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Perspective

Business Interruption Risk and Its Relationship With the Global Economy

March 16, 2016| By Takashi Ishii | Property | English

The risk of business interruption is a major concern for corporate managers worldwide. In a 2015 survey about corporate risk management,1 which studied more than 1,400 companies worldwide, “business interruption” is ranked seventh, after “decline in brand strength” and “recession/delayed recovery.” “Distribution or supply chain failure” is ranked 14th which illustrates the high level of global corporate managers’ concern about the risk of business interruption. The heightened importance of the risk is closely related to changes in the managerial environment of corporations.

Obviously, a variety of circumstances can cause business interruption. In addition to physical damage to factories or production facilities - from fire and explosion accidents to meteorological disasters - one can also imagine the scenario of a pandemic where the minimum number of employees needed to run a business can’t be assured to travel into work, where the stoppage of an operation is unavoidable due to the paralysis of such social infrastructure as electricity, water and gas supply, railroads and roads, and where the supply chain is broken due to an accident at a business partner's company or to a geopolitical problem.

Although it is important to reduce the risks by tackling disaster prevention and mitigation through dispersion of plant locations and customers, risk is multipronged and complicated, and a full response against all risks cannot be undertaken by only those measures. In addition, as can be seen in the example of how computers have developed, production facilities have been highly refined and a trend for high-value products is advancing. Clean rooms, such as those employed in semiconductor integrated circuits, liquid crystal panels, and the biotech, healthcare and food processing fields, are an example of the increased sophistication and higher value of technology. However, maintaining a clean state could become arduous, not only due to fires or power outages but from minute foreign matters entering the room. In this case, a lengthy period of mitigation might be required and major expenses might be incurred in recalls and purification of the products, as well as an investigation into the causes and countermeasures. The likelihood has increased that where once an accident would not have involved major losses, it now includes not only major losses but business suspension.

Additionally, owing to the advancement of the economy’s globalization, the points of acquisition for and the routes of corporations’ energy, raw materials and resources, parts, semi-finished products and so forth have become more complicated, which further increases risk if the supply chain should break. In addition to the increasing difficulty of identifying the causes of business interruption, companies and their management are often changing , making appropriate risk management extremely difficult. An event that causes a domino effect, in which a variety of phenomena occur in a chain-like fashion, could develop into a situation that endangers business continuation.

Whenever disasters and accidents occur, the first stage of the problem begins - physical damage to buildings and production lines, followed by loss of profitability owing to business interruption and the reduction of scale, and then a rise in third-party compensation liability and various emergency response expenses.

If it is not possible to restore the business quickly, then the second stage of damages affects the operation's financial foundation, such as cash flow and share value, and profitability losses will advance rapidly, owing to the payments accompanying the debt performance, such as employee salaries and repayment of borrowings during that time.

If it is not possible to restart the business by this time, then we move to the third stage: various payments pile up and the financial foundation is impaired greatly in the absence of sales; credit from the market is lost, owing to non-performance of the contract, and the business is finally driven to failure.

A business interruption occurring due to the breaking of a supply chain, where it is no longer possible to acquire raw materials due to a customer having suffered an accident or disaster, results in a spread of losses from the second stage, but if the acquisition of substitute raw materials and parts takes a long time, and if the price soars greatly, this can gravely impair profitability.

From the majority of expense items, it can be seen that many other losses in addition to revenue loss actually occur during a business interruption. Therefore, it is necessary to keep any interruption period to an absolute minimum, and to prepare beforehand a Business Continuity Plan (BCP), including a substitute method for acquiring materials and producing energy, to avoid the risk of a domino effect.

Transactions between corporations have also become extremely complex due to the globalization of the 21st century. Given continuous advancements in all fields on a daily basis, it is difficult to predict the damage of business interruptions now also affected by Enterprise Risk Management. In addition, it is conceivable that a break in the global supply chain might occur due to some unexpected event, and a business interruption that extends over a long period of time may well result in a corporation being branded unqualified as a business partner and thus compelled to withdraw from the market.

Along with the importance of minimizing the risk of business interruption by instituting a BCP for tangible assets, the necessity of anticipating changing conditions in the global economy has also become more imperative in recent years. Having a plan in case of business interruption is something that cannot be avoided for insurance companies, reinsurance companies, banks and other financial institutions. We must hasten specific examination of underwriting of business interruption risk in this new era.

Endnotes

1.http://www.aon.com/2015GlobalRisk/attachments/2015-Global-Risk-Management-Report-230415.pdf.

 

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