Preventing business interruption headaches

Why business interruption losses policies do not always reflect the reality of financial losses, and how to minimize discrepancies through scenario planning. Frederique Hardy, director of Forensic Accounting Services at Crawford reports

Frederique Hardy, director of Forensic Accounting Services at Crawford

A few years ago I worked with an energy company. An incident had occurred at one of its coal power generation plants and I was instructed as a forensic accountant for the business interruption (BI) loss. Under the provisions of the policy, the cost of coal was deemed a variable cost within the rate of gross profit. When generation stopped, coal cost was deemed to cease as well.

Although this was broadly true, it failed to reflect that this particular loss impacted only one of several generating units within the plant. And that the coal for the remaining generating units had become more expensive as a result of the incident. The insured benefitted from volume discounts and, as the coal quantity purchased decreased following the incident, the unit price of coal increased.

It did not fit in as a loss of profit as these units were not damaged and generated as planned, nor did it fit in as an increased cost of working. Although there was a genuine financial loss, there was no natural fit within the BI framework.

A few years later, the same company suffered another similar incident. This time however, having learnt from this first experience, the policy now included provision for such a scenario. Working with their brokers and underwriters, the Insured had modified their BI cover to include a provision for lost volume discounts on raw materials.

This is a good illustration of why organizations should thoroughly stresstest their BI cover. This has arguably never been more important, as organizations face a rapidly-changing risk landscape and a broadening range of BI exposures.

According to the Allianz Risk Barometer 2018 BI is the most important global risk for the sixth year in a row. Along with the traditional physical damage losses associated with natural catastrophes and industrial accidents are losses from non-damage BI, stemming from supply chain and cyber incidents among other potential triggers. For the first time cyber was the mostfeared BI trigger in the Allianz risk survey. It is estimated that last year’s global ransomware attacks – including WannaCry and NotPetya – caused total economic losses of $8 billion1, of which half a billion dollars was attributed to direct and indirect business interruption2. Much of this was uninsured.

Crawford is committed to improving pre-loss scenario analysis as a tool to stress test and challenge BI policy wordings before a claim occurs. This process, which brings together all stakeholders in claims, is particularly suited to complex loss scenarios such as cyber losses. Just as risk engineers are brought in to assess the physical aspects of an organization’s facilities, so corporates can benefit from the forensic accountants’ focus on the intangible assets within their business.

(1) https://uk.reuters.com/article/uk-cyber-lloyds-report/global-cyber-attack-could-spur-53-billion-in-losses-lloydsof-london-idUKKBN1A20AH

(2) https://www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/risk/downloads/crs-cyber-risk-outlook-2018.pdf

June 2018