Published On:Friday, July 23, 2010

WHILE the role of loss adjusters and the potential benefit of using them in claims handling is likely to be extremely familiar to readers, there tends to be greater ambiguity and confusion on the need to involve forensic accountants during the claims process.

Mention forensic accountancy to someone in the insurance industry, and consequential losses will probably be the most obvious area that comes to mind. However, there is a wide range of claims where the skills of a forensic accountant may assist in the quantification of losses and, on occasions, establish whether there has been fraud or other wrongdoing.

Put simply, forensic accountants are likely to be able to assist in any claim requiring either quantification or accounting judgment. There isn't a minimum quantification level at which accountants should be involved; indeed, there may be a very low value claim where accounting issues are central, although typically they will be involved in larger or more complex matters. Broadly speaking, the areas where accountancy expertise can assist can be divided into three groups:

USE SCAN

So, who normally looks to forensic accountants to provide assistance in the claims process?

Generally, instructions for insurance claims will come from either the insurance company, the client and, less frequently, the broker. Instructions can also be received from others, such as firms of attorneys (particularly where a claim has gone to litigation) or government agencies. In the diagram below, the central, overlapping area represents the key elements of a claim which are of utmost importance to the insurer, the client and the broker. These elements are likely to include issues such as the size of the claim, where accounting assistance will be sought by one or more of the parties.

USE SECOND SCAN

However, any experienced, commercially-minded, independent accountant is likely to provide support and assistance to all parties in the process, regardless of who instructs him/her, with a view to helping achieve a fair settlement of loss through responsible quantification and commentary.

In terms of timing, accountants can be instructed at any stage of the process, although this will differ significantly between the types of claims. In a business interruption claim, accountants will typically be brought in at the early stages to help minimise the extent of losses. For a personal injury claim, or particularly a professional negligence claim, accountants may not be instructed until several years after the event.

What do forensic accountants do?

The nature of forensic accounting is such that no two assignments will ever be the same, with each claim presenting a unique combination of factors including industry, client size, event and consequence.

However, the most common area where forensic accountants assist in the claims handling process is through quantifying the losses which have occurred to a business (which might be a company, a self-employed individual or a partnership) from a particular event, such as a fire, flood, accident, machine failure or other cause.

In many cases, it will be a claim for loss of profits or earnings, which will require analysis of sales, gross profit and overheads both before and after the event. However, accountants can also assist in identifying the value of assets, such as damaged stock.

Forensic accountants will typically calculate losses based on a detailed analysis of both historic performance and future projections. However, the way a business has performed in the past is often not an accurate prediction of the likely future trend, and projections may be overly optimistic or based on unrealistic assumptions.

Using their commercial and financial experience, forensic accountants will therefore consider what factors, other than the event leading to the claim, may have affected the company's performance. Such factors could include the impact of any changes in the customer or supplier base, the actions of competitors - including their pricing - the way in which the business is financed or the local and wider economic environment.

Forensic accountants should seek to identify the key issues that are central to the quantum at an early stage, then concentrate on those in order to ensure focus and cost efficiency.

When it comes to reporting back, findings should be presented in a non-technical and easily comprehensible format, with a clear summary of the main issues affecting the claim value. If prepared on this basis and without undue bias, the forensic accountant's findings should assist in resolving the claims as rapidly as possible, regardless of which party instructed them.

Beyond loss quantification, forensic accountants can also be instructed to consider liability issues in insurance claims, commenting on the possibility that a fraudulent claim has been made by an entity, or providing expert commentary on whether an accountant or auditor may have acted negligently in a professional indemnity claim.

Below are further details of how accountants can assist in personal injury and business interruption claims:

Business Interruption (BI)

A BI claim is effectively the claim for lost revenues or profits that a business suffers as a result of an incident. In BI claims, forensic accountants are generally instructed by insurers early on, as they can then work with the loss adjusters to help quantify and minimise losses. If appointed at a later stage, this can be because the parties have reached a negotiation impasse, or if one party feels a review of the claim made would be beneficial.

Take, for example, a situation where forensic accountants have been appointed by insurers following a fire at commercial premises. Significant damage has been caused to the building, plant, equipment and stock such that servicing of customers is likely to be disrupted for a few months.

Upon being instructed, the forensic accountant's aim would be to gather as much information about the business as possible, and to try and assess the disruptive impact of the fire. This would include a review of the insured's trading position and financial stability prior to the fire to identify any concerns regarding moral hazard.

