Tag Archives: business interruption

5 Pitfalls on Business Interruption Claims

At the 2018 RIMS annual conference, Christopher Loebler from the firm McCarter & English discussed business interruption claims.

Business interruption usually falls within your property policy. The coverage is triggered by a property loss from a covered peril under the policy that shuts down your business for a time. One in five U.S. companies sustain a loss in this area with an average claim of more than $2 million.

Oftentimes, losses are less obvious, more complicated and larger than the property claim. Unfortunately, the focus on the front end tends to be on the property loss when any incident occurs.

See also: How to Assess Costs of Business Interruption  

Five Pitfalls on Business Interruption Claims:

  1. Failure to include an insurance coverage lawyer on your crisis response claim. Policies tend to be long and complex, so you need someone who has read the policy in advance of the incident to now how to best respond.
  2. Issuing a press release can directly undercut the insurance claim. After an incident, the typical reaction of a company is to issue a press release letting people know that the business can still operate. Later, when you try to file a business interruption claim, the carrier pulls out that press release and questions coverage.
  3. Failure to understand what is privileged communication. Questions should be asked through your lawyer under privilege, not through you broker. Communication with your broker is not protected by privilege.
  4. Failure to communicate. You have an obligation to communicate with the carrier, including putting iut on prompt notice. However, you need to make sure you are not giving it information that can be used against you without going through your attorney.
  5. Failure to retain a forensic accountant. A forensic accountant is an expert in both the policy and making claims. The accountant knows exactly what information is needed to maximize recovery.

NOTE: Claim preparation expenses are usually covered under the policy. This includes the forensic accountant but not attorneys.

Also, you can add contingent business interruption coverage to your policy. This coverage would apply if one of your key suppliers suffered a loss that would be covered under the policy and that particular loss disrupted your business.

When Not to Trust Your Insurer

What is your insurance company telling you about your business interruption values?

In preparing annual business interruption values and exposure analysis for clients, we have noticed several red flags that indicate something may be wrong with how these values are being reported to the insurance company. It’s not so much what the insurance company is telling you about your business interruption values, but what it is not telling you.

Here are three red flags insurance companies are waving by not saying anything:

Great Rates – “We are paying a lot for insurance, but we are getting a great rate!”

Beware, great rates for property policies have the potential to be misleading. The business interruption values are one of the many variables in determining rates. If you are over-reporting your values and the insurance company realizes it, your rate will appear better than others reporting more accurate values. Sure, a better rate may sound like a win, but it may just mean that the insurance company is calculating your values for you. Just as you wouldn’t trust a car salesman when he says you’re getting a great deal, you shouldn’t rely on the insurance company to do the same.

See also: How to Assess Costs of Business Interruption

Free Services – “Our insurer analyzes our values for free.”

The insurance company may actually offer to calculate your values for you – for free. Everybody loves free things, right? Unfortunately, the insurance company will use a benchmark approach to underwriting your risks combined with COPE data and any other information you provide. The result will likely be a higher business interruption value that is not representative of your exposures. When your story is vague, the insurance company will make assumptions about your business based on what others are doing. Let all of your hard work creating incident response plans, business continuity plans and other contingency plans pay off where it can have a direct effect on your premiums.

No Resistance – “The insurance company accepts what we give them for BI Values.”

Watch out – if there are no questions or pushback on your values, that can mean one of two things: 1) you have done your values perfectly and they require no explanation, or; 2) you are reporting higher values than what your insurer is calculating. If you have done your values perfectly, congratulations on being one of a kind. More likely, the insurance company has calculated your values at a lower level than you have. If this is the case, wouldn’t you want to know?

At the end of the day, no one is more qualified to value your business interruption risks than the people who run your company, but you have to know the criteria being applied and how to apply them. Underwriting is a mysterious process, so it’s better for your bottom line to take the mystery out of it by bringing clarity to your business interruption values. If you leave it up to the insurance company, chances are that the number is going to be higher than it should be.

