Business interruption insurance

Technical publishing
Property
Business interruption insurance
Table of contents

Foreword 5

1 A brief history 6

2 Protecting the value of an enterprise 9

Fundamentals 9
Business protection 9
Property values and income 10

3 Susceptibility to disruptions 13
Internal causes 13
External causes 17
The consequences of a disruption over time 19
Loss minimisation 21

4 The income at stake 22

5 Insurance solutions 26
Criteria for cover 26
Basic features for fire business interruption cover 26
Insured perils and exclusions 28
Business interruption systems 30
Estimated maximum loss 34
Extensions of coverage 35

6 Outlook 39

Annex 41

Bibliography 45

Other publications in the “Technical publishing” series 47

Foreword

This publication is based on a previous Swiss Re brochure on the same topic, origi-
nally published in 1997 but now out of print. Since there is strong demand for a
publication of this type, the question was whether to simply reprint it, or update it.

We decided on an update, even though little has changed in the line of fire business
interruption insurance since the year the original publication appeared. One thing
that has changed is the risk landscape – particularly as a result of increasing global
interdependence and the terrorist attack on the World Trade Center. The latter had
a devastating impact on pecuniary loss insurance and raised questions that forced
the insurance industry to reconsider its position, including its exposure under busi-
ness interruption policies.

But there are other reasons why protecting companies’ income streams has become
even more important in recent years. Today, more than ever, risk managers focus
on balance-sheet protection, which adds to the demand for business interruption
covers. At the same time, efficient process management – just-in-time deliveries
and reduced inventory costs, for example – increases the risks for insurers and
reinsurers. Efficiency gains in semi-conductor manufacturing, the pharmaceuticals
industry and petrochemical processing have encouraged the creation of major
industrial parks, which in turn considerably raise the accumulation risk in the event
of a natural catastrophe or man-made disaster.

The aim of this publication is to provide guidance on how to deal effectively with
the complex issue of business interruption. This new version expands the 1997 work
by underlining the importance of sophisticated risk analysis, adequate product
design and prudent underwriting.

Werner Schaad
Chief Underwriting Officer
Property & Casualty Business Group

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1 A brief history

The forerunners of today’s loss of earnings insurances arose in response to the call
for protection against consequential losses resulting from marine and fire damage.
Whereas there was little development on the marine side over the years that
followed, fire business interruption insurance flourished, after some initial problems.

The table following provides a brief overview of significant events that marked the
history of business interruption insurance.

Table 1: 1797 First attempts by Minerva Universal (UK) to insure consequential costs and loss
Historical overview of income.
1817 The Hamburger Generalfeuerkasse covers loss of rent as a supplement to fire
insurance.
1821 Time loss policy introduced in England, also known as the per diem method,
involving daily/weekly compensation.
1857 Chômage insurance introduced in France, known as système forfaitaire. The
consequential cost from a fire loss is covered by a fixed percentage of the fire
sum insured.
1880 Dalton, an insurance agent in Boston (US), introduces the expression “use and
occupancy”, already a familiar concept in fire insurance, for the insurance of the
loss of production following a fire.
1899 The British loss of profits system, where turnover is a key figure, is developed by
Ludovig McLlellan from Glasgow, Scotland.
1906 Business interruption insurance based on the UK model introduced in Sweden.
1910 Machinery business interruption policy approved in Germany by the supervisory
authorities.
1938 The gross earnings form – also known as the US system (see also 1986) – intro-
duced in the United States.
1939 Standard business interruption wordings known as the “standard policy” are
drawn up in England and Ireland, forming the basis of what is known as the UK
system.
1956 Independent fire business interruption policy introduced in Germany.
1986 The ISO recommends replacing the gross earnings form with the business income
coverage form that is frequently used in the US today.
1989/91 Association of British Insurers (ABI) publishes new recommended business inter-
ruption wordings.
From 2000 Greater focus on business interruption exposure in response to society’s increas-
ing dependence on electronic media, globalisation and the terrorist attack on the
World Trade Center.

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Importance of business interruption insurance
Nowadays, business interruption insurance is by far the greatest loss of income line,
which is why it forms the subject of this publication. However, there is a decided
lack of historical business interruption data, such as premiums and losses, following
the disappearance of the fixed tariff markets where business interruption and the
associated insurance data were systematically collected and statistically evaluated.
To make matters more difficult, combined covers under the same property insurance
policy1 have become common in many markets, thereby making it impossible to
break down the figures for premiums, liability limits, deductibles etc.

Nevertheless, a number of general assumptions can still be made:

■ Fire business interruption insurance is by far the most popular form of loss of

income insurance, followed by machinery business interruption insurance.

■ Business interruption policies are common in the industrialised countries,

especially in big industry.

■ Business interruption insurance accounts for less than half of the premiums and

losses in the property insurance line.1

1 Business interruption insurance actually belongs to pecuniary loss insurance, since the calculation of the loss
of income is not based on existing assets. Even if property insurance and loss of income cover are sometimes
offered under the same policy, they are quite different in terms both of their nature and their legal aspects.

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In an automobile plant, industrial robots assemble thousands of individual components in long
and complex delivery chains. A fire in the assembly hall can not only cause considerable property
damage but also lead to delays until production can recommence.

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2 Protecting the value of an enterprise

Fundamentals
A company’s business is determined just as much by profit- and safety-related goals
as by those of a social and ecological nature. A company’s profits are exposed to
risks from a number of quarters, which is why its actual results often deviate from its
business plans. Conducting regular current/target comparisons can pinpoint and
reduce these deviations during the product planning phase or during manufacture.

Entrepreneurial activity is also determined by legal provisions, adherence to which

is monitored by the authorities. Examples include the compliance of new buildings
with fire regulations or rules on safety in the workplace.

Many companies implement safety measures over and above those required by law.
In most cases, however, these were traditionally designed only with the protection
of property or persons in mind. It wasn’t until a few years ago that importance was
attached to risks that posed a direct risk to income, presumably because such risks
are less obvious.

Nowadays, a more holistic approach is increasingly being adopted, especially in big

companies and multinationals. Here, business continuity management – ie making
contingency plans to ensure that a company can continue to function in the event of
a business disruption, such as after a fire – plays a central role.

In order to determine what is posing a threat to income and decide on how to

counter it, a company’s management must identify, assess, evaluate and ultimately
master entrepreneurial risks. Business protection is particularly important if the
consequences of potential disruptions threaten to take on a dimension that the
company cannot bear.

Business protection
Business protection focuses on four areas:

Employees
A large number of employees, or key persons who would be difficult to replace,
might be unable to work for a long period as a result of illness or accident.

Liability claims
Business activities can also cause damage to third parties, eg in the case of product
liability claims. If indemnity has to be paid, the company’s assets are at risk.

Property
Property such as buildings, machinery, raw materials, work in progress, finished
products or personal property that could be damaged, destroyed or become unus-
able in the event of a fire.

Income
Revenue generated by the business is often reduced or cut off completely in the
event of a loss. However, income may also be threatened by external factors such as
production bottlenecks at suppliers, power failures or loss occurrences suffered by
customers.

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 Property values and income
Figure 1 shows the property owned by a metalworking plant, which we will call
Metallo Ltd.

Figure 1:
Metallo Ltd’s property values

5000 Property in 1000 units

4000

3000

2000

1000

Raw materials Manufacturing Foundry Galvanising Assembly Finishing goods Administration

stock hall plant department stock buildings

Total sums insured in 1000 units

Buildings 18 000
Machines and installations 13 000
Raw materials, goods 4 300

The total value, eg of buildings, machinery and facilities, raw materials and finished
goods, is calculated by adding together the separate columns. These values are
generally used to determine the sum insured for the individual groups. The total value
is usually the total sum insured for the pure property cover for buildings and their
contents.

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Figure 2:
Determining the business interruption sum
insured of Metallo Ltd

Start
Raw materials Manufacturing Foundry Galvanising Assembly Finishing goods Administration
stock hall plant department stock buildings

Total sums insured in 1000 units

Variable costs 19 500
Fixed costs 28 000

Determining the insurable value for loss of income is a more difficult and intricate
process.

Figure 2 illustrates the production flow, ie the manufacturing of the finished product
in a series of stages ranging from raw materials to semi-finished goods. The produc-
tion flow becomes thicker after each stage in production, ie the value of the product
increases with each stage in the manufacturing process.

