Time can pass quickly when recovering from a disaster…beware the Maximum Indemnity Period
Business Interruption policies are unique in that they require both a sum insured and a Maximum Indemnity Period (MIP). Through our conversations with risk and insurance professionals, it is evident that accurately establishing the Business Interruption value with an adequate sum insured and an appropriate Maximum Indemnity Period is a constant challenge.
In this article, we show how your Earnings Statement can be impacted when a Maximum Indemnity Period expires and list some of the tips to help you ensure your organization is not underinsured and can fully recover following a loss.
To start with, it's important to specify what we mean by a Maximum Indemnity Period. The MIP in a Business Interruption Insurance policy is a limited post-incident period for which an insurer will indemnify its client for financial loss.
A RIMS survey in 2017 on Business Interruption insurance highlighted the Maximum Indemnity Periods selected by risk professionals:
Maximum Indemnity Periods may extend to 60 months. However, what is important is that once the period has elapsed, any further loss of profit is no longer insured. Therefore calculating a correct sum insured for the worst and most likely losses is critical to helping your business reestablish itself post-loss.
Unfortunately, all too frequently we see claims where an inadequate MIP has been set.
Inadequate Maximum Indemnity Periods leave a gap where the replacement of assets and the business recovery period extend beyond the MIP stated in the policy.
The following example highlights the need for robust loss scenario and business continuity planning prior to selecting the Maximum Indemnity Period.
A client operated an auto parts manufacturing business in an industrial park in Thailand. During the 2011 floods the entire industrial park was flooded, which caused extensive damage to the Insured’s property, including their production machines.
While the client had previously conducted Maximum Foreseeable Loss scenario modelling, they had assumed that the replacement of the production machines was not on the critical path and that these could be readily replaced more rapidly than building damage could be repaired.
Consequently, the Maximum Indemnity Period was six months in the Business Interruption insurance policy.
Following the loss, the client approached the machine manufacturer for a quotation and projected lead time for the fabrication, installation and commissioning of the replacement machines. Unfortunately, owing to the widespread nature of the flooding, many competitors and other manufacturers in similar industries also had similar needs and got in first. As such the client was obliged to wait six months longer than the usual three month lead time for the replacement machines to be delivered.
Manufacturing ground to a standstill as a result of the flooding and the revenue stream stopped. The building and other services were reinstated within the six month Maximum Indemnity Period, but the production machines did not arrive on site until three months after the Maximum Indemnity Period had expired resulting in an uninsured Business Interruption loss over three months after the reinstatement of the buildings.
The Business Interruption loss during the Maximum Indemnity Period amounted to some USD6 million. However, an uninsured loss of some USD3 million was incurred outside the Maximum Indemnity as the business was restored.
A further blow was encountered when competitors were able to reinstate faster and attract market share away from the client, thereby seriously impeding the resumption of normal business operations and previous market position.
As illustrated in the above case study unforeseen circumstances can lead to uninsured losses. In other claims situations we've seen clients being able to recover and repair machinery and buildings quickly, but being unable to recover lost business. This may be due to contract cancellations or perhaps even a lag in post-loss demand.
Business Interruption Insurance policies are specifically designed to encompass this and provide financial assistance that a business would need to return to its previous pre-loss state. This can include overtime wages for employees, additional promotional expense incurred to win back contracts as well as accelerating the installation of new equipment.
As a result, Business Interruption MIPs must take into account not only the time for reinstatement, but also the time taken to restore the business to its pre-loss state, which is often overlooked.
Determining the appropriate MIP is a significant challenge that requires a full understanding of the business operations and its interdependencies and must be done in consultation with relevant business departments. As well as internal factors, external influences must also be understood and analysed, for example customer supply, denial of access, wide area damage effects, infrastructure damage and many more.
From our conversations with PARIMA members, the default MIP seems to be 12 months, however, 18 month and 24 month Maximum Indemnity Periods are not uncommon. Never-the-less, we found that there was an underlying concern amongst members over the difficulty in combining asset replacement timelines with the business sensitivities, impact and recovery.
In addition, several advised that the MIP was an historic selection that had been in place for many years, being simply renewed on a rolling basis. Even lessons learned from previous losses tended to be overlooked.
Swiss Re Corporate Solutions strongly advocates that corporate risk and insurance professionals consider working with brokers, insurers and loss adjusters with Business Continuity experience, to run in-depth scenario planning when assessing their indemnity period. Although the default selection tends to be 12 months, like many international insurers, we are able to offer an MIP of 36 months and 48 months for petrochemical and complex property risks. However, some factors to think about when calculating your MIP and running a pre-loss analysis exercise include:
Note: The list above is not intended to be exhaustive. It will vary by industry and unique exposures, however it does serve as a good starting point when determining your MIP.
Business Interruption Insurance policies do make a huge difference to whether an organization can fully recover after a serious loss. Fundamental to this, is setting an adequate MIP. In order to do this it is imperative that risk management has proper Business Continuity Plans, clearly identifying the exposures and how the organization will respond to those events, be it a fire, flood, cyclone or other NatCat, a breakdown of machinery, terrorist or cyber-attack or any other form of disruption. Without this thorough planning and attention to detail it is unlikely that the MIP can be properly assessed and set.
In my experience of Business Interruption claims over the last 40 years (I know you're thinking surely not looking at my profile picture) I've seen management being overly optimistic about post loss recovery. This is where risk professionals can help demonstrate what can go wrong and help you avoid the traps that can impact Business Interruption Insurance claims.
As with the case study above, even the best laid plans can go awry and time can fly by as a result of unforeseen circumstances – all of which can impact your recovery.
To explore more examples of Business Interruption losses downloaded our publication here.
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