As credit managers, we often get mired into performing the same daily activities. For example, if a new customer requires more than $5,000 in credit, we might only need a credit report. If the credit required increases to $20,000 then confirmation of several trade references might be in order. If this customer requires more than $100,000 then we might look at financial statements or obtain a personal guarantee. We all understand that as the credit limit required increases, the more the customer’s credit worthiness needs to be confirmed.
There comes a point when some customers may become so much a part of our own growth that if the customer ever has a sudden calamity which brings their operation to a complete halt, it could have a devastating impact on our own business. Knowing that our major customer has a Business Interruption Insurance policy as an integral part of their total risk management system, may be a valuable part of our own credit evaluation process.
Events that cause a business to temporarily stop operating entirely seem to have increased in number and variety, as well as severity. In the past few years alone, we’ve seen crazy natural disasters that have included the tsunami that devastated Fukushima, Japan, Hurricane Sandy, tornadoes across the Midwest and even as recently, the storms devastating South Carolina, to mention just a few.
Although I don’t claim to be an expert in the General Property & Casualty insurance products arena, I view some of the P&C products as effective direct extensions of what we do, which is to mitigate trade credit risks, protect cash flow, and preserve the equity that businesses work so hard to accumulate.
Business Interruption Insurance is generally designed to cover the income a company loses when it has temporarily stopped doing all business because of events beyond its control. It can also cover major expenses needed to get back into business and is an extra layer of protection that goes beyond more common insurance policies.
For example, if a factory burns down, Property Insurance can be used to cover the damages to a large extent but it won’t cover the potential income lost by what the factory manufactured and sold, or all of the expenses that might be necessary to continue operations. A typical Business Interruption Insurance policy will provide coverage for several major items:
- The profits on sales the company would have earned if the loss had not occurred.
- Normal operating expenses, even though the business is temporarily closed. This includes employees’ wages to keep them on staff rather than laying them off for an extended period of time.
- The expense of moving the company to a temporary location and the cost to rent a new facility, or to build a new facility, whichever may be deemed more expedient and cost effective, as well as the costs of restarting up the business.
The payout amounts that a policyholder usually receives from Business Interruption Insurance are based on historic records of income and expenses. Historical financial statements and related documents (payroll records, accounts payable journals) need to be submitted to the carrier before any claim can be paid. As part of the policy processing, all copies of the necessary records should be held in possession by the carrier and agent with annual updates. This helps facilitate the claim process.
In most cases, Business Interruption Insurance providers include clear clauses in the policy concerning what will trigger a loss. In general, coverage will start a few days after the incident and reasonably last until the business is up and running again at their existing or new location.
Unfortunately, what Business Interruption Insurance doesn’t cover sufficiently are your payment obligations to commercial vendors who have already sold you their materials and other products or goods that were previously used in your manufacturing process. When the Business Interruption Insurance carrier looks to make vendor payments, they will examine the previous one or two years of invoices and compute an average, which may work in favor of the vendor or significantly shortchange them. Or, more likely, it will be up to you to make all payments to vendors for past invoices out of the insurance proceeds. The problem with this is that insurance payments for lost income are initially applied to the basics of recovery and not necessarily on what was owed at the time.
As credit managers, Business Interruption Insurance can be your good customer’s recovery safety net until they have indeed recovered. But don’t forsake Credit Insurance. Business Interruption ONLY responds in case of a covered physical loss at covered locations. Conversely, Credit Insurance widely extends your safety net from being highly impacted by your customer’s unexpected inability to pay you.
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