First of all, the plant needs raw materials, which are delivered to the raw materials
warehouse. By storing and preparing raw materials for further processing, their
value rises in the same proportion as their share of fixed and variable costs. Most
of the raw materials are transferred to the manufacturing hall, while a small propor-
tion goes straight to the foundry. Since the intermediate products from the manu-
facturing hall are not required in the foundry, the production flow between the two
units is interrupted. A small proportion of intermediate products made in the manu-
facturing hall is only required again in the assembly hall. The vast majority of the
products – together with parts from the foundry – are sent to the galvanising plant
for further processing. The production flow is therefore much thicker here. A few
of the semi-finished products are transferred from the galvanising plant straight to
the finished goods warehouse for use as spare parts, while the rest are worked into
finished products in the assembly hall.

The value of the production flow comprises both variable costs – which depend on
the volume of goods manufactured – and fixed costs, such as capital costs, mainte-
nance costs, rent, etc. The third element is the profit the company stands to earn
from the sale of its finished products.

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 As Table 2 shows, in 2002, Metallo Ltd generated gross output2 of 50.5 million
units, comprising an operating profit of 3 million units, variable costs of 19.5 million
units and fixed costs of 28 million units.

Profit and loss account in 1000 units

Table 2:
Total performance of Metallo Ltd from the Income 2002 2001
point of view of business economics Sales (net) 48 000 42 000
Change in stock of semi-finished products 2 000 2 000
Own work capitalised 500 1 000
Gross output 50 500 45 000

Outgo
Wages, salaries and social costs 17 000 16 000
Depreciation 2 500 2 000
Cost of materials 19 000 16 500
Packing, freight 500 500
Other charges 8 500 8 000
Total outgo 47 500 43 000
Profit 3 000 2 000

The following chapters explain the significance of these types of costs and profit
when insuring against the loss of income in the case of a loss event.

2 Value of sales and services produced in house plus commercial goods sold to other business units, augmented
or reduced by the value of any changes to the stocks of semi-finished products produced in house and by the
value of any self-built plants (see Gabler Wirtschafts-Lexikon).

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3 Susceptibility to disruptions

Figure 3 shows a production plant that manufactures finished products from raw
materials. Revenue from the sale of finished products flows into the company’s cof-
fers and is used to buy more raw materials and to pay salaries and other expenses.

Figure 3:
Normal operations
Income
Energy supply
Sales
Purchaser of
Purchases Company
finished products
Raw materials
supply
Outgo

– Wages and salaries

– Bank (interest, etc)
Cash flow – Investments
Production – Shareholders
– Others

The type of potential disruptions to small and medium-sized enterprises is not

essentially different from those threatening larger companies. Yet the frequency of
potential disruptions increases in proportion to the size of production units involved
in a company’s production line. This is because the larger number of internal and
external units forms a greater network and thus greater interdependencies arise – a
factor that should not be underestimated.

Internal causes
The product, type of production and the conditions under which goods are manu-
factured determine how susceptible a company is to business disruption. As Figure 4
shows, in sequential production, each of the four machines is essential for manu-
facturing the finished product. The breakdown of just one machine leads to a total
production stoppage. The effects of a disruption are therefore usually severe for
sequential production: any malfunction – no matter how slight – can bring the entire
production to a standstill.

Figure 4: Stage of production

Serial production 1 2 3 4
Finished products
Raw materials

K 100 K 100 K 100 K 100

Machines
Company

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 As Figure 5 shows, parallel production reduces vulnerability to malfunctions: the
same operations (work stages) are distributed among several machines.3 The sum
of the individual machine capacities per work cycle amounts to 100% or more,
depending on installed capacity. If, for example, machine K40 were to break down,
production would drop by about 40% and 60% of total output would remain intact.
If a larger and more powerful machine replaces several smaller ones, the conse-
quences of a disruption are more serious, as there are fewer standby options avail-
able.

Figure 5: Stage of production

Parallel production
1 2 3 4

K 10 K 33.3

Finished products
Raw materials

K 60 K 50

K 45 K 33.3

K 40 K 50
K 45 K 33.3

Machines
K = one machine‘s production capacity as a percentage within one stage of production
Company

In parallel production, capacity utilisation also plays an important role: should

certain systems fail to operate at full capacity, the performance of the others can be
stepped up if one breaks down. A production plant with parallel facilities not operat-
ing at full capacity is therefore less susceptible to disruptions, as manufacturing can
be switched to other machines.

Apart from the physical arrangement and capacity utilisation of the production
plant, the following factors are also important in determining the extent and duration
of a disruption:
■ Repair times for damaged machines, installations and buildings

■ Procurement times for spare parts or replacement machines

■ The degree of dependency on:

– computers for process control

– certain interrelated operational premises
– special work conditions such as dust-free or temperature-controlled climates
(in the manufacture of semiconductors, for example)
■ The possibilities of substituting one machine with another

3 When one machine is permanently backed up by another standby machine with similar specifications, we
speak of “redundancy”.

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 Figure 6 shows what can happen if a disruption occurs. Production has been brought
to a standstill following a short circuit with subsequent fire that has damaged the
only die-casting machine. In the absence of an alternative production facility, there
is danger of insufficient liquidity since there are no more finished products, no sales
revenue, and no income. Such a situation can quickly lead to cash-flow problems.
If the stoppage continues, the result might be suspension of payments or even
bankruptcy, since ongoing costs such as for rent, interest and personnel still have to
be paid.

Figure 6:
Disruption to a company
Income
Energy supply
Sales
Purchaser of
Purchases Production
finished products
Raw materials
Disruption
supply
Outgo

– Wages and salaries

– Bank (interest, etc)
Interrupted cash flow – Investments
Cash flow – Shareholders
Production – Other

Recovery from this type of disruption requires time not only for the damaged
machines to be replaced, but also time for cleanup. In manufacturing food, for exam-
ple, hygiene is top priority: the smoke from a fire on the production line pollutes the
entire premises, so that thorough cleanup is required to meet the relevant production
standards and public health requirements.

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A fire in the production area can pollute an entire building with smoke. Not only do the damaged
machines have to be replaced, the clean-up work takes time and delays production.

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 External causes
Figures 7 and 8 illustrate interferences from outside the manufacturing plant:
■ A breakdown in the public electricity, gas or water supply causes a production

stoppage (Figure 7).

■ A hold-up in the supply of raw materials impairs production or even brings

production to a complete standstill (Figure 8).

Figure 7:
Disruption to the energy supply
Disruption Income
Energy supply
Sales
Purchaser of
Purchases Company
finished products
Raw materials
supply
Outgo

– Wages and salaries

– Bank (interest, etc)
Impaired cash flow – Investments
Cash flow – Shareholders
Production – Other

Figure 8:
Disruption to the raw materials supply
Income
Energy supply
Sales
Purchaser of
Purchases Company
finished products
Raw materials
supply
Disruption Outgo

– Wages and salaries

– Bank (interest, etc)
Impaired cash flow – Investments
Cash flow – Shareholders
Production – Other

“Just-in-time” production aims at reducing stock levels. Although this method ties
up less of a company’s capital, it makes its business much more susceptible to risk:
businesses using just-in-time (JIT) methods do not usually have any stock in reserve
to cushion potential disruptions. The problem is exacerbated if companies procure
products just in time from a supplier which is only able to manufacture the products
at one location (combination of just-in-time method with single source/single
location).

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 Often, relatively complex semi-finished products or assemblies are involved which
take considerable time and technical expertise to replace.

Figure 9 provides an overview of the factors that affect a company’s business

performance.

Figure 9: Incoming Outgoing

Factors affecting the company’s performance
State/society Company Purchaser of
Laws finished products

Public utilities Environment

Electricity, water Water, air

Shareholders/ Waste disposal/

banks/capital treatment
Money Special waste,
oil/petrol refuse
Labour market
Employees

Technology
Information,
communication,
machines
Suppliers
Raw materials

= possible disruptions

The next example describes what can happen if the supplier of an exclusive product
experiences a production shortage.

A company is the exclusive supplier of a platform (underbody) to a car manufac-

turer, which uses it for two different car models. A fire in the pressing plant caused
by a hydraulic oil spillage leads to the shutdown of the entire production plant for six
months. The car manufacturer’s remaining stocks are exhausted in a few days.

