Insurance Update

Risk Management: Contingent Business Interruption

By ABD Insurance and Financial Services

Understanding the Contingent Business Interruption (CBI) Exposure: Most companies recognize that, if their buildings are damaged by an insured peril, they may be able to recover a portion of the loss through business interruption insurance. But what about those situations where you are not able to produce a product because one of your suppliers can’t make the components you need? Or your contract manufacturer is swept away in a hurricane? What if a customer that buys 25% of your products has a fire and stops purchasing your goods? What happens if you are located in a strip mall and the anchor tenant’s building is damaged but yours is not? These are a few of the scenarios for which you can purchase contingent business interruption insurance.

Risk Management:
The first step in the risk management process is the identification and analysis of the exposure. There are four key questions to ask:

1. Am I reliant on a single provider for any components of the products I sell?

For companies with hundreds or thousands of products this is a difficult question but you can reduce the scope by focusing on those products that produce the most significant portion of your revenue. Start with a list of your top ten products, ask manufacturing for a list of the materials used and then check with purchasing to see if any of the components are single or sole- sourced. (Single sourced goods are available from other companies but you are currently only purchasing from one vendor. A sole-sourced product is only available from a single supplier and therefore is usually more difficult to replace.) You can also work in the other direction and ask purchasing if they can identify products that are sole or single-sourced and then check with manufacturing to see what the implications are. For those goods that have restricted supply, you should review inventory levels, purchase contracts and vendor contingency plans to assess the exposure.

2. Do I use contract manufacturers or other outsourced service providers?

Many companies have elected to outsource manufacturing operations and other services in order to save costs. One consequence of this decision is that the outsourcer has less control over the operations than if they kept production in-house. The sourcing decision can be partial or complete, meaning that the outside company may produce only partially assembled goods or finished goods and they may produce all or part of the company’s supply. CBI risk is reduced to the extent that there are multiple locations, especially if excess capacity exists. The magnitude of the risk also depends upon the number of locations used by the contract manufacturer. If all the work is done in one building there is more risk than if they have multiple locations. Regardless of the number of locations you should make sure to review their building security and safety and their business continuity plans as part of the selection process.

3. Does a small number of customers account for most of my sales?

If one of your major customers reduces their orders because of an insured peril you may be able to recover your lost revenues from a CBI policy. Factors affecting the magnitude of this risk include the number of locations in which they use your product, their lead times and the number of competitors they have (which will translate to sales they lose instead of delayed sales).

4. How reliant am I on my location, relative to other companies?

This exposure primarily relates to retail operations that draw business because of their location near other facilities. For example, if you are a gas station an amusement park and the park catches on fire, your business will decline. You should review your lease to determine how quickly you can move to another location if needed.

Insurance Implications: After you have assessed the level of exposure from the above questions you will be better able to determine how much insurance you need and what deductible is acceptable. Your retention will generally be stated based upon a number of hours of interruption and may be coordinated with your non-contingent business interruption coverage. The cost of the insurance will depend upon the conditions of your suppliers and customers. For example, if you are reliant upon a sole source for your major product, and that supplier has a run-down building, coverage may be difficult to obtain or very expensive. You can help reduce costs by selecting solid vendors and providing information about their safety and security during the underwriting process.

ABD Insurance and Financial Services provides clients with the tools they need to effectively identify and manage their risks. For more information on their services contact Bob Murphy rlm@abdi.com or call (800)246-0901.