Business continuity is no longer the forgotten risk And globalisation and developments in modern process management have substantially changed the risk landscape for business interruption cover says Georges Galey.

When Hurricane Ivan hit the Cayman Islands in September this year it tested the business continuity plans of the island's growing financial services sector. Ivan may have caused considerable damage to over half the 15,000 homes on the islands, but all indications are that the banks and law firms based in the Caymans continued to serve their customers relatively unhindered, as business continuity plans showed their worth.

Events such as this remind companies of the business interruption risks they face. Not all industries are as well prepared or as able to respond, as the banks of the Caymans. Yet there is a general trend towards recognising the importance of business interruption cover.

Growing importance

The role of risk managers has changed over the years and is now far more sophisticated and focused on the economic and financial risks faced by the company.

Big companies and multinationals employ a more holistic approach to business continuity management - ie contingency plans play a central role in ensuring that a company can continue to function in the event of a business disruption, such as after a fire.

It was only a few years ago that companies began to seriously consider the threat certain risks posed to the balance sheet. But preserving earnings power is now one of the main priorities of company management and there is a growing realisation that significant loss of income can be more of a threat than damage to property and plant. This shift is related to the other key trend in business interruption - drastic changes in the risk landscape, particularly as a result of the increasing global interdependence of business and the threat of global terrorism. Overall these two factors are contributing to the increased importance of business interruption cover experienced over the last few years.

Quantifying demand

But quantifying any perceived increase in demand for business interruption cover is far from easy. There is a decided lack of historical business interruption data, such as premiums and losses, following the disappearance of the fixed tariff markets where business interruption and the associated insurance data were systematically collected and statistically evaluated.

To make matters more difficult, combined covers under the same property insurance policy have become common in many markets. Nevertheless, one thing is certain. Fire business interruption insurance is by far the most popular and important form of loss of income insurance, followed by machinery business interruption insurance.

New issues

In particular over the last 10 years, globalisation and developments in modern process management have substantially changed the risk landscape for business interruption cover. And these changes raise interesting issues for insurers. One of the most striking trends has been the development of efficient process management, such as 'just-in-time' deliveries and reduced inventory costs, against the background of globalisation.

Just-in-time (JIT) production aims at reducing stock levels. Although this method ties up less of a company's capital, it makes its business much more susceptible to risk. Businesses using JIT methods do not usually have any stock in reserve to cushion potential disruptions. The problem is exacerbated if companies procure products just in time from a supplier which is only able to manufacture the products at one location, combining the JIT method with single source/single location.

Companies are under pressure to maximise profits, reduce costs and optimise production processes or service delivery. There is also a growing interdependency between companies, which presents its own risks - in some cases manufacturing partnerships between companies have become specialised and exclusive. See figure 1.

The terrorism principles

The other significant development in the risk landscape has been the changing perception of terrorism risk. There are some principles regarding terrorism risk and business interruption cover.

- International terrorism is basically uninsurable - mainly because of the difficulties in assessing the risk - unless cover is provided on a limited basis and for an additional premium.

- Capacity of the private insurance industry is not sufficient to provide extensive cover of large commercial and industrial risks unless pooling agreements can be combined with a partnership between state and private insurance industry.

- New ways and means need to be found to assess and control terrorism exposures and to price insurance and reinsurance covers.

- The accumulation potential between the different lines of business is much higher than previously assumed and needs to be better controlled not only for terrorism but also for other man-made exposures.

Promising prospects

Prospects for fire business interruption insurance are promising. They have been helped by the deregulation of the markets and the growing realisation that significant loss of income counts as more of a threat than damage to property and plant. Indeed, preserving earnings power is certainly one of the main priorities of management.

The global nature of business combined with the mutual dependency of industry and service companies are leading to a concentration of potential risks, on the one hand, while, on the other, the emergence of 'extended factories' is encouraging international collaboration, which allows substitution and backup facilities. Globalisation can therefore be seen as both a threat and an opportunity.

