Introduction
BI refers to a situation in which the normal business operations of a company are disrupted or halted due to unexpected circumstances beyond its control. When business operations are affected, companies incur significant losses due to the temporary closure of facilities, damaged inventory or equipment, and other expenses. BI could financially strain a company and impact its revenue, profitability, and ability to meet its financial obligations. As part of the overall risk mitigation strategy, companies purchase BI insurance, also known as business income insurance or loss of profit insurance. Traditionally, BI insurance has been designed to protect businesses from financial losses triggered by the total or partial suspension of business operations due to the loss of use or damage to all or part of a building, plant, machinery, equipment, or other property, from perils such as fires, natural disasters, or other covered events. BI insurance provides coverage for business income loss and the extra expenses incurred.
Over the years, successive industrial revolutions, globalization, technological growth, and adoption, and changing customer behavior have transformed the business environment. The risk environment that disrupts businesses has also changed significantly. The confluence of both factors has resulted in a paradigm shift in the basic characteristics of BI. In the current landscape, a major business disruption could occur due to events that may no longer be related to physical damage. Non-physical damage business interruption (NDBI), as it is known, is growing in frequency, severity, and unique varieties.
Evolution of Traditional BI Insurance
BI insurance is an essential component of risk management that enables businesses to recover after unexpected interruptions and return to their pre-interruption state. The origin of BI dates to the early 19th century. In 1817, the “Hamburger General-Feur-Kasse” (Hamburg Fire Office), a German insurer, became the first insurer to offer cover for the loss of rent as a supplement to fire insurance. This marks the inception of a product that bears resemblance to BI coverage sold today. Although this policy did not cover business profits or losses, it addressed a significant concern for businesses impacted by property damage.
The term “business interruption insurance” was not formally used in the initial decades. The coverage versions sold during that period focused only on specific aspects like lost rent or consequential costs. Hence, terms such as “use and occupancy” and “gross earnings” insurance were commonly used as alternatives to BI until the mid-20th century. The term BI insurance gained traction in the early 20th century before becoming standardized in 1986 when the Insurance Service Office (ISO) in the US recommended replacing “gross earnings” with “Business Income Coverage” to include broader financial losses due to business interruption. Since then, coverage has considerably evolved to provide protection against loss from the covered peril incurred directly or indirectly.
The term “business interruption insurance” was not formally used in the initial decades. The versions sold during that period focused only on specific aspects such as lost rent or consequential costs. Hence, terms such as “use and occupancy” and “gross earnings” insurance were commonly used as alternatives to BI until the mid-20th century. The term BI insurance gained traction in the early 20th century before becoming standardized in 1986 when the Insurance Service Office (ISO) in the US recommended replacing “gross earnings” with “Business Income Coverage” to encompass broader financial losses due to business interruption. Since then, coverage has considerably evolved to provide protection against loss from the covered peril incurred directly or indirectly.
BI insurance provides coverage for loss of revenue, reduction in turnover, monthly mortgage, lease and rent payments for business space, loan payments for the business, taxes, payroll, costs related to temporary relocation, training costs for employees to learn how to handle new equipment, and other extra expenses. Extra expense coverage provides financial protection for extra expenses that a business incurs to keep operations running or to resume operations as quickly as possible after a disruption. The benefits under the BI coverage are payable during the period of indemnity, which is typically 12, 18, 24, or 36 months. Insurers will not provide cover for claims beyond the indemnity period.
The genesis and growth of BI insurance are synchronous with industrial revolutions. The first and second industrial revolutions focused on manufacturing with the help of mechanization and mass production. Companies and industrial hubs were established for localized manufacturing. The most important risk faced by businesses during this era was physical damage to property from fire, floods, and other perils. The BI cover created during this period worked in conjunction with and because of damage to the underlying property, which is known as the “material damage proviso.” BI insurance coverage is generally offered as a part of a standard business policy or purchased as an endorsement or rider to a property insurance policy.
The third industrial revolution that followed focused on automation. The highlight of this revolution is the advent of microprocessors, computers, and electronics. It further paved the way for the emergence of globalization, outsourcing, and service industry. At this stage, the factors triggering BI expanded to include contingent business interruption, supply chain disruption, cyber risks, and pandemics that do not have a property damage causation. Contingent business interruption is another such risk, stemming from the interruption of business operations of a critical supplier, customer, or partner due to a covered event such as a fire or natural disaster at their premises. The trigger for BI and CBI is generally direct physical damage from the covered peril to property, but the difference lies in whether the damaged property belongs to the insured or pertains to their supplier, customer, or partner.