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Consequences:
■ Because the platform maker is the single source of the product, the stoppage has

a direct and immediate impact on the car manufacturer, which is unable to make
either car model and suffers a contingent business interruption loss.
■ Since the platform was developed in collaboration with the car manufacturer

and the production facility has been customised for its manufacture, the platform
cannot simply be manufactured in a different location or by a different supplier,
even though it might be possible to use the press tools available (depending on
the press in question).
■ The car manufacturer decides to have the platform built by two independent

suppliers in future, each supplier having to guarantee that it can supply the car
firm’s entire annual needs on its own if necessary.
■ The platform manufacturer who suffered the fire loss loses fifty percent of its

market share with the car firm and, as a result, suffers a loss of revenue.
■ Both parties agree to a contractual penalty, ie a sum of money or other

performance that the contractual partner is liable for if it fails to meet its contrac-
tual obligations within the agreed time or in the manner specified in the contract.

The consequences of a disruption over time

The extent of the business interruption depends on the time taken to restore the
company’s commercial operational readiness, ie so that it can achieve normal finan-
cial results. This includes:
■ The restoration of any buildings affected by the loss event (delays are possible,

such as the time the authorities take to issue building permits or the time needed
to comply with building regulations).
■ The repair or replacement of machines and installations. (Are spare parts available,

along with the skilled engineers to fit them? How long will it take to deliver any
spare parts or replacement machinery?)
■ The replacement of damaged raw materials, work in progress or finished

products.

Further delays are possible even after having repaired the property damage, as the
output of intricate production systems can only be gradually stepped up to target
capacity. It may also take some time to win back those customers who have gone
over to the competition – if they return at all.

As soon as the necessary repairs have been carried out and production starts up
again, we refer to the company as being in technical operational readiness.
Commercial operational readiness, on the other hand, is when the company is once
again able to produce its normal financial results (compare Figure 10, page 21).4

4 Financial results are back to normal once income reaches the level expected prior to the interruption.

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Should the supply of material be disrupted, production may also have to be stopped if energy and
raw materials cannot be procured from other sources. In such cases, suppliers’ extensions offer
some compensation. The minimum requirements: additional premium, a deductible and strict limits!

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Figure 10: Period for commercial
Technical and commercial operational A operational readiness C
100
readiness

80

Turnover in percent
60

40 B
Period for
technical
20 operational
readiness
0

0 3 7 10 12 Months

A Start of business interruption

B Resumption of production
C End of effects on business income

Loss minimisation
There are a number of ways of mitigating the consequences of a stoppage and
ensuing business interruption:
■ Utilising spare capacity in a different part of the same company.

■ Making use of unused capacity in a different company: competitors are often will-

ing to help out.

Example: damage in sugar factory A brings production to a standstill.

Sugar factory B declares it is willing to process the sugar beet on behalf of
factory A. While additional costs for transportation and overtime (extra shifts) are
incurred, factory A avoids having to contend with a reduction in its turnover.

■ Using temporary facilities such as prefabricated or inflated structures, or tents.

■ Procuring replacement machines that are immediately available.

These measures may prevent or at least attenuate a decline in turnover. Whether

they help to reduce an interruption loss depends on the level of the additional costs
incurred.

The success of such measures depends to a large extent on whether contingency

and business continuation plans have been drawn up, whether managers have
been trained in disaster scenarios and whether the employees can be persuaded to
put in an extra effort. The way in which management communicates with staff,
clients and the public in the event of an incident should not be underestimated.

Certain companies constituted under public law – such as electricity and gas
utilities, public transport bodies, public TV and radio stations, telecom carriers and
hospitals – are often legally obliged to provide their services without interruption
(or are forced to do so in the public interest). These types of businesses must imple-
ment measures to prevent stoppages, irrespective of whether such measures are
expedient from a business point of view.

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4 The income at stake

If physical damage prevents a company – for a certain period – from performing

comparably to the way it did before the event, there will be a reduction in income.
If the company’s costs are reduced in the same proportion as its earnings, its profit
will be smaller but the firm will not yet be writing a loss.

Expenses that fluctuate with the level of business activity are referred to as “variable
costs”. These include raw and auxiliary materials, factory supplies, purchased semi-
finished products, commercial goods, depreciation associated with plant operations,
packaging, freight costs and third-party services related to production and turnover.

Costs that are not affected or are not affected directly by a reduction in turnover
are known as “fixed costs”. They have an additional effect on the business result,
and as soon as they are no longer covered by business income, the firm registers
a net loss. Examples of fixed costs are employee salaries5 and social contributions,
rent, depreciation associated with the ageing of machinery (ie more or less uncon-
nected with the plant’s capacity utilisation), maintenance costs for machinery and
buildings, licence and inspection fees, taxes, insurance premiums, administration
and marketing overheads6, capital costs and advertising costs.

In practice it is more difficult to allocate costs for energy consumption (water, elec-
tricity, gas), ie for heating, lighting, air conditioning. On the one hand, a basic price
is usually charged that is allocated to fixed costs. On the other hand, the energy
costs incurred during production decrease in proportion to the degree of business
interruption, meaning that this component actually belongs to variable costs.
Heating, air conditioning and lighting costs develop differently after a disruption
in business – and even increase in some cases. To ensure that these “semi-variable
costs” are not entirely omitted from insurance cover, they are usually allocated to
fixed costs.

5 After employees have served their periods of notice, salaries can be reduced in principle. Nevertheless, they
are usually counted as fixed costs. The core personnel who have been with the company for many years will
not be laid off, as the company will need them again once the business interruption is over.
6 Costs that cannot be billed directly to a specific cost unit group, such as general packaging material, postage,
costs for advertising that is not specific to the product, etc.

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 Figure 11 shows the relationship between production volume, turnover, fixed costs,
variable costs and profit.

Figure 11: Turnover

Turnover, costs and operating profit

Profit threshold

Production volume

Operating profit Loss zone

Variable cost
Fixed cost

As a rule, companies try to avoid or mitigate the impact of a potential disruption in

their business by taking special measures. This is particularly the case if they are
afraid of sustaining a permanent loss in market share or if they have a commercial
obligation to meet, as could be the case for an electricity supplier or public transport
company. This may result in additional expenses to those for fixed costs, which may
improve or further impair the company’s operating result.

Business interruption may therefore at best result in lower net profit or a break-even
result. If the stoppage leads to an operating loss, however, this has to be covered by
company capital. In the worst case, a loss could comprise the company’s entire net
profit and all of its fixed costs.

The income at stake comprises the fixed business costs plus the loss in operating
profit (net profit). Non-operating expenses, such as gains from property deals, are
not included. Put another way: the income at stake is the company’s turnover less
variable costs, ie its contribution margin7.

7 Gabler-Wirtschafts-Lexikon (13th edition) defines the contribution margin as the difference between the
proceeds and the variable cost component of a product.

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Fire is one of the most common causes of property damage in industry, although it is not the only
cause of damage to assets. Water used to extinguish the fire can greatly increase the extent of loss,
and, in some cases, the business interruption.

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 Table 3 shows – by simple examples – how turnover and fixed costs are affected by
a rise in the number of units. The contribution margin shows how many units need
to be produced for a loss-making product to become profitable.

Table 3: Designation Case 1 Case 2 Case 3

Turnover and contribution margin for different Number of units 3 000 6 000 9 000
numbers of units Price per unit 10 10 10
Turnover (net) 30 000 60 000 90 000
Variable costs 6 000 12 000 18 000
Variable costs per unit 2 2 2
Fixed costs 48 000 48 000 48 000
Fixed costs per unit 16 8 ca. 5.3
Profit/loss –24 000 0 24 000
Contribution margin 24 000 48 000 72 000
(turnover less variable costs)

Table 4 reproduces the profit and loss account of Metallo Ltd, showing the fixed and
variable costs and the income at stake.

