By Adam Maclennan
November 28, 2012

The first priority during and after a catastrophic event will always be to ensure the safety of customers and staff members. However, once the human situation is secure owners and asset managers should quickly become very familiar with their insurance policies, as they concentrate on rebuilding facilities and services and getting “back to business”.

Catastrophic events such as Hurricane Katrina, the Deepwater Horizon disaster, or the most recent super storm Sandy, can create significant disruption to the operation of a hotel. In some cases damages to the physical property will prevent owners from operating their businesses altogether until repairs have been carried out. In others, the hotel might remain intact but damage to the market might reduce the ability of a property to generate revenue, or could increase the costs of doing business resulting in a loss of profits.

PKF Consulting USA, LLC (PKFC), and PKF Hospitality Research, LLC (PKF-HR) have over the years been involved as expert witnesses in several business interruption claims evolving from natural and man-made disasters. While insurance policies vary from hotel to hotel and the circumstances resulting in lost profits can also be unique, it is important to take a systematic and objective approach as you prepare to make decisions that could impact the long term success of your business.

Gather Your Historical Data
What is frequently overlooked in the immediate turmoil is the need to secure important data and documents. This information is especially vital for those owners that wish to recover lost business income from their insurance company. While the actual filing of claims and negotiations may not occur until a year or two after the horrific event, several pieces of data and documents need to be gathered in the short-term to achieve a favorable settlement later on.

After working with our clients to recoup business interruption benefits from their insurance companies, we have found certain data and documents to be extremely useful in our calculations of lost revenues and profits. The following is a partial list of reports (effective the day of the catastrophic event) that should be gathered and preserved by management.

• Five-year history of competitive position reports (i.e. STR report), including current year-to-date.
• Five-year history of annual financial statements, including current year-to-date.
• Budgeted performance for the remainder of the current year.
• Budgeted performance for the upcoming year.
• Marketing plan for the current year.
• Marketing plan for the upcoming year.
• Capital improvement plan – current and future years.
• Guaranteed reservations and advance deposit activity.
• Group contracts.
• Group booking pace for the next 10 years

The Lost Business Calculation
Once the historical performance data is gathered from the documents listed above, the next step is to estimate how the hotel would have performed if the catastrophic event had not occurred. To prepare this forecast, we use budget, marketing plan, reservation, and group booking information contained in the secured documents.

Previous research conducted by PKF-HR found that 75 to 80 percent of a property’s performance can be explained through movements in the larger market in which it operates. The remaining 20 to 25 percent of hotel performance can be attributed to the actions of management.

Therefore, when available, we also rely on the most recent lodging forecast developed prior to the catastrophic event for the metropolitan area in which the subject property operates. Since the metro forecast was developed prior to the catastrophic event, it can be viewed as the prevailing outlook for future market conditions as of the day of the event. The metro area forecast serves as a baseline for supply, demand, and revenue conditions within the overall market during the period to be analyzed for lost business.

Using the secured data for the subject property, it is possible to clearly and persuasively demonstrate how an insured hotel performed historically in relation to the larger overall market. Since it can be reasonably assumed, absent the catastrophic event, that these historical relationships would have held true in the future, we then apply the historical penetration rates of the subject property to the metro area forecast. This provides us with estimates of the potential rooms revenue the subject property would have earned had the catastrophic event not occurred.

From these estimates of rooms revenue, we then prepare projections of net income using historical financial statements from the subject property, as well as data from our firm’s Trends® in the Hotel Industry database.

The calculation of lost business is derived from the difference between the performance of the subject property estimated under the “no catastrophic event” scenario, and the data from the actual performance of the hotel during the period analyzed. Estimates can be made for lost room nights, revenue, and net income.

Objectivity Is Key
A key to the lost business calculation is the ability to provide an objective estimate of market performance under the “no catastrophic event” scenario. PKF-HR prepares econometric forecasts of hotel supply, demand, occupancy, ADR, and RevPAR for 50 major markets across the nation. The forecast reports are entitled Hotel Horizons®. Each Hotel Horizons® report contains forecast performance data for both upper-priced and lower-priced hotels in a given market. The forecasts are made for a five-year period, and are updated every three months. The Hotel Horizons® econometric model is based on data from Moody’s Analytics, Smith Travel Research, and PKF-HR. Hotel Horizons ® has been widely adopted by industry participants as an unbiased, objective and scientific approach to estimating the future performance of the major US hotel markets covered.

Details are Important – A Case Study
The details of an insurance policy are important when deciding whether to stay open or to close following an insurable event. Each policy is different, but when a catastrophic event affects an entire market, it could have a longer term impact on profitability that is not adequately covered by your insurance policy.
 
In a recent case that occurred in New Orleans following Hurricane Katrina, a certain luxury hotel, although partially damaged, was able to re-open relatively quickly with some rooms, and progressively open up more and more inventory to the public. While the hotel may have been operational, the market for luxury rooms in New Orleans had deteriorated significantly; the business interruption insurance held by the owners had a relatively low maximum payout for damage to the market.

The owners made the decision to re-open the hotel quickly to mitigate their losses, but were operating against headwinds: the guest profile had changed, and the average daily rate and food and beverage revenues that the hotel was able to achieve were meaningfully lower than before the disaster. The insurance company successfully argued that the market for luxury hotels was damaged and agreed to pay out the maximum allowable payment on that clause. The business interruption caused by damage to the hotel was limited because the hotel had shown that they could still accept guests and that those guests were paying market prices for their rooms. Had the hotel closed its doors, to make full repairs to the damaged floors and reopened only once the repairs were complete, it is very possible that their insurance payment would have been significantly higher.

Conclusion
While each case is different, objective data driven analysis should play a key role in the decision making process related to business interruption claims. PKFC and PKF-HR have provided these services and advice to our clients for over 80 years, enabling them to make better financial decisions, as well as to determine the best course of action following a catastrophic event.

Receiving your business interruption insurance benefits never fully alleviates the emotional damage and pain caused by a catastrophic event. However, the funds do go a long way to help preserve “the business.”

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Adam Maclennan is an Associate in the Atlanta office of PKFC (www.pkfc.com). For more assistance with the calculation of business interruption losses, please contact Adam at [email protected] or (404) 809-3940.