The ongoing fourth industrial revolution embodies new technologies such as the internet-of-things, big data, cloud computing, digitalization, artificial intelligence, autonomous decision-making, and cyber-physical systems. As these technologies mature and gain business adoption, they pave the way for the emergence of new industries and business models, altering the way incumbents operate and shifting the characteristics of BI, ultimately pushing it more towards NDBI.
Tectonic Drift Towards NDBI
The role played by businesses is continuously evolving, transitioning from commodities trader to goods manufacturer, service provider, insight provider, experience stager, and transformation orchestrator. The coordination required for these functions is expanding significantly. The risks affecting businesses have also taken on new dimensions. The dynamic changes in the business and risk environments, and the interaction between them, have fundamentally altered the landscape of BI. While BI stemming from traditional physical damage remains a potential risk, the influence of intangible risks is growing exponentially. Worst-case revenue loss scenarios are increasingly attributed to non-physical damage. For these NDBI risks, the need for material damage as a precondition for BI becomes irrelevant.
Changing business environment
Several factors such as globalization, shift in the business asset structure, change in customer behavior, evolution of service and sharing economy are responsible for changing the business environment (see Figure 1).
1. Globalization: During the last four decades, there has been a fundamental shift in the corporate landscape from localized production and consumption to globalization. In this globalized landscape, companies have diversified their operations and connected to a web of suppliers and consumers across the world. This has resulted in longer and more complex value chains. Even service-based companies are outsourcing their business functions to other providers worldwide. The interconnectivity of businesses, customers, and suppliers has led to a significant increase in the risk surface for business interruption.
1. Shift in asset structure: The assets held by companies and their valuations have shifted from being predominantly physical to non-physical assets. Technology plays a crucial role in this transformation, as an increasingly significant portion of business assets are now intangible, including intellectual property, networks, platforms, and data. For these asset-light technology-dominated companies, physical damage is relatively less concerning or destabilizing compared to non-physical damage that affects income streams and cash flows.
2. Change in customer behavior: Over the years, a significant shift has occurred in how customers and businesses prefer to access products or services. The new generation of customers is increasingly comfortable conducting all their purchases] or service transactions online. The catchphrase for accessing products and services has evolved from “a few meters, a mile, or a call” away, to simply “a few clicks or swipes” away. The widespread adoption of digitalization, e-commerce platforms, mobile apps, and social media platforms has driven this transformation. The demand for personalized experiences has spurred the emergence of new business models such as on-demand services, subscription-based models, and quick commerce, also known as q-commerce.
3. Growth of service economy: Economies have transitioned from being solely product-based to encompassing services, knowledge, and experiences. As this evolution continues, new businesses are emerging with a focus on catering to these intangible metrics. In many cases, even core product manufacturing companies are embracing servitization, which involves creating a wrapper of service or experience around their products. These companies often generate more revenue from these wrappers than from their products themselves. The emergence of connected devices driven by the internet-of-things is further bolstering the business case for the service and experience economy.
4. Emergence of sharing economy: Advancements in technology, the growth of online trust, and economic factors have contributed to the evolution of the sharing economy, also known as collaborative consumption. In this economic system, individuals or organizations share resources, assets, or services directly with each other, often facilitated through digital platforms. These platforms act as intermediaries, facilitating interactions and transactions between two or more distinct groups, commonly referred to as “users” or “participants.” Platform-based companies in the sharing economy benefit from low operational expenses because they do not incur inventory expenses associated with traditional businesses. This shift has given rise to new business and employment models such as gig work and sole proprietorship, which involve blending personal and commercial insurance lines—an aspect not previously anticipated in the traditional business world.
Changing risk environment
In addition to changes in the business environment, the risk landscape in which businesses operate has evolved due to various risk factors (see Figure 2). These include climate change and weather events, technology failures, cyber risks, geopolitical tensions, and regulatory interventions.
1. Climate change and weather events: Climate change refers to long-term shifts in global or regional weather patterns and average temperatures. Unlike weather changes that occur on shorter timescales, climate events unfold over decades or even longer periods. The impacts of climate change manifest in various ways, including increased global surface temperatures, melting polar ice caps, rising sea levels, alterations in precipitation and weather patterns, and extreme weather events such as hurricanes, heatwaves, droughts, floods, and wildfires. The frequency and severity of these events have been on the rise in recent decades. While weather events are known to directly cause physical damage, in the evolving business landscape, business interruption can occur without physical damage to either owned or contingent property.
