Business Interruption (BI) Insurance Time to Reassess

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1 Business Interruption (BI) Insurance Time to Reassess Over 90% of businesses that did not have business interruption insurance failed within two years Barry Woods, Commercial Underwriting Manager, QBE Insurance Ireland, outlines the risks for business of inadequate business interruption insurance Many businesses do not believe that a loss will ever happen to them. The reality is that business losses occur every day. When you consider the investment most business owners make in their business both in terms of capital and time, all of that can be undone in an instant if appropriate Business Interruption (BI) insurance is not in place. Is one of those business owners one of your clients? Will they be next? While this may sound somewhat trite, from my own experience of reviewing risk submissions, it is all too common for businesses to be potentially ruined by an event that was simply never considered a possibility by them in advance. It has been estimated that over 90% of businesses that did not have any business interruption insurance failed within two years. Some were closed as quickly as two weeks after a physical loss at their premises. Very few businesses can afford the direct loss of earnings that invariably accompany a physical loss to premises, stock or equipment. Whilst a business may be able to survive a few days or perhaps a week, in the long term, the survival prospects of any business without business interruption insurance surviving diminish rapidly in these circumstances. To assess the scale of business interruption insurance required each business owner needs to be able to answer four basic questions. 1 Location Is there an alternative premises required to continue in operation? 2 Machinery Is it possible to replace or lease damaged or inaccessible machinery? 3 Raw Materials Can the necessary materials to carry out the business be sourced efficiently? 4 Customers/Market Share Will the business be able to regain customers or market share sufficiently post a breach or loss?

2 Despite the risk of business failure in the event that business interruption insurance is not in place, many companies and businesses seem prepared to take this risk or are, at best, underinsured. We all know and accept that there is much more to protecting the investment of a business than simply insuring the physical assets of the business. Business owners, shareholders, and those that have provided finance expect their investment to be protected. This includes safeguarding the income stream expected to cover such things as financing costs, routine operating costs and generating an appropriate level of net profit for the business. Without adequate business interruption cover, the business is at risk in the event of a loss, something which could be avoided and which those who have invested in the business will expect to be protected. Even when business interruption insurance is in place, our experience suggests that many policyholders do not fully understand it. They often view it as a complex, technical financial exercise, whereas, in reality, it is a relatively modest product offering from a technical perspective. In simple terms, business interruption insurance exists to protect net profit and the on-going expenses of the business after a physical loss which is indemnified under the Physical Damage (PD) policy. On-going expenses can extend to include payroll, management and other items such as staff bonuses and financing costs. All of these are regarded as insurable Gross Income or Gross Profit (depending on the policy) but whatever it is called, these expenses should be fully insured. Exploring the myth The Cover The business interruption policy is designed to put the business back in the same financial position it would have enjoyed before the loss arose. The formula for deciding the level of business interruption cover needed has generally stood the test of time. Despite minor iterations, it is broadly calculated using the turnover of the business less variable charges. The Period Cover starts from the date of the loss and extends to when the business's turnover and profit levels are back to where they would have been but for the physical loss. However, there is a cap set on this known as the Indemnity Period. The Indemnity Period should reflect the maximum period which the business will take to recover to its pre-loss position. This factor should be very carefully explored with the policyholder as, for example, if the period chosen is too short for the business to recover, the business interruption policy will not provide protection for costs or expenses beyond 2

3 the selected indemnity period. Delays in the planning or re-building process can sometimes be significantly underestimated. Even when the premises is re-built, machinery will need to be (re)installed. The greatest risk during this period is that customers will seek out other suppliers and establish long-term relationships with them. The Triggers The trigger for a claim is generally physical damage to insured property caused by an insured peril. The most common would obviously be fire or storm damage. Cover, however, can be extended to cover disruption to the business from a number of sources or events upon which the business is dependent. These can include damage to public utilities, damage or access to customers and suppliers premises, denial/prevention of access to the business premises, closure by a public authority, even a fatality at the premises. The extent of cover can vary greatly in this regard so some care needs to be applied to ensure cover is appropriate to the business needs. The Sums Insured When selecting sums to be insured or in the settlement of a loss, the past performance of the business is a central area for review. The historic turnover and insured gross profit will be analysed and any fluctuations arising from special events or circumstances will need to be fully considered and understood. The purpose is to determine the normal trend of business (turnover and net profit). This or any shortfall in turnover and the knock-on effect on net profit form the basis of policy indemnity. Additions and subtractions can be made to the shortfall to take account of any expenses or savings the business is likely to meet. Importantly, this will not normally include any additional costs that have been incurred in running the business during the period of disruption. The Extensions The standard BI policy may include all or most of the following extensions to cover; Public Utilities Coverage indemnifies the policyholder against loss or damage at the premises of electricity generating stations, transmission networks, gas suppliers, water purification plants, pumping stations and pipelines of an authority, required by statute, to supply water, gas or electricity for public consumption, all of which results in an interruption at the premises of the policyholder. Public 3

