables. We owe this money, we just don't have any, anywhere to, to get the money until you start paying me. Then finally we get into all of the other relevant financial information, which is financial records, accounting procedures, bills, et cetera.
One thing I will say about that is it's very interesting when you talk to certain clients, especially in CAS businesses, and asked for documentation, including tax returns, and they say, well, yeah, but that's not really telling the story. There's an old saying in the insurance business, you can cheat the IRS or you can cheat the insurance company, but you can't cheat them both. Now, obviously I don't mean you should cheat either one, but I tell my clients, look, I don't care if you have a set of book showing all kinds of numbers, if that wasn't what you turned into the IRS, the insurance company only cares about that. It's proof of your damages. So where this leaves us now is what is this formula in a nutshell? If we go back what we've learned, we have the net profit or loss before income tax, either likely net income that would have been earned or incurred had no loss occurred. And we're gonna base that on actual net income earned prior to the physical loss or damage. And we're gonna use other sources to get there as well, like financial records, contracts, et cetera, plus continue normally normal, excuse me, normal operating expenses, including payroll.
The other really key component to putting this number together for your client, gets back to projecting what these future sales would have been. And so we're gonna go over a little bit of some of that. In projecting future sales, you have to look at not just the historical factors and the numbers, but talk to that insured. What was going on? Did you have marketing plans? Were there new contracts in place? Are there economic factors or industry factors that would be causing this business to increase or decrease in the future? And also in terms of methods, you can look at a pre-loss period. For example, you can say, well, I was doing a thousand dollars a month for the last 12 months. So I would have continued to do a thousand dollars a month. I also might want to use a year over year comparison and say, well, every year for the last 10 years, I've gone up 10%, so this year I should go up 10% or maybe it's seasonal business and we're going to look at month over month and say, well, you know what? My loss was January, February, March. And let me look at last January, February or March. Another one is hindsight. Sometimes these claims go on for so long that by the time you get towards settlement, they've already reopened and you can look and see what they did when they reopened and say, well, I would have done that earlier.
And I just briefly wanna mention production. Production meaning, sometimes you're not gonna just look at dollars. For example, a gas station, you know, the price of gas fluctuates. so you might wanna look at a gallon sold versus dollars . All right, so now we know the numbers and we wanna understand how to put it all together. So I put together a hypothetical claim that we can walk through. Our hypothetical business is Callahan Auto Parts. Some of you may be familiar with them. They make brake pads and other things they're out at Sandusky, Ohio. Anyways, unfortunately they had a fire on October of 2019, October 1, and they're gonna be down for six months until repairs can be made. So I'm looking at their financials, and I see if I go back to January of 2019, their sales have been doing really well. They've been going up, up, up and up, but all of a sudden in June, something happened and they were losing money. And then we have the fire in October, but sales were starting to climb again.
So how do I determine what my loss of income is? Well, there's a lot of different things I can look at here. If I just look at the four months prior to the loss and I take an average, you know, it's like $31,000, but that might not do it justice, 'cause I don't know why they lost that money. I could argue that, hey, I should be looking at the entire nine months. Let's look at what happened since the beginning of the year, and then that would give me a little different number. That might give me $67,000. I can also say, well, that might not be the best way to go. I think that this whole situation in June was an anomaly. And if you look at what was happening from January up until May, I was doing really well. So either I should continue to project going up or because of this anomaly, at least get a flat project, give me 110,000 a month. Or you take an average of those months it's 97,000. The real question though, is what happened? And that's a question that's not often asked in a claim when forensic accountants on both sides, just look at the numbers. In that particular situation, a forensic accountant for an insurance company would likely focus on those four or five months. I would say what happened.
There's a lot of reasons for why those numbers dropped. There could have been a competitor that came to town and now they're going to be losing money, and their business is gonna be less. They could have an obsolete product. They might've had a plan shutdown. I've had claims where my clients had a shutdown that they had planned and then they reopened, the shutdown was for maintenance, or there's other factors, for example, with Callaghan Auto, there was sabotage. Somebody sabotaged their system and they were down, but they were getting right back in action. So you have to ask the question, why was there this anomaly? And once you know it, then you can put together your claim.
So here's a sample of what a claim would look like. And this is following the bottom up approach, net income plus continuing expenses and I'll walk through it fairly quickly 'cause I know we're getting close to the end here, but what you'll see is we start at the top and I do identify up here. The claim is for six months, I look at what sales were and then I deduct all of these saved expenses to come up with what my net or what my normal operating expenses are to come up to my net profit, here it's $677 a month. My continuing expenses are 23,000 a month. I add those two together and I multiply it by the six months and now I have my claim, but we've talked about the continuing versus non-continuing expenses. So this is what a net profit or loss plus continuing expense approach looks like. Now I can do the same thing in a top down approach. And this summary would show that I think I've lost 660,000 a month. That's my gross loss sales. And then I come down and I take out what my margin is. And then I look down and say, what is my saved expenses? And the reason this gives more flexibility is because here I go to a schedule two. In my schedule two, I've identified specifically what saved expenses are and I've segregate them by variable, such as credit cards where it's a percentage of my income and fix things like rent so that I have those saved expenses identified. There's other provisions in the policy like co-insurance monthly limit of indemnity, agreed value.
These are all important to review, but again this, this, we didn't have time to get into all of those for this class. I appreciate you listening to me. I know I covered a lot of ground and this is something that can go on, you know, for hours and there could be many questions. What I would like to leave you with is that, you know the numbers, you need to also be able to look beyond the numbers and in working with an insurance professional, you can make sure that you don't miss any of that and we can get to the right result for your client, whether that client is the insurance company or the insured. So thank you for listening again.
My name is Ethan Gross, with Globe Midwest/Adjusters International. If there's any questions you can ask them now, or my contact information is with the packet and you can , you can feel free to call me or email me at any time, so.