Table 4: 2001 2002 2003 2004

Income at risk in the case of Metallo Ltd
1 Profit and loss account in 1000 units
(Figures for 2004 are projections)

Income
Sales (net) 42 000 48 000 55 000 70 400
Change in stock of semi-finished 2 000 2 000 3 000 3 000
and finished products
Own work capitalised 1 000 500 1 200 1 600
Gross output 45 000 50 500 59 200 75 000
Other (non-operational) income 1 000 1 000 1 000 1 000
Total income 46 000 51 500 60 200 76 000

Outgo
a Fixed costs
Wages, salaries and social costs 16 000 17 000 19 000 28 000
Depreciation 2 000 2 500 4 000 5 000
(independent of production levels)
Other charges 8 000 8 500 10 000 11 000
Total fixed costs 26 000 28 000 33 000 44 000

b Variable costs
Cost of materials 16 500 19 000 21 500 29 000
Packaging, freight 500 500 700 1 000
Total variable costs 17 000 19 500 22 200 30 000

Total outgo (fixed and variable costs) 43 000 47 500 55 200 74 000
Profit 3 000 4 000 5 000 2 000

2 Breakdown of total outgo by means of cost accounting

into fixed and variable costs and threatened income

Gross output 45 000 50 500 59 200 75 000

Variable costs 17 000 19 500 22 200 30 000
Income at risk 28 000 31 000 37 000 45 000

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5 Insurance solutions

Criteria for cover

There may be many causes of business interruption: a flu epidemic that reduces
the workforce for several days and makes production impossible, or a shipment of
raw materials which fails to arrive on time. However, the purpose of fire business
interruption insurance is only to cover the consequences of a company’s impaired
business performance following property damage. In other words, fire business
interruption insurance should reimburse the company with the amount it would
have earned had the insurable incident not happened.

For business interruption to be covered by fire business interruption insurance, the

following criteria must usually be met:
■ Property must have been damaged either as a result of an insurable event under

a business interruption policy or one covered under a property insurance policy

that was in force when the loss event occurred.8
■ Property serving the business operation must be damaged or destroyed .

■ The property damage must have been caused at the insured premises.9

It goes without saying that the direct cause of damage under a fire business inter-
ruption insurance policy which leads to a loss of income that can be proven by the
company’s accounts must be proximately caused by the above-mentioned criteria.
If, for example, a company’s operations that have been affected by a fire take longer
to recover due to another cause, such as lack of capital, the resulting loss of revenue
is not reimbursed.

Basic features of fire business interruption cover

Fire business interruption cover bears the characteristics of a full-value insurance.10
The claim is usually settled on the basis of the loss of operating profit and the
insured fixed costs that cannot be reduced in the event of a loss.11 Together, the
operating profit and fixed costs, or gross profit12, provide the basis for assessing the
sum insured.

8 In national and international markets, where the UK system applies, the material damage proviso requires the
policyholder to take out property insurance for the entire term of the business interruption policy. The insurer
only pays the business interruption claim if the insured company has a valid property insurance in place to
cover property damage.
9 See also “Extensions of cover”, page 35.
10 The term “full value” actually comes from property insurance. As already explained in footnote 1, business
interruption insurance is a type of pecuniary loss insurance and, theoretically, the insured interest has no
specific insurance value. However, there is such a close link between turnover, gross profit and sum insured
here that it constitutes a full-value principle in practice.
11 If a company makes a loss even without any disruption to its business, the indemnity paid by the insurer is
worked out from the insured ongoing costs less the expected loss.
12 It should be noted that when the term “gross profit” is used outside the insurance industry, it usually refers
to the difference between the sales price of manufactured or traded goods and the cost of production or
acquisition. This difference in definitions can sometimes lead to misunderstandings. See also footnote 7,
page 23.

26 Swiss Re: Business interruption insurance

The basic cover includes additional costs for economically justified measures to
reduce the consequential losses of business interruption. These loss mitigation costs
must have a positive – or at least a neutral – impact on the overall level of loss and
are therefore already included in the sum insured, expenditure for temporary build-
ings, additional work shifts, warehousing or freight costs, for example.

By contrast, extra expenses13 (UK: “additional increase in cost of working”;

US: “extra expenses”) do not need to visibly reduce the insured business interruption
loss during the policy term. A separate sum insured – or a certain percentage of the
sum insured – must be agreed for these expenses. The associated measures are
expensive and cannot necessarily be justified purely from a financial viewpoint.

If a company suffers damage to property and suffers no (or only an insignificant)

loss of earnings, but expects to incur additional costs for keeping operations going,
it can purchase extra expenses cover only for these additional costs. This type of
insurance is thus suitable for service companies, especially for hospitals, electricity
companies or delivery firms, which must do all in their power to maintain their serv-
ices. Extra expenses coverage alone may also be suitable for companies with a
number of separate plants that are not operating at full capacity and which are in
a position to cushion any loss of earnings by swapping production sites within the
company (eg oil companies, wholesale companies).

In principle, insurance cover continues to apply until the financial consequences of

the business interruption loss have been overcome. However, an indemnity period is
normally agreed upon so as to limit the underwriting risk (see “Business interruption
systems”, page 30). As a rule, the policyholder is obliged to resume operations as
quickly as possible. If business in not resumed, however, the insurer’s compensation
criteria and payouts differ widely depending on the insurance practice in the country
in question. In the US or Switzerland, for example, the indemnity amount paid is the
amount that would have been incurred to resume production as rapidly as possible.
In France, however, compensation is based on the loss incurred up to the point
when it becomes clear that the business cannot continue operating.

As in fire insurance, there are principally two options for cash deductibles under fire
business interruption insurance:
■ A fixed amount of money or a percentage of the loss

■ Franchise deductible

The franchise deductible is not recommended, since when processing the claim, it
is impossible to accurately quantify the loss of sales during the business interruption
period. If the loss amount is close to the franchise deductible, there will therefore
inevitably be differences in opinion because “every penny counts”.

13 Strictly speaking, extra costs represent an extension of cover, but are closely related to the loss minimisation
measures contained in the basic cover, which is why we deal with them here.

27 Swiss Re: Business interruption insurance

The waiting period or time deductible approach can also lead to complications in
some cases, especially because the loss mitigation costs are usually highest in the
first days and weeks after the damage causing the disruption, and it is, after all, the
insurer that benefits from this. Even so, in international business, this type of partici-
pation in companies’ own risk helps to prevent frequently occurring and minor losses
(time deductible of several hours), and is also effective as a genuine deductible
(time deductible of several days or even weeks).

Since the abolition of fixed tariffs, fire business interruption insurance premiums
have been generally calculated on the basis of internal company data. The following
elements are used to calculate premiums:
■ The company’s fire and explosion risk

■ The threat posed by other insured perils

■ The company’s susceptibility to business interruption

■ Loss mitigation measures and backup facilities

■ Deductible and indemnity period

Insured perils and exclusions

The perils usually insured are those listed in Table 5 opposite, as well as any direct
consequences, unless explicitly excluded from the cover. In international commer-
cial and industrial lines, basic cover is referred to by the acronym “FLEXA” (Fire,
Lightning, Explosion, Aircraft). Any additional perils are described as “extended
coverage”.

As far as the terrorism risk14 is concerned, there has been a recent fundamental
change in the conditions for taking out business interruption insurance. Emphasis
is once again on meticulous risk assessment and correct formulation of cover,
technical premiums and capacity considerations. Consideration must also be given
to both existing and new state or private-sector national insurance solutions, manda-
tory and part-mandatory covers.

Natural catastrophe cover must also be compatible with national legal requirements.
As with the risk of terrorism, risk assessment is particularly important, as an event
can have ramifications for widespread areas – and subsequently for the entire infra-
structure, too. Supply markets for urgently needed materials and services, for exam-
ple, as well as local or regional backup facilities, may cease to be available or may
only be accessible under extremely tough and expensive conditions, or government
rulings may delay production. In the case of business interruption cover with natural
perils included, technical pricing, compliance with mandatory insurance and tight
control of the cumulative risk all play a central role.

