The insurance industry recognised the basic principles and practices of business continuity long before the term was coined. ‘Loss of profits’, as an insurable risk, was first implemented in 1797.
Business interruption insurance (BI) requires concentrated attention because it cannot be altered after a disaster occurs. BI insurance is inextricably linked to property damage insurance and is sometimes termed ‘consequential loss’ or ‘loss of profits’ insurance. Many aspects of BI insurance of BI insurance replicate business continuity planning. Especially the business impact analysis aspects of it.
♦ The intention of BI insurance is to restore the business to the same financial position as if the loss had not occurred.
♦ BI insurers insist that any property is insured against loss or damage so that funds are provided to pay for the repair or replacement of the ‘bricks and mortar.’
The following provides a checklist of items to consider when specifying and purchasing BI insurance and shows how BI supports the business continuity plan in many areas:
♦ The sources of revenue to be insured need to be identified and can be either gross income rentals or revenue or fees or rates or other sources of income, or a combination. Some income, such as interest on investments or profits on the sale of assets are not insurable in normal BI insurances.
♦ The business activities to be insured must be identified and need to capture all of the organisation’s business, including future acquisitions, or newly created entities or new ventures.
♦ One problem which can occur with large groups is that the inclusion of inter-group sales can artificially inflate BI insurance by double counting.
♦ is probably the most crucial component of both business continuity planning and BI insurance. This focuses on the total time estimated to full recovery from an insured loss. This incorporates such practical aspects as:
Inventories create an additional complication as businesses may not have any stocks or material in store to immediately use to minimise reduction in turnover.
One major stumbling block with indemnity periods is that they vary from site to site and from peril to peril. A single fire at one factory clearly differs from a massive earthquake or flood affecting multiple sites all at the same time. Most organisations opt for one indemnity period but can have more depending on their individual circumstances and exposures but a smorgasbord of indemnity periods may be a recipe for a disaster in itself when adjusting claims.
Selecting the business interruption sum insured is critical as it dictates the ultimate liability of the insurer. In some cases, the amount to be insured is easily based, but there is one key aspect to consider – it has to be assumed that the major fire or other disaster occurs on the last day of the insurance year. If the indemnity period is, say, two years then the sum insured must be projected three years ahead rather than based on “today’s” amounts with a minimal allowance for inflation.
♦ This formula may appear to invite over insurance, but BI policies can be arranged on a deposit premium and include a premium adjustment clause where, at the end of the year, the premium is adjusted taking the actual gross profit or other insured revenue into account as that would represent the maximum of the insurer’s liability in any event. In other words, this ensures the premium is on a pro rata basis.
♦ Another area to be reviewed with BI insurance is that, after a major incident, some overheads will be proportionately reduced and consequently do not require full insurance. Standard BI policies allow for this.
♦ An important component of BI insurance is the coverage for what is termed ‘increased costs of working’ – these being the extra costs that companies have to pay to keep in business come what may. These can be difficult to estimate and, in some cases, can be the principal exposure of an organisation. Some policies apply a limit per month, but such a restriction should be avoided as it is too restrictive. A worksheet for estimating these costs follows this article.
♦ Another important cost to be insured is that of claims preparation fees which, in complex cases, can be very substantial. Such clauses should include allowance for an organisation’s own internal costs in preparing claims, which can be very expensive.
♦ A property policy sum insured should include full provision for demolition/removal of debris plus architects’ and surveyors’ fees, all of which can be very costly.
♦ Another important area of BI insurance is the correct insurance of wages/salaries/payroll. This incorporates a number of practical factors which have been considered in the business continuity plan; such as which staff would be retained after a major disaster, which staff would be terminated, which key staff would have to be kept on to protect the company when it resumes, and which seasonal staff could be laid off immediately. Provision can be included for redundancy/severance pay and BI insurers have very flexible ways of insuring this important exposure.
♦ There have been literally hundreds of examples where businesses have suffered contingent losses because the premises of a key supplier or customer or utility have been damaged and they suffer inevitable disruption or loss of business. It is possible for such contingencies to be included in an organisation’s policies, but in many instances the coverage is limited and such limitations need to be considered in advance and taken into account in the business continuity plan. The trend to outsourcing has expanded this BI exposure.
♦ The break down of utilities has caused massive disruption in many countries; in some instances, BI insurance has provided full protection, but in some cases, limited insurance protection applied.
♦ A recent UK study indicated that power disruption was the key risk that many organisations identified in the BI exposures and the insurance protection available is not always as wide as some businesses may think. Another factor with policy extensions for dependencies/utilities/customers suppliers is that there is often a time ‘deductible’, i.e. the coverage only commences after, say, seven days and there is invariably an upper limit to the insurer’s liability.
