Business interruption claims: Employee compensation by tips and gratuities

January 21, 2015 by John Hutson Leave a Comment

Coverage for continuing ordinary payroll is something that is an option for many businesses to purchase when they have a business interruption policy. In general, the coverage allows the business owner to continue to pay normal wages to employees during the time the business is closed. The rationale is that it would be difficult for the business to quickly recover, once physical repairs are complete, without having trained and experienced staff on hand to reopen the business. In short, the length and severity of the loss is mitigated.

This works great for employers who fully pay for 100% of their employees, but what happens to those in industries where gratuities make up a significant portion of the employee’s pay? If the business pays the employees for the lost gratuities, in addition to their hourly wages, should the gratuities be recoverable?

The insurance carriers I’ve encountered emphatically answer the above question with a resounding “NO!” Their position is that it is perfectly fine to pay the wages and recover them under the ordinary payroll coverage but not gratuities. Their reasoning is the gratuities are not an expense that is ordinarily paid by the business. The gratuities are paid directly by the customer, to the employee, and the business is under no obligation to guarantee, or pay, any monies related to the gratuities.

I understand their reasoning but view it slightly differently. As a layman, I am not an expert on insurance/contract law. However, I do know when something makes sense or not and this position does not. The idea behind ordinary payroll coverage is to retain valuable employees. If they are only being paid a portion of their income, during the business closure, it is quite conceivable that the employee will seek other employment and not be available. The company will then incur additional expenses to recruit, hire, and train new employees who will most likely be less efficient than the experienced employees for a period of time.

I believe a reasonable consideration is for the gratuities paid by the company to be viewed as an extra expense or an expense to reduce loss. By paying the gratuity portion, the insured is paying an extra expense related to the employees. Having these employees available when repairs are complete will reduce the loss by allowing the company to quickly return to normal operations and prevent the charges related to new employees.

This is not a position that is always accepted by the insurance company but, many forward thinking insurers, are open to the suggestion. The option can save time and money for all parties involved.

We’re not your typical bean counters. We know how to calculate economic damages for business interruption insurance claims and litigations with off-the-charts winning results for our clients. We’d love to help you. Please get in touch.

Values at risk series: Make sure you’re covered when it comes to professional fees

November 11, 2014 by John Hutson Leave a Comment

The very first question I’m usually asked by a potential client regarding their business interruption claim is, “Are your fees covered?” The answer to this question is “maybe.”

First, I look at the policy to see if there is an endorsement for professional fees or loss adjustment expenses. Second, I make sure there are no exclusions that would exempt my services. Third, I look for the words that say these fees are only covered if they are incurred at the insurer’s request. Finally, I have the insured sign the service agreement and forward a copy to the adjuster for approval before starting work. This ensures that there are no surprises for the client, the adjuster, or me.

The follow up question is, “Will you guarantee that your professional fees won’t exceed the policy limit?” The answer to this question is “no.”

Unfortunately, the amount of expert work that needs to be done to fully document, support, calculate, present, and defend a loss valuation is not dictated by the amount of coverage for these services. It is dictated by the documentation available, the complexity of the loss, and the issues that arise during the settlement process. Additionally, I may not be the only expert involved in the claim process. There may be a need for engineers, arborists, economists, industry experts, and various other experts. These expenses are often necessary to ensure the best possible settlement and can get expensive fairly quickly. Insured’s should discuss their potential needs with their broker and work with them to place appropriate professional fee coverage limits.

What To Do When Fees Exceed Professional Fee Coverage Limits?

On a final note, I think it is a mistake to make a decision whether or not to hire an expert based upon whether or not there is enough fee coverage to make the services “free” to the insured. Here’s a story to illustrate the point: I recently finished a file where the insured had to pay over $125,000 in professional fees, when they only had $25,000 in professional fee coverage. At the beginning of the project, the client was in a real dilemma, because they knew that the project would exceed their professional fee coverage of $25,000. Should they move forward and hire their own experts, or simply rely on the experts provided by the insurance company? You be the judge. The insurance company’s experts valued the business interruption / extra expense loss at $0 for almost two years. After incurring the $125,000 in expert fees, the claim was finally resolved for slightly over $2,000,000.

When calculating a business interruption loss for the hospitality industry, lost revenue doesn’t always mean saved expenses

October 23, 2014 by John Hutson Leave a Comment

When calculating a business interruption or lost business income loss for a hotel or resort, it is very common to 1) calculate projected revenue 2) deduct actual revenue from projected revenue to calculate lost revenue and 3) deduct any saved (non-continuing) expenses to arrive at the loss amount. Please notice that it is saved expenses and not variable expenses.

The distinction between “saved” and “variable”expenses is especially significant to hotel and resort operations. In the wake of the BP oil spill, many hotels and resorts submitted claims related to lost room revenue. Some of the losses related to empty rooms. These losses will, of course, have associated saved expenses such as hourly housekeeping, room supplies, water, and electricity. However, the second type of room revenue loss is related to a decrease in room rates. In this case, there is no savings of the above items. The rooms are still occupied and the same expenses are incurred. The only thing that changes is the level of revenue and profitability. Applying saved expenses to these revenue losses would understate the loss to the resort. In this situation, perhaps a better application of these expenses would relate to occupancy. While these expenses are variable, they would most likely have a better correlation with occupancy rather than revenue.

For simplicity, let’s assume that a hotel has only two rooms and that each room usually rents for $100 per night. Let’s also assume that a normal operating expense is a housekeeper who makes $10/hour and that it takes an hour to clean each room. Therefore, under normal conditions, housekeeping is 10% of revenue. We will further assume that normally our rooms would be 100% occupied but because of an unanticipated disaster, which negatively affected tourist travel, one of the rooms is unoccupied and one is rented at a 50% discount. Instead of $200 in revenue for the night, the total revenue was $50 and therefore lost revenue is $150. Well, of course the hotel owner must account for saved housekeeping. The $150 in lost revenue less 10% ($15) means the hotel should recover $135 for the loss right? Not in this case.

Revenue does not drive housekeeping expense. Room occupancy drives housekeeping expense. One room was unoccupied and therefore did not need to be cleaned resulting in a savings of $10. The second room was still occupied and had to be cleaned. There is is no $5 savings in housekeeping due to a decrease in revenue. The actual amount to be paid is $140 and not $135.

This example is oversimplified in order to illustrate a point. When this issue is applied to hundreds of rooms, for several months, and dozens of related expenses, the numbers can be significant. In a large hotel or resort claim, understanding what drives expenses can mean the difference of thousands upon thousands of dollars.

John Hutson is fiercely committed to guiding clients through the process of quantifying a business interruption for litigation or an insurance claim. Please feel welcome to contact John to discuss your project.