14 See also the Annex, “Business interruption insurance and 11 September 2001”.

28 Swiss Re: Business interruption insurance

Table 5: Insured peril Brief explanation
Basic cover and additional perils Basic cover (FLEXA)
Fire
Lightning Including debris damage
Explosion Not damage from low pressure
Aircraft or spacecraft (or parts thereof) Including falling celestial bodies to
crashing or being forced to make an some extent
emergency landing

General additional perils

Smoke Caused by friendly fire
Water From pipe systems, tanks
Leaking fluids Not water
Sprinkler leakage If no comprehensive water damage
insurance exists
Molten material Not intended spillage
Vehicle collision Mostly without damage to the vehicles
themselves
Building collapse Including content

Additional political risks

Malicious damage Often in connection with strike and riot
Strike Usually including lock-outs
Civil commotion Synonym: riot
Sabotage Excluding acts of war

Natural perils
Storms (associated terms: cyclone, tornado, Usually starting from a specific windspeed
typhoon, hurricane, etc)
Flooding And/or high water
Earthquake Mainly debris and fire losses
Other natural perils such as landslide, Depending on market
avalanche, etc

Apart from FLEXA and extended coverage policies, “all risks” is another type of
potential cover. The relevant manuscript wordings should therefore be checked
carefully and only precise and sound formulations accepted, especially since
ambiguous policy wordings are almost standard in this difficult field. If they end up
before a court, they are often interpreted in the policyholder’s favour. The recom-
mendations made above for the risk of terrorism and natural perils also apply to this
business.

Standard exclusions are:

■ War (including civil war, revolution, rebellion and similar)

■ Other political perils (such as expropriation, confiscation and nationalisation)

■ Seepage and pollution, contamination

■ Nuclear energy risks15

15 See also Focus report “Nuclear risks in property insurance – Limits of insurability”, Swiss Re, 2003

29 Swiss Re: Business interruption insurance

When utility companies started building atomic power stations some 50 years ago,
the associated risks were already recognised. It was known that splitting the atom
carried the risk of an uncontrolled chain reaction. This sort of chain reaction may not
only damage the nuclear power station itself, but also lead to radioactive emissions
and widespread devastation (eg Chernobyl).

Since no one in conventional property and business interruption insurance had any
intention of covering nuclear risks, appropriate exclusions were introduced in direct
insurance policies. These exclusions were deemed adequate in most markets, as
long as the danger of nuclear attacks by terrorists using atomic or “dirty” bombs was
still unknown or continued to be perceived as unrealistic. But the 11 September
attack on the World Trade Center in New York in 2001 made clear that international
terrorists have no scruples about using weapons of mass destruction, even against
the civilian population. In addition, the danger of proliferation of nuclear weapons
has risen sharply in recent years.

In many markets, the reassessment of nuclear risks has revealed uncertainties in

nuclear exclusion clauses. These uncertainties and gaps need to be rectified as
quickly as possible. Depending on the wording of the original exclusion, the follow-
ing additional exclusion is recommended:

“Also excluded are losses of any type which are directly or indirectly related to
nuclear reaction, atomic radiation or radioactive contamination, irrespective of
whether other factors have also caused or contributed to these losses”.16

Business interruption systems

The history of business interruption insurance provided in Table 1 (see page 6)
shows there were a number of different types of cover available in the early years of
business interruption insurance: policies providing a form of daily cash payments,
loss of earnings cover for specific types of cost, and coinsurance percentage and
first loss solutions. In small companies, many of these systems are still in use today
as niche products in different markets. But two main systems have tended to domi-
nate: the UK system, where the cover is known as “business interruption insurance”
(formerly consequential loss insurance) and the US system of “business income
insurance”.

The UK system
Under this system, practical formulas are used to determine the gross profit, the sum
insured and the economic limits for additional costs. Furthermore, a sophisti-cated
method makes it relatively easy to work out the actual loss incurred by the business
interruption. The system is transparent, and all of its individual parts are intelligible,
which is why it has not only established itself in the UK, but in other
continental and international markets as well.

16 A special condition can be agreed to exempt radiation and contamination risks connected with fully
pocessed radioactive isotopes used in hospitals and laboratories or with ionising rays used in medicine,
industry or agriculture.

30 Swiss Re: Business interruption insurance

The insurance is based on the company’s gross profit. This was formerly calculated
by the “addition method”, on the basis of net profit and fixed costs. Nowadays, the
“difference method” is used, where the variable costs are deducted from the
turnover, so that types of cost which are not listed are automatically insured as well.

To establish the correct figure for annual turnover, the amounts of opening and
closing stock need to be taken into consideration.17 The payroll for company
employees is either fully included in the sum insured or – if the payroll can be
reduced in the event of a loss – insured in a restricted form as a special cover.

An indemnity period is agreed, since it can take a long time before commercial
operational readiness is restored – if at all. The indemnity period starts when the
property damage occurs and is often set at 12 months. Shorter or longer indemnity
periods are also possible, depending on the type of business activity, plant and
equipment, and the possibilities for procuring raw materials and restoring commer-
cial operations.

With an indemnity period of 12 months, the sum insured needs to be set signifi-
cantly higher than the reported gross profit of the previous year. Not only does infla-
tion have to be taken into account, and with it, the fact that a loss can occur on the
last day of the insurance year, but also the sales trend must be considered. Deliber-
ate overinsurance is even more advisable, as the premium refund clause cushions
the extra costs incurred.

With indemnity periods of several years, the sum insured must be a multiple of the
annual gross profit.18 With indemnity periods of less than 12 months, however, the
sum insured should be based on the annual gross profit, with an appropriate pre-
mium reduction.

The situation is different in the case of the “declaration-linked method”. Here, a sum
insured estimated on the basis of the future expected gross profit is multiplied by
a certain factor (often 1.33) to automatically provide a safety margin. This method
requires no contractually agreed allowance for potential underinsurance.

17 If stock levels are higher at the end of the business year than at the start, the company has produced more
than it has sold. Some of the fixed costs relate to surplus stock and must be counted towards the sum
insured. Conversely, the fixed costs relating to unsold goods produced in the previous year have to be
deducted from the sum insured.
18 As with the procedure for the 12-month indemnity period, a safety margin for inflation and the sales trend
should be added when calculating the final sum insured.

31 Swiss Re: Business interruption insurance

In the event of a loss, once the policyholder has notified the insurance company
of an expected medium or large business interruption loss, a loss adjuster is quickly
appointed, since much depends on the loss reduction measures that must be taken
immediately. When calculating the loss using the UK system, the following criteria
should be taken into account (the list is not exhaustive):
■ How long did the business disruption last? This highlights one of the main differ-

ences from the US system of business income insurance: compensation in the UK

system is based on how long the company experiences a reduction in its operat-
ing result. During the agreed indemnity period, allowances are therefore made for
the turnover that would presumably have been achieved had the damage not
occurred.
■ What “other circumstances” apply before and during the loss event? In an attempt

to settle the claim as fairly as possible, all external circumstances have to be con-
sidered as well.
■ The actual loss of turnover attributable to the damage is determined (taking into

account the trends described above) by comparing the “standard turnover”19 and
the turnover actually achieved while the damage is experienced.
■ The issue of underinsurance is clarified using the “rate on gross profit”20 and the

comparable annual turnover during the 12 months immediately before the loss
occurred.
■ To work out the final loss amount, the loss mitigation costs within the economic

limit21, along with any additionally insured extra expenses, are added to the
insured portion of the loss of turnover and then any cost savings subtracted.

The US system
The development of the US system for business interruption insurance was not par-
ticularly uniform, mainly because of the different laws in each state. But after ISO
standards came into force in 1986, business income insurance increasingly became
the US market norm. Under this type of cover, the insured business income is
defined in a similar way to the UK addition method already described, ie net profit
plus fixed costs. As with the difference method used in the UK system, the former
“gross earnings form” is equivalent to net turnover minus variable costs.

While the US system is less commonplace than the UK variant in international mar-
kets, it is commonly used for corporations with US roots. There is no fundamental
difference from the UK system: the purpose of both is to indemnify the policyholder
for any business interruption losses as if they had never occurred.

19 “Standard turnover” is the revenue actually generated during the relevant period in the 12 months
immediately before the loss occurred.
20 “Rate of gross profit” is the gross profit as a percentage of turnover during the financial year immediately
before the loss occurred.
21 The economic limit is obtained by multiplying the rate of gross profit with the loss of turnover avoided by
increase in cost of working.

32 Swiss Re: Business interruption insurance

 Given long periods of business interruption, however, the results may be different for
each method, because the US system is based on technical operational readiness
rather than commercial operational readiness. In other words, indemnity is only paid
up to the point when the property damage is repaired and production starts again,
but not up until such time as the company is able to achieve its normal financial
results. No time limit applies.22 Loss of income in excess of this can be insured with
special coverage23 which applies until commercial operational readiness is restored,
subject to the maximum agreed indemnity period.