2. Technology failures: In the current business environment, every company is heavily reliant on technology and interconnectedness. The adoption of technologies and concepts such as big data, cloud computing, internet-of-things, artificial intelligence, APIfication, appification, platformization, and digital transformation has significantly altered the way businesses operate. In such an ecosystem, any technology failure event—such as network failure, IT and telecommunication outages, cloud downtime, slow internet connectivity, or even electricity blackouts—could result in substantial losses for businesses.
3. Cyber risk: The heavy reliance on digital assets and technology has expanded the risk landscape, rendering businesses more susceptible to cyber-attacks. Cyber incidents such as hacking, malware, and ransomware can result in the loss of sensitive data, denial of service or access, and disruption of business operations. In contemporary times, real-world conflicts and acts of terrorism are increasingly manifesting as cyber-attacks on business networks. With the maturation of new technologies such as cyber-physical systems, autonomous decision-making systems, and quantum computing, the cyber risk is poised to escalate multiple times beyond what has been experienced thus far.
4. Geopolitical and terrorism: The geopolitical landscape, historically characterized by flux, is evolving towards multipolarity. Economic rivalries, dominance aspirations, and shifting alliances are redrawing battle lines. In such a dynamic environment, government actions, tariffs, sanctions, labor disputes, trade barriers, or organized blockades affecting market access can significantly impact business operations. Geopolitical tensions, trade disputes, or conflicts have the potential to disrupt global supply chains, resulting in delays, shortages, and increased costs for businesses reliant on international trade. The closure of a port or blockade of a trade route could create chaos within the supply chain. Companies may encounter difficulties in sourcing raw materials, components, or finished goods from regions affected by social unrest. Changes in geopolitical alliances can also impact trade relationships and business partnerships. In the digital age, terrorism takes on a new narrative either as cyber terror or loss of business, often causing no physical damage but inflicting significant losses.
5. Regulatory risks: Events such as government-mandated public shutdowns due to health crises, withdrawal of regulatory approvals or licenses from manufacturing companies, or closure of production facilities by regulatory bodies can lead to sudden disruptions. For modern businesses, data, and its management—encompassing sourcing, storage, processing, deriving insights, and initiating action—have become central nervous system activities. In this context, regulations pertaining to data privacy, cybersecurity, digital assets, and the use of artificial intelligence algorithms have an impact on business operations temporarily or indefinitely.
These risks are evolving, and their impact on each business in a dynamically changing environment could be unique. Today, no business can claim to be impervious to NDBI or assert that they are adequately protected by traditional BI insurance covers. Although these protection gaps and uninsured spaces have existed previously, they were considered unquantifiable and uninsurable. In the current environment, where NDBI could cause significant disruption, the primary concern for businesses is the risk of being uninsured or underinsured. The market demand and appetite for comprehensive NDBI coverage, the insurance industry’s sensitivity in identifying these risks, the ability to build risk models, the capacity to design coverage, and the efficiency to deliver them, even for small-ticket opportunities, have significantly improved.
Insuring NDBI
The purpose of NDBI insurance coverage is to offer financial protection to businesses when their operations are interrupted or suspended due to non-physical loss or damage. Like traditional BI insurance, NDBI insurance covers a broad range of losses, including loss of income, extra expenses, loss of property or equipment use, loss of market or reputation, and loss of key employees. In the globalized business environment, just as BI expanded to include contingent BI, NDBI is also evolving to encompass contingent NDBI. Contingent NDBI provides financial protection to businesses if their operations are disrupted or suspended due to non-physical loss or damage to suppliers, customers, or other third parties. However, there are significant challenges in providing protection for NDBI.
Challenges in Insuring NDBI
BI insurance is considered complex for several reasons, including the wide range of perils it covers, complex policy wording, interconnected risks with other insurance coverage, and the challenges involved in assessing losses. NDBI risks, being intangible in nature, are even more complex and difficult to identify, predict, underwrite, price, or manage. Some of these challenges (see Figure 3) are outlined below.
1. Difficult to predict and assess: NDBI losses are challenging to predict and quantify because they can result from events that are difficult to anticipate. Unlike direct physical damage events, which have clear and objective indicators, the indicators of indirect non-physical damages are subjective and thus difficult to assess in terms of extent and duration of interruptions. For creating coverage, both companies and insurers must have a deep understanding of revenue streams, cost structures, operational dependencies, and potential risk sources to evaluate the financial losses they could face from NDBI. They need to assess the impact of business interruption on revenue loss and the additional expenses required to restore operations to design appropriate coverage. Even when the business interruption is caused by a known peril, each industry and company may be impacted differently, necessitating insurers to employ sophisticated risk assessment techniques and data analytics.
