BI Exposure on R&D

Risk managers employed by corporations which may have some involvement in research and development (R&D) activities could unknowingly face a significantly uninsured exposure on their business interruption (BI) coverages. Typically, R&D is regarded as an area of the business that supports the development of the company’s products or technology. BI losses in this regard are fairly standard in exposure and therefore the type of coverage involved. However, the issue of coverage becomes greatly more complex when the type of R&D activity is unrelated to the company’s existing production or enterprise. The first thing to do is to find out the purpose of the research establishment. Broadly speaking, R&D falls into two categories:

To support the existing production by providing services such as testing of raw materials, quality control etc.; and

Pure research unrelated to current production.

Each of these R&D activities has different business interruption insurance exposures. In the first situation, namely research involving support of existing production, any interruption will result in a change in turnover, expenses and/or profit, and it should be treated as a “standing charge” included within the operation’s gross profit. In the second instance, since the interruption will not impact on the turnover, etc., another approach is necessary. The following considerations have to be taken into account:

A considerable amount of additional expenditure (extra expense?) may be incurred for items such as the provision of alternative premises, with all necessary equipment;

The fact that the specialized staff will be either idle or under-utilized until either the original premises are repaired or the alternative premises are usable. These persons will most likely have special training expertise and be in possession of secret information that would be valuable to competitors and therefore could not be laid off and rehired after repairs have been completed;

The cost of replicating documents and/or redoing those experiments that has been destroyed and has to be redone; and

The cost of reloading data onto computers.

INSURANCE OPTIONS

In circumstances surrounding the first bullet point above, the loss can be insured under an “extra expense” or “increased cost” of working form – provided that an adequate “sum insured” can be obtained (without any monthly limitation of payment).

With issues concerning the third and fourth points referred to above, the exposure(s) may be insured by a combination of “valuable papers” and “computer floater” coverages with adequate sums insured and full disclosure of the nature of the operations made on placing the policy.

This leaves the issue of unutilized staff/expertise, which is basically the insurance of “wages and salaries”, but would include other overheads such as heating, lighting, etc., that would be involved in the operation of the establishment. Since the operation or non-operation of an establishment of this type will not affect the sales of the entire business within the probable period of indemnity the normal formula of recovering the gross profit portion of lost sales would not be suitable.

Therefore an arbitrary method of dealing with the problem is used. This is achieved by adapting the old “Per-Diem plan”, in a separate specification to the policy. By this method, one-fiftieth part of the total estimated annual expenditure is paid for each week or part of a week that the operations of the research establishment are suspended or interfered with. Necessary additional expenses incurred to minimize the period of interruption are covered, and a co-insurance clause is included to encourage the purchase of adequate sums insured. An “other circumstances” clause can be added for new or expanding establishments.

BLENDED R&D

It would be nice to be able to categorize all R&D establishments as suggested above, but it is suspected that most of them will be blends – that their work will both contribute to the production of the product and contain elements of pure research whose benefits might not be immediately apparent. In such cases it would still seem better to insure the whole department on a separate basis with its own specification. The reason for this is that if a part of the department is included in the item for gross profit, and a part its own specification, then it becomes difficult to differentiate the two and by not including any R&D costs in the standing charges for the gross profit item – a lower gross profit rate will be obtained, thus avoiding a double indemnity.

There is a third possibility for R&D establishments. In cases where research is being carried out with an immediate view of starting production of a new product it would be wise to insure the project under an “advance profits” wording. The specification for such a wording would detail the following:

That indemnity would begin on the estimated date of the actual commencement of the business, not on the date of the destruction;

That the lost production would be obtained by comparing the actual production with a pre-agreed estimated production. The co-insurance requirement would be suitably amended; and

Although the indemnity period would not commence until the estimated date of the commencement of the business, provision is built in for expenses to avoid or reduce loss to be payable before such date, as may be necessary.