Immediately after instruction, the forensic accountant would seek to build a picture of the business using all publicly available information, including that on the company's website and any publicly filed accounts.

Typically, the forensic accountant would attend the initial meetings with the insured and the loss adjusters. It is common for additional financial and business information to be requested at this point. This includes monthly management accounts (often for two years prior to the incident), annual accounts, budgets or forecasts, and any other material that may prove useful to assess and quantify the claim.

Loss adjusters and forensic accountants then work together in supporting the insured with steps to recover the business and quantify the claim. This can include regular meetings when progress to-date and future mitigation options are discussed and assessed. At this point, loss adjusters and accountants can report back to insurers the interim losses calculated, enabling interim payments to be made to the insured.

Regardless of whether the insured's formal claim is made on an ongoing basis or at the end of the disruption period, the forensic accountant will be involved in assessing areas of the claim and supporting the loss adjuster with analysis and commentary on the level of considered loss.

Loss settlements are often achieved after negotiation of various claim areas. They rely heavily on the underlying accounting evidence, including historic turnover and profitability trends, rates of gross profit and the applicability of forecasts and budgets. Forensic accounting expertise is also required to consider the level of increased costs incurred in mitigation initiatives, and to quantify any overhead cost savings that may have been achieved due to the lower operational activity levels.

All aspects of forensic accounting work must take account of changes in the business or its environment. For example, new product development and marketing prior to an incident may suggest an increase in sales, whereas closure of a manufacturing centre or process may suggest a sales reduction or a change in operational approach if production is outsourced or reorganised.

More than anything, it is essential to provide clear analysis and commentary that is unbiased and reasonable, thus ensuring negotiations are efficient and productive, and costs minimised.

Personal Injury

Forensic accounting support is generally only required in a minority of personal injury and dependency claims, where there are particularly high value losses or complex issues.

Forensic accountants can be of assistance where complex calculations need to be undertaken, such as in loss of pension claims. However, most accounting expertise will be required in loss of earnings calculations where an individual was self-employed, meaning their past earnings are likely to have been more variable. Future earnings are therefore harder to estimate than those of an employee.

For example, let's imagine that Mr X, who is self-employed, was involved in a motor accident and is claiming he wasn't able to work at all for two years following the accident. He then was only able to work part-time from that point onwards.

It's possible that Mr X will have instructed his own accountant to prepare a report quantifying his losses. From experience, where that occurs, it's often the case that, as well as being highly subjective, the accountant's report may also have been prepared by someone unfamiliar with personal injury claims. It may make basic mistakes such as not considering all deductibles, or failing to apply a multiplier to future losses.

So a forensic accountant may be instructed by the insurance company, or possibly the broker, to quantify a more accurate loss of earnings by Mr X.

Initially, the forensic accountant will set out the information and documents required to undertake the analysis. As well as financial documentation such as accounts, projections and invoices, it is likely reports that might have been prepared by other experts, such as employment reports or medical reports commenting on the likely impact of the injuries, will be used.

Once this information is received, it is analysed and the forensic accountant tries to estimate what Mr X's earnings would have been if it hadn't been for the accident. Historic trends are likely to be the best guide of future performance. However, it often happens that Mr X will claim he had taken certain decisions that would have led to future earnings being higher than those historically achieved. The forensic accountant will need to consider these claims in light of the available documentation.

It may also be necessary for the forensic accountant to address claims by Mr X that not all earnings had historically been recorded in the books and records. The forensic accountant will also need to consider any evidence of actual earnings by Mr X since the accident.

A detailed report is prepared, setting out the work undertaken, the documents examined, the main assumptions and the calculation of loss. Where there is uncertainty, it may be appropriate to assume a range of calculations, based on different assumptions being used.

The report, prepared without bias and based upon the documents provided, would hopefully be accepted, at least in part, by both parties and therefore assist in settling the claim in a timely manner.

Summary

Forensic accountants provide expertise and useful assistance in the claims handling process. However, in order for their work to be of real benefit to the parties, they need to demonstrate impartiality and independence.

John S. Bain has provided reports to assist loss computations for various professionals, including the top four law firms in the Bahamas. While we are not advocates for any party, we will use our scientific expertise to produce factual reports based on proven formulas.

NB: John S. Bain is a chartered forensic accountant with offices on Shirley Street. He may be contacted at 242-322-6656 or at john@johnsbain.com.