October 3, 2014
A Nuisance Form Can Be Your Friend
by William Myers and Christopher Hess
The annual business interruption worksheet can be supplemented with information that generates a realistic look at risk -- and cuts premiums.
If you are like most companies, the annual ritual of filling out the business interruption worksheet is a nuisance administrative task. The worksheet is generally required by the insurance company to track changes in the business and may be used as the basis to price your program. Along with general industry knowledge, this worksheet may be the most important item that underwriters have at their disposal to price your risk. However, the worksheet is woefully inadequate to explain the intricacies of most businesses and is biased to err on the high side – which usually means a higher premium for you. For a routine that is regularly glossed over, the results can have some pretty substantial consequences.
The worksheet is meant to estimate the business interruption exposure for the policy period by estimating a value for the coming year. The business interruption value (BI value) is revenue minus certain specific direct variable costs, possibly adjusted to account for the payroll of for skilled wage employees who may be retained even if operations cease for a period. The result is an annual ratable BI value that assumes a complete outage for 12 months with no mitigation.
Only by coincidence can this BI value number come close to a realistic exposure to business interruption loss.
What does the ratable BI value tell the underwriter? In theory, the premiums required to cover the risk. How can this be when the number used is so unrealistic?
The underwriter would like to know more about your business. His problem is that he needs some mechanism to measure your risk against others in your industry. The BI values worksheet is an attempt to do this.
But, if the worksheet is so far off, what else can you do to tell your story?
You need to supplement the ratable BI value with information to differentiate your business from the pack. Developing realistic, worst-case loss scenarios, known as maximum foreseeable loss (MFL) and probable maximum loss (PML), and measuring them using a methodology that would actually be used in a claim is a better way to present your exposure. Measuring MFL and PML exposures will allow you to highlight your ability to mitigate losses through business continuity planning (BCM).
Just as improved physical safeguards generate lower premiums, adequate business continuity planning should also result in premium savings. This step is completely missed when providing the worksheet alone.
The effort to identify and measure exposures can be challenging — after all, it is impossible to predict everything that might happen. History of actual claims and current industry experience can be very helpful. In most cases, it is best to tackle this project in manageable pieces and try not to do it all at once. For example, start with the largest or most troublesome businesses or locations and work down from there.
This may end up being a multi-year project that will require some dedicated effort from you and third parties. But chances are the cost of a project like this will be justified by allowing you to make more precise decisions on coverage and possibly reducing premiums.