Don’t expect insurers to guide you to the answer that is best for you. They have a different agenda and process. They will categorize and group your risks based on some information, but if you do not provide what they need, they will default to general assumptions. You may get lucky and end up with a reasonable assessment of your risk. Or you can have a say in your luck by matching your opportunity with preparation.

What Can Derail an Important Event?

As Brazil copes with the Zika-virus outbreak, political turmoil, civil unrest, crime, water sanitation and the looming threat of terrorist attacks, thousands of athletes, fans and officials are making their final preparations for the Summer Olympics. While none of the crises look likely to derail the Rio 2016 Games, the list of concerns reads like the list of covered exposures in a well-designed cancellation of event insurance policy.

The International Olympic Committee is not alone in struggling to cope with the world of extreme events. Just look at some major sporting events that have recently been canceled, relocated or postponed:

  • National Football League (Buffalo)
  • English Premier League (Manchester United)
  • Major League Baseball (Pittsburgh and Miami)
  • Southeastern Conference Football (LSU and Tennessee)

If the list were to be expanded beyond sports, the number of concerts, events and conventions suffering the same fate is too large to compile. So, what should be considered when planning an important event, whether large or small?

Infectious diseases:

Zika is the latest of many infectious diseases to result in global travel advisories, the banning of large concentrations of people or implementation of public health control measures Communicable disease resulting in quarantine or restriction in people movement by a national or international body or agency is simply one exposure that concerned parties can eliminate through effective use of insurance solutions.

See also: How to Think About the Zika Virus

Extreme weather:

In today’s world of extreme weather events, once remote weather-related possibilities are becoming more and more frequent. Previously safe geographic areas have experienced hurricanes, earthquakes, wildfires, snowstorms, hailstorms, etc., all of which can leave event planners madly scrambling to determine the extent of damage incurred and whether their carefully choreographed event can go on. Even if the adverse weather does not damage the venue(s) of the event itself, the mega-facility guidelines of the nation may require the requisition of the venue by emergency personnel or evacuees in the event of a hurricane, wildfire, dam-breaking or some other catastrophe.

Terrorism:

Despite recent World Health Organization warnings, foremost in the worries of most risk managers for large-scale events is the rise of terrorist actions worldwide. Protection against terrorist acts can be included in cancellation of event policies for an additional cost. Such coverage would typically exclude the use of nuclear, chemical or biological materials, or radioactive contamination post-Fukushima, but even these eventualities can be covered if a thorough market analysis is conducted. Many policies do not require that a terrorist event actually take place; they can be designed to protect an entity’s financial interest if the event is affected by the mere threat of terrorism, if the threat is confirmed by a recognized competent authority on the state, national or international level.

Key person coverage:

For events that rely on the attendance of certain personnel, performers or speakers, organizers can buy coverage specifically protecting against the non-appearance of key people.

Public sector strikes:

Public sector strikes, particularly those involving transportation services, and damage or loss of utility service to a venue also lead to many events being canceled, relocated, postponed or interrupted and are all insurable exposures.

Business interruption coverage:

Contingency insurance exists to provide protection for the expenses an entity occurs in organizing an event as well as the revenue the event should generate for the organizers, promoters, municipalities, etc. There is no “boiler-plate” solution for a specific event. It is essential that the event organizers and insurance representatives spend time evaluating the actual financial exposures the entity has. Expenses are normally the easiest to determine because they are fixed costs. However, many streams of revenue are often ignored if too much attention is given to the largest items, such as ticket sales, instead of supplementary income generated from merchandise sales, concessions, sales, lost sponsorship monies or even parking fees for attendees.

See also: The Defining Issue for Financial Markets

It is equally essential to determine who the financial responsibility ultimately rests with. Sponsorship contracts serve as a good example of complex obligations. If a corporation has agreed to spend millions to be the signature sponsor of an event, and the event is moved to a different venue where companies other than the sponsor already occupy desired signs and exposure, it should be determined if the expense is a sunk cost to the sponsor or if the hosting party has to reimburse the sponsor. This contract clause should dictate who receives the insurance policy benefit. Experience in determining financial exposure that each party incurs when events are in their initial planning stages is invaluable when custom-designing insurance policies to cover all possible financial liabilities.

