When faced with a business income loss claim, the most frequently asked question is “which documents are required?”
Most standard business income loss policies afford an element of coverage for the “likely” net income of the business during the period of restoration. What separates likely from unlikely is the quality of the documentation supporting the determination of the net income amount. All businesses prepare and maintain some level of financial/accounting documents. The range of documents prepared by businesses depends on such characteristics as the size and complexity of the business, the nature of the business, the regulatory environment and the level of financial sophistication of the owners/managers.
There are literally scores of different accounting documents. To understand documents from a practical standpoint, I have designed a category system. Thus, the multitude of business documents can fit into one of the following categories:
Compliance documents are those that the business is required to prepare. The requirement to prepare such documents is set forth by federal government agencies, state and local governments, and business partners such as a banks, franchisors or customers.
Informational documents are usually generated for internal use, meaning use by the owners/managers of the business. Since there is not a requirement to prepare such documents, information documents are subject to the record keeping practices of a given business.
Corroborating documents are those that serve to substantiate records, reports or transactions of the business. Corroborating documents are prepared by, or involve third parties.
The categories provide a way of grouping documents, and allow us to think about documents in a systematic manner. Now that we have a platform for understanding documents, we can apply that knowledge to claims with the following general rules:
1. Always obtain compliance documents.
The necessity of compliance documents is twofold. First, the business is required to prepare the documents, so they should be relatively easy to obtain. Next, compliance documents tend to have a high degree of accuracy. Since compliance documents are routinely prepared, and since these documents are often reviewed by others (IRS, CPA, bank), the probability for a material error is greatly reduced.
2. Obtain informational documents to the extent the business has them and to the extent that they will assist with the evaluation.
Informational documents are useful in a loss determination, but they are not always required. Moreover, some businesses may not have informational documents.
3. Obtain corroborating documentation when the records of the business are incomplete or believed to be inaccurate.
Corroborating documents can be difficult to obtain, as well as time consuming to evaluate. Therefore, corroborating documents are limited to those occasions when other business records need substantiation. Also, corroborating documents may be used when a business has no compliance or informational documents.
4. Consider the nature of the business.
It is important to understand the nature of the insured’s business in order to know the best information to request. If the insured’s operations are complex in nature, then it is likely that a more in-depth analysis will be required. As such, the amount of information requested should increase in order to assist with the analysis.
The nature of the insured’s business dictates the type of document that should be requested. For instance, if the business is a manufacturing company or medical practice, then production reports should be requested. Also, rent rolls should be requested for apartment complexes. In either case, it would be inappropriate to ask for a sales report. Asking for the wrong type of document can confuse the insured, and cause them to doubt that one understands the nature of the business.
5. Consider the length of the restoration period.
The length of the restoration period often dictates the amount of information requested. The longer the period of restoration, the more information should be requested to evaluate the operating history of the business and project the results of operations for a longer period of time. Because more expenses discontinue over a longer period, more documentation is required to perform an expense analysis.