Business Interruption: Beyond the physical
At its very heart, traditional Business Interruption cover is simple and should always be kept this way to avoid any ambiguity. To trigger or activate the policy there must be proven physical damage at the insured address and to the physical asset. With the physical damage confirmed, Business Interruption will provide just two elements of cover. Firstly the loss of sales multiplied by the Rate of Gross Profit (RGP) and secondly any increase in cost of working to avoid a loss of sales.
Yet, normal business operations can also be impacted when physical damage does not occur, for example cyber-attacks, pandemics, supply chain disruptions, power outages and terrorist threats to mention a few. This is sometimes referred to as Contingent Business Interruption (CBI) or Non-damage Business Interruption (NDBI).
The good news is that, coupled with a well-established risk management programme, there are a number of risk transfer options and means by which businesses can address these exposures beyond any sub-limits written into a standard Business Interruption policy.
In this article we’ll explore some of those options that are available to extend cover without altering the tried and tested Business Interruption formula.
To deem or not to deem
“The last thing you want to do is to change the tried and tested policy formula,” says Peter Newall, Senior Claims Manager at Swiss Re Corporate Solutions. ‘To alter the formula often introduces ambiguities, conflicts and uncertainties all of which serve to make a bad situation worse. Business Interruption insurance policies can be extended or expanded very simply by altering the triggers not the formula.”
The most efficient way, and one where Corporate Solutions has been helping clients to expand cover, is by using the “deeming” term in the policy wording. In this way, unfortuitous and extraneous events or damage to the property of others can be deemed to be damage to property at the Insured’s address in the policy. Similarly, for those who remember the H5N1 (SARS) epidemic, the consequences of this event could be ‘deemed’ to be damage to the property insured, thus triggering the business interruption cover.
Peter adds; ‘This can extend to instances such as denial of access, cyber-attacks, port blockages or damage to airports, power and utilities outages, regulatory actions, raw materials shortages, product recalls and any other event that an underwriter is willing to accept a premium to insure.”
This is simple to execute and has been available for decades, however, somehow it has been ignored in recent times and in favour of tinkering with the critical Business Interruption formula. This has resulted in hybrid versions of the original Business Interruption policy, which in turn can and often do introduce claims uncertainty. Inevitably it’s better to go back to a simple tried and tested version that is clear and transparent and understood by all parties.
Understanding supply chain exposures
Before the days of complex global supply chains it was straightforward to determine the effect of physical damage on a business, as production and distribution was usually contained within a single factory or plant. As such, there was an immediate and obvious correlation between the physical damage and the interruption to business operations. But now, when we are talking about Contingent Business Interruption, it can be less obvious especially when there are multiple suppliers within a value chain that are diverse and spread across the globe.
Deciding how best to insure against supply chain damage involves first gaining a comprehensive understanding of the exposures. For this we would always advocate for working with a professional broking partner to identify the full range of indirect exposures that could impact your business as a result of non-physical damage to your property. A professional broker will have a wealth of experience in this area as well as tools to help map enterprise risk and supply chains as well as ready-made industry specific templates.
‘When a complex supply chain is being used it’s almost impossible to evaluate each and every supplier. We would urge clients to be able to identify suppliers along the critical manufacturing path to at least tier 3 level. In addition, we would recommend documenting all critical assets and services that contribute to your revenues.’ says Peter Newall.
‘Once this is understood you can then work with your broker and insurer on scenario and stress testing to identify any gaps in cover and possible improvement areas. With a full assessment of the possible exposures you can engage your insurer to determine the best form of insurance cover.”
Wide Area Damage strikes back
Natural disasters, such as storms, earthquakes and tsunamis, typically cause wide area damage and particularly affect the tourism and hospitality industries adversely. These are not new phenomena as the devastating impact from Japanese tsunamis, Thai floods and New Zealand earthquakes clearly show. Cyclone Debbie was a more recent reminder of a wide area damage incident in 2017.
In these circumstances there are often challenges in understanding how property damage/business interruption (PD/BI) and contingent business interruption (CBI) wordings will perform during a claim and how the pay-out is calculated and measured.
For instance, a manufacturer might see a spike in the price of a vital raw material (such as iron ore, coal or steel) because of a sudden increase in demand following a natural catastrophe. How does a BI policy respond to that?
Similarly, hotel operators are often impacted by wide area damage causing a loss of attraction to the area. They may claim that they would have been fully occupied if the disaster had not occurred, but in reality how would they have fared if they had sustained no damage to their own property, but were nonetheless located in an otherwise devastated area? What if there were no flights to the affected area owing to airport damage, meaning no-one could get to the area, or if media reports had deterred visitors, or the tourist attractions had been washed or blown away anyway?
A real-life case study of a wide area damage incident to a hotel operator is illustrated below:
Case study: Cyclone Pam and a Pacific Island hotel
The Insured operated a hotel, which in 2015, was hit by Cyclone Pam as it swept across the Pacific islands causing widespread devastation. Their policy provided cover for the Loss of Gross Profit over a Maximum Indemnity Period of 36 months and while the hotel was reinstated in June 2016, turnover did not return to pre-loss levels for some considerable time thereafter.
What was the challenge?
Tourism is an important part of the economy and as a result of the wide spread damage, there was a significant dip in visitor arrivals. Therefore, the overall Business Interruption Loss sustained by the Insured was not consequent upon physical damage to the Insured’s own property as a result of the cyclone but also:
- The falling visitor numbers deterred by media coverage of the cyclone event.
- Issues with the local airport runway, which resulted in reduced flights to the island and therefore the numbers of tourists visiting.
Being one of the largest hotels on the island, its occupancy is closely correlated with the number of visitor arrivals. As such, the tourism statistics obtained from Government were used as a yardstick to measure the Standard Occupancy. That is the occupancy that the Insured could reasonably have anticipated if his property had not sustained damage.
What was the impact?
As the Insured’s policy did not have a Loss of Attraction extension, the impact of falling visitors and a reduced market was factored in to reduce the amount payable.
Lessons learnt
- Particularly in Nat Cat prone zones, consideration should be given to the likely consequences of the natural disaster and how the business will be affected directly and indirectly when choosing the appropriate policy, extensions and Maximum Indemnity Period.
- Basic Business Interruption Insurance policies while covering the Insured for losses arising from interruption to their business as a result of damage to the Insured property, typically do not provide sufficient cover in the event of wide area damage where financial losses can be incurred not as a result of damage to the Insured’s property, but as a consequence of the event itself.
Complex risks, simple understandable solutions
With risks becoming ever more interconnected and interdependent on a global scale, ensuring your businesses’ resilience depends on how well you manage disruption, no matter whether that’s caused by physical or non-physical exposures. By fully understanding your exposures it is possible to blend traditional and innovative risk transfer solutions that will comprehensively protect your critical assets and your bottom line. We would always advocate for keeping the traditional Business Interruption policy as simple as possible, extending coverage in an efficient way so as not to disrupt the policy formula and by adopting additional parametric solutions to compliment the traditional coverages.
For further information about parametric solutions visit https://corporatesolutions.swissre.com/insights/knowledge/what_is_parametric_insurance.html
