Business Income: Why Worksheets Alone Don’t Work

Predicting the impact of a catastrophic event on an organization’s future income or profit is an exhaustive risk management exercise when done correctly.

Typically chief financial officers, risk managers and intermediaries have sought to determine potential lost income with worksheets that request information on payroll and compensation, overhead and facilities expenses and other fixed charges.

However, as businesses have become operationally more complex, the worksheet has proven to be an inadequate assessment tool. A more accurate way to assess business income is to perform an actual risk management evaluation on how a loss may occur, how long it may last, and think through the many different elements of the business to determine what the value of that risk is. That type of detailed information doesn’t make it onto a worksheet.

Piecing Together a Puzzle

The first piece of the puzzle is allotting a significant amount of time and resources to properly evaluate all the categories of risks, including the different ways a loss could manifest itself in a given region or industry. This means assessing the more common sources of catastrophic losses such as hurricanes, tornadoes, or hailstorms as well as seemingly minor disruptions such as power failures, loss of computer data or even frozen pipes.

Second, it is important to have a thorough review and understanding of a company’s business continuity plan – if one exists. Some hastily prepared contingency plans end up being ineffective and could be the determining factor as to whether or not a business will reopen following a major loss event.

If a company doesn’t have a contingency plan, one should be created, where warranted as part of the evaluation process. Interestingly, a study conducted by Travelers Insurance Co. found that 48 percent of small businesses are operating without any type of business continuity plan even though 95 percent felt they were prepared for a disaster.

The third piece of the puzzle involves reviewing the numbers typically collected through worksheets – profits and continuing expenses, among others – in order to determine an appropriate business solution for the client. These figures, however, cannot be evaluated in a vacuum.

Risk Management-Driven Solutions

A broad yet in-depth approach to a business income solution should be designed that helps a business deal with common operational challenges.

For example, a manufacturer of electric motors and switches, with annual revenues of $40 million, experienced a two-week long power interruption that caused loss of revenue. It was determined that the company’s property policy had a standard limitation requiring power outages to occur on the manufacturer premises for resulting income loss to be covered. Off-premises utilities interruption coverage was negotiated at no additional cost, eliminating the manufacturer’s uncovered loss exposure of $350,000 per week.

Another example: one of three pieces of customized equipment at a skin gel manufacturer’s factory was damaged. The company was able to receive reimbursement for lost wages of approximately $250,000 – $100,000 more than it would have received had management not been alerted to the significant risk to their income stream if critical equipment was damaged or destroyed. A risk management evaluation resulted in an agreed limit for critical equipment and earnings replacement when production is interrupted. Even though the company increased its coverage by a significant amount the premium only increased by 2 percent. This small increase, as it turned out, was well worth the money.

Recent studies show 25 percent of businesses do not reopen following a major event. Still, many companies do not know how to correctly calculate business income limits.

With businesses becoming more operationally complex and catastrophic events becoming more costly, it’s time to place an accurate value on business income risk by implementing an actual risk management evaluation.