♦ As with property insurance, it is important that the BI insurance allows for ‘progress payments.’ Additionally, the BI policy should also permit the business to be involved in the selection of a mutually acceptable claims adjuster. It is preferable to have the same adjuster(s) involved in both property and BI claims to avoid delays or demarcation disputes.
♦ A critical cost to ensure in BI insurance is that restoration of records whether ‘hard’ or ‘soft’ is specifically included in the cover.
♦ A classic clause to include in BI policies is for claims to be settled on loss of turnover or output or whatever definition applies to capture the variables.
♦ As with property insurance, it is important to know what risks aren’t insured by a BI policy. This is obviously much better than hearing after a major disaster that “you aren’t insured for that”.
♦ Another problem with BI insurance is that specialised covers are needed for the break down of critical plant or machinery and exactly the same considerations apply to computers/EDP/IT systems. Here any interruption, particularly for ‘real time’ operations, can be financially devastating and appropriate, specialised, insurance is needed.
♦ Some businesses which are dependent on immediate cash flow, such as restaurants, can have insurance arranged where a pre-agreed daily, weekly or monthly amount is paid by the insurers immediately. Whilst most policies require an ultimate proof of what the actual losses were, for certain organisations where cashflow is vital this specialised cover is invaluable.
♦ Some businesses with a very wide spread of sites throughout the country may decide they have sufficient in-built provisions to operate from another location and, consequently, only insure for increased costs of working, which would be the main expense they would incur because they figure that their gross income would not be reduced.
♦ What is termed ‘advance profits’ is another aspect where specialised cover can be arranged where long term projects are either planned or are in the course of being completed – if such projects are damaged during the course of construction and the anticipated income is significantly delayed, this can be insured against. These types of policies can also be extended to cover specialised plant ‘on the water’ and can be an important feature when arranging finance for such ventures.
♦ Some government or municipal organisations, whose income is guaranteed, may not require insurance for reduction in revenue but for increased costs of working, which can be substantial.
♦ Business interruption policies invariably only insure actual loss or damage sustained and do not cover incidents where damage has not occurred. For instance, a standard BI policy would not cover consequential losses arising from a ‘flu pandemic. It is such absence of BI cover that reinforces the necessity for organisations to upgrade their business continuity planning as this is their only insurance. But the World health Organization has just mooted the concept of major corporates and countries creating an insurance pool system to fund ‘flu vaccines which shows how centuries old insurance techniques can be adapted to help manage pandemic risks.
♦ In addition to the insurance company’s claims adjusters, some businesses prefer to bring in their own separate specialist and the policy claims preparation fee clause should cover such expenses. Whilst adjusters are meant to be impartial it must be remembered they are paid for by the insurer and have sometimes been suspected of protecting the insurer’s rights firsts.
♦ In some cases, business interruption policies apply ‘average’, i.e. where, after a claim, under insurance is apparent then the insurers only pay a portion of the ultimate claim. This factor alone reinforces the need for an annual review of BI insurances. It is emphasised that ‘rolling over’ policies to save on premiums can prove fatal.
♦ The loss adjustment formula in a standard BI policy is extremely flexible and able to take into account trends in the business and other relevant factors. However, it is still dictated by the original sums insured, basis of coverage and the indemnity period selected.
♦ If a company has a robust business continuity plan, it should be conveyed to the BI insurers so that the plan can be taken into account when establishing coverage and, more importantly, premiums. After all, the BC plan protects the client and the insurer.
♦ There is also a standard assumption in BI insurance that the business will be continued and not wound up. This is to prevent any company from deciding they will not resume business and think they can make a substantial claim on their BI insurance – not so – you can’t shut up shop and expect a business interruption claim to be paid.
♦ Another extension under BI policies is that contractual commitments imposing fines and penalties can be insured.
♦ Claims deductibles can be applied separately to BI insurance but, in many cases, it is combined with the property insurance. It is preferable that any deductible should be a dollar amount rather than a percentage of any loss because if the loss is very substantial a percentage deductible can be equally substantial and, possibly, far more than originally anticipated.
♦ Some businesses, such as utilities, can have convoluted sources of revenue some of which is fixed and some which is variable. Consequently, any ‘off the hook’ BI policy may be inappropriate and if a major claim occurs there could be substantial under insurance or, in a worst case scenario, no insurance at all, because the BI insurance was not thought through properly at inception or renewal.
♦ The classic arguments against implementing business continuity plans apply equally to insurance, i.e. ‘it hasn’t happened before’ – ‘this place will never burn down or be flooded’ – ‘we will never lose everything all at once’.
When completing business continuity plans, organisations can make estimates of what extra costs they would incur if they had to relocate to alternative premises. In addition, they also factor in additional personnel costs plus other likely expenses.
In some instances the amount selected is purely a guestimate and may be adequate or woefully underestimated. It is important to realise that these are additional costs, i.e. over and above standard incurred overheads