In our last blog about the local economy, we explored the impact in regards to the sales portion of a business interruption claim. Now let’s talk about Expenses.
The second half of a business interruption claim is the expenses. We would all like it if revenue just kept going up while expenses remained constant, but that’s not always the case. Some expenses are going to vary directly with sales. For example, the more you sell, the more product costs you have; some expenses are fixed, like your rent; and some expenses have a fixed element and a variable component, like utilities. Plus, all expenses are subject to change based on supply and demand.
Payroll is one of the hardest expenses to project and the one that carriers most often get wrong. A business can place great value on their skilled or trained employees. They know that if they lose certain employees, they will not be able to reopen functionally the same as before the loss happened. It’s important to understand the job functions and classifications of the business, the length of time employees have been with the business, and what the unemployment rate is for the local economy. If the local unemployment is very low, it’s very difficult to hire new employees. And if you lay off your employees during the shutdown, you may not be able to get them back when you reopen.
A lot of carriers will rely on the fact that an employee is paid hourly vs. salary, arguing that an hourly paid employee is easier to replace than a salaried employee. There are many industries whose skilled laborers prefer to be paid hourly so that they’re paid for the overtime they work. Just because an employee is paid hourly does not change any of the skills or importance of that position.
Another important expense is cost of goods sold. We have all experienced prices going up at the grocery store, and understand that gas prices going up means the cost of food goes up. This is not only true for food and restaurants, but for any business that relies on transportation. You have to ask if the increase in the cost of goods sold is going to be passed on to the customers or if it is going to decrease the business’ margins. Are these price increases permanent or are they seasonal? Do they affect all of the goods or just a portion? The best resource again is the business owner and the management.
One final area of expenses to touch upon is rent. Two years ago, rent for businesses and tenants in downtown Boston was constantly increasing. Then COVID hit – now businesses are reimagining their office situations and have some employees working from home. This further impacts the supporting businesses in those areas. The lunch rush is gone. Coffee shops in the city are seeing less foot traffic. Colleges went remote and Boston did not have the influx of students in September that they usually do. All of these factors have an impact on rents in the area.
You need to understand how rent impacts the subject business. Is the insured a new tenant with a 10-year lease agreement or a tenant at will? Is there a percentage rent clause in their lease agreement? Was the insured renegotiating their lease with the landlord before the loss happened. This is all information that could change the overall measurement of the claim.
No matter how big or small the business is, the local and global economies are constantly affecting the everyday operations of the business. It’s important to understand not only the business but the economy in which they live and operate. The owners and management are keys to getting a crash course in the subject business, but your own research and understanding are just as important.