Navigant’s Stephanie Tombling on the considerable challenges firms face when dealing with business interruption
Business interruption usually accounts for the lion’s share of losses in insurance claims stemming from damage to property resulting from fire, explosion, weather events, equipment failure, faulty design, or simply human error. The loss of buildings, equipment and inventory impacts a business’s ability to service its customers, negatively affecting sales. According to Allianz Risk Barometer 2016, business interruption ranks number one, for the fourth year in a row, among the top risks facing businesses worldwide.
Calculating damages for business interruption is more complex than property losses as it requires projecting into the future and the impact may occur at one or more facilities.
Increasing supply chain risks
The globalisation of manufacturing and trade has brought valuable efficiencies to business, notably in terms of locating production in lowest-cost geographies. However, global supply chains sometimes leave major manufacturers, wherever they are located, exposed, as cumulative effects are felt up and down the distribution chain of affected businesses. The full impact of catastrophic losses resulting from weather events or natural disasters may take months to be felt around the world. Most business interruption policies reflect this with a clause covering supplier claims, or extensions to customers.
Calculating losses for business interruption claims
The first step in making any claim is to examine the insurance policy to understand the wording and to ensure that all items are included. For instance, in the event of a factory being flooded, all damaged machinery is included in the property damage claim, together with an assessment of whether it can be salvaged.
The valuation of damages starts with the practical ramifications of the event and involves detailed analysis of financial, operational and market data to derive the best factual matrix of the impact of the event. Establishing liability for any loss involves analysing the root cause of the insured incident. Business interruption models can be developed by location or facility.
‘Calculating damages for business interruption is more complex than property losses as it requires projecting into the future.’
Stephanie Tombling, Navigant
A projection of a policyholder’s financial statements is done based on financial and operational data. That projection may be compared to the actual result of an event, using the difference as the starting point for loss determination.
Challenges in calculating losses include allowing for an asset rebuilding period with safety modifications and upgrades made to the process, or the availability of an alternative or sister plant in mitigation of the losses. Seasonality may be a factor, depending on the nature of the policyholder’s business. Measurement includes analysis of increased costs and mitigation related to alternative sales during the period of restoration.
Large or small business interruption claims
For large claims, experts are often appointed by the insurers to work alongside the loss adjusters, to ensure that remediation actions are prioritised for the short and medium term, and that costs are controlled.
Claims can be especially complex in process industries such as oil and gas, or chemicals. Given the nature of process operations, it is no surprise that calculating losses for an insurance claim is complex and involved. Establishing the chain of events is made more complex when untangling multiple incidents with the same root cause. To ensure business continuity, an investigation into a claim may run while minimum production is maintained, even if intermittent shutdowns occur.
The economic cycle has an influence on claims. In economic downturns, there tend to be fewer claims resulting from industrial equipment failure, when plants are running below full capacity, allowing for preventive maintenance during production downtime. Conversely, there tend to be more equipment failures when the economy is strong, as plants are running at full capacity.
Although a large claim is usually complex, it is often a mistake to assume smaller claims are straightforward. Both can benefit from the experienced forensic eye of a business interruption expert. If the asset is business-critical, for instance a road-cleaning vehicle in a small fleet, every day of downtime is expensive. Small and medium-sized businesses may have an enhanced need for expert assistance as, for instance, they might not routinely prepare audited financial statements or monthly management accounts, which typically form the basis of a claim. Furthermore, they are unlikely to have sufficient resources to prepare, manage and negotiate a claim. When information requests come in from insurers, experts in business interruption can help identify the data deep inside the claimant’s organisation, or suggest alternative ways the aggregated information can be generated from transactional systems.
The views expressed in this article are those of the author and do not necessarily represent the views of Navigant Consulting or any of our clients.