Why Concerns Over Business Interruption Exposures Are Increasing
Natural disasters, fragile supply chains, and other factors call for more attention to business continuity planning
A fire, water leak or windstorm that severely damages a commercial building is a terrible event made worse by a lengthy disruption in normal business activities and revenue caused by the disaster. This one-two punch is fast becoming a worrisome prospect for more mid-sized companies.
For the third year in a row, QBE’s Mid-Sized Company Risk Report, produced in partnership with the Association for Corporate Growth, reveals that the possibility of a significant interruption in business income is the third most concerning macro risk for mid-sized organizations, just behind financial risk and digital risk.
Moreover, concern about business interruption has risen each year, with 65 percent of executives expressing a high level of concern in 2022, up significantly from 56 percent in 2021 and 53 percent in 2020.
This concern stems not just from potential property damage to company locations but a host of factors, as well. For instance, the survey revealed that the loss of a critical supplier/subcontractor and a fragile supply chain are among the most concerning micro risks overall, with the level of concern up significantly since 2020 as global trade relationships have grown more tenuous. Critical infrastructure breakdown also ranks highly as a concern.
The survey findings were published just a few weeks before Hurricane Ian, considered to be one of the most damaging and destructive weather events in U.S. history.1 It is anticipated that the hurricane will produce total economic losses possibly exceeding $100 billion, a figure representing direct physical damage losses, non-physical financial loss and net-loss business interruption, according to a recent study.2
The impact of Ian will likely increase costs that were already up sharply for building materials like lumber, steel and gypsum, as well as construction labor. Moreover, the replacement of machinery and equipment is more expensive since a significant and prolonged restriction in supply during a period of high demand produces a ripple effect that increases the price of all goods and services.
Added up, a combination of inflation-fueled price increases, more frequent and destructive natural disasters, and a slowdown in supplies is resulting in longer and costlier business disruptions. What used to take three months to remediate a property can now take six months and more.
Although mid-sized company risk professionals have no control over the changing weather, infrastructure breakdowns and spiraling inflation, they can take prescriptive actions to mitigate the duration and related cost of a business interruption.
The possibility of a significant interruption in business income is the third most concerning macro risk for mid-sized organizations”
Planning for Disaster
Chief among these actions is the drafting of a business continuity plan led, managed and governed by an internal team composed of senior management, IT professionals, Legal and front-line employees. A typical plan is divided into three stages—disaster preparation, response and restoration.
The first stage entails the evaluation of current business processes, such as how products are received through the supply chain and what might happen to the flow of these goods during a disaster that results in the discontinuation of normal operations. The assessment also should account for potential damage to critical equipment, impairment, loss of power or other utility-provided services, and disruptions in freight transportation and employee access. Once completed, identify possible backup plans to fill in gaps in supplies and services like transportation, gas and electricity.
A related concern is the need to expeditiously rebuild damaged structures to restore normal operations. Following Hurricane Ian, the length and cost of business disruptions has increased due to unprecedented demand for building materials and skilled labor, which were already in short supply before the storm.3 To get to the front of the line, consider securing legally reviewed agreements in advance with licensed restoration contractors.
Similar agreements may be useful to secure alternate suppliers and qualified providers of equipment, construction materials and transportation. Cultivate relationships with
all these parties and weigh the value of contractually incentivizing them with step-level payments based on their prompt delivery of goods and performed services.
The second stage of a well-crafted business continuity plan concerns the actions needed to put it in motion. Alert regular suppliers and other vendors of the event and its potential repercussions. If for some reason they cannot provide service in customary timeframes, activate the aforementioned agreements with the alternate suppliers and services providers. At the same time, contact the building restoration contractors to repair the damage.
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The plan’s third stage entails the need to report the extent of the property damage and interrupted income flow to the insurance broker and/or carrier. Retain all invoices and receipts involved in the restoration of the property and the related impact on normal business activities. Up-to-date and accurate records of financial operations are critical to support the stated income lost in the claim.
Other Insurance Considerations
Aside from a thorough and regularly updated business continuity plan, it is important for mid-sized company risk professionals to carefully review the business interruption elements of the property insurance policy. Business interruption coverage typically applies to income lost due to covered damage to insured company property.
A key consideration is the period of indemnity, as some insurers limit indemnity to two years while others have no time limitations.
Like many other insurance policies, business interruption insurance includes a deductible giving buyers the opportunity to self-insure a portion of the loss, in return for a lower premium. Whereas the deductible in automobile insurance is the financial amount paid by the policyholder before the insurance covers the remainder of the loss, with business interruption insurance the deductible could be a specified number of days before the insurance kicks in.
In addition to lost income, many business interruption policies cover a range of so-called “extra expenses,” such as the added cost for a supplier to expedite a shipment or the need to shift production elsewhere. These financial records also must be accurate and available to the insurance broker and/or carrier in the filed claim following a loss.
Another valuable insurance coverage to consider is contingent business interruption insurance. Offered as optional coverage in a commercial property policy, it typically covers lost income as a result of damage to a supplier’s or recipient’s property that impairs delivery of the promised product. It is important to understand specifically what perils are covered by the policy. In most cases, the coverage is an extension of the perils that are covered in the company’s property insurance protections. But what if the perils at the supplier’s location are very different from those at the company’s location? For instance, the company may have decided to forgo flood or earthquake insurance because those risks are extremely low at their locations. The supplier, however, may be in an area highly exposed to floods or earthquakes. Power outages and labor strikes are other risks often overlooked in the policy terms.
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Contingent business interruption policies are frequently limited to named locations of the suppliers. While coverage can extend to unnamed locations, insurance companies are understandably much more selective about assuming risks for locations they cannot inspect. To secure the best coverage and rates, risk professionals at mid-sized companies may find it is well worth the effort to understand and document all the locations of their suppliers for inclusion on the policy – and to keep the information up to date.
Contingent business interruption insurance has wide applicability, depending on the insurer and the policy features. A case in point is a mid-sized company that derives the lion’s share of income from its nearby proximity to a theme park or other major attraction. If the theme park is sidelined by covered property damage, the insurance would compensate for the reduction in the mid-sized company’s normal flow of income. In some cases, the insurance also would cover lost revenue caused by a key customer no longer able to purchase a company’s goods or services.
In all such cases, it is prudent for all risk professionals to discuss their organization’s exposure to property losses and both the risk mitigation and risk transfer opportunities presented by carriers.
1 Hurricane Ian’s Damages Are Forecast to Be Worse Than 1992’s Andrew, Bloomberg, 9/27/22
2 Gallagher Re’s assessment of damage caused by Hurricane Ian, 10/18/22
3 Post-Ian Reconstruction Needs, Tight Construction Labor Market Add Up To Delays Nationwide, Biznow National, 10/25/22
Charles Greer is VP, Large Property Underwriting Leader QBE North America
Monique McQueen is VP, Property Claims QBE North America
James Vachon is VP, Risk Solutions QBE North America