The damage caused by the March 2011 earthquake and tsunami in Japan caught the world by surprise. The devastation was indescribable at the local level. Also shocking were the resulting losses by businesses thousands of miles from the wreckage—losses suffered due to an interrupted supply chain.
You always hear the term “global economy,” but it takes something like what happened in Japan to prove it’s real. Stories quickly surfaced of auto manufacturers, distributors and other companies here in the U.S. unable to continue operations because their product source overseas was shut down indefinitely.
Your firm’s commercial property policy covers only direct physical damage by a covered cause of loss such as fire or windstorm. Your firm’s business interruption policy (assuming you have one) kicks in to help compensate for lost income resulting from a covered cause of loss. So what happens if your firm is not directly damaged by the cause of loss, but a business that your firm depends on is?
Consider the following:
-If a business that buys a significant amount of product from you suffers damage in a hurricane, would you be able to replace the money they can no longer pay you?
-If a business from which you buy a significant amount of product suffers damage in a hurricane, would you be able to find a replacement supplier?
-Could such a loss cause you to have to negotiate less favorable purchasing terms?
-Could you face a breach of contract due to the inability to uphold a contractual requirement, such as a pre-determined quantity of product?
Securing adequate business interruption coverage can be complicated for many insurance buyers, and the complexity often scares business owners away from the purchase—a frightening truth due to the fact that most businesses don’t fully recover after a disaster because of lost income.
The Japan disaster adds a couple of additional concerns to the already nettlesome process—specifically, cause(s) of loss, coverage territory, and period of restoration.
CAUSE(S) OF LOSS
Coverage under a typical business interruption policy is triggered only if the event causing the loss, such as windstorm or fire, is covered by the policy. In the Japan disaster, major causes of property damage included earthquake and tidal surge, both of which are excluded by standard commercial property insurance.
To bring excluded perils under your policy, consider purchasing earthquake and/or flood coverage by endorsement. If such endorsements aren’t available, you may need to turn to a specialty policy sometimes called a “Difference in Conditions” (DIC) policy. If you go this route, keep in mind that they are not traditional insurance policies and should be carefully reviewed in order to determine if business interruption is applicable.
“Dependent properties” is a term used by the business interruption policy to describe businesses on which your firm depends for the purchase or sales of goods and services. For example, consider how a building materials manufacturer relies on a large home improvement store or building materials wholesaler. If the store or wholesaler suffered damage that prevented them from doing business, the manufacturer would likely suffer lost income.
It’s important for your firm to consider those companies on whom you depend to operate at your normal capacity. This is the first step to securing adequate coverage. Ask yourself these questions:
-How long could I tolerate that company’s inability to supply things to or purchase things from me?
-Is a contingency plan, such as an agreement with an alternative supplier, in place?
-Are there contractual obligations, such as a purchase agreement, that I could violate if that company is shut down indefinitely due to the loss?
Most business interruption policies can be modified by endorsement to cover damage to a dependent business. Some companies may ask for a separate limit of insurance applicable to the dependent business. Others will pay the loss out of your business interruption limit. Some insurance companies will offer coverage if the dependent business’s operations are reduced due to the loss; others may require a complete cessation.
A typical business interruption policy will require that the dependent business be located within the policy’s coverage territory. Traditionally, this territory includes the U.S., its territories and possessions, Canada and Puerto Rico. If the dependent business is located outside the coverage territory, such as in Japan, a different version of the dependent business endorsement may be required.
PERIOD OF RESTORATION
This term refers to the time between the date the loss that interrupts the business occurs and the date by when the damaged property should be repaired or reopened elsewhere. It represents the amount of time you are usually able to receive payment from your business interruption policy. If you are adding coverage for dependent businesses, consider potential differences in this time frame. For example, if your business is damaged, you may be able to make repairs and reopen in only a few months. However, if the dependent business is in Japan, it may be several months before repairs are able to begin.
There are many factors in determining adequate business interruption insurance. The process becomes more complicated when insuring dependent businesses. We can help you with this important process, including determining your exposure and setting coverage limits. Call today.