Business Interruption Claims for COVID-19 and Beyond: What Manufacturers Need to Know
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In January of 2020, no company leader would have ever imagined that their business would come to a halt due to government orders caused by the outbreak of COVID-19. By March of 2020, the economic landscape started looking quite different due to operating restrictions brought on by the pandemic. Considering how much has changed unexpectedly over a short period, now is an excellent opportunity to evaluate how prepared you are for interruptions to your manufacturing business. Although it is unknown if interruptions due to the pandemic will be covered within the scope of business interruption policies, the COVID-19 crisis is a prime example of how fast things can change and why the best time to prepare is now.
Based on prior experiences with property damage, equipment breakdown and business interruption claims within our Manufacturing Practice, there are many things you can do right now to prepare for potential claims for business income. Some examples include the following:
Recordkeeping – Many businesses believe they have sufficient recordkeeping when, in fact, there are often significant opportunities for improvement. One critical area is making sure you have copies of tax returns for prior years and that your financial and production data for the current year is accessible. In addition, it is essential to ensure you know where source documents supporting your historical and current financial statements and production information are located. These documents are critical as many of the records necessary to support a claim may include items outside of your tax returns and financial statements. As an example, daily production reports, bank statements, employee time keeping records, vendor invoices and other types of internal or third-party records are often necessary for preparing a well-supported business interruption claim.
In addition, companies in the manufacturing industry will likely need to obtain and document work-in-process and inventory records in a short timeframe. What documentation does your accounting department use to prepare the company’s weekly and monthly books? Where is this documentation stored? How quickly can you access it? It is vital to have quick and easy access to these records.
Act Quickly – When an event occurs, you will need to act quickly and document everything you can. Time is of the essence, and it is crucial for you to contact your insurance company as soon as possible when you believe a claim has first occurred. Carefully review your policy notification requirements so you can understand and fulfill your claim reporting obligations. Laws vary across different jurisdictions, but many courts have determined that failing to notify your insurance company promptly can result in the outright denial of coverage for your claim.
Claim Support – One of the first things you will need when making a claim is your general policy information and a background of the events leading up to and consisting of the event. Most of the policy information is contained within your policy on a document known as the declarations page. The declarations page includes information such as the named insured, address, policy number and effective policy period. In order to complete a claim investigation, the insurance company will also need general background information related to the event to understand what it consists of, how it occurred and when it happened.
To help manufacturing companies better prepare for business interruption, we have listed the following examples of typical information needed for a claim.
Claim Support Documents for Manufacturing Companies
Background Information and Requests:
1. Copy of the insurance policy, including all forms.
2. Timeline of events related to the claim, including the following:
- Date and timing of loss,
- Explanation of the loss (e.g., fire at plant),
- Location of the loss (e.g., plant 1 located at 123 Main Street),
- Any other pertinent facts that would assist in understanding the nature of the claim
3. The current location(s) and physical condition of the subject Company’s facilities and operational assets.
4. Personnel organization chart.
5. Any claim analysis that has been initially prepared by you and/or your team (e.g., lost revenue, extra expenses, property losses, etc.).
Primary Financial Information
1. Monthly and Annual Financial Statements (e.g., Income Statement, Balance Sheet and Statement of Cash Flows) for the last 3 years,
2. Tax returns, including all schedules for the last 3 years (e.g., 1120, 1120S, 1065, etc.).
3. Any sales, capital expenditure and/or operating budgets or forecasts prepared for the current year (monthly, quarterly or annual),
4. Monthly sales records for the last 3 years,
5. Monthly production records by location (by production line or piece of equipment if possible) for the last 3 years,
6. Inventory listing (including quantities and values) as of the date of loss as well as by month for the last 12 months.
7. Depreciation schedules, as of the date of loss, which illustrate the costs, useful lives and accumulated depreciation for fixed assets.
Contracts and Agreements, and Operational Documents:
1. Any ongoing contracts with customers, including, if available, required monthly outputs, usage or supply of products or shipments.
COVID-19 Specific Considerations
Manufacturing companies will likely be impacted by COVID-19 in a number of different ways. These impacts might result from actions associated with the forced shutdown of operations by a Civil Authority (e.g., Federal/State/County/City), employees testing positive for COVID-19 and impacts to suppliers as a result of the pandemic. As mentioned previously, it is unknown if interruptions due to the pandemic will be covered within the scope of typical business interruption policies, but understanding how your business is impacted by COVID-19 is the first step in making a potential insurance claim. Below are some items that manufacturing companies should consider in evaluating the potential impacts of COVID-19 to their business:
- If your business is impacted by an Action from a Civil Authority, such as a mandated closure, document any information regarding this impact and keep records of any communications referencing orders by the Civil Authority.
- If you think your financial results have been impacted by COVID-19, compare historical financial performance (prior to the pandemic) to current financial results and document reasons for declines (e.g., production interruptions, supply interruptions, other delays).
- Due to cash flow constraints, some customers might be more inclined to request refunds or return unsold products. It may be helpful to track returns or refunds that are specific to COVID-19. Comparisons to prior periods can help companies identify abnormal impacts due to an unexpected increase in returns and refunds.
- If production has been impacted by a lack of available raw material supply, you should track these interruptions and document how it has impacted the company’s financial results.
- Some manufacturing companies have a “high season” where they are producing a higher volume of products. Did your company miss its high season due to COVID-19? Are there additional opportunities to recover these lost sales?
- Did you lose specific large customers or opportunities as a result of COVID-19? If so, document the reasons for the customer/opportunity loss, including keeping records of communications with the customer.
- Have you considered other mitigation efforts?
- Are your customers likely to purchase your products in higher demand after the COVID-19 crisis is over?
- Can you move production to in-demand products? If so, what is the line-rework cost?
- Are you incurring extra expenses for items as a result of COVID-19 (e.g., extra cleaning, more PPE equipment, additional overtime due to shift size limitations, etc.)? If so, you should document and track these expenses.
- How does employee retention prior to COVID-19 compare to the current period? Are you incurring additional expenses to hire and retain employees?
Final thoughts
Many times, business owners will try to prepare claims and calculate financial losses themselves, but they often miss opportunities to maximize claim benefits. As a result, if you are planning to make a business income claim related to COVID-19 losses, you might consider hiring a forensic accountant with business interruption claim preparation experience in the manufacturing industry. It is a common mistake to wait until late in the process to hire a forensic accountant; however, we suggest that you engage experts as early as possible.
Tyler Wright, CPA/ABV/CFF, CFE, is a Director in the firm’s Consulting Practice. Drawing on 15 years of experience as an external auditor, internal auditor and forensic accountant, Tyler provides accounting and financial advice in forensic investigations and commercial disputes.
Jonathan Levens, CPA, is a Partner with Moore Colson’s Tax Services practice. Jonathan’s primary focus is on tax compliance and consulting services for private equity-owned as well as closely-held businesses and their owners in the manufacturing and distribution, retail, service, restaurant, healthcare, staffing and financial services industries.
