MOST BUSINESSES RECOGNISE BUSINESS INTERRUPTION (“BI”) INSURANCE AS A CRUCIAL RISK MANAGEMENT MEASURE AND APPRECIATE THE IMPORTANCE OF BI COVER TO ENSURE TRADING PROFIT IS PROTECTED, SHOULD INSURED DAMAGE BE SUSTAINED.
Challenges in Minimising Business Interruption Losses
When a loss occurs, it is in all parties’ interest to minimise the interruption and mitigate the loss. In reality, however, the process is often not as efficient as it could be, due to various factors. In this article, we discuss some of the challenges faced when trying to minimise business interruption losses. In simple terms, the concept of BI coverage is to fill the “hole” in an insured’s financial performance as a result of insured damage. There are two main considerations when taking out cover – i) ensuring cover is suited to the nature of the insured’s business and industry and ii) ensuring there is sufficient cover. Any deficiencies in either of these aspects could mean the Insured is not fully covered for the risks it faces. The responsibility for these considerations lies with the insured and its advisers. Not having appropriate or sufficient cover will adversely impact the ability to mitigate losses and is a common cause of adjustment across Asia, especially in small to medium-sized risks. The intentions of both parties should be made clear from the outset to avoid disputes in the event of claim. It is not always the insured’s intention to cover the full extent of its potential exposure but if this is the case, it should be clearly evident in the policy wording. Common areas of dispute include:
In simple terms, the concept
of BI coverage is to fill the “hole” in an insured’s financial performance as a result of insured damage.
i) the schedule and policy wording indicate different bases of indemnity; ii) the way in which a time deductible should be applied; iii) expenses intended to be considered as uninsured working expenses; iv) the treatment of increased sales at locations insured under other policies; v) clauses that may allow adjustment of the sum insured or average relief; and vi) whether contract penalties were intended to be excluded or not – this is prevalent in power generation, where an insured can achieve ‘negative’ turnover during an interruption (did the sum insured contemplate this?). The underlying principle of cover is that BI loss is caused by physical damage suffered. The longer it takes to reinstate the damage, the larger the business interruption loss will be. Hence, it is paramount to reinstate damage as quickly as possible. Naturally, there will be limitations to how much time can be shaved off and sometimes, the best course of action may not be the one that minimises the business interruption loss, if the cost to reinstate the damage quickly is prohibitively high. Sometimes delays are caused by bureaucratic process and government regulation. These delays can come in many forms e.g. release of site by fire investigators, long waits for certification of repairs and premises, or obtaining the necessary licenses to utilise land for the intended purpose, etc. Even in situations with pro-active insureds and fast-acting adjusters and insurers, there can be a limit to how much mitigation can be achieved. Lack of a Business Continuity Plan (“BCP”) could result in unnecessary delays that prove to be an obstacle to mitigating business interruption losses. A business with a strong BCP may react quicker because it has already considered what needs to be done in a particular situation, rather than fumble around in confusion e.g. negotiated terms with substitute suppliers, identified vacant premises, etc. Depending on the industry, even a short interruption can be detrimental for business after damage has been reinstated. Customers may have moved to other competitors and winning them back may be difficult. With such a risk, the insured may wish to consider outsourcing production to a third party (often a competitor) to enable it to continue supplying its customers. However, this option is often not economical, meaning that the increase in cost exceeds the loss of gross profit averted and the excess cost would only be considered by insurers if Additional Increase in Cost of Working (“AICW”) cover has been purchased. An approach often used to minimise the impact of a loss is to bring forward planned maintenance work into the loss period, especially if the interruption period due to insured damage is lengthy. After all, if the insured is unable to operate anyway, it is an opportune time to carry out maintenance scheduled for later. However, issues around the mobility and availability of service personnel, parts and equipment can be an obstacle to achieving this and result in a missed opportunity. In businesses with ample buffer of finished stock, it is possible to significantly mitigate a sales loss even if production is significantly impaired, assuming that the insured is able to rebuild its inventory levels after production resumes without the loss of further sales (i.e. it is capable of producing more than it can sell). For some businesses, however, it may not be practical to maintain large quantities of finished stock due to factors such as lack of storage space, perishable stock or simply having insufficient financial resources. Business interruption losses are often complex and are increasingly becoming a bigger proportion of total insured losses. Efforts to mitigate business interruption losses are often well rewarded, but can be fraught with challenges. The issues discussed in this article are by no means exhaustive but it is hoped that with a greater degree of awareness, the parties to a BI loss will be in a better position to navigate them.
Business interruption losses are often complex and are increasingly becoming a bigger proportion of total