Off-The-Shelf Business-Income Policies Can Sink TechCompanies

Change comes ever more quickly in todays markets, and companiesthat dont keep pace may not survive. Nowhere is the pace of changemore rapid than in technologyespecially the life sciences andinformation and networking technology industrieswhere newadvancements have led to extraordinary growth for manycompanies.

Growth, however, creates special challenges for corporateinsurance buyers when it comes to business income coverage. Astandard, one-size-fits-all policy may not adequately protecttechnology companies that are growing rapidly, investing heavily inresearch and development, or competing in ever-changing markets.While such companies often bet their future on their latestproducts, inadequate business income insurance is a gamble theydont have to take.

Although technology companies may share some characteristicssuch as rapid growth and change, their businesses can differgreatly. Those differences mean that business income insuranceneeds can vary widely from software developers to integratedcircuit designers, medical device manufacturers or biotechnologycompanies. For example, a software developer may be able to fullyrecover from a loss within weeks, while a pharmaceutical companymight take years to restore operations and still never recovertheir market position. This shows why it is crucial to tailor abusiness income policy to a companys individual needs.

Companies developing new technologies and drugs anticipate rapidgrowth from those products. Strong growth, however, can render thisyears business income limits inadequate for a loss that continuesinto the following year.

For example, a company growing at a 25 percent annual rate thatbases its business income limits of $5 million on this yearsprojected income of $25 million and then suffers a loss on day 364of the policy year, would find that those limits fell short of itsactual needs by $1.25 million, or 25 percent.

To make sure a policy provides adequate protection, it iscrucial to look not only at where a business might be a year fromnow but where it will be two years, and then establish limits basedon that calculation. Besides growing organically, many companiesare expanding rapidly by acquiring businesses to add to theirproduct offerings or expertise. Growing companies also may add newmanufacturing capabilities or move into new markets. An insurancepolicy for such a company needs to take into account the expectedevolution of that business.

New products are the lifeblood of technology companies, andspeed to market is crucial. Often, its not necessarily who has thebest product, but who gets it to market first. When new productsare delayed by a property loss, a company can suffer significantincome losses by being beaten to the market by a rival. A businessincome policy that includes protection against such a new productdelay can help offset the lost profit opportunity. This importantfeature recognizes that the income loss from a new product delaymay take significant time to manifest itself. To address this, theinsured is given up to 24 months to make a claim after a directphysical loss.

The competition to be the first to market means a heavy relianceon research and development. Technology companies may invest 30percent or more of their profits into R&D. Those companies needa policy with a two-part definition for business incomethetraditional definition of net profit or loss, plus continuingexpenses for the core business. They also need a separatedefinition for the R&D operations that includes continuingexpenses and net profits, if any, but does not subtract losses fromthose operations.

For many technology companies, operational profits are a longway off. A standard business income policy would not respond to anincome loss when, after calculating the amount of loss, it wasdetermined that the companys losses exceeded its expenses.

For instance, a telecommunications switch manufacturer, that hasboth R&D and manufacturing operations, would not be eligiblefor any recovery under a standard business income policy if it wasoperating at a net loss of $3 million and incurring continuingexpenses of $2 million.

Under the standard business income definition (net profit orloss plus continuing expenses), the recovery in this case would bea negative amount, $1 million. For this reason, policies targetingcompanies heavily engaged in research and development operationsshould always include insurance for continuing expenses andextraordinary expenses for R&D operations, regardless ofwhether the company is profitable.

Start-up and research firms often rely on milestone paymentssuch as endowments or grants to further R&D operations. Aproperty loss that prevents them from completing a milestone ontime could cause a loss of funding.

Business income policies for such companies should protect theinsured against the loss of benchmark payments that the insured wason track to earn, but for the property loss occurring.

Many technology companies find their fortunes tied to thedecisions of government regulators. A pharmaceutical manufacturermust not only restore its property to a pre-loss state, it alsomust secure regulatory validation of the facility before it canresume production. A damaged facility may not start generatingrevenue for months after it has been restored, because the companymust await regulatory approval before it can resume operations. Abusiness income policy for such companies should include anindemnity period that continues beyond physical restoration ofproperty to operational restoration.

Rapid growth, market changes, research and development, andreliance on government regulators are key issues when developingbusiness income programs for technology companies, as are newproduct delays and reliance on outside financing. Other factors toconsider include:

An extended or unlimited period of indemnity. Companiesmay face continuing losses for years after property is restored asthey woo back customers that have switched to their rivals.

Unique property exposures. Because business income canonly be triggered by a covered property loss, a tailored approachto unique technology industry property exposures, such as cellcultures, scientific animals, communication towers, R&Ddocumentation, or prototypes, is critical.

Controlled environments. Technology firms may rely oncontrolled environments such as clean rooms, which presentcatastrophic business income loss potential even in the wake ofrelatively small property losses, like a small, smoky fire.

Extraordinary expenses. Because of competition,technology companies need the flexibility to incur extraordinaryexpenses to resume operations as quickly as possible. Disasterrecovery plans and extra expense insurance limits should bedeveloped accordingly.

Reliance on data and communications. Companies that aredependent on the Internet are susceptible to network failure orcorruption of products and data by physical damage or maliciousprogramming. Malicious programming costs businesses $1.5 trillionworldwide, according to estimates by PricewaterhouseCoopers.Insurance may help offset such losses.

Interdependencies. Companies not only outsource work,they also provide outsourced services. They need dependent businesspremises insurance (also known as contingent business interruptioninsurance) with a global coverage territory, in case of the loss ofa key customer or supplier.

An off-the-shelf business income policy can spell disaster for atechnology or life sciences company. Insurance that doesnt keeppace with the speed of these businesses can leave a company unableto recover from a loss. A policy tailored to a companys needs,combined with underwriting, claims and loss control representativeswho truly understand the business, can not only protect it from aproperty loss, but also make sure it regains its competitivefooting in todays unforgiving markets.

Steven R. Pozzi is managing director and senior vice presidentat Chubb & Son, as well as chief underwriting officer forChubb's Commercial Insurance business unit. Mr. Pozzi, based inWhitehouse Station, N.J., can be reached at [email protected].

Reproduced from National Underwriter Edition, January 20, 2005.Copyright 2005 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.