Uninsured (or Under-insured) Revenue – The Ripple Effects of a Large Loss.

By Joe Anderson, CPCU, ARM AFSB, CBRA

Principal & Fractional Chief Risk Officer

Many businesses insure their corporate assets to protect against known threats, like fire and flood. This is a smart strategy, as many of these assets are required for the business to continue to operate. These assets might include buildings, equipment, inventory, vehicles, cash, and even sometimes things like patterns and molds, software, and patents.

However, this same smart decision-making is rarely deployed when it comes to revenue protection. So how does a business protect its revenue after disaster strikes? This is a challenge because revenue is not always a known number, and future earnings can be somewhat ambiguous to project. With buildings we can calculate a replacement cost value, with autos, actual cash value. But with revenue, there is only past performance and future goals to project out.

This said, many businesses are either not insured or significantly underinsured for losses to their revenue over time.

Let’s look at a case study to illustrate this (numbers and some facts are changed to protect the client):

A $16 Million manufacturer called Roll the Dice, LLC (RTD), decided to decline coverage of $3,000,000 limit on business income and extra expense for $16,000 in premium annually. This represented a significant portion of their exposure. They did, however, maintain $10 million in building and $6 million in contents insurance, as required by their lender.

One night a call came in to their insurance producer of a plant fire. This fire had completely partially burned up one building in their operation, damaging a lot of machinery and inventory stored for future orders.

When the insurance adjuster adjusted the claim, it was determined that the total loss to building was about $5,000,000, with $3 million in contents (equipment and raw materials) damage. The loss of revenue and extra expense to get back up and running was going to cost roughly $3,200,000.

Since they had no insurance to cover loss of revenue, they needed to find a financial partner to sell part of their business, to stave off bankruptcy court. They also had specialized dies and casts for specific custom orders that a client had bought and let them hold that was not insured property. So, this client not only lost their original molds, but they could not deliver their finished product to their client. This created a $8 million loss in sales for this client, and they sued RTD for losses of $8 million. Total loss was $11,200,000.

In this scenario, how would they have better protected their revenue stream? There are multiple answers, but each company has different relationships with their vendors, employees, clients and owners. The first step is to assess the revenue risk.

At Fortify Risk, our fractional chief risk officers, would work with your team to identify all of the major threats to revenue in your business. Then we would look for ways to eliminate, reduce or transfer the risk these threats pose to your revenue. In the case of the above manufacturer, they had the following threats to their revenue (to name a few):

1. Only one site available for manufacturing.

2. Custom or rare machinery that might be hard to source and replace.

3. Dies and molds stored on site that could be damaged in a fire.

4. A paint booth in the same location as manufacturing, with no fire sprinklers.

5. Dependent clients for whom they were the sole source manufacturer.

In response, here are just a few different options to reduce or eliminate some of these threats to revenue:

a) Develop a reciprocal agreement with another manufacturer with similar machinery.

b) Purchase backup machinery stored offsite or coordinate with the manufacturer to pay for a “buy up the order list” status to be first in line if a disaster strikes.

c) Identify an alternative site at which to manufacture.

d) Store the dies and molds in a fire-resistant box.

e) Locate the paint booth in a separate building with fire sprinklers.

f) Assess your revenue risk and purchase low-cost business income and extra expense insurance to transfer most of this risk.

g) Check with your client to see if they have purchased dependent business income and extra expense coverage to protect themselves and their clients from a fire at your locations.

h) Have a pressurized water tank system available for use.

While most companies do not think about revenue protection, instead focusing on asset protection, this is a major mistake most of the time. Revenue protection is just as critical as asset protection, because it protects your ability to operate and make use of the assets you have.

The threat of fire is only one threat to the revenue of a business. Assessing all the threats to revenue and then focusing on the Top Three maximum exposures is a good place to start.