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In business, as in war, some of the biggest risks are--as former Secretary of Defense Donald Rumsfeld once put it--the unknown unknowns. For many companies, the biggest unknowns stem from their contingent business-interruption risk.

"I would say both business interruption and to some extent contingent business interruption are two of the most difficult values for a business to assess," says Craig Lapsley, vice president at Travelers Global Technology.

"It's difficult for insurance professionals, who do it all the time, and it's extremely confusing for insureds," Lapsley says.

Whenever there are large losses or catastrophic events, a very large percentage of insureds invariably turn out to be underinsured when it comes to business income, he says.

What makes contingent business interruption particularly tricky to assess is that it involves operations that are outside the company's direct control. A company's own operations may be in fine working order, but it may nevertheless suffer a significant loss of business income because of a disruption in the neighborhood, or with one of its suppliers, or with one of its buyers.

For some companies, however, the risk of contingent business interruption can seem remote. But as businesses in New York and New Orleans learned after Sept. 11, 2001, and Hurricane Katrina in August 2005, disaster can strike in unexpected and devastating ways.

Some of the most easily overlooked exposures are connected with a company's business partners--with either its suppliers or the buyers of its goods. A disruption at a nearby attraction--a theme park or a convention center, for instance--also could spell trouble for businesses that depend on those attractions for their own livelihood.

Added to that are any number of disruptive incidents--a fire, a gas main explosion, a chemical spill, a bomb threat--that could force civil authorities to close down operations in an area or simply scare customers away.

Another risk that is often overlooked is the threat posed by communicable or infectious diseases.

SUPPLY/DEMAND CHAIN

Many companies are well aware of how dependent they are on their key suppliers and have worked hard on developing contingency plans in case of a problem.

But what if that supplier's supplier has a problem? The disruption may not be with the insured's supplier, but with that vendor's supplier, or even several steps further down that supply chain.

"You could conceivably have a contingent and recipient business interruption loss two steps down the line from the actual vendor who is producing the raw materials that you need, and there's a lot of that that is probably being overlooked," says Don Corrigan, executive general adjuster, GAB Robins North America, a risk management services firm.

"The issue for most insureds is, when they look at that, they may be looking at what we call Tier-1 suppliers and recipients," Corrigan says. "I think you've got to look beyond that to two or three layers beyond," he says.

Suppliers are just one part of the potential problem. The loss of a major customer can be just as problematic for a company as the loss of a supplier. And yet many companies overlook the risk of a cancellation of an order from a major customer, or the cancellation two or three steps up the demand chain.

Contingent and recipient business interruption provides coverage only if the peril that disrupted the supplier or the recipient is a covered peril under the insured's policy and the policy extends coverage far enough up the insured's demand chain.

Other companies have a backup plan and an alternate supplier. But they are still at risk if other companies have also identified the same alternate supplier. That alternate supplier could become overwhelmed by demand if some event forces a number of companies to form a conga line at its door.

"That's certainly something I don't think the client necessarily takes into consideration," Lapsley says. "But they need to recognize that there's many other companies--whether they're competitors or not--who are creating similar plans and looking at the same facility," he says.

The reliance on offshore vendors can also create some unexpected risks. In other countries, the infrastructure might not be as reliable, leading to more frequent problems with electricity and utilities. Fire protection and other building construction codes could also be inadequate.

Like companies in the United States, suppliers in other parts of the world are also vulnerable to catastrophes. U.S. risk managers, who may be well aware of the risk of California earthquakes and Atlantic and Gulf Coast hurricanes, might not be as familiar with the catastrophe risks in other countries.

Although foreign catastrophes are not typically covered under the typical contingent business-interruption policy, risk managers still need to be aware of the risk and plan for them.

Risk managers should make sure that they have coverage on the company's global program and not just on a separate foreign property program, Lapsley says.

A loss at a foreign-owned location will more than likely have an impact on the domestic side of the company. But the domestic policy might not cover the loss, and there might not be coverage under a separate foreign property program, he says.

The best alternative, therefore, is to be sure that there is a true worldwide program and to have blanket limits.

LOSS OF ATTRACTION

In this example, imagine a city that has built its economy around a major theme park. Many businesses--hotels, restaurants and other shops--depend on the tourists that come to the city to enjoy that attraction.

If a fire or some other problem were to occur at the theme park and it had to close for a few weeks, the impact would not be isolated. Instead, the entire economy of the city would be affected as a result of the loss of tourists and customers.

There is a ripple effect whenever there is an incident that forces police, firefighters or other government officials to get involved.

Companies sometimes overlook the fact that, even though they might be following best practices, their neighbors may not be. And some things are just impossible to predict.

Consider these possibilities:

* A bomb threat completely shuts down your company at one location, and no one knows how long the disruption will last.

* A case of meningitis breaks out in a building in your company's business park, and the authorities shut down the whole park.

* The building next door to your facility has a fire or chemical spill, and the government shuts down the area for four blocks around.

"Most people don't appreciate that kind of risk," says Joseph Gerber, a member of law firm Cozen O'Connor's Philadelphia office, chair of the firm's client relations activities, and co-chair of its crisis response and management practice.

"In each scenario, your building is untouched, though you're shut down as if your building burnt to the ground," he says.

And then there is the risk of communicable disease.

This threat gained a lot of attention with the outbreak of SARS in 2003. Much has been written over the last year or two about the threat of a pandemic from avian flu.

But even so, many risk managers are still not prepared or even aware of the risk.

"I still think that it's largely something that is not always considered by risk managers, and I still truly believe that it is undeveloped in terms of an insurance product to cover," says Paula Woolworth, senior vice president of account management and Med Insight at GAB Robins.

"It usually is not going to trigger contingent BI because there's not necessarily going to be a property loss first," Woolworth says.

An infectious disease like SARS or a flu pandemic, however, could shut down suppliers and keep employees out of work. Government officials could be forced to impose quarantines. Air traffic could come to a halt. Businesses that were affected by the SARS outbreak in Toronto learned that it would be wise to prepare in case it happens again.

And officials say that there will be a pandemic. The question is not if, but when.

Because there is no insurance to cover such losses, companies need contingency plans that say who would be in charge in case top executives became ill, and how they would handle absenteeism by employees.

PATRICIA VOWINKEL lives in New Jersey.

May 1, 2007

Copyright 2007© LRP Publications