In an environment with persistent supply chain disruptions, price escalations, cyber-attacks, and natural disasters, businesses are facing risks that are more difficult to avoid. Financial losses resulting from a business interruption are a significant risk for nearly every business. According to the Allianz Risk Barometer 2024, business interruption (BI) remains one of the greatest risks businesses face worldwide and has been considered one of the top risks for nearly a decade. While it may not be possible to avoid all risks, business interruption insurance helps manage the risk, allowing businesses to restore profitability during the period the business is impacted after a loss.

The annual task of calculating and submitting Business Interruption Values (BIVs) is burdensome and may feel unwarranted and/or repetitive, but it has never been more necessary than in the current environment. The accurate measurement and reporting of potential losses safeguard a business; having adequate insurance coverage can offset partial or total losses at one or more facilities, minimizing the risk to the business and protecting its future viability. Establishing a well-defined and consistent system that produces an accurate measurement of your BIVs and actual exposures can take some of the pain out of reporting values and give management a better chance to evaluate and protect their business.

Managing Business Interruption Risk

Beyond ensuring adequate insurance coverage, performing a thorough review of BIVs and exposures can have many benefits. These include:

  • Allowing for the full understanding of business exposures and insurance programs.
  • Allowing for the customization of the insurance program to meet a company's exposures and needs.
  • Aligning insurance spending with the true exposures of the business and alleviating the risk of paying too much for certain coverages on an annual basis. This is particularly salient as premiums continue to increase year-over-year.
  • Alleviating the risk of incurring a co-insurance penalty, volatility clause, or similar policy terms which may limit your payment based on inaccurately reported values.
  • Providing for consistent analysis and approach in addressing BIVs at each plant and/or location as well as proper accounting eliminations to avoid over-reporting.
  • Eliminating uncertainty by having a transparent model that ties back to reported financial statements.
  • Building credibility with underwriters by having a comprehensive and transparent model.
  • Helping facilitate the renewal process by highlighting exposures and mitigation opportunities.

Insurance Carrier Standard Worksheets

Many insurance companies have their own business interruption worksheets to calculate annual business values (also known as annual ratable values). However, these are general worksheets focusing only on high-level financial figures, may be limited to select industries, and may not fit your specific business. In addition, guidance can be limited, difficult to interpret, and require some judgment calls.

Furthermore, these worksheets are only intended to measure 12 months of ratable values and are not set up to consider a business's true values at risk, including such things as interdependencies, a company's ability to mitigate internally and externally, and other considerations discussed further below. Without addressing these factors, a business's actual exposure is not fully known, potentially adversely impacting the insurance program and coverage, and ultimately proving detrimental to the business in the event of a business interruption loss.

What To Consider for Business Interruption Values

The following are factors to consider when calculating business interruption values, along with some recommendations:

  • Utilize standard financial statements. This will help a company or retained forensic accountant develop a consistent business interruption model that can be applied across every location. A consistent model will remove much of the headache of calculating BIVs, though variances between locations may need to be built-in to the model to consider nuances.
  • Consider what expenses are variable (non-continuing) and fixed (continuing) in the normal course of business.
    • Variable expenses are those which tend to vary with revenues (i.e., as revenues increase, variable expenses increase in a similar manner). Examples of variable expenses include raw materials, direct labor, delivery charges, and credit card fees.
    • Fixed expenses are those which stay fairly consistent regardless of movements in revenue. These expenses are necessary for operations but not necessarily tied to changes in revenue. Examples of fixed expenses include salaries, rent and lease expenses, depreciation and amortization, and insurance premiums.
    • Mixed or semi-variable expenses are those which have both variable and fixed elements. For example, utilities can include a fixed fee (e.g., a flat rate of $500 a month) as well as a usage fee (e.g., $0.50/kilowatt); thus, a portion of utility expense may fluctuate with output and be impacted in the event of a loss. When analyzing mixed expenses, the variable percentage of the expense should be estimated or a three-column approach (projected less actual = difference/change) should be utilized to determine the change in expense.
  • Consider if the company needs ordinary payroll coverage, and if so, how much. Ordinary payroll is labor expense related to revenue-generating operations (generally direct or hourly labor), including all corresponding variable benefits and taxes. Ordinary payroll coverage will provide coverage if a company retains employees who are unable to perform their normal duties after a loss. This coverage can be for the entire loss period or limited to a defined number of days (e.g., 30, 60, 90, 180, etc. days) depending on the insurance placement. The inclusion or exclusion of ordinary payroll can dramatically impact a company's BIVs and the actual insurance recovery should a loss occur.

Business Interruption Exposures

Beyond 12-month BIVs or annual ratable values (including ordinary payroll), a company should evaluate its business interruption exposure by considering:

  • Anticipated changes in the business (e.g., expansions, acquisitions, divestitures, etc.).
  • Anticipated changes in market conditions.
  • Additional exposure related to interdependencies within the company as well as potential downstream impacts.
  • Ability to mitigate a loss through use and replenishment of on-hand inventory.
  • Ability to mitigate a loss through the use of alternate internal capabilities and capacity.
  • Ability to mitigate a loss through use of external resources.
  • Losses continue beyond the physical interruption period because of losing a key customer or market share.
  • Business continuity plans and recovery time objectives in the event of an event.
  • Key suppliers and customers, and the financial impact on your company should one or more of these businesses be interrupted by a loss.
  • Mitigation and extra expense costs associated with loss scenarios (e.g., temporary locations, labor force working overtime, etc.)
  • Financial or operational factors to aid in the allocation of values by location.

These considerations should be identified, evaluated, measured, and factored into an exposure model to help a business determine its true values at risk beyond a hypothetical 12-month business interruption measurement.

Final Notes

Creating a BIV and exposure model can be a time-intensive process and the aforementioned factors can add to the complexity of the model. However, considering and incorporating them during the creation of the model will ultimately streamline the BIV and exposure measuring process in the future. Further, it will allow for accurate reporting of values, giving management a clearer view of the risks the business faces and allowing the business to be better prepared and protected in the event of a loss.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.