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Checklist to Prepare for Business Interruption

Business interruption (BI) losses are among the most confusing types of claims in the insurance industry. As claim specialists, we are often asked for a “checklist” filled with action items for when a loss occurs. A “checklist” isn’t practical because there are too many variables and “if/then” scenarios to map out. When you have a significant property damage and business interruption claim, only experience can guide the way to a fair recovery.

However, there are actions that can be taken ahead of a loss to ensure you are prepared. The following seven items represent such a “checklist.” It will not only help with your next loss but can have an immediate benefit to your risk management program.

1. Prepare accurate ratable business interruption values

The annual ritual of preparing the business interruption worksheet is often treated as an administrative nuisance.  It should be looked at as an opportunity to accurately account for the insurable risk for which you pay your premium and to accumulate annual values for future trending.

The worksheet provided by the insurance company is woefully inadequate to explain the nuances of most businesses. Go beyond the worksheet and explain your business more completely to underwriters. For an effective BI values methodology, solicit help from the specialists, such as an experienced forensic accountant. The results will be appreciated by underwriters and should translate into more appropriate coverage and possibly a more favorable rate. Once a system is in place, accuracy, consistency and efficiency should be improved.

2.    Analyze exposure scenarios and calculate MFL and PML

Once the ratable BI values are calculated, policyholders should explore realistic loss scenarios. The BI value is an annual number that does not factor in real-life responses that would generally mitigate a claim. To get to the actual exposure to risk, companies should determine the maximum foreseeable loss (MFL) and probable maximum loss (PML) measurements. The MFL measures a “worst case scenario” in which all of the loss-control protections fail. The PML is the more realistic loss scenario, in which mitigation systems work and contingency plans are executed properly. In both cases, the property damage and business interruption effects would be calculated as if they had occurred.

Loss scenarios should be postulated in detail, e.g. by location and by occurrence, considering all factors. These numbers should not be measured by simply applying a daily “BI rate” to an engineered loss period. It is more realistic to prepare as if presenting a claim, exploring all “what if” possibilities. Insurers may offer some assistance in this process, but remember, their version will be from their perspective. As with any claim, you should always prepare your own scenarios and your own calculations according to your understanding of your operations. An independent forensic accountant will have prepared claims just like your scenarios and would be able to accurately value the losses.

3.   Analyze contingent risks

Concurrent with the MFL and PML analysis, you should work to understand contingent risks to your business. Knowing what your suppliers’ and customers’ exposures are is important. Policyholders should involve leaders in operations, procurement and sales to help identify contingent exposures. If you have a sole supplier, your contingent exposure may be greater than anticipated and should be examined.

It is important to understand how your current policy language would respond to the contingent loss scenarios you’ve identified. For example, if suppliers in your policy are referred to as direct supplier,” make sure you understand how this would be interpreted in a claim. If “direct” means only those suppliers with whom you have a direct contract, and an indirect supplier, i.e. a second-tier supplier, has a loss that affects you, would you be covered? These scenarios should be discussed with your broker and underwriter to ensure your policy will respond as expected.

Once the values and scenarios are updated, you will be better able to make informed decisions about your insurance coverage, limits and terms.

4.    Business interruption vs. extra expense

Another common discovery from performing an exposure analysis is which type of time element coverage is the best risk transfer solution. Considering each location, if the risk is a lost of sales, BI would cover the lost earnings. If sales are not the risk or they can be sustained at an extra expense, extra expense coverage would be more appropriate. If sales are at risk but can be mitigated to the degree contingency measures are enacted at an additional expense, it’s a combination loss exposure.

It’s of value to risk managers to know what the exposure truly is because, if an exposure can be covered by extra expense coverage, it may eliminate or reduce the need for BI insurance. For example, if you are a distributor with multiple warehouses whose inventory is insured at selling price, what’s at risk? If you have alternative space or can quickly secure temporary space, the likelihood of experiencing a sales loss that exceeds the sales value of your lost inventory is remote. How much BI coverage should you buy vs. extra expense? Exploring your loss scenarios and subsequent contingency plans would allow you to better quantify your risks and select the option best suited to your needs. Extra expense is a more “tangible” risk than BI, making it easier for underwriters to rate, and it generally will cost less.

