Supply chain disruptions and indemnity periods

Supply chain disruptions may have significant impacts on indemnity periods for insureds. Indemnity periods refer to the time taken to restore normal business operations following an insured event.

Disruptions that occur during an indemnity period can cause delays or interruptions in the flow of goods or services from suppliers. Such delays may lead to lengthier periods of repair. In turn, increasing lost sales, missed deliveries and other operational challenges.

A key example, post-Covid-19, the construction industry experienced significant disruptions in available labor and material resources. Construction-based labor and material resources have had a cascading effect on nearly every supply chain resulting in increased costs, i.e., impact on supply & demand equilibrium. Additionally, the time it takes to obtain building permits and investigate losses has become an additional stressor for insureds and insurers alike. Bottom line: what should have taken six months to repair prior to the pandemic, is now taking nine to twelve months; ultimately increasing the period of restoration. This undoubtedly impacts the business income loss computation, potentially triggering the extended period coverage.

Disruptions across the supply chain

Furthermore, supply chain disruptions can impact other industries as well.

The availability and cost of raw materials and other inputs for manufacturing and logistics facilities can drive profitability to a grinding halt during a loss event. Keep in mind the insured is likely making every effort to mitigate their losses and get back to pre-loss levels as quickly as possible. Timing is critical during a loss event and may result in missed or canceled orders. Given the earlier example, the manufacturer may have to source the component from an alternate supplier, which can result in longer lead times, increased costs, and other complications that prolong the indemnity period.

A contingent business income loss may also arise when a key supplier has a covered loss, rendering a critical component unavailable or requiring significant effort to obtain and incorporate into the manufacturing process. Often, alternative suppliers may not be able to meet the pre-loss specifications, resulting in further delays.

Additionally, supply chain disruptions can create a ripple effect throughout the supply chain, impacting downstream customers and suppliers. For example, a delay in the delivery of goods from a supplier can affect the ability of downstream customers to fulfill their own orders, leading to further delays and operational challenges that can extend the indemnity period. This certainly gives rise to the possibility of a contingent business income loss for the downstream customer.

Supply chain disruptions & indemnity

Overall, the effects of supply chain disruptions on indemnity periods can be significant, and it is important for businesses to carefully consider and plan for the potential impacts on operations and insurance coverage.

Extended indemnity periods may have a significant impact on a company’s operations and financial performance. Here are some of the ways businesses are affected:

-Increased Costs:

Extended indemnity periods can result in increased costs due to the additional time required to restore normal business operations. These costs may include but are not limited to costs of hiring temporary staff, overtime pay, expedited shipping, or other expenses related to getting the business back up and running in the most expeditious manner.

-Reduced Productivity:

Longer indemnity periods can lead to reduced productivity, as the business may be unable to perform its usual operations during the recovery period. This can lead to lost sales, missed opportunities, and other negative impacts on the company’s performance.

-Damaged Reputation:

Extended indemnity periods can damage a company’s reputation, especially if customers or other stakeholders are affected by the disruption. This can lead to a loss of confidence in the company and can make it more difficult to attract and retain customers.

-Delayed Recovery:

Longer indemnity periods can delay the recovery of the business, which can have a long-term impact on its financial performance. The longer it takes to restore normal operations, the longer it may take for the company to regain its market position and competitiveness.

-Insurance Premiums:

Extended indemnity periods can also impact insurance premiums, as insurers may view longer indemnity periods as a higher risk and may charge higher premiums as a result.

In summary, extended indemnity periods can have a significant impact on a company’s financial performance, reputation and operations. It is important for businesses to carefully consider the potential impact of indemnity periods and take steps to minimize the risk of extended disruption. Businesses should develop contingency plans, invest in technology to enhance supply chain visibility and resilience, and diversify suppliers.

Forensic accounting firms focus on providing accurate and credible calculations regarding these types of complicated losses especially regarding business income and extra expense claims (i.e., time element). Hurricane Katrina (2005), the Thai floods (2011) and the pandemic (2020) triggered supply chain issues that ultimately extended the indemnity periods and increased the final measurements of losses. Between raw material shortages, reduced or migrating labor, transportation bottlenecks, quality of workmanship, regulatory and capacity constraints, it behooves insurers and insureds to work closely together.

Anthony Natole, CPA, (anatole@riskaccountants.com) is the managing principal of Risk Accountants LLC and has over a decade of experience in risk accounting and claims investigation. He has examined hundreds of claims for insurance carriers and served as an expert witness for both sides of insurance disputes. Michelle Boots, CPA, is a senior accountant with Lowers Forensics International. Marc Johnson, CPA, CFF, is president of Lowers Forensics International.

 Related:

Assessing business interruption claims for real estate owners

Inflation, labor challenges are the biggest risks facing construction sector