Insurance Market Update: Subsequent Business Interruption

While there are very few constants in today’s business world, the need for insurance is one that every CFO takes time to review annually or even more often. And with the insurance marketplace offering fewer offerings and increasing tight limit availability, the need to assess and adjust to the continually rising premiums is more important than ever.

Whereas general property and liability account increases usually hold steady at around 10 to 15 percent, certain industry segments are seeing substantially higher increases. Those sectors that are especially vulnerable to cyber-attacks are a case in point, given that cyber-related claims continue to climb in both the frequency and severity of losses. The result is predictable: premiums rise, and limit availability is dropping. Losses for the cyber segment last year were 3x the premium collected. That trend is continuing, so it is imperative that CFOs ensure that strong cybersecurity controls and risk protocols are in place. In fact, documentation detailing such protocols is increasingly becoming an essential part of an application even to receive a quote from many insurers.

This blog will discuss a critical area that CFOs will need to attend to as part of their post-pandemic analysis and strategic planning for 2021 and beyond: Subsequent Business Interruption.

Subsequent Business Interruption

While reopening and rebuilding costs are certainly making the news in 2021, an overlooked issue lies in what is known as “subsequently triggered business interruption coverage.” A recent article in Enterprise Risk magazine marks business interruption as the top item on the business executive worry list in 2021 (41 percent of votes), ahead of the pandemic outbreak (40 percent) and cyber incidents (40 percent). The article cites Allianz’s annual risk barometer, which notes that: “All three risks – and many of the others in this year’s top 10 – are interlinked, demonstrating the growing vulnerabilities and uncertainty of our highly globalized and connected world, where actions in one place can spread rapidly to have global effects.” 

 “All three risks – and many of the others in this year’s top 10 – are interlinked, demonstrating the growing vulnerabilities and uncertainty of our highly globalized and connected world, where actions in one place can spread rapidly to have global effects,” the report said. “Building greater resilience in supply chains and business models will be critical for managing future exposures.”

Defined as “insurance coverage that replaces business income lost in a disaster, business interruption insurance “is not sold as a separate policy but is either added to a property/casualty policy or included in a comprehensive package policy as an add-on or rider.”

The most immediate concern, as Investopedia explains, is that most “ standard business interruption insurance does not reimburse policyholders if the business is closed due to a pandemic. Even some all-risk insurance plans have specific exclusions for losses due to viruses or bacteria.” According to James Lynch, chief actuary and senior vice president of research and education of the Insurance Information Institute: “The standard business interruption policy only applies when the business sustains direct physical loss or damage, such as a fire. Business interruption can also apply when a nearby business sustains direct physical loss or damage, and a civil authority like the government closes all businesses as a result.”

Given the situation of the past 18 months, a CFO would be remiss not to undertake a full review of the company’s business interruption rider and complete thorough due diligence into the costs and benefits associated with ensuring at least partial coverage for pandemic viral or bacterial situations like those associated with COVID-19.  

Generally, most business interruption insurance covers reimbursement in whole or in part of the following:

• Profits that would have been earned had the event not occurred, usually based on the prior month’s performance.
• Fixed costs, including operating expenses and other incurred costs of doing business.
• Costs involved with moving to and operating from a temporary business location.
• Costs associated with the commission and training associated with equipment or machinery replaced or brought into use due to the interruption event. 
• Extra expenses beyond the fixed costs required to keep the business to continue operating while the company gets back on solid footing.
• Employee wages, though it is essential to clarify that the policy rider has been structured to all include full payroll for every employee for the usual limit of 12 months.
• Taxes.
• Loan payments. 

As noted, the standard loss period is traditionally limited to 12 months starting the day of loss but be sure to check the limit clause when reviewing quotes and policies. That said, some policies might cover payroll for key personnel and others for 90 days, especially if you are a family business, have many skilled staff, are a vital employer in town, or want security for your staff at all levels. An amendment can be negotiated as part of a policy to cover this additional time limit.

Another issue that has emerged in the past year is that many brokers and businesses are not adequately trending out their financials for the 12 months that commence on the last day of their policy period. For example: With a January to December policy and company fiscal period, the limit set for 12 months of coverage for January 1 might be sufficient for some or most of the coming year. However, suppose you suffer the fire on December 31. In that case, your loss is now a reflection of the next year’s financials, which, if not trended out in January of the policy inception, will see the business fall short for things like common inflation to your expenses or any new revenue generators coming online that next fiscal year.

This issue can extend to the reconstruction of buildings lost due to interruption events as well. Standard policies limit this period to 12 months, starting the date of loss. That said, the pandemic was anything but normal. Rebuild times were often extended significantly during the recent pandemic. In some jurisdictions, getting rebuilding permits approved was taking as long as 8months. Lessons should be learned that this limit period might not be long enough and demands negotiation with the insurer.    

 In short, CFOs should attend carefully to extended trending on an annual basis and be aware of the implications of not doing so as thoroughly as possible.

Conclusion

The lessons from COVID-19 have been profound and deeply felt. Business can be disrupted radically and suddenly in ways many business owners cannot comprehend, whether through familiar events (fire or flood) or something as aggressive and devastating as a global pandemic. But to simply acknowledge the fact that many standard form insurance policies excluded pandemic business interruption is, Adiyta Khanna notes, a dangerously “shallow look at the issue” (“New CAS Research Brief on Pandemic Business Interruption Risk”).

The bottom line: CFOs must continue to educate themselves on the shortfalls that standard form insurance policies as much as they do on the rising price of insurance premiums. And they need to act on this new left of knowledge to build a new, more creative, and inclusive template to guide future negotiations with insurers as well as strategic business development and comprehensive risk mitigation.