Exposed and unprotected
06 september 2018
Many businesses are not aware of just how exposed and unprotected they are in relation to business interruption (bi) risk, says Caroline Woolley of risk and forensics. They may think they can turn to their insurance or stakeholder contracts for help. However, often traditional bi insurance policies offer only restricted cover for loss of business following damage to physical assets. The events faced and the causes of interruption have no such restrictions.
Stakeholder contracts, such as those with suppliers, are also not always as robust as you might expect. Liquidated damages are not usually payable if the event causing interruption is outside of the suppliers’ control…
Very few companies fit into the traditional image of a manufacturing firm for which most Business Interruption insurance policies were originally developed. For a start, manufacturing firms often generate more profitable income through services rather than manufacturing. Also, no company works alone; it is usually part of a complicated value chain from supplier to customer and everything in-between. It relies on a lot more than its own assets to operate successfully.
Insurance for repairing those assets is just the beginning, what about the loss of income?
Business interruption insurance covers the loss of income and increased costs involved in getting business back on track. It is therefore the Business interruption insurance which is the life line in any major loss. There is much improvement needed even to traditional business interruption insurance, and don’t forget the trigger is very narrow, usually damage to your own property only.
Does traditional business interruption insurance still meet the needs of modern businesses?
In short, no. We will always need insurance for damage to physical assets, as a major property damage event is often the worst loss scenario that many businesses face. But the insurance needs to cover losses from other events too, which can come from any event, anywhere in the chain.
Doesn’t my contract with suppliers cover me for any delay in the chain, through liquidated damages?
Some events will be covered, but the existence of a ‘force majeure’ clause means they don’t have to pay liquidated damages for listed events that are outside their control. Many of those events are also not covered by insurance either. A full understanding of the insurance and its interaction with key contracts, such as those with suppliers and customers, is required.
But does major loss only occur after a physical damage event?
Absolutely not. The events that can cause an interruption to business go way beyond damage to property. The potential worst loss scenario for some businesses is rapidly changing from property damage to a major cyber event. But it is not just the perceived ‘catastrophic’ events that businesses need cover for, as the ‘major loss’ definition depends on the size of the business, its cash-flow requirements, debt servicing arrangements, investors’ expectations and the sympathy and tolerance of customers…
Traditional Business Interruption insurance summary:
- Cover for loss of revenue, net income or gross profit and increased costs.
- Loss in consequence of damage (used to be referred to as ‘consequential loss’).
- The trigger is usually damage to owned physical assets only.
- Restricted/no cover for contingent business interruption (losses contingent upon events elsewhere) such as wide area damage affecting infrastructure and transportation or supply chain risk.
- Limited/no cover for intangible assets and non-damage events.
The evolution of Business interruption insurance
With the increasing exposure to global risks and a broader spectrum of risk, such as supply chain, infrastructure, service providers and transportation, the development of Business Interruption insurance needs to reach beyond physical damage to assets. Traditional business interruption policies don’t offer sufficient protection; businesses and projects remain exposed and unprotected, with potential for significant impact on shareholder value…
What events can interrupt a business, with loss of income/value without direct damage?
- Natural catastrophes (Earthquakes, tsunami’s, floods and storms causing wide area damage affecting the value chain and infrastructure upon which the business relies but does not own.)
- Extreme weather (UK storms and freezing temperatures resulted in road and business closures and the potential for forced gas restrictions on businesses. Power was restricted in Belgium under similar circumstances).
- Environmental issues (global warming and subsequent Governmental controls, scarce resources, weather patterns).
- Major events (Terrorist attacks, political related incidents such as the attack in Salisbury, shootings, political unrest, fraud, product recalls or explosions such as the Tianjin Port Explosion).
- Infectious disease (localised contamination or pandemics such as Ebola, Zika or SARS, or terrorist related attacks).
- Insolvency in the value chain (for example Hanjin shipping affecting transported goods or Carillion that caused knock-on problems for customers and suppliers).
- Cyber-attacks or failures (affecting own networks or those of suppliers, customers and service providers such as online banking issues or a power grid incident as experienced in the Ukraine).
- Terrorism threat (little or no damage, but wider spread disruption still occurs for example in Brussels, where the whole city was locked down after the airport incident).
We therefore have an opportunity to develop insurance solutions to meet these varying needs; cover these diverse risks; and help businesses survive any major loss. Many Insurers already offer some cover for these risks. A separate new policy for each different event does not seem to be the answer, as we’d end up with hundreds of them. If a single broad policy is more attractive, the main stakeholders need to be ready to commit to this development before progress can be made, that means Insurers and insureds.
For Insurers the development options and choices are vast but can be summarised into Cause and Effect.
Cause– Which risks to cover from the broad spectrum, including non-damage events and contingent risk. The aim should be to provide cover that goes beyond the basics of damage to physical assets.
Effect- Loss of income and/or increased cost with decisions to be made on insurance capacity and limits to be offered, level of loss to be retained by the insured and appetite of both insured and Insurer.
An insured needs to go through a basic process of understanding before making any decisions on risk transfer, otherwise the question ‘is this insurance value for money?’ can never to answered. This includes how the business makes money, quantification of exposures using actual/expected losses (medium, large or catastrophic) and the risks it faces directly and indirectly, itself and from the industry/community in which it operates.
All of us in the industry need to work to establish the risks and test the water, collect data (maybe through a captive), consider options, identify underwriting requirements, and develop suitable wording. But the price has to be right too, enabling the normal forces of supply and demand to operate. The price has to be high enough to fairly represent the increased risk being accepted by Insurers, and the uncertainty around this topic (there is limited claims data available on which analysis can be based). But also, competitive enough for insureds to actually take the next step, the step towards feeling more in control, being less exposed and having more complete protection…