5.   Gross earnings, gross profit and business income

The names are different, but the intent is the same – to protect earnings lost because of damage or loss of use of insured property. The history of each of these forms would take a separate paper to detail, but, in a nutshell, gross earnings is a form commonly used in the U.S. with a basis in manufacturing risks, while gross profit is used throughout the world and has its basis in mercantile operations. Business income is the term used for the current ISO forms. Today, all forms have been modified to accommodate almost any business — however, there are some situations where one form may be preferable. The terminology and the mechanics of calculating business interruption loss varies among the forms, but the answer should be the same, regardless.

The exception to this has to do with the period of indemnity — the gross profit form is usually limited to a specific time, while gross earnings will continue until repairs are (or should be) completed with “due diligence and dispatch”; there is the ability to add an extended period to recover sales. It is important to make sure the form you have would cover your potential loss period. For example, if you have a manufacturing company with specialized production equipment that have long lead times to replace — longer than the period that a gross profit form would cover — you should probably have a gross earnings form. If you do not see a scenario that would exceed the gross profit period and you cannot accurately predict an extended period required to add to gross earnings, the gross profit might be a better option. If there isn’t any scenario that would create a loss that exceeds the gross profit period of indemnity and you are comfortable that you can cover that time to recover sales, than either form would work. There are new options that allow you to pick which form you would like to use up until the closure of a claim — these forms eliminate the need to determine which form is right for your business. Just make sure you have a form that will cover your worst-case scenario.

6.   Professional fees coverage

Most policies now include professional fees coverage. Insurers recognize the need for dedicated claim preparation experts and are willing to pay for it as part of the claim. Often, this coverage is subject to limits that can be negotiated. If you are not familiar with this coverage or do not have it, you should discuss with underwriters. For the most part, this coverage can be included at some level just by asking. The benefits of having specialized claim preparation experts available as a resource for a claim can make the difference between a successful claim and a headache.

7.  Organize your claim team

In addition to forensic accountants, a claim may include forensic engineers, attorneys and others. It is a good idea to know those you want to use before needing their services. Meet with the various providers beforehand and select those that fit best for your organization. Typically, paperwork associated with hiring someone can be completed before needing their assistance (i.e. non-disclosure, purchasing, W-9, etc.) so that if something happens they can begin work immediately. Additionally, there may be an opportunity for the provider to help with reporting issues on business interruption values.

While no business wants to suffer a loss of earnings, the more prepared you are the better the results will be. The steps shown above may take years to fully develop and should be evaluated annually to account for changes to your business.

If these recommendations are incorporated into your insurance program, there’s no need for a claim checklist. Your risk management team will be prepared for any worst-case situations with the best-case solutions.

A Nuisance Form Can Be Your Friend

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.

3 Common Errors in Managing Claims


No one wants to deal with a property claim. Unfortunately, claims do happen, and that is why you buy insurance. There are right ways and wrong ways to manage a claim — here are three common mistakes and how to avoid making them:

Too many cooks…

cooks

One of the first things you should do after a loss is assign a point person to handle communication and dissemination of information to the insurance company. Oftentimes, this role defaults to the risk manager, but she is not always the best choice. Obviously, the risk manager needs to be part of the team, but you need someone who can dedicate a substantial amount of time to the claim. This ensures consistent communication and avoids the insurance team’s relying on information that has not been vetted.




Not controlling the schedule…

stickies

As with most projects, planning and execution are necessary for a successful outcome. It is critical in the claims process to assign responsibility to the team members at the policy holder and require that they provide information in a timely manner. This compels the insurance company to provide feedback in a similar fashion. A timeline should be established early on, and the parties should be held to it. For example, claims will be submitted by the fifth day of the month; feedback will be provided by the 15th day of the month; and payment will be received by the end of the month. Scheduling like this can improve cash flow and ensure progress on the claim. Get the parties to commit to this early!

Unreasonable expectations…

pie

It’s true that the insurance company is not likely to accept your entire claim, but building up your claim to unrealistic expectations is not the answer. By claiming a “pie-in-the-sky” number, you can hurt your credibility and dramatically slow down or prevent a reasonable settlement. The better approach is to present a reasonable claim that is fully documented. This prepares you to counter the insurance company’s rebuttal with confidence. It’s reasonable to be aggressive, and, by all means, do not lower you claim in anticipation of pushback from the insurer. Just do not build up the claim to unrealistic totals with the plan to fall back to a lower position — this gives all the credibility to the insurance company.