The business income form offers a choice between annual gross profits cover and
coinsurance percentage cover. The policyholder, depending on how long he thinks
it will take for technical operational readiness to be restored, can insure a certain
percentage of the turnover anticipated over the next 12 months. This might be 50
or 70 percent, for example, or also 120 or 150 percent for periods longer than
12 months. Thus, the purpose of the coinsurance system is to place a limit on liability,
in the same way as the indemnity period applied in the UK system. When calculat-
ing the loss, any underinsurance comes into consideration if the selected coinsur-
ance percentage is less than the proportional share of the actual gross profit.24

Table 6: Item UK US (ISO)

Comparison of UK and US system Policy Separate conditions Appendix to property policy
Scope of cover/ Commercial operational Technical operatinal readiness
insurance protection readiness Option: 1 month post indemnity
period
Finished stock excluded
Loss of market as a Covered during Not covered
result of loss of income indemnity period
Income at risk/ Gross profit (fixed costs Business income
insurance value/ and operational profit) (fixed costs and operating profit)
sum insured Option: salaries separate Option: wage amount separate
NB: insured amount dependent
on coinsurance percentage
Limitation of liability Indemnity period Coinsurance percentage;
usually 12 months no liability period
(compare footnote 22)
No waiting period in Standard waiting period: 72 hours
some cases
Premium calculation/ Fire premium rate Fire premium rate (building)
premium rate (contents) multiplied by multiplied by adjustment factor
adjustment factor (coinsurance percentage)
Premium Premium rate multiplied Premium rate multiplied
by gross profit by insured amount
Indemnity principle Restore operations as Loss of production during
if no loss had occurred repair time
Other Material damage proviso

22 Fortunately, a new trend is starting to emerge in the US market: an indemnity period from 12 to 24 months
can be stipulated for the repair or restoration period.
23 Through a “period of indemnity endorsement”.
24 Example: If the actual annual business income comes to USD 800,000, with a coinsurance percentage of
70%, at least USD 560,000 must be insured, otherwise the underinsurance clause is applied.

33 Swiss Re: Business interruption insurance

Estimated maximum loss
Every insurer must select his participation in an individual risk so that the capital put
at risk is optimally used on the one hand, while ensuring that the probability of ruin
is minimised, on the other. Tried and tested rules help to establish the fine balance
between business risk and profit.

Basically a company’s share of the sum insured reflects its financial obligation. How-
ever, in industrial and commercial insurance in particular – and therefore in fire busi-
ness interruption – the entire sum insured is seldom at risk. Because of this, shares
are established on the basis of the estimated maximum loss. There are a number of
different terms and definitions used in this area: EML, MPL, PML, MFL etc.25

The assessment of the estimated maximum loss is a complex process for large cor-
porations. The thorough analysis involved not only requires business management
and technical expertise, but also experience in risk management. This task not only
comprises estimating the business consequences of damage to property with the
help of loss scenarios, but taking into account loss reduction measures and assess-
ing their effectiveness. In some cases, the latter can play a central role in claims set-
tlement.

Determining the risk of business interruption cannot therefore be based purely on an

assessment of the fire risk, even though this is used as the starting point for evaluat-
ing the time and the extra organisational, human and financial resources needed to
restore the company’s operational readiness. This is because the duration of the dis-
ruption depends on how susceptible the company is to business interruption, ie the
type of production or business it is engaged in. Here are just some of the issues that
need to be clarified:
■ Bottlenecks (eg when using conveyor systems)

■ Internal backup alternatives

■ Redundancies in the operating process (machinery not running at full capacity)

■ Workforce (flexibility regarding overtime and location, trade unions)

■ Similar businesses in the vicinity (for outsourcing)

■ Helpful competitors

Determining the EML from property damage and business interruption losses is
therefore not simply a question of totalling the individually assessed EML amounts.
The secret is to use the maximum combined amount arising from the same loss
event.

25 EML = Estimated maximum loss

MPL = Maximum possible loss
PML = Probable maximum loss
MFL = Maximum foreseeable loss

34 Swiss Re: Business interruption insurance

 Figure 12 illustrates a company with three separate production sites:

Figure 12:
EML at a company with three production sites
A

Output
Input
C

Production sites
Company insured
Production flow

Production areas A B C
Property damage (EML) 5,5 4,5 1
Lost income (EML) 1 4 5
Combined EML 6,5 8,5 6

For each site, the estimated maximum loss has been calculated per property loss
and per business interruption loss. The highest combined sum is produced by
adding together the two EML figures for property and business interruption in each
of the three plants. In our example, this is to be found in plant B.

Extensions of coverage26
The first day of the new millennium immediately presented a tricky challenge to all
property and pecuniary loss insurers: the “Y2K” or “millennium bug” problem. In
the space of just a few years, billions were invested worldwide in preventive meas-
ures. Although the fears turned out to be unfounded on New Year’s Eve and on
1 January 2000, far more importance has since been attached to the specific
problem of date recognition and, more generally, to insurance cover for data under
property and business interruption policies.

This trend has been encouraged by the increasing threat from malicious actions,
which is forcing not only multinationals, but also large national corporations and
even SMEs to take expensive precautions. Excellent products on the market now
provide insurance against temporary impairments to business activity as a result of
IT systems failure. These mainly provide cover for data (eg straightforward loss or
corruption), programs (eg bugs, hacking) and applications software. Such cover is
usually excluded from normal fire and business interruption policies.

26 For more details about extension of cover in business interruption insurance and related income protection
cover, see “Contingent business interruption and other special covers”, Swiss Re, 2002.

35 Swiss Re: Business interruption insurance

Electrical power lines down after the Canada ice storm of January, 1998. External dependencies
are often underestimated. They can be insured by special endorsements added to the basic cover
if strictly limited.

36 Swiss Re: Business interruption insurance

One of the most important extensions of cover, yet one that has been increasingly
disputed in recent times, is the insurance of business interruption following an
officially ordered denial of access (often called “ingress/egress” in the US) to the
company’s own premises following property damage outside the insured site. The
events of 11 September 2001 unleashed claims from companies located a long
way from New York who believed that they had suffered an insured business inter-
ruption because of the terrorist attack. But the product was not designed to cover
such cases. It is therefore important that the policy is limited to the immediate
vicinity (small radius of a few hundred metres at the most). Policy wordings that
allow for “impaired usage” or “obstructed access” only are dangerous.

Another type of extension is known as “loss of attraction” cover. This comes about
when a nearby business, known as a “customer magnet” (eg a big department
store) suffers property damage, and this – in turn – leads to a fall in the turnover
of smaller shops in the neighbourhood. Geographic limitation and – on a general
level – extreme caution are advised with this type of cover.

Suppliers and customers extensions have been around for a long time and provide
supplementary cover for business interruption caused by property damage at
suppliers or customers. But the risk of dependency on external factors has increased
significantly, as many links in the supply chain are directly or indirectly connected in
a global economy – and not just in the case of multinationals.

What used to be modest first risk amounts and percentage rates for contingent loss-
es have in some cases risen so high in recent years that the product is in danger of
losing its original character as an extension to basic coverage. As such, the sublimits
need to be reduced and the deductibles, raised. In the case of named suppliers of
suppliers, and unnamed suppliers and customers, the sublimits should not exceed
roughly 10 percent of the limits for named first tier suppliers because the cumulative
(and partly hidden) risk is very large. In order for contingent business interruption
losses to be covered at all, the following are required:
■ Technical assessment of the risk (rating)

■ Limits for named suppliers/customers

■ Strict sublimits for unnamed suppliers/customers

■ Deductibles and waiting periods.

Finally, greater consideration has to be given to requirements in the reinsurance of

contingent business interruption.

37 Swiss Re: Business interruption insurance

Strict limits need to be set for the often underestimated extension of cover to contin-
gent losses following property damage to public utilities. A time-based deductible of
24 hours or more is essential, since numerous high-frequency losses can pose the
threat of a large cumulative risk. Undesirable risks (exclusion or strict limits) include
disruption through bad weather and damage to overhead power lines.

