Interdependency of Business and Supply Chains Demands Robust Business Interruption Strategies

Business interruption insurance is
critical to keep the revenue generating ability of a business intact following
an insured event such as a fire, flood or other catastrophic circumstance that
can torpedo the financial health of an enterprise.  Yet despite its
importance to business continuity and the ability to fully recover from a loss
event, business interruption insurance is largely misunderstood and as a
result, the sums insured are often wholly insufficient to cover a catastrophic
loss and the increased costs of working during the recovery period.

“Business interruption
insurance is designed to compensate the business for the financial impact of
the interruption or interference as a result of the insured suffering physical
damage to the insured property or other key external events, for example damage
at a key customer or a supplier’s depot, or own operations that prevents the
normal business operations from continuing and generating revenue.  The fact that we see businesses that
are often underinsured on their Business Interruption sums insured is indicative
of the enormous complexity that comes with calculating the correct insured sums
that takes account the knock-on effects and increased costs of working
following an insured event,” explains Tony Webster of insurance brokerage and risk advisors, Aon
South Africa. 

There are three key factors that
play a major role in the compilation of a Business Interruption (BI) insurance
schedule that is fit for purpose:

• Sum insured – As explained above, correctly insuring your business for business
  interruption is crucial.  The sum insured must be calculated based on the
  insurance gross profit, not necessarily the accounting financial gross
  profit.  This requires a deep understanding of a client’s financial
  records and its operating models.
• Indemnity Period – An indemnity period associated with BI insurance refers to the period of
  time it will take for the business to recover from a worst-case scenario. 
  The appropriateness of the indemnity period needs to take into account factors
  such as the nature of the business and its assets, such as specialised
  machinery and equipment, seasonality of the business and competition within the
  market.  As a simple example, if a hotel located at the coast suffered
  major structural damage following a fire, the BI insurance claim would look
  very different during winter months than it would during their peak holiday
  season.  The indemnity period needs to account for complete building
  reinstatement, possible legal ramifications/delays if investigations due to
  human casualties are involved, building plan approvals, site preparation and
  the like. 
• Business Continuity – While business continuity in itself is not an insurable risk, poor risk
  management can render a business uninsurable.  Risk mitigation efforts
  undertaken by a business has a fundamental effect on the eligibility for
  insurance and the cost of insurance.  Another critical aspect that is
  considered is the interdependency of different business units, and what impact
  each has on the continuity of the entire business.  A catastrophic event
  in one business unit could impact other divisions or subsidiaries across the
  entire network as well as the ripple effect on customers and suppliers not to
  mention one’s own staff.

One of the most
miscalculated areas of BI is how long it will take to overcome a catastrophe
and get back to business.  Getting a large production line or mining
concern operational can be a very lengthy process, and more so when there are
regulatory or investigative hurdles to leap. BI insurance should cover at the
very least 12 months, if not 24 months, depending on the business complexity
and environment – and then consider that this does not even begin to address
the issue of lost market share during the downtime. 

“If risk
managers are approaching business interruption as a pure balance sheet
exercise, they run the risk of buying transactional insurance, and not
strategically relevant insurance tailored to their needs.  If the adequacy
of sums insured and declared values are not properly calculated, insurance
cover will run out long before the business is back in operation, with dire
financial and operational implications’” adds Tony. 

Given the complexities of assessing
the sums insured for a major BI loss, Aon South Africa engages with RSM
South Africa to assist our clients with independent training and analysis of
the financial consequences of various business interruption scenario’s. RSM is
the 6^th largest global audit, tax and consulting network and offers
professional services that are specific to BI risks and the quantification of
related losses.

“By working with RSM, Aon is able to provide the peace of mind of
knowing that when it comes to business interruption, all the complexities such
as exchange rates, interest, increased operational costs during a crisis, loss
of market share, down- or up-stream complications, regulatory hurdles and many
more are adequately
considered, enabling the business to recover from a major insured peril with
their reputation and bottom line intact,” he
says.  

Business
Interruption Risks Underestimated

BI has been on
the Top 10 list of risks facing businesses since Aon’s Global Risk Management
survey started in 2007.  

“As supply
chains have become global, there is increasing interdependency among companies.
Such an industrial environment is heavily affected by uncertainties that have
the potential to turn into unexpected disruptions. Moreover, the focus on
inventory reduction and lean supply chains has also amplified such potential.
For example, China’s city of Tianjin, the world’s third largest port, is home
to offices of more than half of the Fortune 500 companies, and to factories
that build cars, airplane parts, and mobile phones. As one can imagine, the
deadly explosions in 2015 caused supply chain disruptions for companies around
the globe,” explains Tony.

More
importantly, the proliferation of cyberattacks has also added new urgency and
dimension to BI. Cyberattacks can now cause electric outages, shut down
assembly lines, block customers from placing orders, and break the equipment
which companies rely on in order to run their business. Officials at Lloyd’s
estimate that cyber-related business interruption could cost businesses as much
as US$400 billion a year.

In Aon’s report
entitled “Cyber—the fast-moving target” released in April 2016,
participants identified BI, both during a breach and post breach, as the top
cyber risk concern. In addition to cyberattacks, one cannot ignore those
occurring on a smaller scale, such as arson, a bomb threat, a fire or a power
outage, all of which could cause disruptions on a scale equal to a natural
hazard or a well-coordinated act of terrorism. In 2014, a contract worker set
fire to an airport control centre in Chicago, resulting in more than 2,000
flights being cancelled. Incidents like this highlight the business
vulnerability.

The
interconnectivity of the global economy has amplified the negative impact of a
single BI event. At the same time, with the emergence of cyberattacks,
businesses can no longer use a litany of traditional risk management solutions
to handle BI. New innovative solutions are needed. Even though disasters, both
natural and manmade, are not always preventable, having an innovative business
continuity plan in place can help reduce the impact of both traditional and new
emerging risks related to BI.

“More
importantly, risk managers should take a much broader view of risks, both
traditional and emerging ones, and address them in a coordinated and holistic
way. Being prepared enables companies to keep running during natural disasters,
cyber or terrorist attacks or reputational crisis. While insurance can cover
some of the property and operational losses, it cannot make up for the loss of
market share, reputational damages, decline in investor confidence, or a
decline in the share price caused by an interruption. Therefore, a fortified
and robust business continuity plan will boost a company’s resilience in the
event of a BI,” concludes Tony.

In a world of growing complexity and
the interrelated nature of risks, no company can rest on its laurels in
terms of its BI recovery strategy.  Continuity plans should always be
ongoing works of improvement and constant risk mitigation. Everyone in the
business should be asking what the worst-case scenario could be, and as a
business, how to respond to it.

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