Enhanced Business Interruption for SMEs

Should a major incident such as a fire occur at the premises of a manufacturing company it is highly likely that there is going to be an interruption to the business that will mean that the company loses income. They will also incur additional costs to try to maintain the business.

In its basic form a Business Income insurance policy can indemnify a company for the loss of income. However, conventional business interruption policies provide only limited cover and leave companies severely exposed to significant uninsured loss.

Limitations include that the loss result from a defined peril that all too typically is described as all risk of physical loss or damage but then excludes such things as earthquake, flood and subsidence. Additionally, only incidents at the insured´s premises are covered so that if there is an event at a key supplier´s premises for example there is no cover under the standard commercial insurance policy. Lastly, the business interruption policy only provides an indemnity to the company during the period of restoration of the damage; the business interruption policy does not continue to respond if the there is an ongoing interruption to the business after the physical loss is rectified.

Whilst there are many more business interruption policies commercially available such as Supply Chain Business Interruption and Reputational Risk these tend to be offered only to the likes of S&P 1000 companies. SMEs are left with few options.

With commercial insurance being limited many companies and increasingly small and medium size enterprises (SMEs) in particular are looking to captive insurance structures to plug the gaps in business interruption exposures.

The advent of captive insurance products for SMEs has seen the development of several business interruption covers to meet middle market demand. Such insurance policies include such things as supply chain, key customer, key personnel, loss of license, loss of utility and reputational risk to name but a few. These policies are being taken out by companies wishing to augment commercial insurance protection by using captive insurance as a control mechanism within their enterprise risk management (ERM) framework.

Enterprise Risk Management

ERM is a risk based approach to managing an enterprise that integrates internal control with strategic planning to increase overall stakeholder value.

The risks faced by an organization may include the following by way of example: -

• Hazard - Liability torts, Property damage, Natural catastrophe

• Financial - Pricing risk, Asset risk, Currency risk, Liquidity risk

• Operational - Customer satisfaction, Product failure, Integrity, Reputational risk;

• Internal - Poaching; Knowledge drain

• Strategic - Competition, Social trend, Capital availability

An interruption to the business is a fundamental exposure faced by an SME that can be addressed by ERM. Incidents may arise from each of hazard, financial, operational and internal risks. Working within the ERM framework and controlling exposures by nonconventional insurance methods can significantly add to stakeholder value.

Captive Insurance and Risks it can Insure.

It is important to distinguish between the risks being faced by an organization and what can be insured. ERM encompasses all risks faced within the organization and not all can be insured as a means of response.

Businesses face a plethora of risks some are speculative where there is a chance of loss or gain such as currency movement and some are pure risks where there is no chance of gain e.g your building either remains undamaged or it is burnt down by fire. Only pure risks and fortuitous losses are insurable.

Insurable risks may appear to be more tangible and therefore more easily identified, more easily evaluated, transferred and monitored. Whilst it provides a limited approach insurance can be an important part of ERM. Further, this approach may fit better to the focus of the entrepreneur run business.

Whilst there are many subtleties that are required to be addressed in a captive structure, in its most basic form a captive insurance company is an insurance company owned by an organization that insures the risk of the organization. Rather than using a commercial insurance company the operating entity places insurance risk with its wholly owned insurance company.

There are several benefits for an SME to operate its own captive, including: -

• Individually designed Insurance policies

• Control over claims handling

• Control of underwriting

• Retention of underwriting profit

• Formal monitoring of losses

• Encouraging a risk management focus

By providing bespoke insurance coverage captive insurance can help protect an SME for risks that commercial policies fail to insure, for example: -

• Supply Chain – the policy provides protection should an event occur (not necessarily limited to damage) so that a supplier cannot provide needed goods or services. Such an event may be a port strike for companies needed to import goods or a fire at the supplier´s premises, or a volcano eruption that stops flights bringing in needed parts such as occurred in Iceland in 2010.

• Loss of key customer – this policy indemnifies for the loss of a key customer due to a sudden and unexpected event such as a fire at the customer´s operations or political risk such as an export ban being imposed or the insolvency of the company.

• Reputation risk – probably the greatest intangible asset that an organization has is its reputation. Should something happen to impair a good name significant loss of income can occur and it can take several years to regain that reputation.

• Loss of key employee – the loss of a key employee can have a major impact on the running of a business. Loss may be due to such things as death or disability or breach of a contract of service.

• Loss of license – the loss of a license due to a fortuitous event such as a medical malpractice that leads to the suspension of a medical license or the loss of Medicare accreditation due to an administrative action.

• Loss of utilities – interruption to telecommunication or electricity due to a prolonged outage can have significant impact on a modern business. The interruption may be due to severed cables or denial of access of servers for example.

• Cyber risks – companies are evermore dependent upon technology and such technology is evolving faster than commercial insurance can respond. This policy should be “broad-form” to ensure developing risks are accommodated.

• Other contingent risks – this is a “sleep easy” coverage that picks up any sudden unexpected and unforeseen events not otherwise covered by more specific business interruption policies.

These policies, designed for the individual SME, do not need to be limited to the period of restoration as employed by the commercial insurance policies. Instead the indemnity period can be established to give the business time to fully return of full capacity.

There may be limitations on what can be spent in terms of extra expenses under a commercial policy that are not present in the captive policy. All expenses reasonably needed to maintain the business and return it to its pre-loss state are accommodated.

In conclusion

Commercial insurance is limited in its protection of SMEs. SMEs are susceptible to significant loss due to events not provided for by commercial insurance and / or to an extent in excess of commercial insurance coverage.

A blended approach of enterprise risk management and captive insurance can provide a company with enhanced protection to cyber risks that adds to stakeholder value.

Working with risk professionals that can establish and manage a captive insurance company provides the SME with resources to identify, evaluate, design a response and monitor the SMEs particular business interruption risks and help them maintain the business should an interruption occur.

SMEs should speak with risk professionals such as Albion Risk Consulting S.A. to discuss how a captive insurance company can help them.

Albion Risk Consulting S.A.