Appalling Consequences of an Interruption to Business
A board's failure to heed experienced advice about the consequence of a "Business Interruption" sent its company into liquidation almost two years after a serious fire.
The stock and premises of the 25 year-old printers were 90% destroyed. The insurance failed to meet its immediate needs and after a desperate struggle for survival the £5m turnover company was put into receivership.
Just after the fire took place, the directors had discovered the company's insurances weren't up to the task expected of them. They included Business Interruption Insurance (BII) and this, in particular, was the root of the company's downfall.
Business Interruption Insurance replaces lost revenue when a business cannot trade following a fire, flood or other serious (insured) loss. It is an essential lifeline for any business; without it the overheads cannot be paid.
BII consists, broadly, of the sum insured required to keep the business afloat while recovering from the event and the period of indemnity, the time that it will take to achieve a return to operational breakeven, usually a period of between eighteen and twenty-four months but in special circumstances up to thirty-six months.
To calculate the sum insured and the period of indemnity insurers provide a formula. Information from the company's accounts is applied to the formula so that the amount available equals the amount required to keep the business afloat. However, there is a trap.
Information required by insurers is often expressed in different terms from those used by an accountant. This requires interpretation and interpolation of the accounts to make the formula work. People get bored; they start to guess or to make assumptions on gut feel, hoping for the best
Since the premium is broadly proportional to the sum insured and the period of cover, there is a temptation to underestimate both, to save money. Insurance is a grudge purchase and management boards typically take no interest in anything other than the premium from year to year. Great savings can be achieved by convincing oneself that:
- "We're not likely to have a fire; flood explosion or anything else."
- "It would only take us a few months to recover even if the whole lot went up"
- " We can get a loan if we need more cash"
The effort of preparing for an unexpected event in the print company’s case was "too difficult" and "too expensive" to contemplate. The insurance broker tried hard to explain the need for adequate protection and advised the board that it looked seriously underinsured. The advice was ignored.
After the fire, the insurer’s loss adjusters found that the company was in breach of the policy conditions for cover:-
- The seat of the fire was in overheated machinery that should have been switched off.
- Stock had been stored above the permitted height level.
- A new alarm system had been installed without insurer’s knowledge.
In addition, the company had underestimated its BII both in terms of period of indemnity and values at risk as:
- It really needed insurance cover for 30 months to ensure it could get back to breakeven. It had bought 12 months cover.
- It was also underinsured by 40%. The management board had not given proper attention to the calculation of values at risk for the sum insured.
The directors were simply unaware of the policy terms and conditions because none had read it nor the exclusions and conditions of cover. They had no idea of the impact of the terms of their insurance.
As a consequence of the breaches of policy conditions and underinsurance:-
- The Insurers decided to investigate the company and its directors. It had reasons to entitle them not to pay the claim. Whether this was fair within the policy terms was an issue.
- Meanwhile, the interim payments or other payments that the insurer may otherwise have paid, were not forthcoming;
- The company’s bank would not make loans to a company in distress particularly one with such a deficiency in its insurance cover.
- Insurers prevaricated on payment until the company declared itself insolvent - and so avoided payment under the policy.
In the light of this grim story we set out our thoughts.
Avoiding the pitfalls - Where to start?
If a management board is serious about wanting good protection it must start by properly assessing the levels of risk. This is often in the “too difficult” box for management and so it is not done. It is very easy to overcomplicate the assessment of risk, likely losses, their costs and outcomes.
The essence of every business can be simplified into five compartment:.
- its customers/clients
- its people (employees and outsource contractors)
- its financial resources and reserves (especially cash)
- its infrastructure (the premises, machinery and plant, tools, fixtures, fittings, stock and raw materials, computer systems and all the other properties and contents that form the essential infrastructure of the business)
A good way of starting to assess costs and outcomes of a business interruption is to take each of these in turn and, identify first of all the “must haves” and “can’t do withouts” in each heading and then consider how the dependencies of one upon another may affect the business operation and flow.
This is not a five-minute job but if it is carried out efficiently, and with expert advice, once every three to five years, with an annual refresher review for significant changes, that is probably a good benchmark.
The company’s woes were not caused solely by inadequate insurance protection. The discipline of assessing the reality of a business interruption event is as important as buying the insurance protection for those parts of the interruption for which insurance is available. Only by carrying out a periodic reality check does a management board have any warning of the consequences they might one day face.
After the event – getting paid by insurers.
Insurance companies in today’s highly competitive insurance industry go to great lengths to establish whether or not they are legally obliged to pay a claim in any given situation.
They employ loss adjusters, forensic accountants and lawyers amongst other professionals, to meticulously scrutinise the causes of the loss and damage and this can include looking at company management documentation to see how the company was run, managed and directed. They are seeking to ascertain if there has been any failure to disclose material information (which can entitle them to avoid the policy in its entirety) or any breaches of terms and conditions which will allow them to escape liability for the claim.
All this can take a very long time and can be very stressful for the insured. Investigations can run on for months or years and be complicated by unfamiliar legal and insurance language. Insurance companies recognise that if the business cannot continue to trade without its insurance coverage then there may no longer be a claim to be paid out once the company has disappeared.
The moment there is any doubt as to whether the insurers will pay quickly and in full is the moment to seek independent expert advice.
This can be obtained from some insurance brokers, loss assessors or independent insurance claims advocates. These are insurance professionals who are familiar with insurance market customer, practice and precedent. If the claim is delayed for purely legal reasons then solicitors can be an appropriate source of advice but very often the delay in paying claims concerns insurance market practice and commercial issues.
There is much benefit in trying to resolve disputes about insurance coverage through negotiation and commercial dispute resolution means before resorting to litigation.
In summary: our top tips on BII insurance cover
- Never assume your business cannot suffer an “unexpected event”
- Do not assume insurance will protect you and pay for everything that happens; it rarely does.
- A business interruption usually turns out to be more costly and reputationally damaging than is contemplated round a boardroom table - don’t underestimate the cost of the consequences.
- Get expert help in assessing your business interruption damage potential and review it at three-year intervals.
- If insurers start to quibble about paying a claim take early advice from insurance professionals.
- Don’t enter into litigation before you have expert insurance professional opinion as to the likelihood of success and the cost of losing.