2. Dynamic and evolving: NDBI risks are constantly evolving and to cover them insurers must continually update their risk models, adapt their underwriting criteria, and revise their coverage offerings. Risk triggers such as governmental and regulatory actions can be challenging to model accurately. The changing risk exposures of businesses present a significant challenge for insurers to remain agile and adept in managing the latest risks. Any delay in responding to the evolving nature of NDBI risks could lead to underestimation of the impact, potentially resulting in severe consequences for both insurers and policyholders. Therefore, it is crucial for insurers to stay proactive and responsive to the dynamic landscape of NDBI risks to ensure effective risk management and coverage provision.
3. Lack of historical data: Insurers traditionally depend heavily on historical loss data to establish risk coverage. While some NDBI risks have existed for years, they did not receive adequate market attention until recently. With growing demand, technological advancements, and the capacity to develop coverage, there is now renewed interest in NDBI coverage within the market. However, the availability of limited data poses a challenge for insurance companies to accurately model, assess, and price the risk associated with these types of losses. This scarcity of data makes it difficult to fully understand the potential impacts and adequately mitigate NDBI risks.
4. Higher cost of insurance: NDBI can be triggered by various risks, including natural disasters, fires, equipment failures, cyberattacks, supply chain disruptions, and pandemics. It is crucial to recognize that each of these risks can be influenced by multiple perils, either individually or in combination. While it may be beneficial to the businesses to include coverage for all these perils in an NDBI policy to ensure comprehensive protection, doing so could lead to higher premiums that could make it unaffordable or economically infeasible for businesses. Therefore, insurers and businesses must carefully evaluate and prioritize the most significant and likely risks to determine appropriate coverage levels that strike a balance between protection and affordability.
5. Complex policy wording and coverage determination: Standard insurance policies often have limitations or exclusions that restrict coverage for NDBI events, such as cyberattacks or pandemics. Defining the scope of coverage and policy terms for NDBI requires careful analysis of a company’s unique risk exposures and coverage needs. Insurers must meticulously draft policy wording to ensure that coverage adequately addresses the specific needs and exposures of policyholders. Drafting clear and accurate policy wording presents a challenge, as the complexity related to NDBI could give rise to silent risks when policy inclusions or exclusions are not clearly described. For instance, a business interruption event could be caused by a secondary event that is not excluded in the policy wording, occurring sequentially to a primary event that is explicitly mentioned thus resulting in legal disputes. Furthermore, the legal and regulatory landscape surrounding NDBI coverage is still evolving, adding another layer of complexity for insurers and policyholders alike.
Until recently, traditional indemnity-based insurance contracts have been predominant in the protection landscape. These contracts compensate policyholders for actual financial losses incurred due to covered events or risks. NDBI coverage has been offered by insurers either as standalone policies or as add-ons to existing BI or property insurance policies. Insurers have provided coverage for specific NDBI risks with lower limits, selectively based on the type of peril, industry, and company. In some instances, NDBI coverage is included as sub-limited coverage within broader BI policies. However, the claims settlement process in traditional indemnity-based policies can be complex and lengthy, which may not be ideal for addressing the urgent cash requirements associated with NDBI losses. The challenges associated with managing NDBI risks through indemnity-based insurance have led to many of these risks being considered uninsurable, resulting in significant insurance gaps. In recent years, parametric insurance has emerged as a suitable alternative for providing coverage for difficult-to-manage risks such as NDBI.
Emerging Parametric Solutions
So far, the insurance industry has approached NDBI exposures in an extremely selective manner. Given the complexity and uniqueness of NDBI risks, there are no one-size-fits-all solutions available. Providing coverage tailored to each peril, industry, and company requires a different approach to risk identification and assessment. As a result, NDBI policies are typically more customized than other insurance products. To create coverage for NDBI risks, insurers and companies must first understand the types of non-physical losses the business is vulnerable to and their impact on cash flow and revenue. Following this understanding, they need to assess whether these risks are insurable and, if so, at what cost. Therefore, it is unlikely for businesses to find off-the-shelf solutions that perfectly fit their needs when it comes to NDBI coverage. Instead, a collaborative approach between insurers and businesses is necessary to tailor coverage to specific risk exposures and ensure adequate protection against NDBI events.