Close collaboration between the client and the insurance provider is a key success factor, especially in the area of fire business interruption insurance. Mutual understanding and trust are vital for the collection of business data and for efficient claims settlement. In order to meet the challenge of business interruption cover, and at the same time to make the business profitable, follow the basic underwriting rules:

- All insurance cover has to be paid for; extensions of cover that do not seem crucial can have a broad impact on the portfolio and therefore need to be charged as well.

- Supplementary cover producing a cumulative risk must be limited to well below the sum insured.

- Extreme caution should be exercised when underwriting hidden risks, such as unnamed suppliers or customers.

- Frequently occurring losses are uninsurable, since insuring them would mean a certain loss for both the insured and the insurer.

- Furthermore, substantial participation is now a matter of course for risk-aware companies. Deductibles are therefore unavoidable for fire business interruption covers.

Swiss Re has updated its "Business interruption insurance study", originally published in 1997. The aim of the publication is to provide guidance on how to deal effectively with the complex issue of business interruption.

The new edition expands on the 1997 work by underlying the importance of sophisticated risk analysis, adequate product design and prudent underwriting.

Copies of "Business interruption insurance" are available on

- Georges Galey is the co-author of Swiss Re's publication "Business interruption insurance" and works for Swiss Re's chief underwriting office.

Criteria for cover

There may be many causes of business interruption: a flu epidemic that decimates the workforce for several days and makes production impossible, or a shipment of raw materials which fails to arrive on time. However, the purpose of fire business interruption insurance is only to cover the consequences of a company's impaired business performance following property damage. In other words, fire business interruption insurance should reimburse the company with the amount it would have earned had the insurable incident not happened.

For business interruption to be covered by fire business interruption insurance, the following criteria must normally be met:

- Property must have been damaged either as a result of an insurable event under a business interruption policy or one covered under a property insurance policy that was in force when the loss event occurred.

- Property serving the business operation must be damaged or destroyed.

- The property damage must have been caused at the place of insurance.

The direct cause of damage under a fire business interruption insurance policy which leads to a loss of income that can be proven by the company's accounts must of course be proximately caused by the above-mentioned criteria.

If, for example, a company's operations that have been affected by a fire take longer to recover due to another cause, such as lack of capital, the resulting loss of revenue is not reimbursed.

Figure 1: Case study

A company is the exclusive supplier of a platform (underbody) to a car manufacturer, which uses it for two different car models. A fire in the pressing plant caused by a hydraulic oil spillage leads to the shutdown of the entire production plant for six months. The car manufacturer's remaining stocks are exhausted in a few days.

The consequences are as follows.

- Because the platform maker is the single source of the product, the stoppage has a direct and immediate impact on the car manufacturer, which is unable to make either car model and suffers a contingent business interruption loss.

- Since the platform was developed in collaboration with the car manufacturer and the production facility has been customised for its manufacture, the platform cannot simply be manufactured in a different location or by a different supplier, even though it might be possible to use the press tools available (depending on the press in question).

- The car manufacturer decides to have the platform built by two independent suppliers in future, each supplier having to guarantee that it can supply the car firm's entire annual needs on its own if necessary.

- The platform manufacturer who suffered the fire loss loses 50% of its market share with the car firm and, as a result, suffers a loss of revenue.

- Both parties agree to a contractual penalty, ie a sum of money or other performance that the contractual partner is liable for if it fails to meet its contractual obligations within the agreed time or in the manner specified in the contract.

Globalisation brings new risks as well as opportunities. Companies with businesses interests and partnerships outside their domestic markets are exposed to global risks. In addition, efficiency gains in semi-conductor manufacturing, the pharmaceuticals industry and petrochemical processing have encouraged the creation of major industrial parks, also in emerging markets. These centres for production considerably raise the accumulation risk in the event of a natural catastrophe or man-made disaster.

Source: Author's own.