Recent earthquakes in Ridgecrest emphasize a frequently overlooked property risk. Thanks to the Small Business Administration, they identified this pronounced need for funding of a clearly identifiable and measurable risk — the first step in the risk management process for any organization.
Most businesses, if not all, totally missed this risk!
What surprised most business owners: This risk was an issue not only for businesses in Ridgecrest but also for those outside that immediate earthquake zone. This included firms in Bakersfield that sustained financial losses emanating from this seemingly remote disaster.
Most business owners recognize the risk of direct business income — or business interruption — when their business structures are destroyed. In this basic example, most businesses are forced to shut down. Most, if not all, revenue ceases, even though several fixed expenses continue.
What is missed is the indirect risk of loss when there is no direct damage to owned business property, yet such indirect business income losses can be significant.
Here are some examples experienced in Ridgecrest:
Most businesses had basic business interruption insurance, but few had earthquake coverage. (That’s another issue, of course.)
Even fewer businesses — in Ridgecrest or elsewhere — had contingent business income coverage for their loss of revenue where a major customer or supplier in Ridgecrest was shut down in its operations because of the earthquake.
SBA helped fund what it calls “economic injury” for businesses not damaged by the earthquake yet experienced revenue losses from customers or suppliers that did shut down all operations because of the earthquake.
Here are the risks you need to visualize and think through about your own business revenue for such contingent business income losses you may sustain:
Customers: Do you have one or more major customers whose revenue, if lost, would have a significant negative impact on your organization’s revenue?
Suppliers: Do you have one or more major suppliers whose product(s) or service(s) are critical to your ongoing operations? (Remember the supply chain issues that arose in the Fukushima earthquake and tsunami?)
Leader location: Is your business located in a center that would likely be “cordoned off” by civil authorities to prohibit access to the damaged building as well as to your business when a nearby anchor is destroyed by fire or other risk?
Other leader location: Similarly, is your revenue dependent upon customers who are attracted to a nearby anchor store who would not be available to your business if that anchor store were shut down by an insurable risk, even if not cordoned off?
Service interruption: Any concern about off-premises interruption of power, telephone or other utilities that would shut down your business for an extended period of time? (Your policy’s coverage extensions may already include this particular risk.)
Should any of these scenarios apply to your business, you’ll want to ask your insurance broker for a proposal of appropriate contingent business income coverages to be added to your current program.
However, where earthquake and flood risks are concerned, you will likely need to use a separate policy, e.g., a “difference in conditions” policy. It typically offers lower cost, lower deductibles and no “insurance-to-value” requirement. Your broker should quote each alternative. Then you’ll understand the differences.
In addition, if available, you should specify “actual loss sustained” rather than a specific dollar amount of insurance. This will help you avoid underinsurance and penalties.
Also, you may want to extend your policy’s “period of restoration” from the basic shut-down period to several months beyond resumption of operations. A company’s revenue is rarely restored immediately to its formal level as it was before the loss. Such extensions fund diminished revenue until pre-loss levels are resumed.
As part of any business continuity plan, risk management alternatives to commercial insurance are always important. For example:
Diversify your customers to a reasonable extent so no single loss will adversely affect your overall business revenue. The same is true for backup suppliers. Then noninsurance risk assumption becomes feasible.
If risk assumption is not feasible, you should connect with local SBA officials to learn what disaster loan services will be available to you. A line of credit with your own bank may be a viable alternative.
In all cases, including “business risks” not commercially insurable, a sinking fund or other cash reserve can effectively fund these indirect risks and, at the same time, avoid payment of insurance premiums and/or loan interest.
In your treatment of these risks, you’ll enjoy one of the major benefits of practicing sound risk management, viz., a quiet night’s sleep.