Managing business interruption risks amidst uncertainty

Events like the global pandemic and the Russia-Ukraine conflict have led to substantial economic consequences for businesses in many sectors. The widespread global volatility¹ creates challenging situations for businesses and impacts:

• supply chains; 
• labour costs; 
• and inflation.

This raises questions about how we can better understand these impacts and their effects on insurance programmes. There may be a need to re-evaluate the values of business interruption (BI) insurance. Additionally, it may be necessary to extend indemnity periods.

For instance, if your property or contents, such as machinery and equipment, are damaged, will it take longer to source replacements? How would such a delay affect your trading results and the need for BI cover?

Why is BI insurance necessary?

BI insurance is vital to a comprehensive risk management strategy. Different types of cover are available, including loss of profits. This also includes extra expenses incurred if your business must temporarily suspend operations due to an unforeseen event. 

BI insurance is closely linked with property insurance. The typical trigger for a business interruption (BI) claim is an insured property damage loss. Such as a fire at the insured's premises. It can also be caused by extreme weather events, like flooding damage to the insured contents. The BI consequences of such events can be financially and operationally devastating.

Exploring the benefits of BI insurance

1. Income protection

BI insurance can safeguard a company's income stream during disruption. This is crucial to:

• maintain cash flow; 
• pay your employees; 
• and meet your financial obligations. 

Even when revenue generation is temporarily halted.

2. Survival in a crisis

Unforeseen events may require unplanned or extra expenditures to continue trading and meet contractual commitments. Purchasing extra expenses cover, also known as additional increased costs of working, is generally a valuable addition to a BI policy. 

3. Competitive advantage

BI coverage can help your company quickly resume operations and meet customer demands. This minimises the risk of losing market share to competitors during downtime.

4. Customer trust

Maintaining business operations or quickly recovering from a disruption can instil confidence in your customers. It also reassures stakeholders about your company's resilience. BI insurance helps protect the reputation and trust that your business has built over time.

5. Supply chain resilience

A disruption affecting your customers or suppliers can have a cascading effect on your business. In some cases, BI insurance can be extended to cover losses that result from damage to third-party premises forming part of your supply chain. This is a complex area that will require discussion with an insurance expert.

Optimising BI cover to build financial resilience

While BI insurance is essential, its effectiveness depends on how well it is tailored to your business's needs. An insurance expert can help you to assess your exposures and consider various risk management strategies. Here are some strategies to consider:

1. Accurate risk assessment

Carry out a thorough risk assessment to identify potential threats to your business. This includes assessing your supply chain's vulnerability, key assets, and critical functions. Understanding these risks allows for more precise coverage selection.

2. Check the accuracy of ‘gross profit’ values declared to your insurer

The insurance market definition of ‘gross profit’ differs from an accountant's. For example, BI policies often include salaries in the definition of gross profit. This is because businesses typically need to continue paying their staff. Even if trading operations are temporarily disrupted.

Importantly, the insurer will deduct any ‘uninsured working expenses’ specified in the policy from the gross profit claim. You must check the policy definitions and amend them if necessary and possible.

Ensure that any financial declarations or projections you provide to your broker or insurer are accurate. They should also be based on the agreed formula.

3. Adequate indemnity period

The maximum indemnity period in a BI policy is a highly important decision. It is typically expressed as the number of months following the date of loss. During this period, the policyholder can recover business interruption (BI) losses arising from a claim. Your maximum indemnity period should be long enough to enable your organisation to fully recover from a potentially catastrophic event.

Remember, "recover" includes fully rebuilding the insured property. It also involves returning to expected levels of financial performance. Every organisation is unique, and factors to consider include:

• the potential for regulatory investigations; 
• time to clear and remove debris; 
• planning permission; 
• lead times to replace equipment; 
• and time to recover lost customers.

4. Accurate valuation

Ensure that the valuation of insured property and assets accurately reflects their replacement or repair costs. An undervaluation can result in insufficient coverage, while overvaluation leads to higher premiums. BI policies will not cover additional delays caused by under-insurance. They also do not respond to situations where the policyholder has insufficient funds to replace damaged property.

5. Consider extra expense coverage

You can add extra expense coverage, also known as additional increased costs of working, to your policy. This coverage helps cover expenses incurred to expedite the process of returning to normal business operations. This can include the cost of temporary facilities, equipment rental, and fast-tracked shipping.

6. Review and adjust coverage

Regularly review and update BI coverage to account for changes in your business, such as:

• expansions; 
• new product lines; 
• or shifts in supply chain dynamics. 

Ensuring that your coverage remains aligned with your evolving business is critical.

Key takeaways

Regularly reviewing financial projections and the broader risk environment, along with advice from an experienced insurance broker or agent, can help ensure that businesses have the appropriate cover. This protects their operations effectively.

• Review your existing BI insurance policy to ensure it suits your business.
• Identify potential BI exposures and evaluate the impact of each risk.
• Seek advice from an insurance broker, which can provide bespoke BI cover for particular needs. Such as a dependency upon a key supplier or customer.
• Ensure the values declared to insurers are accurate. For instance, that gross profit values are in accordance with policy definitions. 
• Evaluate the benefits of longer indemnity periods.

Broader coverage and longer indemnity periods typically lead to higher premiums. However, they may offer greater protection in the event of a disruption.

Sources

1. weforum.org/global-risks-report-2023

Got a burning question?

Let us know what you'd like to learn more about, your question may help others too! An adviser will be in touch to answer your question shortly.