High inflation, increasing commodity prices, supply chain disruption, geopolitical conflicts and the effects of climate change are some of the issues creating a challenging environment for food and drink manufacturers. To reduce the impact these factors can have on operations, businesses need to review and adjust their business continuity plan (BCP) and the business interruption (BI) cover they have in place.
Business interruption insurance is designed to cover losses of revenue or profit that a business experiences during periods where it cannot carry out its usual activities due to an insured peril. The cover should protect the business until it has fully recovered. It is an indemnity-based coverage which aims to put the business back into the position it would have been without the event occurring.
Inflation has seen elevated levels for some time now despite central banks’ interest rate interventions. As a result, the insurance industry is experiencing significant and ongoing increases in rebuild, material and labour costs when responding to claims. Similarly, both domestic and overseas supply chains have seen ongoing challenges in the past years, with delays in sourcing key machinery, parts and materials. Coupled with labour shortages in the UK, this has led to significant delays in project completion and thus stretched indemnity periods.
Increased costs and significant project delays are a reality. It is therefore essential that businesses undertake a more regular and thorough review of their sums insured and indemnity periods. This will help avoid potential underinsurance and cash flow issues at an extremely difficult time, and determine if businesses will be able to recover.
The most common business interruption policies issued in the UK are based on gross profit and gross revenue calculations.
The cover protects against the loss of gross profit following a reduction in turnover, and provides for continuing fixed costs/standing charges and increased costs of working. The gross profit sum insured calculation can be complex and requires detailed analysis and review. In its simplest form, it is the amount by which the sum of the turnover and closing stock and work in progress, exceeds the sum of the opening stock and work in progress and uninsured working expenses.
This cover option allows for the deduction of certain costs such as uninsured working expenses (UWEs) that vary directly with turnover to arrive at the gross profit sum insured. Common UWEs include purchases such as raw materials and components, packaging, carriage, discounts, commissions, bad debt, and more.
Estimated gross profit and declaration-linked gross profit covers both provide mechanisms to reduce a business’s exposure to the impacts of underinsurance.
Gross revenue provides a simpler method for arriving at the sum insured with the only consideration being:
How long the cover should last; and
How much turnover is forecast for the chosen period.
This option avoids the pitfalls of potential underinsurance when arriving at a gross profit sum insured. It is most appropriate for businesses that have relatively lower costs directly variable with turnover.
Business interruption sums insured must be increased accordingly if an indemnity period greater than 12 months is selected. The indemnity period should take into account site clearance, design and planning applications, rebuild time, replacement of plant and machinery, sourcing stock and rebuilding the customer and supplier base.
One of the most misunderstood aspects of setting suitable indemnity periods is that it must also reflect the timescale a business anticipates will be necessary for it to return to its pre-loss trading level. Importantly, it must reflect and build provision for potential delays. Even after the property has been reinstated, it can take an extended period for a business to integrate new equipment, train new staff, or win back lost customers.
Considerations for food and drink manufacturers when calculating business interruption sums insured and indemnity periods:
The impacts of climate change on the regularity and severity of significant weather events is causing disruption to supply chains and commodity prices, particularly in the food and drink sector e.g. flooding, wildfire, excessive heat
Pressure on prices and delivery times are particularly acute after a catastrophe, which may affect the wider economy, region, or a particular industry segment, creating high demand for repairs and building materials facing insufficient national or local resources
Geopolitical tensions and flashpoints in key trading regions are impacting the ability to source products’ key ingredients – relevant dependencies should be reviewed and factored in
Commodity and raw materials prices are very vulnerable to fluctuation in an increasingly volatile world
Businesses that are reliant on import and exports are exposed to currency fluctuations – depending on the market, this may add potential material variability to results
The nearshoring trend to reduce supply chain disruption and increase security of supply will, where undertaken, impact the cost of goods and the rate of gross profit calculation
Product substitution and reduction in product lines will also impact a business's rate of gross profit calculation
Potentially longer lead times for the replacement of key equipment, plant, machinery, and other essential items due to stretched supply chains, high demand, and lack of supply
Labour shortages are driving the costs of reinstatement up and increasing the length of reinstatement programmes
Recruiting and retraining staff may delay the process of getting the business back to speed – local labour supply should be factored in
The difficulty in winning back lost customers and opportunities, in particular, in highly competitive markets
Is there a business continuity plan? When was the last time the business continuity plan was reviewed? Has it been robustly tested to meet the needs of the business in the current environment? Will it still be fit for purpose in 12mths time?
Lockton have been specialising in providing risk and insurance solutions to the food and drink sector for many years. For further information, please visit the Lockton Food and Drink product page (opens a new window), or contact:
Luke Withers, UK Food and Drink Industry Leader
Alex Neave, Vice President Property Damage and Business Interruption