For years, supplementary cover has been available for notifiable infectious diseases.
Unfortunately this type of insurance, which was originally limited to certain risk cate-
gories such as hotels and hospitals, was also granted almost indiscriminately during
the 1990s in certain markets for any type of service or industrial enterprise. The out-
break of Severe Acute Respiratory Syndrome (SARS) in southern China in 2003 and
its rapid spread across Asia brought the problem of cumulative risk back into the
spotlight in a highly dramatic way.

First, “notifiable disease” covers need to be properly rated, and second, stricter limits
need to be applied again (coverage and types of client). The cover should only come
into force when a business is closed by order of a public authority. The exclusion of
SARS is advisable, because we are still uncertain about its causes, method of trans-
mission and preventive measures. For reinsurers, cumulative control of this funda-
mental risk is essential in countries where this type of cover is common.

38 Swiss Re: Business interruption insurance

6 Outlook

Prospects for fire business interruption insurance are very promising. These have
been helped by the deregulation of the markets and the growing realisation that sig-
nificant loss of income counts as more of a threat than the loss and destruction of a
property and plant. Indeed, preserving earnings power is certainly one of the main
priorities of management.

The global nature of business combined with the mutual dependency of industry
and service companies are leading to a concentration of potential risks on the one
hand. On the other, however, the emergence of “extended factories” is encouraging
international collaboration, which allows substitution and backup facilities. Globali-
sation can therefore be seen as both a threat and an opportunity.

Close collaboration between the client and the insurance provider is a key success
factor, especially in the area of fire business interruption insurance. Mutual under-
standing and trust are vital for the collection of business data and for efficient claims
settlement. In order to meet the challenge of business interruption cover, and at the
same time to make the business profitable, the following basic underwriting rules
should be followed:
■ All insurance cover has to be paid for; extensions of cover that do not seem

crucial can have a broad impact on the portfolio and therefore need to be
charged as well.
■ Supplementary cover producing a cumulative risk must be limited to well below

the sum insured.

■ Extreme caution should be exercised when underwriting hidden risks, such as

unnamed suppliers or customers.

■ Frequently occurring losses are uninsurable, since insuring them would mean a

certain loss for both the insured and the insurer.

■ Furthermore, substantial participation is now a matter of course for risk-aware

companies. Deductibles are therefore unavoidable for fire business interruption

covers.

39 Swiss Re: Business interruption insurance

Indeed, 11 September 2001 may well have been the “day that changed the world.” Accurate
assessments of the full extent of damage will only be possible over the course of time. This is
particularly the case for business interruption, whose financial impact is considerably more difficult
to assess than property damage alone.

40 Swiss Re: Business interruption insurance

Annex

Business interruption insurance and 11 September 2001

The following is a shortened version of an article by Werner Meier, Group Product
Manager Property/Engineering, Swiss Re. The original article was published by
the Geneva Association in August 2002 in the report “Insurance and September
11 – One year after”.

Large parts of the 11 September 2001claims have not yet been settled and paid.
This is especially the case for time element coverage. Property damage and extra
expense can usually be assessed much faster and with more certitude than covers
referring to the financial consequences of impacted business activities. The large
number of businesses directly or indirectly affected makes timely and accurate
claims adjustment very challenging. It will take years until a more reliable overview
on the extent of business interruption insurance losses is possible.

Whatever the final consequences of 11 September will be for time element covers,
there are certainly many lessons to be learnt by insureds and insurers. This cata-
strophe cost many lives and not only caused huge property damage of previously
unthinkable scale for man-made events, but also interrupted or affected thousands
of businesses directly or indirectly and even slowed down the worldwide economy.
Many of the lessons to be learnt are valid for all classes of insurance:
■ International terrorism is basically uninsurable – mainly because of the

impossibility to assess the risk – unless cover is provided on a limited basis and
for an additional premium.
■ Capacity of the private insurance industry is not sufficient to provide extensive

cover of large commercial and industrial risks unless pooling agreements can be
combined with a partnership between state and private insurance industry.
■ New ways and means need to be found to assess and control terrorism exposures

and to price insurance and reinsurance covers.

■ The accumulation potential between the different lines of business is much higher

than previously assumed and needs to be better controlled not only for terrorism
but also for other man-made exposures.

Consequences specific to business interruption

Overall, this event revealed that BI types of insurance represent huge exposures not
only for manufacturing industries but also for service companies. Over a long period
of time, changes in manufacturing practices (eg just-in-time production) and inten-
sive use of IT, particularly also in the service industry, made business operations
much more vulnerable and created substantially higher BI risks. Usually such risks
are beyond the control of the insured, for instance with suppliers or customers’
extensions. Many insureds, becoming aware of the potential exposures in this area,
wanted to transfer the risk to the insurance industry. Due to the soft markets,
insurers and reinsurers steadily increased the scope of covers and limits – often
without the corresponding risk assessment and without the necessary premium
charges – and increased their commitments without always controlling their expo-
sures in the appropriate manner.

Even before 11 September 2001, some risk carriers started to take measures to bet-
ter control this situation and to bring back best underwriting practice. This attack
showed how important such actions are: the broad covers and the high limits of lia-
bility for time element coverages and in particular for contingent business interrup-
tion could, in other scenarios, lead to an unprecedented loss amount. This aware-
ness creates an increase in demand for corresponding protection but it is, for the
same reason and because of a hard market, facing more restrictive underwriting
behaviour with clearer defined and narrower covers, lower limits and higher prices.

41 Swiss Re: Business interruption insurance

Design of covers
Underwriters must verify previously used forms more thoroughly. In many instances,
clarifications or alterations have to be made in the following areas:

Interests covered
It is important to exactly know the subject matter of the insurance and how it is
defined. It should be specified if loss of income or extra expense or rental values or
leasehold interest, etc are covered.

Triggers for cover

In order to allow risk assessment and exposure control, basic cover should only
apply if the loss is a direct consequence of insured physical damage at the insured’s
premises. For a broader scope, coverage must be clearly defined and reasonably
limited. Safety margins should be included in premium charges to compensate for
problems with adequate risk assessment and exposure control.

Coverage extensions
Loss of income or extra expenses should be covered only when access to the
insured business is prevented by order of civil authorities following an insured prop-
erty damage. There is a tendency to apply these extensions only if the insured event
occurs within a certain distance (eg one mile) of the insured premises; this should
limit the accumulation potential and help reduce problems with dubious claims.

Contingent business interruption (ie suppliers or customers extensions, public

utilities)
This should be limited to named exposures only at reasonable limits. If, by way of
exception, blanket cover is granted, limits should be very low. Since it is difficult to
calculate the necessary premiums, underwriters must rely on their own judgment,
and again include safety margins. For terrorism and natural perils, such extensions
should be granted selectively, taking into account accumulation potential, and
should be avoided for unnamed locations.

Indemnity period
Forms used in the US often cover loss of income during the period of restoration of
the damaged property. As this period will be very long in the case of 11 September,
an additional time limit (eg 12 months as from the date of the loss) is introduced, as
is normal for BI covers in the rest of the world. Without a concrete time limit, losses
can assume dimensions never catered for and claims assessment for such long peri-
ods would become extremely difficult.

42 Swiss Re: Business interruption insurance

Risk assessment, premium and capacity
A proper risk assessment must be conducted, with quantification of loss potentials,
not only for manufacturing risks, but also for the service industry. The findings
should lead to prevention measures and contingency planning and should have the
appropriate consequences for premium charges and capacity considerations.

Risk assessment and contingency planning for business interruption is time consum-
ing for all parties concerned. Because of the workload, it is not always possible to
carry out these tasks adequately, and therefore, the exposure remains to a large
extent unknown. We should not forget at this point that if risks cannot be assessed,
they are basically uninsurable!

The following aspects, which represent best underwriting practice, need to be thor-
oughly addressed:
■ What are the effects of insured property damage on business operations?

■ Have the necessary loss prevention measures been taken?

■ Are data backups safely stored at locations well away from the insured’s critical

operations?
■ Does the insured have contingency plans? Is there a business continuity manage-

ment concept in place?

■ What is the likelihood and extent of potential losses (MPL/PML) for individual

insureds?
■ What is the accumulation potential when one event affects several insureds? How

can it be controlled?
■ What premium is required to cover such exposures?

■ What is the influence of BI elements on capacity usage?