Given the challenges in creating traditional insurance products for NDBI, parametric or index-based insurance is emerging as an efficient option to enhance the insurability of difficult-to-insure exposures. Unlike traditional policies that pay claims based on the damage, parametric policies pay claims based on objective triggers. Parametric insurance contracts pay out a predetermined amount of money upon the occurrence of a predefined event, as measured by a predefined index or parameter. This provides policyholders with quicker access to funds in the event of a covered loss. This rapid response can be crucial for businesses facing NDBI-related disruptions, allowing them to mitigate financial losses and expedite recovery efforts However, the biggest challenge in creating parametric contracts lies in identifying the risk, defining appropriate predictor variables, and establishing effective ways of monitoring it.
With the advent of new age technologies enabling the sourcing of granular, reliable, real-time data and the processing of this data for deriving risk insights, the landscape of protection is undergoing transformative evolution. Advancements in big data, internet-of-things-enabled connected devices, satellite data, geographic information systems, artificial intelligence, and machine learning are providing insurers with a new perspective on risk management. The availability of real-time risk data and the ability to derive intelligence from it allow insurers to create parametric contracts tailored to specific industries and companies, considering their unique business models. This capability is now extending to risk areas where traditional indemnity-based insurance struggled to provide coverage. Using these technologies, insurers can define a wide range of parameters or indices for different risks and perils, which can serve as parametric triggers. This approach enables insurers to offer more flexible and tailored coverage options that better align with the evolving needs of businesses and industries.
The advantage of parametric solutions lies in their ability to offer insurers the flexibility to design bespoke risk transfer solutions for niche areas. Given that NDBI risks involve unknowns, uniqueness, and novelty that insurers must contend with when defining coverage, parametric contracts help insurers manage their risk exposure by limiting the coverage amount. This makes parametric products an effective instrument for expanding the limits of insurability with respect to NDBI cover.
Over the last few years, innovative parametric solutions have emerged in the market, addressing the gaps in protecting earnings and cash flow. Here are some scenarios where innovative coverage is provided for NDBI.
- Airport closures due to fog or volcanic eruptions.
- Drop in business transaction volume, footfall, hotel occupancy levels, or loss of income for gig workers following a terror attack, such as a shooting in a specific area.
- Disruptions in the supply chain, including shipment delays, and protection for gig workers and builders experiencing loss of income after a natural catastrophe.
- Social or political unrest and consequent government actions resulting in denial of access to property.
- Loss of business for water-based theme parks due to droughts and water shortages.
- Loss of attraction for the tourism industry during heatwaves or no snowfall periods.
- Shortage in renewable electricity output due to lack of sunlight, wind source volatility, or water shortages.
- Transport disruptions that are caused by port blockages or lower river levels.
- Technological disruptions such as cloud downtime, internet disruption, or downtime of third-party IT service providers
The innovation of parametric insurance for NDBI losses has only just begun. These early products have seen limited success and have yet to achieve widespread adoption. However, it can be stated with certainty that in the dynamically evolving business and risk landscape, NDBI risks are likely to find an ideal solution in parametric insurance contracts.
Road Ahead
Awareness and interest in coverage for NDBI risks have increased following the Covid-19 outbreak. Looking ahead, NDBI is poised to become a significant area of insurance activity. While businesses are demanding comprehensive all-risk coverage for NDBI, including all perils and causes, insurers are still in the early stages of experimentation. Due to the novelty and innovation involved, the initial coverage developed by insurers is not comprehensive but rather focused on specific perils with low limits. As the new-age NDBI policies are tailored to individual needs, the effectiveness of data sources, parameters, and policy wordings remains relatively untested. The true test of their efficacy will come when claims arise, particularly in large numbers. As parametric policies are still in the initial stages, premiums for these tailored contracts may be relatively higher, where the perceived benefits are outweighed by the premiums. However, as insurers gather more data on these niche risks, they will be better equipped to accurately quantify exposures, refine parametric triggers, and reduce premiums. Given that providing indemnity-based insurance solutions for many NDBI exposures may be financially unfeasible, we can expect to see more parametric solutions emerging in this space. The current parametric structures for NDBI are designed with single parametric triggers, however as the product landscape expands, coverage may evolve to include multiple triggers, stepped payouts and hybrid models that combine elements of both indemnity-based and pure-parametric solutions.
