Coping with the Aftermath of Flood
Article, General Insurance – September 2007
Insurance / Property
Catherine Rawlin stresses the importance of having adequate business interruption cover and describe how such cover would have come into play after the summer floods.
After what has been one of the wettest and certainly most miserable summers on record, large swathes of flood affected areas in the UK are beginning the long road to recovery.
Over the period May to July 2007, 387.6mm of rain fell across England and Wales, 208% more than the average rainfall for the period May to July 1971 to 2000. Rivers which had not burst their banks for a century spilled into urban, industrial and agricultural land across England from Oxfordshire to Yorkshire.
Other rivers such as the Severn and the Thames, both prone to flooding of some degree, burst their banks with a ferocity not seen in many years. The disruption to businesses situated in the flood affected areas has been dramatic. Premises have been contaminated, machinery has been destroyed, stock has been ruined, key documentation has been lost and it will be many months before most of these firms are back up and running as normal again.
The success or failure of recovery for many businesses will be driven by two key factors: first, a comprehensive business recovery plan; and second, adequate insurance cover. A detailed business recovery plan will be invaluable during and after the flood.
We have heard stories of managing directors and staff trapped in their offices by floods overnight producing their plan on the spot. However, a well thought out plan with contingencies prepared in advance will enable a business to minimise the impact of the loss and get back to normal in as short a time as possible.
Most businesses have insurance for damage to buildings and contents but not all have business interruption cover. BI cover is designed to cover the loss of profit due to lost sales and any increased costs during a period of disruption such as this. Most policies are intended to compensate the insured for these losses and give sufficient time and scope to keep the business going and get back to normal.
For those involved with BI claims across the country due to the flooding a number of key themes have begun to emerge.
Extent of business interruption
Insurance cover – length of cover. The length of cover of business interruption policies has been a defining feature of whether a company makes a full recovery or is left struggling and in the worst cases is forced to shut down.
Companies with relatively short periods of cover, such as 12 months, have been hard hit as this gives only a very short window in which to order new machinery/equipment, set up temporary premises and rebuild customer order books.
In particular, it is apparent that although premises and equipment should be ready within this period, the order books may not be full. Many customers of affected businesses will have had to look elsewhere and some will never return. Those who do return have been opted for dual supply agreements to prevent any disruption to their businesses from a similar event.
Specialist firms have appeared to fare the best in retaining their customers but firms in commoditised industries will struggle due to the availability of alternative suppliers. Companies with longer periods of cover have had the luxury of rebuilding their businesses and filling their order books whilst their insurance cover continues.
Shortage of resources – the ‘demand’ effect.
Further delays and problems have been caused by the severe shortage of resources in the flood affected areas.
Demand for short term lets is very high and most of the best spots have been snapped up by those with good business recovery plans. This has driven up rents and eaten into the insurance limits on many businesses’ policies.
Similarly, tradesmen and builders are in equally high demand, which has further driven up prices and led to delays in obtaining the necessary people required to rebuild damaged properties.
Additional increased costs of working cover.
Responding to some of the challenges of a severe disruption such as retaining customers can be made easier if a company has additional increased costs of working cover. Increased costs of working are normally covered under the business interruption policy if they are economic, i.e. if the costs incurred are not greater than the gross profit that would have been lost due to the disruption. Additional increased costs of working cover allows decisions to be made which under the terms of a normal policy may be uneconomic.
However, in the long run they will allow the business to retain customers. For example, companies can expedite machinery, offer discounts and other incentives to retain customers.
Multiple losses – strain on insurance limits. The extent of the flooding has been so great that some companies have found themselves dealing with multiple loss situations. This has stretched management resources and highlighted the need to have sufficient company-wide BI insurance.
Some companies have found that they have only purchased insurance in the event of one major incident at one plant, and so do not have the coverage for several large incidents across the country.
A fresh start. For some businesses the flooding has wiped the slate clean. Some of these businesses have been located in places such as Sheffield for over a hundred years.
In this time the world has changed dramatically and much of the world’s manufacturing is done in low cost countries such as China. This has cut margins and eroded markets. Some businesses have chosen to refocus on new sectors or products. Where this is the case a number of issues have arisen in the quantification of the BI losses:
- How long should the loss run for as the changes may take longer than a like for like reinstatement of the business prior to the flood?
- Will the BI loss be increased due to any increased reinstatement period?
Loss of documentation. Getting back up on your feet and obtaining a quick payment from insurers is made much simpler if documents are available. Many companies will have lost records of customer orders, contact numbers and other accounting information during the flooding.
This has highlighted the need for companies to conduct regular system backups and store IT mainframes on the second floor of buildings, otherwise without these documents the claims process is much slower as it will take time for specialists to recover damaged data and documents.
Not quite high and dry. For the firms not directly affected by the flood, business can still be disrupted and one has seen a number of business interruption claims arising from denial of access, loss of attraction and supplier extension clauses.
Loss of attraction. Summer sales bargain hunters are not usually put off by the rain but a trip to the Meadowhall shopping centre in Sheffield in late June 2007 may have deterred even the most committed shopper.
Several feet of flood water from the nearby river engulfed a large section of the ground floor of this indoor shopping centre. The centre was closed for a week and shops affected by flooding have remained closed as the mopping up began. Many are not expected to reopen for at least another couple of months.
Not all of the shops were affected and the whole of the upper floor and parts of the ground floor were spared the flood water. However, the potential effect of the store closures and damage to the centre will be felt by all of the stores even if they are not damaged. People are less likely to come to the centre to shop as the environment will not be as pleasant nor will the variety and selection of shops be as enticing. This will inevitably lead to a downturn in business and loss of sales for those still trading.
A business interruption policy will only respond to this if it includes a loss of attraction clause. This is designed to compensate business for a shortfall in the number of customers attracted to the vicinity of the premises.
Denial of access. The flooding has disrupted transport networks across the country, bridges have collapsed, and rubble and other debris still remain. The implications of this for business are twofold: first, can they themselves access their properties; second, can customers reach them?
This lack of access may lead to reduced sales and ongoing losses until the bridges are repaired, drains unblocked and roads cleared up, which may take many months. Similarly, as access to warehouses and road is denied, the supply chain of companies may be disrupted leaving customers short of stock.
Without denial of access BI cover which will compensate a business for losses stemming from prevention or hindered access to a premises, the resultant losses will be borne by the business and inevitably affects its profitability.
Supplier Extension. On the flip side, where businesses have suffered due to supply problems, claims have been brought against supplier extension policies. These provide compensation for any losses which result from interruptions at suppliers’ premises.
These raise several interesting issues such as how can the business mitigate its loss by seeking alternative supply arrangements and how it can best utilise its inventory.
As the mopping begins will any lessons be learnt?
The impact of this summer’s flooding on businesses is far reaching. As the water recedes, it is becoming clear that only the prepared and those with adequate insurance will survive, and the outlook for others is looking bleak.
Flood plains were historically the location of choice for industry in the last century but with climate change a very real threat to business, lessons have to be learnt. Flood defences must be improved, companies need to actively engage in disaster recovery planning and ensure that they purchase adequate insurance.