Number of under-insured small businesses increasing

The number of under-insured small businesses are increasing and weather catastrophes highlight the risks to business continuity for those that are under-insured.

Flooding was identified as the second largest peril across the globe and the most prevalent peril on the African continent, with a devastating economic loss of R1.185bn in Aon’s latest 2023 Weather, Climate and Catastrophe Insight report, says Clayton Ellary, from Aon South Africa’s commercial risk solutions.

“While the KwaZulu-Natal floods of April 2022 were noted as the largest flooding event on the continent with an economic loss of R64.672bn, what is more concerning is the fact that only 18% of losses were insured.”

He says while technological innovation allowed for better insight as catastrophes unfold, allowing for faster and more thorough assessments of damages following an event, the report examines resilience and the ability to overcome climate-related consequences.

The report highlights the reasons why businesses need to factor possible losses from climate-related risks into their insurance portfolio, especially for small and medium sized businesses where under-insurance can cripple business recovery from an outright or severe loss.

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Underinsurance can have devastating consequences

“As economic pressures mount, cases of business underinsurance are noted, with small and medium commercial businesses hardest hit. In the context of weather catastrophes, such as fire and flood which often result in losses, underinsurance on property, plant, fleets, stock, machinery and business interruption will have potentially severe consequences for the balance sheet and the ability of the business to recover from an uninsured or underinsured loss.”

Ellary points out that insured small businesses do not always keep up with the impact of volatility and changes in their operating environment, which means that their valuations as well as the terms of their cover may be out of date.

“Some businesses may insure for the market value of their premises rather than considering what it will cost to rebuild at today’s prices. It may also be that a business changed its operating model and as such its exposures have changed, but it is still using previous, outdated valuations that are not applicable to the changed business circumstances.”

He uses the example of a business that is holding more stock on the premises to counter supply chain vulnerabilities. This business would need to re-evaluate its sums insured to reflect the change in stock holding levels.

“Another example is a business that has changed the very nature of its operation, where an insurer may require additional fire prevention measures to be put in place if the nature of the business being conducted on premises has changed.”

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Business interruption insurance

Under-insurance for business interruption can be catastrophic to business continuity and the ability to recover, even if cover for assets is in place, he warns. On average, 43% of business interruption insurance is underinsured by 53%, according to the Chartered Institute of Loss Adjusters (CILA).

“One of the reasons is that the selected maximum indemnity period turns out to be far shorter than the actual period of disruption caused by an insured peril to the property. Your broker will be in a position to do a business interruption calculation that factors relevant data into the equation that will allow you to make an informed decision that will better support your business during an interruption,” Ellary says.

Business interruption insurance is critical to keep the revenue generating ability of a business intact following an insured event such as a fire, flood or other catastrophic circumstance that can torpedo the financial health of the business.

“Yet despite its importance to business continuity and the ability to fully recover from a loss event, sums insured can be insufficient to cover a catastrophic loss and the increased costs of working during a recovery period.”

Ellary says the fact that businesses are often underinsured on their Business Interruption sums insured indicates the enormous complexity that comes with calculating the correct insured sums that takes into account the knock-on effects and increased costs of working following an insured event, like a fire or flood. 

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Consider these three factors

He says small businesses must consider three key factors when it comes to setting the correct sums and indemnity periods for Business Interruption (BI) insurance: 

• The sum insured must be calculated based on the insurance gross profit, not necessarily the accounting financial gross profit. This requires a deep understanding of a client’s financial records and its operating models.
• An indemnity period associated with BI insurance refers to the period of time it will take for the business to recover from a worst-case scenario. The appropriateness of the indemnity period needs to consider factors such as the nature of the business and its assets, such as specialised machinery and equipment, seasonality of the business and competition within the market. If a hotel located at the coast suffered major structural damage following a flood for example, the BI insurance claim would look very different during winter months than it would during the peak holiday season. The indemnity period needs to account for complete building reinstatement, possible legal ramifications/delays if investigations due to human casualties are involved, building plan approvals and site preparation.
• While business continuity in itself is not an insurable risk, poor risk management can render a business uninsurable. Risk mitigation efforts undertaken by a business has a fundamental effect on the eligibility for insurance and the cost of insurance. Another critical aspect that is considered is the interdependency of different business units and what impact each has on the continuity of the entire business. A catastrophic event in one business unit could affect other divisions or subsidiaries across the entire network as well as the ripple effect on customers and suppliers, not to mention your own staff.

“One of the most miscalculated areas of BI is how long it will take to overcome a catastrophe and get back to business. Getting a large production line or manufacturing plant up and running again can be a very lengthy process, as opposed to an admin office, for example.” 

Ellery says as risk advisors, Aon works with clients to understand their insurance programme as a strategically important exercise and not simply a transactional insurance exercise.

“If the adequacy of sums insured and declared values are not properly calculated, insurance cover will simply not be able to put the business back into operation on the same footing as before the peril, with dire financial and operational implications.”

He warns small businesses not to let underinsurance scupper their ability to recover from a major event and urges them to engage with an expert broker to comprehensively identify, evaluate, quantify and mitigate risk with a solutions-based management approach that covers them for worst case scenarios.