Insuring Business Continuity: Transurance Helps Companies Protect Themselves from Losses That Aren't Covered by Their Traditional Property and Casualty Insurance Policies
Thomas, Bruce B., Preston, L. Ware,, III, Strategic Finance
AFTER A LONG SERIES OF HIGH-PROFILE DEBACLES, companies are finally beginning to practice what the Boy Scouts preach--"Be Prepared." Whether they describe them as disaster recovery or business continuity plans, most businesses now have organizational and operational initiatives designed to mitigate damage from adverse events and resume operations with minimal disruption. But how will they finance the implementation of these plans? A new insurance product called Transurance helps companies pay for business continuity expenses that are collateral to insured property and casualty losses but aren't covered by those policies.
KEEP THE BUSINESS GOING
Because they work in such an increasingly connected and leveraged world, business managers must contemplate how various events might affect their company and its stakeholders, which include customers, employees, suppliers, capital providers, and regulators. The purpose of thinking through a variety of scenarios isn't to imagine everything that might go wrong but to evaluate how the firm's human, physical, and financial resources could be deployed most efficiently to deal with some major setback.
In addition to the immediate acts of restoring plant and equipment and resuming operations, managers must confront the long-term effects and indirect implications of any event. Large losses often force companies to rethink and redesign their businesses. Managers may realize that they need to change hiring practices, safety programs, inventory control protocols, distribution systems, how they relate to customers and regulators, and their organizational and financial structures. A complete business continuity plan must envision both operational and strategic changes and the steps that may be required to restore the company's reputation. It also must contain a financial component because costs to restore operations and continue the business may be considerable.
If the event that triggers activation of the business continuity plan is uninsurable--for example, a botched conversion to a new computer system--then the company has no choice but to rely on its own capital structure for financing. On the other hand, if the event is covered by property or casualty insurance, as in the case of a fire, then some or all of these costs can be covered by Transurance.
HOW TRANSURANCE WORKS
To Transure collateral losses, a company must create a relationship between the amount of collateral losses and the size of the insurance recovery it is likely to receive. For example, if a company believes it will have uninsurable collateral losses equal to 20% of the amount it recovers from its insurance policy, it can purchase a Transurance policy that pays 20% of the amount that its insurance policy pays to create a budget for collateral losses.
Transurance enables the insured and the insurer to agree in advance how large the collateral losses will be in relation to the amount of the proceeds from an underlying property or casualty policy. By predefining this relationship, business continuity costs that are coincident to insured losses but aren't covered by traditional insurance because they are too difficult to define or substantiate can now be insured.
As shown in Figure 1, there are essentially two types of losses that are collateral to insured events. The areas shown in yellow are technically insurable and include the deductible, amounts in excess of a policy's limit, and any disputed amounts. These amounts could have been insured, but the parties chose not to, or, in the case of disputed amounts, the parties found that they didn't agree on the extent of the policy's coverage after a loss had occurred.
For business interruption and extra-expense coverages, the actual amount of loss is often unknowable. As a result, substantiating these losses involves a great deal of judgment and discretion, which makes claim settlement contentious. …