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Risk Management: Hurricanes and Other Disasters
By Glen Pomerantz
The 2005 hurricane season has shown that you never can plan too much. Widespread human suffering, including massive displacement of a population center, was compounded by near total destruction of infrastructure that also had a catastrophic effect on businesses.
As the most devastating hurricane season on record drew to a close, risk managers reflected upon what they might have done differently and how they might prevent or cope with any recurrence. Although it is impossible to avoid all the effects of such storms as Katrina, some lessons are valuable.
A comprehensive disaster recovery plan prepared well in advance is one of the best means for minimizing the risk and damages from a storm. In addition to insurance, responding to a disaster will require timely mobilization of resources including employees, owners, management and business partners (and including community and government).
Disaster Recovery Plan
Executing a disaster recovery plan is the first step in mitigating the risk faced by a business from a hurricane or other disaster. Often, initial actions can determine whether or not a business survives. After life and safety issues are addressed, insured businesses should make sure property is protected. Failure to take reasonable precautions to protect property before, during and after an occurrence can jeopardize the recovery process; this is a requirement under most commercial property policies. Expenses incurred to protect properties from imminent destruction usually are covered under the "sue and labor" provision of the property policy.
Timely notification, either directly to underwriters or to the broker/agent, is also a requirement under property policies. Certain states deem late notice as prejudicial, which can void the right to indemnification. Underwriters, agents and brokers are a vital resource for identifying contractors to assist with the physical damage and they may be familiar with government programs available for commercial properties. (BDO Seidman, LLP provides such services as part of its Business Location Incentives and Site Selection (BLISS) Services.)
Insured business persons often overlook the value of their business partners when recovering from a catastrophe. Suppliers, customers, lenders and employees should be informed as soon as possible. They can be instrumental in mitigating disruption and play a major role in reconstructing records.
Are You Covered?
Insurance is the most common tool used to reduce losses from natural disasters. In the case of Katrina, many businesses found themselves with insufficient coverage. When contemplating business interruption coverage, it is important to remember that physical damage to property is the primary trigger for business interruption claims, but significant losses often occur absent physical damage.
Contingent Business Interruptions Coverage
One of the most important coverage areas in play following Katrina was contingent business interruption and contingent extra expense. Coverage for lost income and extra expense due to physical damage to customers, suppliers and feeder-type properties has been essential to many organizations that normally relied upon Gulf State firms for products, supplies or as customers. Those businesses without this coverage extension found themselves at the mercy of supplier or customer rebuilding schedules. In some cases, they were forced to shut down completely due to a supplier's or customer's physical loss.
Off-Premises Power Coverage
Business interruption also arises from disruptions from utilities. This type of loss was prevalent following Katrina and inhibited operation of properties that suffered no physical damage. Many insured businesses suffering from loss of utilities during the 2005 hurricanes were not prepared for the economic consequences of this peril.
Business interruption coverage for off-premises services interruptions will provide the necessary coverage in such event. Coverage, however, usually includes a waiting period, and may exclude some of the more common off-premises power losses such as those from downed poles, towers and transmission or distribution lines.
The Indemnity Period
An organization that has purchased business interruption coverage will be indemnified through the period of interruption, often known as the “indemnity period.” This is often defined as the time to rebuild or restore the damaged property to its pre-loss condition using due diligence and dispatch. Complications arise when enhancements are made, if the rebuilding process takes place at an alternative location, or if the reconstruction period is delayed.
The extended period of indemnity allows for continued indemnification for the time necessary to ramp up the business following physical restoration. Businesses in the Gulf States without extended indemnity period coverage may have a prolonged period of uninsured income losses as the region slowly returns to normal. Thus, coverage for an extended period of indemnity beyond the physical restoration of the damaged property is highly recommended for businesses in a competitive environment.
Inventory of Damages
Property policies require the insured to prepare an inventory of damaged property. Practical difficulties often arise when the peril is so severe that property no longer exists. When preparing for possible disasters, it is imperative to take pre-loss pictures of property and equipment. All documentation, including pictures, blueprints and floor plans, as well as accounting and legal records, should be kept off-premises since the information can be used to recreate the inventory required under an insurance contact.
Keeping Track of Losses
Because business accounting systems are not designed to track property and business interruption losses, modifying accounting systems is often necessary to document losses in accordance with the policy. Concepts such as extra expenses, debris removal, ordinary payroll, sue and labor, and expediting expenses are alien to normal course accounting systems.
Time to Act
Because the timing, location and magnitude of hurricanes and storms is anything but predictable, it is easy for property and business owners to delay the necessary planning in the hope that the next disaster will be somewhere else. The lesson of 2005—when the number of hurricanes and major storms was the highest in decades—is that risk management and the purchase of adequate property and business interruption insurance is a matter of high priority.
Glen Pomerantz, CPA, is a partner and National Director of Insurance Claims Services in our New York office. He can be reached at 212-885-8379 or by e-mail at gpomerantz@bdo.com.
For information about BDO Seidman’s Business Location Incentives and Site Selection Services, contact Harry Silverman at (617) 422-0700.
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