It is only a matter of time before a global spectacle of an event is canceled due to an unforeseen peril. While the emotional loss experienced by the participants and attendees is high, the financial impact can be mitigated or completely eliminated through the insurance market.

BPO for Life & Annuity Market

Life and annuity insurers are focusing on three areas to drive growth: distribution, product and brand. Growth is hard enough in today’s market, but it’s even harder when your back office holds you back, both in terms of fixed costs and limited capabilities. Accordingly, achieving operational efficiency is table stakes for life and annuity insurers competing in an extended soft market.

Fortunately, given recent advances in technology and expansion of provider capabilities, business process outsourcing (BPO) has become a feasible way to reduce costs and increase efficiencies. Based on what we’ve seen in the market, we think BPO providers are ready to move from their traditional role as vendors to true business partners. With scale, advanced technology and money to invest, the best of them offer great opportunity for insurers to significantly lower costs and benefit from complementary services over the long term.

Why BPO and why now?

For years, insurers have tried numerous methods to achieve greater operational efficiency, including process reengineering, Six Sigma, and LEAN. Many companies also have pursued sourcing (primarily in IT) to stem the tide of rising fixed costs. While these initiatives have reduced costs and complexity to a certain extent, they have not lowered costs and operational complexity enough to enable the business to focus first and foremost on growth.

Fortunately, times have changed. Some BPO providers have recently offered savings on a per-policy basis (inclusive of both operational and IT costs) of anywhere from 20% to 40%. (Benefits depend on how much savings a company has already realized and how much additional opportunity for savings remains.)

BPO now offers the potential for greater long-term cost reductions and efficiencies than the methods insurers have used in the past.

In Europe, BPO and ITO (information technology outsourcing) has already played a major role in closed block businesses. Life, annuity and pensions BPO has a global market of more than $2.6 billion, nearly half of it in the U.K. In this case, the main point of BPO has been legacy policy cost reduction, but it also offers carriers an alternative operational platform for achieving faster speed to market for new products and for tapping into advanced customer service capabilities.

Legacy modernization is another important reason for considering BPO. As key staff retire, there is a real threat of knowledge loss, not least because legacy systems are concurrently moving toward the end of their effective working lives. Many BPO providers feature up-to-date and evolving technology platforms that are an attractive alternative to incurring continuing fixed costs in-house.

The key for carriers is to select a BPO provider that will keep its platform current rather than simply provide a “your mess for less” service (i.e., administration of your aging platforms). Without the right scope, BPO can backfire and actually result in a more complex operating model, with resulting stranded costs and a suboptimal customer experience.

What is large-scale BPO?

To understand what BPO entails, it is helpful to compare the different kinds of shared services that are available:

  • Captive shared services are when a carrier creates a wholly owned subsidiary to deliver services at a reduced cost. They can be established domestically, near-shore or off-shore.
  • Out-tasked shared services occur when a carrier hands over administration of its systems to a third party that offers wage arbitrage, but the carrier maintains ownership of the process and underlying systems.
  • In contrast, in a BPO transaction, the insurer hands over administration to a partner, who runs the former’s technology platform. In other words, the partner owns the process. Implementation may occur through a lift and shift approach (i.e., the partner takes over the carrier’s legacy platforms), through conversion (data is converted from the carrier’s legacy to the partner’s modern platform) or through a phased combination of both. To smooth the transition, ameliorate community and reputational concerns and improve change management, there is typically a significant amount of rebadging of employees from the carrier to the BPO partner.

Ideally, after BPO, the insurer is a service level agreement (SLA) manager, and the BPO partner controls the process. (N.B.: Contracts should be in place that stipulate performance requirements.) The insurer’s focus on the sourced business should be on performance and analytics, made possible through regular data feeds from the BPO partner.

  • In brokered BPO, the insurer contracts with a third party that isn’t itself offering BPO services but instead will manage the transition to a BPO provider. Ideally, the third party manager will have successful past experience with the BPO provider and managing the complex details of conversion from legacy platforms to new ones.