These are the most difficult aspects of business interruption coverages and most
unresolved issues – again, not specific to terrorism but in general. As soon as there
is more than one location involved, it is often not possible to assess the risk and
achieve transparency. Interdependencies within the same corporation are normally
automatically covered if all locations are included in the same (master) policy. A loss
at a bottleneck or an event affecting several locations at the same time can produce
a huge loss. Because of lack of risk information and time, these scenarios are often
not satisfactorily analysed and therefore premiums and capacity usage do not prop-
erly reflect exposures.

43 Swiss Re: Business interruption insurance

If this means that limits of insurability are already reached for single fire or explosion
scenarios, then they are most probably exceeded in case to natural catastrophes
and for terrorism. Therefore, when BI coverage for such events is given, it has to be
limited and exposure control for accumulations has to be tight.

Claims adjustment
The adjustment of an individual business interruption loss is already a challenging
undertaking that requires special skills, staying power and a great deal of negotiation.
With catastrophes with hundreds of thousands of policies affected, this becomes
extremely difficult. And when the event coincides with a general slow-down of the
economy, which started before the loss occurrence and influences business far
beyond the directly affected area, it becomes almost impossible to find out the ac-
tual insured losses. How much is directly caused by the insured event? How much
is caused by contributing effects which are not insured? What would have been the
impact of the general economic trend not linked with the insured catastrophe?

Conclusions
The terrorist attack on the World Trade Center had a serious effect on the insurance
and particularly the reinsurance industry and made clear that many changes are
needed. Where terrorism continues to be insured, limitations are key and premiums
have to be charged. There are not so many issues exclusive to business interruption
covers and its derivatives, but some of the more generally applicable lessons are
of special importance for BI. Many of the deficiencies and needs for change in BI
underwriting mentioned above were known before 11 September. To a large extent,
it simply means getting back to basics. This event demonstrated in an alarming way
the urgency and importance for considerable change in underwriting behaviour.

44 Swiss Re: Business interruption insurance

Bibliography

Cloughton, David. Riley on Business Interruption Insurance.

London: Maxwell Limited, 1999.

Eno, Joel, and Prévotès, Jacques. L’assurance des pertes d’exploitation.

Paris: L’Argus Editions, 1996.

Gabler, Thomas. Versicherungs-Lexikon. Wiesbaden: Betriebswirtschaftlicher

Verlag Dr. Th. Gabler GmbH, 1994.

Gamlen, Edwin, and Philips, John. Business Interruption Insurance.

London: Buckley Press Ltd, 1992.

Hauswirth, Jürg, and Suter, Hans Rudolf. Sachversicherung.

Zurich: Schweizerischer Kaufmännischer Verein, 1990.

Helfrich, Klaus J., Büchner, Klaus, and Keller, Ludwig, et al. Feuerversicherung/FBU,
Technische Versicherungen. Munich: Deutsche Versicherungsakademie, 2002.

Hickmott, Gordon J.R. Interruption Insurance, Practical Issues.

London: Witherby & Co Ltd., 1999.

Swiss Reinsurance Company. Business interruption insurance. Zurich, 1997.

Swiss Reinsurance Company. Contingent business interruption and other

special covers. Zurich, 2002.

Swiss Reinsurance Company. Terrorism – Dealing with the new spectre.

Zurich, 2002.

Swiss Reinsurance Company. Nuclear risks in property insurance and limitations

of insurability. Zurich, 2003.

Swiss Reinsurance Company. Terrorism risks in property insurance and their

insurability after 11 September 2001. Zurich, 2003.

Trieschmann, James S., and Rodda, William, et al. Commercial Property Risk
Management and Insurance. Volume 1. Malvern, Pennsylvania: American Institute
for Property and Liability Underwriters Inc., 1994.

45 Swiss Re: Business interruption insurance

Other publications in the “Technical publishing” series

Terrorism risks in property insurance and The economics of insurance The brochure entitled Swiss Re Publications
their insurability after 11 September 2001 How insurers create value for shareholders includes a complete overview of all available
The focus of this publication is on the identifica- The greatest shareholder value is generated by Swiss Re publications.
tion and assessment of terrorism risks and their those insurers who identify and capitalise on Order no.: 1492220_03_en
insurability. The authors examine how these the best business opportunities and have opti-
risks have changed and how the risk community mum operating efficiency. Although this publi-
is dealing with those changes. They compare cation is founded on a detailed economic study,
the insurability of terrorism before and after it caters specifically to practitioners. Examples
11 September 2001, and present a global per- that clearly demonstrate how to apply the
spective of the initiatives and schemes taken by structure in practice are provided, making it
various countries. invaluable for insurance management seeking
Order no.: 1498373_03_en/de/fr to improve long-term profitability.
Order no.: 207_01310_en/de
Contingent business interruption and other
special covers Facultative non-proportional reinsurance
What happens to a business after a fire? and obligatory treaties
Production slows down or stops and turnover Reinsurers often sell non-proportional faculta-
decreases, profits begin to diminish and even- tive covers which use the proportional treaty
tually turn into losses as wages and other limit as the basis for non-proportional cover.
charges continue to accrue. What happens, But to prevent unpleasant surprises to both
though, if goods or services cannot be supplied parties in the event of a loss, cessions to pro-
because of material damage at the premises of portional treaties must be based on the original
a supplier or, perhaps even worse, after a fire risk. The publication explains how proportional
on the premises of an important customer? This treaties should interact with non-proportional
work outlines these special aspects of business facultative covers and aims to counter misun-
interruption insurance, which have gained in derstandings regarding so-called “treaty com-
importance significantly in recent years. pressions”.
Order no.: 1491956_02_en/de/fr Order no.: 207_00230_en/de/es

The insurance cycle as an entrepreneurial An introduction to reinsurance

challenge This teaching aid explains the reinsurance sys-
The fact that insurance buyers, cedants, rein- tem to prospective underwriters and introduces
surers and industrial lines insurers have to live working methods involved using examples and
with fluctuating market prices does not mean graphics. The publication does not pretend to
that the individual company has to sit out the be self-explanatory but is intended as a support
cycle compliantly. There are supply-side strate- for both trainer and trainees.
gies which ensure better results over the cycle Order no.: 207_9682_en/de/fr/es/pt
than by passively standing by and allowing the
cycle to take its course.
Order no.: 1492633_02_en/de In the “Focus report” series:

Nuclear risks in property insurance and limi-

tations of insurability
The international insurance industry has been
screening its existing terms and conditions for
potentially ruinous risks and has identified cer-
tain weak points. One of the most perilous
shortcomings in traditional property insurance
and reinsurance concerns inadequate nuclear
risk exclusions. This focus report examines the How to order
risk by the example of nuclear terrorism and To order a copy of a publication, please send an
outlines possible solutions. email to [email protected].
Order no.: 1500103_03_en/de/fr You can also place your order via our portal at
www.swissre.com. Please include the title of
the publication, the order number and the lan-
guage abbreviation. Language versions are
indicated at the end of the order number as fol-
lows:
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Swiss Re’s P&C publications are edited and

produced by Technical Communications,
Chief Underwriting Office.

47 Swiss Re: Business interruption insurance

© 2004
Swiss Reinsurance Company
Zurich

Title:
Business interruption insurance

Authors of the original 1997 version:

Werner Meier
Michael Kuhn
Antonio Simone
Ezio Sormani

Revised in 2004 by:

Georges Galey
Ezio Sormani
With an annex by:
Werner Meier

Editing and production:

Technical Communications
Chief Underwriting Office

Graphic design:
Logistics/Media Production

Photographs/picture copyright:
Cover: Getty Images, Andy Sacks
Page 8: Keystone, Damien Meyer
Page 16: Keystone, Gaetan Bally
Page 20: Keystone
Page 24: Das Fotoarchiv, Markus Matzel
Page 36: AP, John Lehmann
Page 40: Keystone, David Kapp

The material and conclusions contained in this publi-

cation are for information purposes only, and the
author(s) offers no guarantee for the accuracy and
completeness of its contents. All liability for the inte-
grity, confidentiality or timeliness of this publication or
for any damages resulting from the use of information
herein is expressly excluded. Under no circumstances
shall Swiss Re Group or its entities be liable for any
financial or consequential loss relating to this product.

Order number: 1501270_04_en

Property & Casualty, 09/04, 3000 en
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