A Sideways Look At Business Interruption

In my days as a Commercial Large Loss Adjuster, it was always more straightforward to estimate the size of loss for the physical damage, than the business interruption.  

The difference between the two is fundamental.  Physical damage can be seen, photographed, measured and priced- up by appropriate experts, so maybe the cost of replacing computer hardware, a CNC lathe or a building.  Whereas, calculating the financial losses arising from the resulting disruption to activities is altogether more subjective and based on projected financial performance.  

As a loss adjuster, I was of course obliged to arrive at an evidenced final figure using science rather than guesswork.  I had to source the data for analysis, and the business owner was asked to answer (or more accurately, try to answer) my questions for the first time under stressful conditions.  For example:

  • How is this going to affect your business in the coming weeks and months?
  • How quickly can you have production up and running?
  • What are your customers going to say and do?
  • How will your suppliers react, and crucially….
  • Can you give me figure for your anticipated loss of revenue and gross profit?

It struck me back then that if the owner of a business can’t accurately assess the impact and fallout after a real incident, how well qualified or able is he/she to defend it and prevent such loss?  Equally, and more specifically, how can a broker be sure of agreeing with them the correct level of Business Interruption cover?

Clearly, over-insuring is money down the drain for the insured, whilst under-insuring - potentially misinforming the underwriter as to what is at stake - could invalidate the claim or reduce the pay-out.

The broker’s challenge

Insurers and brokers have well-established risk surveys to evaluate physical and liability risk developed over many years. The issues are tangible and relatively straightforward to identify and record.  I believe the picture is less clear for Business Interruption.  In my view, limiting questions to turnover, products and services, lead times on critical equipment amounts to scratching the surface. The true dynamics of what can trigger losses in a business, composition of likely impact or maximum interruption period require an altogether deeper dive. 

The drivers of BI uncertainty seem to me to be technology, volatility and cultural change.  Business today is IT-dependent, fragile, complex and fast-moving with near-instant communication of any false move. The likelihood of a small incident becoming amplified into a significant event with financial impact on business has grown accordingly and seems indiscriminate.    The threats that drive this lie within and outside of businesses, although arguably the external threats are becoming the more significant and many lie beyond our direct control.

Given this situation, how can an insurance broker confidently evaluate a client’s business resilience and accurately advise on the scope and level of Business Interruption cover they need?  The pressure is ratcheted up by the Insurance Act which places new legally-binding responsibility on brokers to get it right. The Act also requires a wider range of disclosure and knowledge from the Insured’s team, which will possibly not be satisfied by the traditional approach and leave the potential for unpaid claims.   

An unlooked-for Ally

Business continuity planning (BCP) has always been a difficult sell to boards and executives, partly because no return on investment is assumed.  If catastrophe strikes, then the BCP has material payback, but if no disruption occurs, it seems like money down the drain.

The key to achieving buy-in to the BCP process by senior management has been to quantify the potential impacts on a business from a range of loss scenarios. This enables management to evaluate a range of risk-reducing measures and to create response plans. The upshot is that we now have a well-defined mechanism that can help us pin down BI cover.

The Business Continuity Process has the potential to deliver a detailed proposal form containing much of the BI information required by an insurance broker. I find that business owners are so immersed in the operational, that they can easily fail to acknowledge the changes they have initiated into their business. The BCP process provides a clear route map to gather key facts about the business and unearth the DNA of what makes it tick.

The magic ingredient is called Business Impact Analysis (BIA) and informs three vital BI components:

  • Maximum Indemnity Period is the time after an incident during which qualifying BI losses will be repaid by the insurer; in other words, the expected time to return to anticipated pre-loss levels of business performance. This can be revealed by the BIA as it examines the path to recovery from worst-case scenarios. It deals with actual recovery times and its format overcomes business owners’ natural tendency to underestimate. As I mentioned before, the management team rarely anticipated the full extent of financial impact following an incident, so they certainly struggle to “do the math” without the loss staring them in the face.
  • Business Insured is a statement of scope for BI cover and demands itemisation of all product and service lines across all business locations. These same detailed lists are output by another stage in the BIA, as we map key risk assets and transmission paths in the business.
  • Policy Extensions are adjustments to reflect an organisation’s unique loss profile and are clearly important if cover is to be fully effective. A third part of the BIA models the full extent of a client’s financial dependencies on external parties, such as customers, suppliers and utilities.  It allows us to pinpoint and quantify patterns that might otherwise go undetected.

Complementary medicine

Clearly, businesses are different and BI needs to fit accurately if insureds, brokers and insurers are all to enjoy full value.  I believe Business Continuity Planning provides a welcome but unexpected platform for achieving the necessary precision.  Its outcomes allow the business owner, possibly for the first time, to really grasp the inner workings of their business from a risk perspective.  It raises their awareness, empowers them to manage-out inherent risks, prepares them for loss scenarios and helps explain and justify the level of BI cover they need.

Business Impact Analysis can now be carried out relatively easily by specialists, often in just a few days, and yet it manages to offer true benefits to all concerned: 

  • The Insurer receives high-grade Business Interruption policy decision data. They are more confident that cover is adequate and that losses will be better managed
  • The Insurance Broker gains a more in-depth, independent view of the client’s business and risk profile, satisfying Insurance Act requirements
  • The Insured enjoys a far better understanding of the risks they face, of the value of business improvements and peace of mind that they have the correct cover. The Insurance Act imposes additional responsibilities on the Insured for disclosure of the relevant information about their business. The BCP process output can fulfil and meet those requirements.

The moral of all this is to look beyond convention when renewing BI policies.  By requiring organisations to adopt Business Continuity Planning, we not only encourage them to reduce post-interruption claims, we also help them specify the BI cover that will pay the claim, and go some way toward satisfying Insurance Act requirements.

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