Canadian Underwriter

Recovering Costs

November 30, 2011   by Lorne Montgomery

Print this page Share

The policyholder was a manufacturer with several locations. Some locations had unutilized production capacity. There was an accidental fire in one production plant.

Repairs were completed by use of various outside contractors. The insured also used corporate resources to assist with the repairs, including various vehicles, inventory and equipment.

Special skilled hourly paid employees, such as electricians and technicians, were enlisted to work with contractors to repair important and complicated installations. The insured also used its salaried engineering staff to help coordinate damage assessments, reinstatement, engage and direct contractors, issue purchase orders (PO’s) and work orders (WO’s) and generally supervise the fire repair work. The controller and accounting staff organized incoming invoices to PO’s, made payments to contractors and submit invoices to the loss adjuster.


In addition to the invoiced expenses from outside contractors and suppliers, the policyholder claimed time and expenses for all of the labour utilized to complete repairs, including hourly and salaried personnel along with a component of plant overheads, plus costs for use of its equipment and the parts drawn from its own inventory.

The individual pieces of equipment were charged at a daily rate, comparable to rental rates from rental companies, plus the cost of fuel used. The stores inventory was charged at replacement cost.

The fire caused a partial interruption of production at that location. Operations generating revenue were immediately moved to other available plants with excess capacity and to the undamaged area of the plant. Excess inventory was used to continue sales and satisfy customer orders. Apart from some increased costs of working, no sales were lost over the course of the restoration.


The coverage under which the claim was made consists of an all risk property policy covering property of every description (POED) with time element business interruption and extra expense and containing typical policy terms and conditions.


As to the physical assets used in the restoration, the reasonable cost to the policyholder was recoverable from insurance, but that aspect of the claim is not the primary purpose of this discussion.

The issue was whether the policyholder was entitled to recover for use of its personnel and calculated overheads chargeable to the business.

The insured said that the cost of its hourly workers used to make emergency, temporary and permanent repairs would normally have been used to make production. Had the workers not been involved in the post fire restoration, and because they were unable to work in production, at least some of them would have otherwise been sent home and not paid. Therefore the cost of the hourly labour used in repair was a cost for which no production benefit was received.

The policyholder also said that the salaried engineering staff involved in the repair work had other work to do and their work was delayed, thus a portion of their salaries should be recovered from the insurance. The insured admitted there was no replacement engineering staff hired to continue the normal work, which was in progress prior to the fire. It was also reported that the salaried accounting staff, including the controller, put in a lot of time organizing information, paying contractor invoices and submitted the claim to the adjuster and, but for the fire, they had other work to do, but again, no substitutes were hired.

Further, in addition to the calculated rates for the labour, both hourly and salaried, payroll benefits were added, plus a rate for overheads. The insured explained that in the normal conduct of its business, those overheads are built in to the product pricing, and since the insurer had the benefit of this labour, they should pay that share of the overhead.

In determining the amount payable under the policy for repairs, there was no issue with the logged time of the hourly workers and it was agreed that had these workers not been added to the repair workforce they would have been temporarily laid off. Therefore, the adjustment reflected the cost of the labour plus the paid payroll benefits.  The adjustment excluded the addition of overheads to the labour but the insured protested.

Should the policyholder be entitled to collect the value of overheads from the policy?

Overheads (OH) are the fixed costs of the business which are allocated on a pro-rata basis to the cost of the labour force. (Fixed or non-variable costs = all those in-direct costs which continue regardless whether production is achieved.) For example, say the annual fixed or non-variable expenses of the business are $10 million, not including the labour expense. There is a labour force of 240 hourly and salaried men and women on a 40-hour work week, plus paid vacation.

The simple theoretical calculation used is based on the total paid hours over the course of the year in order to achieve the hourly OH value applicable to the various labour rates (indirect costs / direct costs – i.e payroll expense). See chart 1.

In the claim submitted, the policyholder calculated the real cost of the hourly labour, then added the OH rate to determine the total charge-out cost per hour for the use of the hourly employee. The same method was used for salaried employees that participated in one way or another to the restoration work.

Are overhead values recoverable for the hourly workers?

As a general rule any new cost incurred by the policyholder to reinstate or repair insured physical damages to insured property is claimable from the insurance. Even where overheads are included as a contribution to the value of labour for the purposes of valuing the insured’s products, they are still fixed costs and immediately recognizable as a time element or business interruption loss component. In simpler terms, in the event of a sales loss during the indemnity period, business interruption insurance covers the insured’s unavoidable or fixed costs, plus any lost profit.

In this case, there were no sales losses, so the revenue of the business that normally covered fixed costs and profit continued to be received. Therefore, overheads were not a new cost to the insured and had they been allowed in the claim they would have been recovered twice by the insured (once from the original sale of products and once from insurance).

If the policyholder did not have business interruption coverage, would overheads then be payable under the property damage feature of the policy? The answer is no. The insurer will not pay because the insured did not buy the time element coverage designed to cover such time element expenses, nor should they, because it would amount to free insurance. The regular hourly wage and payroll benefits used for the purposes of repair is all that is payable. Any overtime paid could be considered as an expediting expense and payable under the policy if such coverage was provided.

What of the salaried employees?  

The engineering staff made valuable contributions to enable a timely repair and, but for their efforts, the policyholder would have had to engage outside engineering consultants to do the same work. Clearly this would have increased the loss payable by the insurance. The insured said that had its staff not been tied up with the fire, they would have been working on their other projects, however it admitted no outsiders were engaged to take up those projects and also agreed the projects were delayed. Further, such projects could not be seen to have otherwise increased revenues.

Salaries are considered a fixed cost of the business and typically are taken into account in determining insurable business income losses. In order to obtain policy benefits to pay for salaried workers assigned to repa
ir the damage, the expense must be seen to be a new cost to the policyholder. It is presupposed salaried employees would have been paid whether they did or did not work on the restoration project, as if no loss event had occurred.

If there was no business interruption insurance, there could be another way to find a policy benefit for the value of salaried employees utilized for repairs. On extremely rare occasions the sales or revenue of the company might be reduced during the repair period because salaried workers were assigned to the repair project.

Sometimes highly specialized technical personnel are not immediately available elsewhere and such specialists assumed responsibility for repair. Their absence from production could impact the insured’s ability to make planned sales. Even if this turned out to be the case, the claim for the salaries could not exceed the contribution to salaries from the lost sales. In any event, however, the overheads attached to the cost of those salaries are not recoverable because the insured’s products were not being purchased by the insurer.

In the theoretical fire case the insured had purchased business interruption coverage but no sales losses resulted. Salaries and overheads are time element or business interruption issues and since the insured did not lose the revenue stream it ordinarily expected, the income was available to pay the fixed costs and no contribution to salaries is required by the insurer.

The all risk property insurance is intended to indemnify the policyholder for new costs resulting from an insured event and it is only reasonable that all available policyholder resources are utilized to reduce its loss. Using salaried employees for such purpose is expected as a means of loss mitigation and insurers expect the policyholder will do what it can to minimize the loss. Coverage only applies to any additional costs experienced in consequence of the fire, such as purpose-made travel expenses, meals, etc.

The argument that the normal work of the engineering and accounting staff was delayed does not have any value. During the loss investigation it was demonstrated the work these staffers were doing did not impact the revenue of the business in the short term (or even the long term). The delay of such work was ultimately of no particular consequence to the business, which was contingent on the overall productive activities of that plant(s). In effect, the fire put certain administrative activities in suspension until the staff could resume normal activities at a later date. This was the labour related adjustment. See chart 2.

Again, because the cost of the salaried labour paid by the insured business during the period of restoration was not new, it is not compensable under the policy. The insured warned that if they ever had another loss they would engage outside consultants for all the clean-up or repair work of its staff and charge it to the insurance claim. Fair enough, but it is an illogical argument because given the same circumstances the insured would still not collect any compensation for the idled salaried employees unless business interruption was insured and a sales loss resulted. The variance between claimed and adjusted was not a real loss to the policyholder.

Some manuscript policies are designed to include compensation for overheads when the policyholder uses its own labour resources to restore its property damage by an insured loss event. Such rates are usually defined and an additional premium paid. Typically such additional coverage is restricted to policies that do not include business income coverage.

Lorne Montgomery is an executive general adjuster international with Crawford Canada’s Global Technical Services.