Almost a year after the devastating hurricanes and other natural disasters of 2005, we still hear daily accounts of ongoing issues impacting businesses located in the affected areas, many of which may never recover.

Risk managers of organizations fortunate enough to have avoided large losses in 2005 have an opportunity to focus their efforts beyond the obvious concerns over building and contents coverage. It's a good time particularly to address often overlooked time element exposures.

For those who did suffer losses, it's a time for introspection and review of their risk management plans and time element exposures to determine which approaches did, and did not, work.

Prudent risk managers should perform periodic reviews of their operations and their time element coverages as part of their routine due diligence work. A solid risk management program will have a formalized disaster recovery or contingency plan in place in case the worst happens and disaster strikes. Although the depth of these plans can run the gamut, there are usually a few key components to review. These address mitigating the impact of a serious loss and restoring operations.

Risk managers need to emphasize the question "how will we respond if we have a serious interruption of our business?" The answer helps determine how they tackle the company's time element exposure.

One method involves a three-pronged approach to address company needs. The first is getting reacquainted with "business interruption basics," which includes considering the adequacy of traditional coverages. It also means looking into the wide range of available coverage enhancements that might make sense for a particular business' circumstances.

Second is to understand the interplay of business income and extra expense--or additional expense--and what that interplay would mean to your company.

The third--which most risk managers dread--is preparing the much-maligned business income worksheet. Unfortunately, there's no getting around it. A detailed calculation of business income and extra expense exposures is a necessary evil for any risk management plan aimed at addressing a company's time element exposures.

It's obvious that most commercial entities need to purchase business income insurance to recover lost profits and continuing costs during a period of interruption. But what often is not so obvious are the benefits of certain enhanced time element coverages offer by many carriers.

Consider the example of a fictional New Orleans-based company. In three months time its storm damage was repaired, but as of early 2006, its sales and market share were still below pre-loss levels. Extended period of indemnity, or restoration coverage, could have provided this firm with additional time and funds, beyond the physical restoration period, to rebuild sales and attempt to regain market share.

That same company might also have employees whose skills are in high demand, and who the company would like to retain and pay during the interruption period. Making sure their property policy includes the appropriate number of days of ordinary payroll coverage is important in a case like this.

Another business interruption coverage to consider might be an alternative valuation of inventory. Contents coverage is often valued at actual cash value or at replacement cost, but perhaps a selling price valuation is more appropriate. For example, a distributor whose inventory moves slowly might choose to cover a loss of its inventory at selling price and consequently purchase little or no business income coverage.

There may be a risk factor here if no business income coverage is in place. But if reimbursement for lost profit on those goods at a selling price would mirror what would have been collected under business income coverage, some consideration for this risk management alternative may be warranted.

Recent examples of this are companies whose primary customers or suppliers were located in New Orleans or coastal Mississippi. Loss of income due to the inability of a company's key customers and suppliers to purchase or supply goods and materials--which can happen to any company--generally would be covered by contingent business income coverage, if any. This would be the case as long as the peril causing the damage to the customer or supplier was a covered cause of loss under the company's policy.

Service interruption, civil authority and ingress/egress coverages are also important for businesses whose operations are vulnerable to a utility service interruption or damage/governmental action that may prevent access to company locations. This is particularly the case during storm-related catastrophes. Specific coverage choices such as the types of utility interruption covered, the length of any waiting period or deductibles, and the duration of some of these coverages are critical issues for risk managers and underwriters to address.

While every company needs a disaster recovery plan, there is no "one-size-fits-all" approach. A multilocation service operation has different disaster recovery needs than a one-location heavy manufacturer. A company that is a service provider with minimal exposed physical assets may easily be able to relocate operations after a loss, with little disruption.

A heavy manufacturer is not as mobile, however. It may need extra expense coverage for other plans in place to help mitigate their loss of production. Options such as arranging to have friendly competitors manufacture replacement product should be considered. While this will probably cost more than producing goods themselves, it may be less expensive in the long run if it helps retain customer relationships.

Most carriers offer extra expense exposure measurement worksheets that a risk manager can complete at renewal in conjunction with standard business income worksheets. After crunching the numbers, risk managers often realize their extra expense coverage limits are inadequate. The process of determining how much a company may need to cover these extra expenses, though, should help frame some of the components of a company's disaster recovery plan.

The last piece of the time element puzzle is the business income worksheet. Leading industry suppliers of valuation estimating tools have suggested that a large percentage of commercial entities are highly undervalued. Although these vendors generally provide building and contents valuation tools, the same likely holds true for time element exposures.

Preparation of an accurate business income worksheet is paramount for customers looking to ensure that they have adequate limits, as well as underwriters looking to charge an appropriate premium for the coverage provided. Risk managers need to understand, however, that a business income worksheet is not designed to pre-adjust a loss.

All variable expenses saved during a period of interruption won't be reimbursed under business income coverage, since having been saved, they were never incurred. Conversely, the business income worksheet generally only deducts costs for materials and supplies and not all variable operating expenses.

In response, risk managers often state that amounts computed on business income worksheets are higher than the coverage they believe they need, particularly for blanketed accounts with good spread of risk that can get back into business quickly after a loss. While this may be true, the reporting of accurate values is an important component that assists underwriters and helps give them a better understanding of a company's overall risk.

In addition, risk managers can manage the premium due for these coverages by exploring options such as coinsurance or margin clauses, a lower business income loss limit, or eliminating ordinary payroll coverage. For many, however, the business income worksheet process will always be a painful exercise.

Companies that survived the impact of last year's catastrophes are fortunate in that they can have a second chance to correct any deficiencies those storms may have revealed in the companies' approach to time element exposures. Risk managers now have an opportunity to refine their company's disaster recovery plans and adjust gaps in their property programs to ensure coverages are in place to minimize future time element losses.

Special Reports /

Disasters Set Risk Management Focus On Time Element Exposures

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