*(Note: Bob Glasser is a managing director at BDO Consulting, a division of BDO and Seidman, LLP, in the New York office. Mr. Glasser is a certified public accountant, a certified fraud examiner and a certified insolvency reorganization accountant, with more than thirty years of diverse financial management and accounting experience at public and private companies. Mr. Glasser leads the firm’s New York Insurance Claim Services practice).
Most CFOs and risk managers have an understanding of their property and liability insurance needs and dollar limits and are comfortable purchasing coverage that protects their companies from a loss due to an insured peril. However, it has been my experience that their comfort level drops dramatically when it comes to business interruption coverage and limits. The uncertainty surrounding business interruption coverage, extensions of coverage and respective limits of that coverage consistently results in many middle-market organizations finding themselves underinsured and short of cash when faced with a major loss. Even the fortunate CFOs and risk managers who have not experienced a major loss may eventually discover that they have been significantly overinsured for business interruption losses and paying unnecessarily higher premiums for their coverage. Of course, the more devastating situation is finding out after a shutdown of operations from a loss that company management has not mitigated the company’s risk of lost profits and now has insufficient coverage to protect profits and cash flow during a potentially long period of restoration.
How can you, the CFO or risk manager avoid that day of reckoning when your company cannot afford the economic consequences of an underinsured loss?
When you meet with your broker to review your insurance policy for renewal, focus on your reported or insured values for your business interruption coverage and on the numerous extensions of coverage that are available based on your organization’s specific operations and needs. Calculating the appropriate business interruption values will help you select the proper coverage and respective limits and will enable you to better manage and, more importantly, minimize your financial risk.
Fundamental to obtaining the proper limits/sub-limits and type of business interruption coverage is an updating and reevaluation (or assessment for the first time) of your business interruption values. From my prior experience as a CFO (and being responsible for insurance), I recall the temptation to take business interruption worksheets provided by the broker and subsequently give them back to him or her, along with a copy of the company’s most recent financial statements, and saying, “I don’t understand this form. It does not relate to my business operations. So take my financials and tell me how much BI coverage I should have!” If you recognize yourself in that scenario, you are not alone. CFOs and risk managers should work with brokers and insurance consultants to create a comprehensive analysis of the needed coverage by identifying and quantifying potential operational and financial risks to the organization and by shifting that risk to the company’s insurance carrier(s).
When preparing your updated (or initial) business interruption values calculation, I recommend the following five-step action plan:
- Communication – Meet with your senior management to review existing business risk assessments, previous loss history, business plans and financial projections and to identify potential mitigation strategies.
- Diagnosis – Identify contingent and extended exposures, internal and external interdependencies as well as other exposures that may not be triggered from first-party property damage.
- Technology – Integrate technological solutions to create an efficient and timely valuation process.
- Analysis – Review and analyze risk exposures to facilitate the quantification of business interruption values.
- Documentation – Create detailed schedules supporting calculated values by operation and location, including the underlying assumptions.
Preparing a Maximum Loss Scenario (“MLS”) analysis is also beneficial and is generally well received by both senior management executives and underwriters. An MLS analysis is the process of simulating an occurrence in which an organization experiences a catastrophic loss event. The financial impact of this simulated loss event is quantified and addressed in a report to underwriters that provides a more comprehensive analysis and understanding of the risk that they are evaluating and underwriting. Senior management benefits from the MLS analysis because it may identify critical path weaknesses and interdependencies in an organization which may then be used to update their strategic and disaster recovery plans. The MLS analysis should also include an assessment of potential extra expenses that could be incurred as a result of the simulated risk, in addition to the business interruption losses.
As part of the process of determining your business interruption values, you also need to understand the numerous extensions of coverage that are available to mitigate your risk. Many of these additional time-element coverages may be critical to safeguarding potential lost profits from a catastrophic event, and therefore need to be individually analyzed and addressed with your broker. The following are some of the additional coverages to consider:
- Contingent business interruption
- Provides additional coverage as a result of a covered loss to suppliers and receivers of goods and services. Without this coverage extension, companies that have critical suppliers, customers or feeder-type properties may find themselves at the mercy of a supplier’s or customer’s rebuilding schedule. In the worst-case scenario, you may have to shut down due to a supplier’s or customer’s physical loss.
- Ordinary payroll coverage
- Your managerial and salaried employees are normally covered as a continued expense. However, your hourly non-managerial employees may not be covered. If you have hourly skilled labor or if you are located in a tight labor market and cannot afford to lose trained workers from not continuing to pay them during a business interruption, you can purchase an extension of coverage that will allow you to pay these workers for a specified period of time while the company is shut down, generally, the coverage is purchased for a specific number of days, e.g., 30, 60, 90, and up to 365. To determine how many days of coverage you may need to purchase, you must determine the skill level of your workforce and evaluate the risk that they will not return to work after a closure.
- Extended period of indemnity
- Your business interruption coverage indemnifies you through the period of interruption, which is also referred to as the period of indemnity or restoration. This period is often defined as the time it takes to rebuild or restore the damaged property to its pre-loss condition using due diligence and dispatch. An extension of coverage allows for continued indemnification from your insurance coverage for the time necessary to ramp up your business to its pre-loss levels following the physical restoration. This is an important coverage for businesses in a highly competitive environment, such as the hospitality industry.
The following are some additional types of extensions of coverage to consider with your broker:
- Claim preparation fee
- Service interruption/power outage, including off-premises service and overhead transmission lines
- Extra expense
- Expediting expense
- Finished goods inventory selling price
- Loss of attraction (primarily for the hospitality industry)
- Sue and labor
- Civil authority
CFOs and risk managers should meet with their brokers to closely examine their business interruption values, limits and available extensions of coverage in their current policies. The critical takeaway is that properly calibrated business interruption coverage can be one of your most valuable assets for providing the critical working capital needed to survive a catastrophic event.
– Bob Glasser