4 Utilities coverage may often exclude damage directly or indirectly caused by drought, pollution of water, shortage of fuel or water, faults at the premises of the policyholder, or the exercise of an authority empowered by law to withhold or restrict supply of such utilities unless such withholding is directly attributable to damage at their property and not that of the policyholder. Suppliers/Customers Coverage indemnifies the policyholder for supplementary modest cover for business interruption caused by property damage at suppliers or customer s premises. In these modern times, the risk of dependency on external sources has increased significantly, as many links in the supply chain are directly or indirectly connected to the global economy. Over the past two years, high profile catastrophes and large loss events such as the Tsunami in Japan, Flooding in Thailand and, more recently, Superstorm Sandy in the United States, have presented challenges for those dealing with specific business insurance claims involving retail and logistical customers. Closer to home, in the UK or Ireland, the rapid development of business largely characterised by global supply chains and dependence on third party outsourcing, has left today s virtual companies challenging insurers to protect this supply chain. Businesses have become experts in supply chain management, regardless of the product they produce or supply. On this aspect alone we, as an industry, need to grasp the changing face of modern business and the embedded complex supply chains, which are almost unrecognisable from even ten years ago. The question then arises do we fully understand the client s business proposition and is the business insurance policy they hold fit for purpose? Denial of Access Coverage indemnifies the policyholder against being prevented or hindered from entering their premises to conduct business due to damage to their own property or that of another party. A distance limit from the policyholder s premises is usually imposed in respect of third party premises. Public Telecommunications Coverage indemnifies the policyholder against interruption or interference with their business as a result of the failure of public telecommunications facilities at the premises of the suppliers. 4

5 Other Other exclusions might include some or all of the following: Bomb (hoax or actual), Terrorist Activity, Murder, Suicide or Rape at the Premises. Each will indemnify the policyholder against interruption or interference with the business as a result of the premises being evacuated or closed by any of these circumstances. Conclusion Despite having purchased business insurance cover, if the level of cover is inadequate then the chance of the business surviving a significant interruption is very slim. It also raises an issue within the insurance industry as a whole, because if premiums are based on inadequate sums insured, then insurers are clearly receiving inadequate premiums across their portfolios. The current situation in which insurance buyers find themselves is a vicious circle where financial constraints leave businesses with little choice but to reduce cover, despite the potentially crippling cost of future exposure. During a recession, it is understandable that business interruption values or sums insured may be reduced as profits are squeezed, but business interruption cover must not be reduced to the extent that businesses are left exposed to significant losses for what may well be only marginal premium savings. Businesses are often overly optimistic in assuming they won t suffer large-scale losses. They believe their business is highly resilient and customer and supplier loyalty will ensure a swift return to the marketplace. There is now an opportunity for insurers and brokers to bring real benefit in a particularly price sensitive market, showing a real understanding and appreciation of the business needs and delivering a product which is entirely appropriate and structured for the specific needs of the policyholder. //Ends 5

6 QBE Ireland Riverside Two Sir John Rogerson s Quay Dublin 2 tel +353 (0) fax +353 (0) QBE European Ireland is Operations a branch and is a trading name of of QBE QBE Insurance (Europe) (Europe) Limited Limited and QBE ('QIEL') Underwriting and a trading Limited, name both of which QBE Underwriting are authorised Limited by the ('QUL') Prudential and Regulation QBE Underwriting Authority and Services regulated (Ireland) by the Limited Financial ('QUSIL'). Conduct Authority QIEL and and QUL the are Prudential authorised Regulation by the Authority. Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority.