Business Interruption (BI) insurance often has been seen by risk managers as a “smoke and mirrors” portion of an insurance contract. Terms such as “necessary suspension of operations,” “period of restoration,” “continuing normal operations incurred,” and “extra expenses” have companies with a business loss looking for their brokers, forensic accountants, or public adjusters to assist them in preparing the documents to quantify the loss.
A variety of ways define the business losses in first-party policies, including the business interruption form. Business interruption occurs when an insured suffers loss or damage to physical property (real or personal) by a covered cause of loss, and a loss of earnings or suspension of operations ensues. For example, a fire damages an insured’s building and equipment, and the business is suspended for six months.
5 Steps to Calculate Business Interruption Coverage
Review the insurance policy for covered causes Keep in mind that the policy has to be triggered by a covered peril in order to allow the policyholder to recover any loss of income.
Confirm that the potential for makeup is included in the policy Assume that the insured was losing not only gross revenue but profits from net income and fixed costs that cannot be recovered. The potential for makeup is viewed as an obligation of the insured under the “Conditions” of the policy and forms part of the basis for the contract. To keep it simple, let’s assume that the business suffering the fire does not have potential for makeup of lost income and, therefore, we need to measure a BI loss.
Determine the period of restoration Loosely defined, “Period of Restoration” is the time in which the damage to real and personal property can be repaired or replaced and/or the insured’s business is restored. What makes the BI measurement unique is that rarely does a business suffer a loss of real and/or personal property that when restored, the business immediately returns to pre-loss revenues.
Measure the business interruption loss Determine the revenue stream: Look at a relative, representative period of time and see what revenues the business was producing. In most cases, look at least 12 months, and perhaps 18 months, to develop a monthly value for the BI loss. If there is no seasonality in the revenue stream, just look at a representative 6 months. Determine the loss profit: Look at the Profit and Loss Statements (P&Ls) and identify the profit and operating cost components for the business. Many insureds believe that BI is the loss of gross revenues, but for the purposes of insurance, BI is defined as the loss of profit and fixed charges that continue. When the business operations are closed, the variable cost components of the operation discontinue. For example, raw materials used in production are not used, and therefore raw material costs are suspended. As the insured is not incurring or paying those variable costs, the insurance company does not want to reimburse the variable costs. Measure the fixed cost, continued and incurred: Both continuing costs and incurred costs are needed for calculating recovery. Look back at P&Ls for the 6-, 12- or 18-month period and determine if expenses are fixed (continuing) or are variable (discontinued). Put it together: Estimate the revenue stream that was lost or impacted by the event. Take the monthly revenue stream, multiply the profit and fixed components to identify the gross BI loss.
Apply policy deductible The final step is a review of the policy to determine the applicable BI deductible. This deductible can be a dollar amount or a time-period deductible.
For the sake of this exercise, a business incurs a 6-month suspension of operations that resulted from a fire. This fictional business cannot make up the lost revenue through any other means. The insured lost gross revenue of $1.5 million. The business has an 18% profit margin and fixed costs make up 25% of the costs incurred. The business has a $250,000 BI deductible.
Recall earlier statements that gross revenue is not insured. Variable costs are not incurred and, therefore, not recoverable. In our example, fixed costs of 25% of revenue and profit of 18% of revenue are recoverable. This revenue stream is, therefore, insured at 43%.
Multiply the revenue stream to the lost gross revenue (.43 x $1.5 million= $645,000). The net BI recovery under this loss scenario is $645,000 – $250,000, which is $395,000. The insured has suffered a loss of gross revenue of $1.5 million and will recover only $395,000 from insurers.
Measuring the BI loss a company can suffer is an art, not a science. All aspects of the insured’s business, variables, anomalies not related to the loss, timing of the loss period, and many others have to be considered to develop a BI value that is recoverable.
Use a Realistic Timeline for Business Income Coverage Limits
Part of selecting proper business income limits is coming up with an accurate determination of how much it will cost and how long it will take to get operations moving after a catastrophe. Be sure to factor in these items affecting the rebuilding process:
Time for the direct-loss adjustment process
Federal, state, or local government involvement
Time for plans to be drawn and approved
Time necessary to choose the contractor
Scheduling and completion of demolition and site work
Building permits must be applied for and issued
Time necessary to rebuild, which may be adversely influenced by outside factors (e.g., weather, strikes, and availability of materials)
Time necessary to find and obtain replacement machinery or stock
Taken from The Risk Report, "Tactics for Arranging Business Income Coverage," by Christopher J. Boggs.
Supply chain resiliency
Supply chain resiliency is more critical to business profitability and reputation than ever before. Within the content of your CBI Program (also known as Contingent Time Element cover in the US), there are three key insights into supply chain resiliency you should consider:
• Know your key suppliers and customers, where they are based and an understanding of the profit/revenue exposure if they fail. This is a fundamental performance issue as much as it is a risk management issue.
• Remember that your supply chain can be disrupted by more than just physical events, and it’s important to consider this in your overall resiliency strategy.
• To obtain the CBI insurance coverage you need for your key suppliers and customers at an appropriate price point, it is important to provide your insurers with the relevant information they require.
For more information, contact us for a free White Paper on this subject
State gaps in emergency preparedness
The nation's ability to respond to a wide range of deadly emergencies, from salmonella-tainted melons to such weather events as Superstorm Sandy to bioterrorism, is losing ground after years of progress, says a 50-state report out Wednesday.
The top-ranked states (Maryland, Mississippi, North Carolina, Vermont, Wisconsin) met eight of 10 measures used to evaluate public health preparedness. Two (Kansas, Montana) met only three. Among measures examined: Do states have plans to evacuate schools in emergencies? Have they met vaccination requirements? Can they staff labs for prolonged disease outbreaks?
Thirty-five states and Washington, D.C., met six or fewer measures in the 10th annual report, by the Trust for America's Health with the Robert Wood Johnson Foundation.
The main concern, authors say, centers around deep budget cuts: 29 states cut public health funding from 2010 to 2012; 23 states cut their budgets for the second year in a row; but 21 states and D.C. increased or maintained funding levels.
The cuts affect public health teams that join first responders and provide emergency care, and those that help communities, such as aiding in recovery efforts from Superstorm Sandy in New Jersey and New York.
"Investments made after Sept. 11, the anthrax attacks and Hurricane Katrina led to dramatic improvements, but now budget cuts and complacency are our biggest threats," says Jeffrey Levi, executive director of the Trust for America's Health.
The nation has not paid "sufficient" attention, authors say, to "the everyday threats public health departments and health care providers face repeatedly." In addition to extreme weather and food-borne illnesses, "we have suffered a deadly rise of West Nile virus, a fungal meningitis outbreak and a resurgence of old diseases we thought were largely conquered -- whooping cough and tuberculosis -- all in a growing era of antibiotic resistance."
Among report findings:
49 states increased or maintained capacity to deal with chemical terrorism; Massachusetts decreased its capacity; and Washington, D.C., declined to answer the question.
37 states and D.C. can staff public health labs to handle a prolonged infectious-disease outbreak.
30 states and D.C., have multihazard written evacuation plans (including gun-related violence) to relocate children in all K-12 schools.
Only Hawaii and Nebraska met a federal goal to vaccinate 90% of children ages 19 months to 35 months against whooping cough.
"This study doesn't paint a pretty picture," says Kathleen Tierney, director of the Natural Hazards Center at the University of Colorado in Boulder, not involved in the report.
"You have to be able to invest in sustaining problems, keep up with emerging problems, keep up with state of the art equipment, and learn what best practices are out there," she says. "Even for states that are maintaining their budget that really means their budget is going down because costs are increasing."
Copyright 2012 USA TODAY
Ten Strategies for Building a Resilient Supply Chain
Natural disasters are among the top triggers that cause supply chain disruptions.
A resilient supply chain requires a commitment from the top and collaboration between enterprises.
Business continuity plans are an essential part of a resilient supply chain.
The 2013 floods in Eastern Europe are an example of how a natural disaster can impact supply chains. One automobile manufacturer was forced to temporarily close its factory after a major supplier that had been affected by the floods could not ship parts. On a global scale, such natural disasters and other disruptions can lead to billions of dollars in lost production and sales.
According to a 2012 World Economic Forum survey, natural disasters were among the top three disruption triggers, along with extreme weather and conflict/political unrest. These three events fall into a type of risk category known as a macro environment, because they impact the entire supply chain.
Deloitte breaks risks down into three main categories: extended value chain risk (supplier consolidation, outsourcing); operational risks (lean manufacturing, just-in-time inventory); and functional risks related to finance, human resources and information technology (failure of critical systems). Deloitte has identified more than 200 supply chain risks across these categories.
Another survey by the Business Continuity Institute found that 73 percent experienced at least one disruption in 2012 and 61 percent of disruptions originated with the immediate supplier. However, the level of disruption is likely to be higher because most respondents do not track supply chain disruptions across the entire enterprise. More than one fifth incurred costs of more than $1.3 million for a single incident. Almost 60 percent cited loss of productivity as the primary impact.
The impact to the manufacturing sector was even higher, with 85 percent experiencing at least one disruption. Again, most disruptions occurred with Tier 1 suppliers. Top causes were currency volatility and energy scarcity—both at 15 percent.
Key ingredients of a resilient supply chain
So what can you do to avoid disruptions and prevent the associated costs and damaged reputation? Experts recommend the following:
Secure commitment from the executive suite. This requires an understanding of the broader trends driving supply chain vulnerability and its disruption, which must be clearly communicated to top management. Larger companies should appoint an executive-level position with accountability and ownership of supply chain operations and risks. This position must be supported by the appropriate people, processes and technology.
Create a collaborative culture. Keep all employees informed about the business and how supply chain disruptions will affect it. Provide access to product manufacturing, shipment data and other relevant information. Empower employees to take necessary actions when a disruption occurs. Develop close relationships with suppliers.
Build in flexibility. Adopt standardized and simultaneous processes, and manufacture products in semifinished form. Flexibility keeps operational costs low and minimizes the impact of a critical disruption. Develop a dynamic supplier network for efficiently adding or changing suppliers as needed. Add redundancy across critical functions and supply lines.
Make things visible. Visibility is being able to track and monitor supply chain events and patterns as they happen or before they happen. This requires improved alert and warning systems, as well as mapping systems for tracking external problems impacting supplier availability.
Establish business continuity (BC) plans. These plans are essential in dealing with supply chain disruptions; they provide a fast recovery and deliver key products and services. Crisis communications should be integrated across supply lines. Identify and eliminate supply chain bottlenecks in the aftermath of a disruption. Make sure all suppliers have BC plans that coordinate with yours and request documentation of these plans as part of the procurement process.
Validate that key supplier plans will work in practice. Conduct joint exercises and workshops. Request documented outcome reports and actions. Review BC plans whenever there is a major change at the buyer or supplier end, and whenever an external threat is identified.
Make changes in procurement policy as needed. Secure redundant sources (where possible); make provisions for alternative suppliers, transport routes and payment methods; and introduce buffer stocks. Expand procurement packages to include manufacturing process data. Implement proper procedures and processes, and establish control mechanisms to ensure they are followed.
Implement technology. Risk event software will help identify which suppliers are more at risk. Advanced technical data packages (A-TDPs) provide suppliers with information such as two-dimensional drawings, three-dimensional models, process maps and computer-aided manufacturing (CAM) data. A-TDPs help identify the most qualified suppliers.
Develop scalable and secure IT systems. The Business Continuity Institute survey found that unplanned IT or telecom outages were the number one sources of disruption. A resilient IT system provides analytics, data and information sharing in real time, as well as scenario modeling and pre-programmed responses. Information sharing infrastructures must have an element of redundancy in order to minimize potential cyber risks.
Once you have built a resilient supply chain based on these strategies, your company will be more competitive because it can react to market changes more quickly.
Toward a standard
The new international business continuity standard ISO 22301 is designed to make alignment easier and improve resilience. The standard can be used by organizations of all sizes and types. A more extensive standard (ISO 22313) is being developed to provide greater detail on each requirement in ISO 22301.
Building Resilience in Supply Chains. World Economic Forum. January 2013.
Supply Chain Resilience 2012. The Business Continuity Institute. 2012.
This article previously appeared in the Oklahoma Manufacturing Alliance newsletter, and is used with permission.
Service failures by outsourcers reach top three causes of supply chain disruption
Zurich, November 7, 2012 - Zurich Insurance Group (Zurich) today announced a newly published survey which reveals that outsourcing failure is now a significant cause of supply chain disruption.
Service issues attributed to outsourcing jumped to third place in the causes of supply chain disruption at 35%, up from 17% in 2011, highlighting the importance that outsourcing decisions have in supply chain resilience. It also showed that 73% of organizations recorded at least one supply chain disruption in 2012 with 39% of analyzed disruption originating from below the immediate supplier.
532 organizations from across 68 countries and 14 industry sectors responded to the survey, which is supported by Zurich and conducted by the Business Continuity Institute (BCI).
Further findings include:
The leading cause of supply chain disruption is unplanned IT or telecom outages with 52% of organizations surveyed experiencing some or high impact disruption as a result, followed in second place by adverse weather, experienced by 48% of firms
Currency volatility rises to fourth place in this survey of disruption. While not traditionally seen as a business continuity area, it shows that the business continuity thinking can be more widely applied
Disruption is also becoming more consequential – financial costs are higher than in 2011 with one in five companies registering a single incident loss of more than €1 million
The UK leads the USA in considering supply chain disruption within continuity programs with 75% doing so in the UK, but only 44% of US-based respondents.
The survey report concludes that effectively managing supply chain continuity is critical not just because of the immediate costs of disruption, but also the longer term consequences to stakeholder confidence and reputation that may arise following a supply chain failure.
