Insurance is the last priority when entrepreneurs think of commencing their business activities; they are more concerned with obtaining the governmental licenses and scouting for customers to sell their products and services.
When businesses, especially those in the small and medium sector, think of protecting their assets against potential accidents, the foremost insurance they think of are fire and liability insurances for their premises, but few realize that they need specialized insurance coverage to limit their losses from a disaster.
Common Omission
One of the biggest omissions found in their decision to buy insurance, is financial protection from business interruption. Many of them fail to think as to what could happen if their businesses are unable to open again following a fire or other accidents. The banks and financiers who fund a project also fail to foresee the potential losses they could face if the project does not complete on schedule and as such they are happy to have fire insurance policy as collateral. Research findings point out that business interruption insurance should be part of a company’s business plan and the blueprint needed for any kind of loan or financing.
The reduction in activities after a material damage involves could even put at risk the future viability of the business. The risk management has two tools to provide solutions to protect companies from this threat: Contingency plans and business interruption insurance.
Contingency plans are required not only to survive unexpected disasters, but also to meet interruptions hitting suppliers or customers. For example, if a substantial portion of your supplies comes from companies in India and China, any natural catastrophe causing damages to the country’s infrastructure can disrupt the supply chain, resulting in financial losses to you. In a recent survey conducted by Marsh, the leading global insurance brokers, it was found that infrastructure risks, pandemics and natural catastrophes cause the greatest concern to businesses with Asian supply-chain risks.
Contingency Business Interruptions
The recent announcement of a two-year delay in the delivery schedules for the A380 has sent shivers through major airlines, the biggest impact being felt in the Middle East. The delay, caused due to technical faults, is perhaps outside the scope of insurance, but accidents caused due to external forces could also create similar chaos.
Back in 1995, when disaster in the form of an earthquake struck Kobe, the world’s sixth largest port, the tremors were not felt in Japan alone. The businesses all over the world, which depended on supplies from city based companies, suffered financial losses due to delayed deliveries and reduction in turnover. Toyota Motor Company which had their major factories in the city had to close down for weeks resulting in production cut of 20,000 cars. The Toyota car dealers outside Japan, dependent on delivery from Kobe Plant, were severely impacted.
For an effective contingency plan, the managers need to, continuously, map their risk exposure, identify and prioritize the major issues, run in-depth analysis and program implementation, and finally monitor and control the process.
Business interruption insurance on the other hand basically covers profits that are lost and expenses that continue to be incurred when a company is forced to shut down by a disaster, or even by an event such as an extended power outage. Policies typically have a 48-hour waiting period before coverage starts, but interruptions up to 360 days or even longer period can be purchased.
The quantum of business interruption insurance a company should buy, of course, is not easy to compute. Though primarily an individual decision, the value of business interruption insurance should be considered along with a disaster recovery plan. If businesses are certain they could quickly relocate operations to another site and keep working, they may not require the maximum quantum available. However, disasters like the Sept. 11, 2001 terror attacks and the earthquake in Kobe have shown that the unthinkable can happen. Companies can be uprooted and put out of commission for months, even if they are far away from the zone of disasters.
Without business interruption insurance, with an appropriate extension for contingencies of supplier and customer risk, many have failed in the past. It is better to earmark a small sum for insurance rather than regret later!
(V.A. Tommy is deputy general manager with Al-Rajhi Company for Cooperative Insurance, Riyadh. The views expressed herein are his own and not necessarily subscribed to by his employers.)