Risk management is a delicate matter – risk managers have to balance several factors to make sure the company is well-covered, but must also justify the costs to management.
One tricky area that risk managers must navigate is the maximum indemnity period (MIP) of their business interruption insurance policies. If they fail to get this setting right, then damages may fall outside the maximum indemnity period and end up uninsured and ultimately harming the company.
Corporate Risk and Insurance spoke with Peter Newall (pictured), senior claims manager, Swiss Re Corporate Solutions, on the importance of the maximum indemnity period and how risk managers can determine what period to select for their company.
“Determining an appropriate MIP is contingent on having proper business continuity plans, clearly identifying exposures and how the organization will respond to events – whether it’s a fire, flood, cyclone or other natural catastrophes; a breakdown of machinery; a terrorist attack or cyberattack; or any other form of disruption,” he said.
To illustrate the importance of an appropriate MIP, Newall shared a case study in Thailand.
“During the monsoon season in Thailand one year, an auto parts manufacturing business located in an industrial park incurred an uninsured loss of some US$3 million outside the maximum indemnity period,” he said. “This client had set the maximum indemnity period in its business interruption insurance policy at six months – three shorter than the eventual nine months it took to fabricate, install and commission replacement production machines. What the client had underestimated was the ease with which they could replace the production machines; they had assumed that building repairs would take a longer time. Unfortunately, due to the widespread nature of flooding, competitors and other manufacturers also had similar needs and managed to submit their requests earlier to the machine manufacturer for the fabrication, installation and commissioning of the replacement machines.”
Newall added that the company fell behind its competitors, which were able to resume business quicker and draw away some of its market share. As a result, the client was seriously impeded from regaining its pre-catastrophe market position.
In order to come up with the correct MIP, Newall advised risk professionals to work with brokers, insurers, and loss adjusters that have experience in business continuity. Together, they can conduct in-depth scenario planning exercises to assess the correct indemnity period.
“Maximum foreseeable loss modelling should be undertaken for all businesses prior to setting the maximum indemnity period,” he said. “Scenario modelling should also be applied prior to setting the MIP. This should address the elements of the critical path of reinstatement and repair assets and assumptions utilised in the model should be stress-tested for potential external impacts. Wide area damage can result in delays due to increased demand for loss adjustors, contractors, and specialised equipment, and larger companies may get preferential treatment due to spending power.”
Newall stressed the importance of risk managers involving senior business management and technical department heads in the process, to get a better view of the situation. Other factors outside the business must also be considered, such as infrastructural damage to power and water supply, roads, ports, airports, and bridges that prevents business operation.
“Determining the appropriate MIP is a significant challenge that requires a full understanding of the business operations and its interdependencies, and it must be done in consultation with relevant business departments,” he said. “As well as internal factors, external influences must also be understood and analysed. These include, but are not limited to, customer supply, denial of access, wide area damage effects, and infrastructure damage.”
