4 Steps To Managing Supply Chain Contingent Business Interruption Loss

By: Morgan Machado, CPA, CFE - Senior Manager of Imperium Consulting Group

In today’s economy, businesses' supply chains are more integrated and complex than ever before. The global nature of many supply chains makes them more vulnerable to economic, political, legal, and regulatory issues. As a result, today organizations have higher exposure to myriad adverse risks outside of their operations and control.

Some property insurance policies include coverage that attempts to mitigate these risks, known as Contingent Business Interruption (CBI) coverage. Contingent Business Interruption insurance provides coverage for loss of income resulting from physical damage at a third-party location that impacts the Insured’s ability to carry out their normal course of business. Therefore, even if the Insured does not suffer direct physical damage from a loss event, their financial losses could still be covered under their policy. However, this coverage is commonly overlooked, often misunderstood, and the losses are difficult to quantify. Additionally, it is possible that there may be a delay in communication from the time of physical damage to the time the Insured is notified from their supplier or distributor.

In the midst of hurricane season, risk managers need to be aware of indirect losses to their operations due to physical damage that hinders their suppliers, distributors, or principal customers. When evaluating these impacts, risk managers should:

IDENTIFY risk exposure in the business’s supply chain: Factors to consider include whether the business is dependent on a third party to supply, distribute or purchase their products or materials, as well as the location of these third parties. This risk can be magnified if a business relies on only a single or small number of third parties. Any disruption may cause a significant business interruption loss.

DETERMINE the loss of income to the business: If an event occurs, risk managers need to calculate the potential loss of income to the business. Catastrophic events such as Hurricane Ida could result in significant losses to organizations far outside of the impacted area if they rely on suppliers, manufacturers, distributors, or customers in the impacted area. How loss of income is quantified depends on what part of the business’s operations were affected. Documentation such as production reports, profit and loss statements, and inventory reports supports the evaluation and calculation of lost income and are necessary to prepare a claim. Further complicating matters, if a business’s income was affected by the pandemic it is critical to understand how that may or may not impact calculations. The impacts from multiple events/disruptions typically need to be segregated and looked at independently.

DOCUMENT any additional expenses incurred due to the interruption: When an interruption occurs to the supply chain, the Insured may incur additional expenses over and above regular operating expenses to return the business to its pre-loss levels of operations. An interruption to a major supplier or distributor may require a business to obtain or transport goods and services through other means to continue operations. Some examples of this include increased transportation costs, increased cost of materials, or increased internal labor costs and employee expenses. It is important to retain documentation of these costs (invoices, POs, etc.) for purposes of ultimately preparing a claim. The lingering impacts of the pandemic on the global supply chain may increase the complexity of these costs due to its effect on the current price and availability of supplies, materials, labor, and transportation.

EVALUATE the timeline of repairs and ongoing impacts to operations: It is essential for risk managers to understand when repairs were completed at the dependent property, and any additional time it will take the Insured to return to normal operations beyond the restoration period. This will dictate the period of time that the financial impact will be covered under the Insured’s policy.

Due to the complex nature of contingent business interruption coverage, risk managers should consult with insurance professionals to help identify potential areas of coverage under their policy and assist with claim preparation and the quantification of these losses.