Part 1 of 2: Property Insurance
Insurance is rarely highlighted in business continuity plans, but, after any disaster, inevitably the question is raised, "Are we insured?" Like any well-formulated business continuity plan, insurance must be given detailed advance consideration. In this series of articles, insurance risk consultant John Sloan discusses the principal types of insurance affecting business continuity.
What to Look for
"Property" can mean any tangible asset, including buildings, contents, computers, motor vehicles, new structures, infrastructure, mammoth projects, aircraft or watercraft. Yet despite this diversity, the same insurance fundamentals apply.
Key questions to consider are:
Are all buildings/structures/assets insured for their current replacement value? Including upgrading and meeting new codes? Property can also be insured on an indemnity, that is, depreciated basis, which is sometimes referred to as "actual cash value."
Are all contents insured for their current replacement value?
Does the policy make any provision for agreed or functional replacement value?
A problem with removal of debris costs is that the insurance amount or allowance can be based on removing debris from an insured building and not an entire, external site, which does occur with massive floods. It should be remembered that the very costly demolition and cleanup costs for the World Trade Center disaster were picked up by Uncle Sam and not the insurers, whose original provision for such costs was probably a fraction of the actual costs, since all concerned would not have imagined an absolute total loss of both towers at once.
Does the policy permit rebuilding with any type of construction or rebuilding on another site?
Does the policy allow for progress payments and fully cover claims preparation costs, including your own employees' time?
Are newly constructed or acquired properties automatically insured by the property policy during the year?
Does the policy allow for reimbursement of protection costs incurred to protect the property after any major loss or damage?
Is the policy subject to any limits which restrict coverage? It is vital for businesses to know the key policy exclusions, exceptions and coverage limitations, especially where property or perils aren't insured at all or only on restricted terms. Insurers' harsh interpretations of "flood" impacted many victims of Hurricane Katrina who thought they were insured. For instance, in some parts of the world, "terrorism" is an absolute exclusion in property and business interruption policies, even though in some cases, the risk is insured or insurable.
Are all accidental damage perils fully insured, or do some perils have limited cover?
Does the policy include a provision for a mutually acceptable claims adjuster to be appointed? This avoids having the insurer's sole choice foisted upon you.
Simple Questions
A few disarmingly simple "future building insurance" questions capture the very essence of business continuity:
If the building were totally destroyed, would it be replaced?
Would it be replaced as new and upgraded to meet modern building codes?
Would a bigger or smaller building be built?
Would a building of different construction, design, usage and utility or location be built?
Would the building not be replaced at all?
Depending on the answers, the future property insurance could comprise variations of current replacement value, functional or agreed value, depreciated or actual cash value or it could be not insured at all.
Thinking AheadHaving different insurers involved with different policy conditions and definitions was the key reason for the lengthy delay in finally settling the World Trade Center claim. The same insurers should be involved for both property and business interruption policies to avoid arguments over coverage or who pays for what.
Businesses should be aware of the basis of settlement for claims to avoid any misunderstandings. For instance, insurers are normally obliged to repair or replace; demanding replacement is not always permitted. Insurers rarely, if ever, pay for property deliberately abandoned, but they may pay for property deemed a "constructive total loss," that is, where the estimated repairs will exceed the building's total insured value. If a building is not replaced at all, insurers invariably will only pay the indemnity/depreciated/actual cash value/market value or agreed value according to the pre-agreed basis of settlement and policy definitions.
Insurers may agree that, if a total loss, a building can be replaced with a totally different type of building as long as their liability is not increased. However, the policy clause must be included in advance.
It is important to have comprehensive coverage for items in transit or at any storage or off-site location at an adequate sum. This can also apply to property stored or located or in transit overseas.
Insuring stock can create a challenge, especially if the values fluctuate during a year. A traditional method is to establish the estimated maximum at any one time and insure for the limit, but declare each month valued at risk and pay premiums or the average. A policy can also include a seasonal percentage increase.
If valuable property is stored at other people's locations, the terms of storage are reviewed to identify liability for loss or damage and to avoid either duplicate or no insurance, as well as to clarify each party's risks and responsibilities.
The accumulation of a large number of highly valued vehicles or mobile plants at one location can create a conflagration risk. The insurance complication is that the total replacement value of the vehicles or plants could be well in excess of what they are insured for, as many vehicles are insured for their current market value, which is not full replacement value. This type of "gap" can be insured by a special policy extension.
Maximum Damage
Another major problem area, which emerged dramatically with the World Trade Center, was insuring on what is termed a "first loss" basis, i.e., the maximum possible damage is estimated and the insurance is based on that amount. Whilst the maximum possible loss concept is internationally recognised and applied in insurance, the inevitable danger is that the final loss could significantly exceed the estimated maximum sum insured, which is all the insurer will pay.
The increased cost of construction, especially after a major disaster, is a big problem when valuing or insuring property and can create underinsured claims. Policies should include coverage for the destruction of undamaged foundations or other property necessary to effect repair or replacement.
Another point is to ensure that any property policy includes what is called an "automatic reinstatement" clause, i.e., that the coverage will be restored immediately after an insured loss just in case another one occurs shortly thereafter, which can happen, especially with natural disasters.
Yet another problem is that of insurers cancelling policies mid term, which many can do. A standard notice period can be 30 days, but, often, broker-arranged policies extend that to 90 days to give time to arrange replacement coverage. Better still is to have no mid-term cancellation provision at all.
Businesses should also ensure their asset register is related to their insurance schedule, so that any property is not overlooked or uninsured, as does happen.
As many insurance policies contain "inner limits" for some risks, such as subsidence, businesses should keep a close eye on these limits during their annual insurance policy review to avoid liability becoming inadequate.
Peace of Mind
With a mega-catastrophe in mind, businesses should guarantee they are insured with financially secure insurers; after all, when a major catastrophe occurs, they do not want their insurers to become insolvent. Businesses whose insurance is dictated primarily by premium costs can find that "el cheapo" premiums can wind up with "el cheapo" protection when disaster strikes.
Next article in the series: Business Interruption Insurance.
John Sloan is the principal of New Zealand-based Sloan Risk Management Services, which is a fee-based independent consultancy concentrating on insurable risks. John's main projects are insurance risk audits and policy reviews. The articles in this series originally appeared in Continuity Central.
© Capital ME 2007