Nick Wildgoose, Global Supply Chain Product Manager at Zurich’s Global Corporate, commented: “The BCI Annual Survey has consistently shown that over 70% of respondents suffered significant supply chain disruptions. In the latest survey, the costs associated with just a single incident are in over 20% of cases in excess of 1m Euros rising to 100m Euros. It is therefore critical, especially in the current economic climate, that organizations invest the right amount in their supply chain due diligence and risk management treatment. This should include organizations setting out robust business continuity plans that include consideration of dependency on key suppliers and customers. These plans need to consider what should be needs to put in place prior to the disruption event taking place , what can be done while it is in progress and the improvement lessons post the event. There are a number of encouraging aspects to the survey including the benefit that organizations have got out of carrying out joint business continuity exercises with their suppliers.”
Lyndon Bird FBCI, Technical Director at the BCI, commented: “The jump in disruption caused by outsourcer service failures underscores the importance of viewing service chains differently from traditional product supply chains when it comes to resilience planning – service chains are more complex, and can be harder to unwind or replace quickly when they fail. In-house skills are also lost over time, so dependency on the outsourcer increases, and thirdly decisions to award contracts are often based on transferring a problem or cost savings, not necessarily the criteria for selecting a product vendor”.
The survey, which is supported also by the Chartered Institute of Purchasing & Supply and DHL Supply Chain, is in its fourth consecutive year.
Zurich Insurance Group (Zurich) is a leading multi-line insurance provider with a global network of subsidiaries and offices in Europe, North America, Latin America, Asia-Pacific and the Middle East as well as other markets.
Major shocks over the past few years — including the global financial crisis, the Yemen parcel bomb scare and the Japanese earthquake and tsunami — highlight the most significant threats to supply chains and transport networks: natural disasters, conflict and political unrest, terrorism and sudden demand disruptions.
A new report from the World Economic Forum (WEF), produced in collaboration with Accenture, highlights the urgent need to review risk-management practices to keep pace with rapidly changing contingencies facing the supply chain and transport sector. The report is based on input from executives in automotive, aviation and logistics industries, as well as an interview series and survey involving industry, academic and government experts.
Approximately 93 percent of respondents indicate that supply chain and transport risk management has become a greater priority in their organization over the past five years.
According to the surveyed experts’ assessments, the top management priorities today are:
Trusted networks across business and government;
Effective risk legislation and incentivization;
Improved quantification metrics;
Appropriate data and information sharing; and
Enhanced scenario planning.
Most major organizations have some form of enterprise risk-management approach that addresses local and internal operational risks. In a 2011 survey of almost 400 executives across 10 major industries, Accenture found that more than 80 percent of respondents had an enterprise risk-management program in place, or plan to implement one within the next two years.
Although companies are placing more emphasis on risk preparedness, threats beyond an individual organization’s control can have consequences that cannot be mitigated by the organization alone.
“[T]he interconnected nature of global supply chain and transport networks means modern businesses are often reliant on thousands of independent suppliers and partners located in many countries,” the WEF report states. “Consequently, they both affect and are affected by risks at various stages, from the sourcing of raw materials to the destinations of goods and services, and these risks are not always within the confines of the company’s control.”
According to the report, systematic supply chain and transport risk should be more effectively managed through multi-stakeholder action and collaboration. The key players are the supply chain and transport industry itself, its customers and government policymakers.
Emphasizing the need for significant interaction between businesses and governments to drive improvement in various risk-management methods, the report provides the following recommendations for government and business:
Improve international and inter-agency compatibility of resilience standards and programs;
Explicitly assess supply chain and transport risks as part of procurement, management and governance processes;
Develop trusted networks of suppliers, customers, competitors and government focused on risk management;
Improve network visibility through two-way information sharing and collaborative development of standardized risk assessment and quantification tools; and
Improve pre- and post-event communication on systematic disruptions and balance security and facilitation to bring a more balanced public- and private-sector discussion.
The WEF/Accenture study was published on the same day that the Obama administration launched the National Strategy for Global Supply Chain Security, an initiative aimed at strengthening the global supply chain to protect the American people and secure the country’s economic prosperity. The new program would plan for worst-case scenarios, enabling the government and industries to respond quickly to disasters that could disrupt access to vital commodities. The National Strategy for Global Supply Chain Security outlines clear goals to promote the efficient and secure movement of goods and foster a resilient supply chain system.
“We must continue to strengthen global supply chains to ensure that they operate effectively in time of crisis; recover quickly from disruptions; and facilitate international trade and travel,” Secretary of Homeland Security Janet Napolitano said in a statement.
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