From its origin back in the 18th century, the appetite for a form of insurance to cover losses of a business due to an interruption has continued to mature and grow. Whether the risk be fire, explosion, hurricane, cyber-attack, or political event, the risks to a business’s financial success have never been greater than they are now.
Back in 1797 a London based insurance company decided that insurance for physical assets was just not enough and they attempted to introduce a form of consequential loss insurance covering a company’s ability to pay interest as a result of losses to its physical assets. Whilst this did not really catch on due to an absence of standard accounting principles, the concepts were not forgotten and then in 1817, the English Hamburg Fire office began to offer loss of rent insurance as an extension to its fire insurance policy.
It was not really until the creation of uniform accounting standards in 1854 when the development of business interruption insurance really commenced. At that time Alsace France introduced a cover known as “Chômage” Insurance, which meant cover due to factory or labour stoppage or unemployment. This cover provided a fixed additional indemnity, say 15% of an asset’s value due to loss or damage. Over the coming years, London insurers adopted this concept and similar cover was offered in the London market starting around 1868. Later, across the pond in America, fire insurers introduced the concept of cover for “Use and Occupancy”, which provided a fixed indemnity per day for each day a company was prevented from operating.
Whilst each of the above forms of insurance provided cover for financial losses due to an inability to operate, these covers failed to provide a “true indemnity” for financial losses, as the amounts recovered were not based on a business’s actual financial loss, but rather an agreed additional fixed amount. It was not until 1899 when an actuary and insurance broker, Ludovic MacLellan Mann crafted what was called Consequential Fire Loss Indemnity (in other words, loss in consequence of damage). This later became what is universally known as Consequential Loss Insurance which was unique in that it moved away from a fixed or per diem indemnity and instead focused on a company’s real financial losses.
It was from that point that today’s widely accepted principles for consequential loss became common, albeit different names were used, including Consequential Loss Insurance, Gross Profits, Business Interruption Cover, Gross Earnings, or Business income. With the exception of amounts retained by the insured for deductibles or limitation of cover due to time, these policies tended to be policies of indemnity which sought to provide cover for a company’s true financial loss. However, these original consequential loss policies had one significant concept in common – they responded to financial losses stemming from physical damage to an insured’s own property.
Whilst these modern day consequential loss policies provided a great improvement over the earlier policies, they still did not address the fact that many risks, that may materially affect an insured’s business, come from external factors whether this be from customers, suppliers, contractors or intangible factors such as the weather, geopolitical factors, cyber attacks or disruption of the supply chain. Further to this, businesses have financial exposures due to product recall, terrorism and loss of reputation.
With these increased risks comes an appetite for more comprehensive and broader wordings and insurers have responded with new policies and extensions. For example, a quite common extension to most Property Insurance policies is Contingent Business Interruption Insurance, or cover for losses contingent upon an event at a third party, which responds to losses suffered by an insured due to damage or interruption at a customer or supplier. For insured’s building new factories, power plants or industrial complexes, insurers have created Advance Loss of Profits or Delay in Start-up insurance which provides cover for financial losses due to insured accidents or events which delay the commencement of business operations, therefore covering future potential losses.
Markets such as Russia are well placed to benefit from the development and advancement of business interruption cover elsewhere in the world and to educate businesses about the financial risks and benefits from business interruption insurance. As other regions such as China begin to embrace business interruption insurance, it is essential that the new and improved practices are adopted, rather than older versions which may not suit the businesses of today.
Where do we go from here and what is the future of business interruption? Accountancy enabled the introduction of Business Interruption insurance and remains integral to its future. As forensic accountants dealing with business interruption losses across the globe, we are finding today’s businesses more complex than ever before, with tight links to suppliers and customers, and fortunes highly dependent on what happens in the broader economy. As such, comprehensive insurance programs that address a plethora of business risks are required. With more market sophistication and increased knowledge about the financial losses businesses face, we expect there will be more focus on risk analysis, including pre-loss review and risk mapping. Forensic accountants who specialise in Business Interruption risk can help businesses ‘upfront’ to ensure potential exposure data is available and policies are matched to the risks faced by the industry in which the company operates (one size does not fit all). Because of this enhanced understanding, we expect the evolution of business interruption loss cover to continue to evolve, working to achieve a financial protection package addressing most business risks. The latest big development is cover for non-damage risks, such as weather, cyber, geopolitical factors, or events incurred in a business’s supply chain. This is just a sign of things yet to come as Insurers continue to innovate to meet the needs of their clients.
By Flemming Jensen and Dmitry Norkin. Published in the UIEA (Union of Insurance Experts and Adjusters) Up-to-date Insurance E-Almanac.