My focus will be upon the way in which large scale disasters result in very different business interruption exposures and consequent financial outcomes. While chaos theorists may debate the effect of a butterfly flapping its wings, we can see at first hand how supply chains are disrupted, and the business impacts are not always what we may have anticipated.
What happens following a large scale incident can be simply stated thus: either the business cannot supply its products or services or alternatively there is no (or reduced) demand. The logic of both results is readily apparent. The first is easier to reconcile; the business is so damaged it cannot trade, business is lost and a claim for gross profit results.
The second proposition is more complex; here the business may have suffered damage, major or minor, but its revenue has collapsed because its customers are not returning. Either they do not want to do so or they cannot.
For example, there may be a "loss of attraction" of a damaged area that results in customers going to what they see as a less vulnerable location do their shopping. It may perhaps turn out that their businesses, such as offices or factories, permanently re-locate to safer locations. A company relying on the regeneration of a damaged area, thus, finds that its market has gone. Alternatively, the business is rapidly back in shape, but the customer base is just not ready.
A prime example is often seen in the Caribbean area after a storm. Power may be rapidly restored, but the customers are just not there or their homes are so wrecked that they have no need of power. A lot of effort goes into restoring the business quickly and, most major loss claims handling techniques focus on minimising business interruption periods, yet losses are still sustained. The example is an extreme one, but the point is there none the less.
Not in isolation
Where does this take us? It seems apparent that handling the impact of major natural catastrophes from a claims perspective is no easy task.
Not only is it necessary to understand the individual business where damage has occurred, but also to grasp fully the implications of damage around the region, in particular how long key elements of infrastructure will be disabled. In many respects, our example of a power supply is a straightforward one. Since clearly customers will want power as soon as possible, it must be back in the shortest possible time.
Other examples may be harder to address, so let us look at such an example.
We can consider hurricane damage to a hotel, which relies on tourists who come by road. Options are available to fast-track repairs to the hotel and get it ready for action some six weeks quicker than might otherwise be the case. However, the road will not be rebuilt for those six weeks and, indeed, it may well be a few months after that before it is suitable for tourist traffic. What is the right decision from a claims mitigation perspective? The maths are easy, the business pressures and commercial considerations less so. Miss the window for repair and the hotel may be closed for a long time.
What can we learn from those brief examples? As ever, it is critical to understand the business that has been affected, but now we are also concerned with a wider arena of damage and how that will affect the recovery plan for each individual business. From a macro perspective, it may be necessary to get to grips with a particular critical path or blockage that affects all businesses in their ability to recover. The impact of a catastrophe is to remove the single incident from the supply chain in which it would usually sit to the wider business system that is around it.
As a result, coordination of a portfolio of claims is essential to ensure that the best decisions can be made on the best information. Here, we need to link to what local government agencies are doing to get infrastructure back up and running. No longer is the claim to be evaluated in isolation, but it must be considered in the context of what might be called the art of the possible.
Such a pattern emerged following major IRA bomb blasts in London and Manchester. September 11 threw the whole issue of interlinking losses into a starker perspective, but many of the issues had already been debated in the previous incidents. In both London and Manchester, large numbers of office workers changed their work locations after the bombs. For a period, this influenced buying patterns and, hence, income for businesses in both the affected area and immediate surroundings. Clearly-no customers, no demand.
Why should this matter to the claims adjuster and risk manager? The business interruption policy is one that sees no loss at day one but can take into account what happens after the damage. This happens since the policy is triggered by the insured peril, and the measure of quantum is typically evaluated in UK and US wordings as the difference between the gross profit that would have accrued if the business were undamaged and that which did. This is described as "but for" the damage, and it becomes important to understand what factors have affected the revenue of the business and, in turn, the gross profit and which of these factors flow from the business' inability to trade.
If revenue is lost because a business is unable a meet a demand for its products as a result of the damage it has suffered, then that revenue will probably be recoverable. However, if an event permanently blights an area to the extent that the customer base no longer exists, this may be deemed "loss of attraction" and it will not be covered by a standard policy wording. The exact terms of the policy, whether US or UK wording, will dictate the relevant period but the principle is established. Thus, if the city has been flooded but after clean-up, no tourists want to visit, that loss of attraction may well not be part of the claims payment.
The answer for the risk manager is to get the necessary extensions to cover and curtail grounds for debate. The nature of catastrophe is to magnify losses and so there is, perhaps inevitably, greater uncertainty to an outcome than we might see in the case of a single fire. In the isolated incident, post incident planning and risk management will be not dissimilar in their ways of looking at the business and developing plans to get it back in action as quickly as possible. For the one-off event, much of the planning will concern the supply chain rather than the whole issue of demand.
In large scale catastrophes, we need to reflect on how best to mitigate loss and to plan for its impact. The best plans are likely to be those that allow development of multiple scenarios and which ensure collection of good information in a timely and effective fashion. The risk manager needs to consider carefully the scope of cover for business interruption.
Loss of attraction and customers' and suppliers' extensions can play key roles in resolving catastrophe situations.
Large scale incidents have always occurred. What we see now is how globalisation plays out against the natural world, and there is always still much for us to learn in managing the impact of disaster.
- Jonathan Clark is a senior vice president with Crawford & Co.
Web site: www.crawco.co.uk