BPO is not one-size-fits-all. There are different varieties that insurers can match to their individual goals and circumstances.

Managing retained alongside sourced business

While moving the entirety of operations and IT to a BPO provider may seem appealing, insurers realistically will continue to be involved in many operational and IT activities. They often will retain key components of their operations and IT that they deem to be market differentiators. These most often relate to the customer experience (both with the agent and insured) and include call centers, portals and analytics. To remain effective, the operational platform that support retained components will continue to require maintenance, upgrades and BPO integration. Extensive up-front effort will be necessary to promote seamless integration of retained and outsourced components.

In addition, despite inclusion of a broad scope of operations and IT components, certain operational functions will remain with the insurer, namely HR, legal and compliance. Given significant sourcing, the question is if the insurer’s reliance on these functions will decrease and, if so, how to shrink them without increasing operational risks like:

  • Interruption of customer channels and operations: Businesses have been caught by surprise when service grinds to a halt at a provider.
  • Brand-damaging criticism: Businesses that fail to meet customer expectations – even if the cause is outside their walls – may see an increase in complaints, some going viral on social media.
  • Regulatory violation: A data error or breach at your service provider can put you in violation of regulations and jeopardize your customers’ trust.
  • System vulnerabilities: In a complex infrastructure that has dependencies you don’t even realize, a service interruption might trigger a series of problems that can affect your business.
  • Inaccurate reporting: Service provider processing errors can cause a misstatement of compliance, performance, operational or financial information.
  • Risk management lapse: Not knowing the controls around service contract terms can lead to unreported breakdowns in areas hitherto considered secure.

A good way to reduce the chance of BPO-related risks is to insist on a provider that comports with advanced service organization control (SOC) reporting. SOC 2 provides assurance that the provider has controls around the sourced technology and systems supporting the sourced business processes, but only to a pre-defined audience. SOC 3 provides the same assurance but more broadly to anyone interested in the provider’s control and allows the posting of a public seal on the provider’s website.

Embarking on BPO: An end-to-end approach

Given the significant potential for disruption to distribution partners, policy/annuity holders, employees and the community at large, BPO requires a more iterative approach to execution than many other forms of operating model transformation.

When evaluating BPO partners that best match criteria for in-scope functions and blocks of business, some carriers find that a single BPO partner may not meet all needs. Accordingly, it is imperative to determine the best BPO fit for each block of business.

Implications: Insights from BPO initiatives

  1. Plan big. Scope thoroughly enough to actually simplify management instead of just adding another layer of complexity to what you already have.
  2. Choose a partner, not a vendor. Approach the BPO as a relationship that will grow over time. Vet your prospective partner’s record of investment in other relationships and appropriately provide incentives to each other with thoughtful contracts that promote accountability.
  3. When vetting BPO providers, consider the amount of investment they’ll make to upgrade their platforms over time to continue delivering effective service.
  4. Don’t underestimate the amount of time that staff need to prepare for BPO. Identify all necessary business rules and ensure that key individuals and cryptic systems are aware of and understand them. You do not want any service interruptions.
  5. Map all dependencies on the policy administration platforms you’re seeking to move, inclusive of all ancillary applications.
  6. Realize that each part of the operating model you retain will add another layer of integration complexity to BPO.
  7. The prevalence of shared services and the opacity of many service-based cost-pools mean that many companies struggle to understand their IT spending. Therefore, it is vital to have an agreed-upon allocation method that won’t leave significant stranded IT costs post-BPO.
  8. Considering there will be more lines of accountability for running the business during and after the BPO, unless you use a brokered approach, you’ll have to create or augment an existing service provider management team.
  9. You may need multiple BPO partnerships. For example, the BPO partner that best meets your life book needs may not be the best choice to meet your annuity book needs.
  10. Ensure contracts account for all reasonable contingencies (e.g., growth, M&A, divestitures and spin-offs).

How to Assess Costs of Business Interruption

As a professional loss accountant with more than 20 years of experience with business interruption (BI) valuation, I can understand why policyholders struggle with finding a repeatable, efficient system that produces an accurate measurement of their BI exposure. Over the years, some of my clients recognized the issues with the traditional BI values approach, and decided to make a change. Unfortunately, too many companies continue doing what they have always done, even when there is a better way available.

