By: Bukhosi Khumalo, AIISA, B.Com Hons
Increase & additional increase in costs of working covers: Their increasing relevance in today’s business world
Business continuity planning (BCP) can help businesses understand what risks they face, how best to combat them, and to also interrogate if their insurance cover would be adequate in the event of a large range of possible loss scenarios. This puts the business in a better position to assess and plan for the probable consequences, thereby hopefully reducing the burden during the period over which they will be affected by a loss. Increasingly, we are as brokers required to have an understanding of this and how it affects the advice we give to our clients during our interactions with them.
Fully insuring assets of the business against fire and any other defined events that pose a risk is generally good business practice. However, some do not know or understand what the implications would be to future profits or costs should a loss occur. This article will briefly explore the importance of understanding increase in costs of working and/or additional increase in costs of working and their importance to a business’s ability to continue operating following a loss.
Global Business Interruption Under-insurance
According to the Chartered Institute of Loss Adjusters, 37-52% of business interruption (BI) policies are underinsured with an average shortfall of 45-63% as of 2016. According to the Allianz Risk Barometer (2018), Business interruption once again came top of the list of risks worldwide for the 6th consecutive year. This was according to a research done on data provided by 1900 corporate officials and experts in insurance from 80 countries. Also of concern are natural phenomena which further increase the BI risk in some areas.
Business Continuity Planning
Whilst insurance plays a crucial role for any losses incurred, implementing pre-loss preventive measures is equally important. An effective business continuity plan can make all the difference to the size of a loss and the ability of a business to continue trading and make a full recovery. Some businesses unfortunately never recover from a large loss. There have been many cases where businesses have not been able to recover from a large loss due to the inadequacy of their insurance or inadequate preparation through a solid BCP.
There has been a lot of research into how valuable keeping your current market and clients is with different researchers saying it is anywhere between 5 and 25 times more difficult to get a new market/clientele than to retain an existing one. In the United States of America, according to the Federal Emergency Management Agency, 40-60 percent of small businesses close permanently after a disaster. Among businesses that are closed for at least five days, 90 percent fail within a year.
The insurance industry understands this and there are possible solutions of dealing with the risk of big losses in order to minimise reduction in turnover and/gross profit as well as an increase in costs.
Increase in costs of working (ICOW)
The typical definition on a policy would in summary read as ‘This is the additional expenditure necessarily and reasonably incurred for the sole purpose of avoiding or diminishing the reduction in turnover’. In this situation the insurer will cover the client either for a financial loss due to a decrease in the turnover, or an increase in spending or a combination of both, as long as it is aimed at ensuring there is no further decrease in gross profit.
This concept can be explained by the following example: Suppose a business suffers flood damage and in the process a machine that costs R200,000 is also damaged and importing this machine takes two months as it will be shipped from Russia. On the other hand, the company would have the choice of flying it and that would take two weeks including the ordering time. For every week that the company does not have the machine it loses R15,000 in revenue. This further causes a loss of gross profit of R6,000. If it is flown instead it would reduce downtime by 6 weeks and in the process save the company money.
For a cost to be recoverable under this section it has to satisfy two tests. The first one being the fact that the increase in the costs should be for the sole purpose of avoiding a reduction of turnover and eventually gross profit. In the example above the purpose was to reduce the chances of having a decrease in turnover. The second test is that of the economic limit test Simply put, it means the claim cannot be more than what the client is avoiding to spend; i.e. every R1 spent should be to save R1.
Additional Increase in Costs of Working
This cover is far reaching and gives more as compared to the ICOW above and is an essential part of the advice given to clients as policies are structured as it does not necessarily need to reduce the loss in turnover for the policy to respond. The costs under this section are not subject to the economic test as the ICOW but should be reasonable and linked to the loss at hand.
Some examples of this are:
- Overtime – Paying existing workers for overtime
- Marketing & Retention – Payment for marketing in order to retain customers
- Outsourcing – Having a competitor manufacture on behalf of the company during the downtime period.
- Hire of extra equipment – the hiring-in of plant and equipment to continue with production
- Meeting demand/targets – Employing extra personnel to copy with demand or catch up on targets if applicable
- Welfare – Reasonable food expenses to allow people to put in the extra hours required.
- Employee Safety – Expenses to hire transport for workers who finish their work late.
It is important for businesses to have practical and viable BCP’s in order to deal with future losses. This, coupled with the correct and adequate covers in terms of assets cover, ICOW and AICOW will substantially increase the chances of a business’ survival following a bad loss.
In giving advice, it is important to have in-depth understanding of these three concepts and how they work together to the benefit of a client in the event of an unfortunate incident occurring.