BI

Consider for a moment, just how important BI information is to your underwriter. The numbers you report give the underwriter the basis for writing coverage and calculating premium. Each renewal provides policyholders the opportunity to present their unique BI exposure. Unfortunately, this opportunity is often squandered because of a misunderstanding of business interruption values and the exposures they represent. The point of this article is to share a proven, alternative approach.

Understanding BI Values

First, there’s the ratable value. It is the “big number” that is calculated for the business as a whole, assuming a 12-month, total shutdown of all revenue-generating operations. This worst-case and often unrealistic scenario is the information requested by the insurance company, usually in the form of a one-page worksheet. Without additional information, the underwriter will use this information to set limits and charge premium.

The ratable value calculated is somewhat meaningless, except that it establishes the base assumption that is used as the BI value in all other scenarios, such as unincurred cost categories. The ratable value is seldom a reflection of your exposures. Better ways to assess your exposures are to examine your maximum foreseeable loss (MFL) and probable maximum loss (PML) scenarios.

What Is Maximum Foreseeable Loss?

The MFL, as the name indicates, is the worst-case scenario. This is not as extreme as the ratable value scenario, but pretty close. The assumptions used here include a complete breakdown of protection and loss mitigating factors while you are hit where it hurts at the worst possible time. An example would be the loss of a unique distribution center to a retailer during the holiday shopping season — say the distribution center that handles online orders goes up in smoke on Cyber Monday.

The factors used to measure the ratable value would be used in this scenario to determine the business interruption value. Certain assumptions may change depending on the duration of the loss scenario. For example, labor expense may be considered completely saved in the ratable value scenario because of the assumption that there is nothing left, but only partly saved in an MFL scenario.

What About the Probable Maximum Loss?

The PML is the same as the MFL, except that loss mitigation efforts and protections work properly. The PML also takes into account pure extra expenses used to retain customers. The PML can help with decision making on purchasing extra expense coverage.

What Happens in Underwriting?

Although I’m not an underwriter, I’ve typically seen insurance companies take an engineer’s approach to MFL and PML scenarios that vary only in duration. This singular perspective does not account for the rest of the pieces of the puzzle. The other pieces are the finer details that actually occur during a claim. In a real claim, topics like seasonality, make-up and outsourcing would surely come up, but you won’t see them on any BI worksheet.

The MFL and PML should be based on realistic loss scenarios and measured as if they were a claim. Simply applying the ratable value to loss-period assumptions produces misleading and inflated numbers. This is precisely why it is in your best interest to develop your own valuation method based on real scenarios.

Why Create Exposure Scenarios?

If BI values are based on assumptions, and you are using the worksheet, then the assumption is a 12-month loss scenario. Can you imagine a scenario in which your operations would only be affected for six months? The worksheet makes a blanket assumption of 12 months whether realistic or not. Coming up with various loss scenarios by location would flesh out a more realistic representation of the impact of each particular loss. The scenarios would also highlight high-risk locations along your supply chain, which could improve your business continuity planning.

An exposure analysis project is not only an accounting project; it’s an integrated business exercise offering multiple benefits to an organization. The goal is to identify and examine loss scenarios and the resulting ripple effects.

It isn’t necessary, nor is it practical, to anticipate every possible loss scenario. It’s better to prioritize by perceived risk and probability. Then, develop a good sampling of loss scenarios from which you can determine the impact to operations and the mitigating actions that would be taken. Depending on the exposure, involve the appropriate internal personnel, e.g., operations, sales, business continuity, IT and accounting. The external experts you may involve are your broker, legal counsel and, of course, a forensic accounting firm that specializes in insurance work. Additionally, your company’s business continuity plan (BCP) and incident response plan should be factored in. However your scenarios play out, the loss accountants can calculate the business interruption as though it were an actual claim.

As you can see, this approach would produce a more accurate BI value by location and overall. It’s the right way to look at business interruption, so make it a part of your approach with underwriters.