Back To Basics

With the increasing focus on strategic and operational risks, it's easy to play down the importance of hazard risk management. But fire is still the most common cause of loss for most UK companies. Andrew Parkhurst writes

Fire claims are spiralling out of control. According to figures released by the Association of British Insurers (ABI), the cost of this year's fire and business interruption claims are up by a massive 80%, on last year.

These figures come on top of horrendous results in 2001, when fire claims topped £1bn for the first time in 10 years. Including lost production and uninsured losses, the cost to British industry was nearer £7bn. Analysts are now expecting 2002 to be even worse.

This could not come at a worse time. Between 1998 and 2000, UK insurers incurred an underwriting loss of over £500m. Last year's terrorist attack on the World Trade Center wiped out $80bn (£50bn) of worldwide capacity and caused reinsurance costs to increase by an average of 25%. This year, the wild fluctuations in world stock markets have hindered insurers from rebuilding capital.

Capacity is therefore in short supply, and, with fire losses increasing so rapidly, insurers are hiking up their prices and being very selective in the risks they accept. The ABI says that UK commercial property insurance premiums are up by an average of 50% compared to last year's prices.

The message to businesses is therefore clear: if they want insurance at an affordable price, they must put more effort and resources into reducing the risk of fire. John Parker, the ABI's Head of General Insurance says, "All businesses need to ensure they have comprehensive risk management programmes to identify the fire dangers they face, and implement measures to minimise the risks. Costly disruption, lost productivity, higher operating costs, more expensive insurance premiums and the risk of business collapse all follow from the failure to treat the risk of fire seriously."

Disregarding the risks of fire could also result in prosecution. Since the Fire Precautions (Workplace) Regulations came into force in 1997, employers have been required to carry out a fire risk assessment of their workplace. The aim is to identify fire hazards and the control measures needed to deal with them, thus reducing the likelihood of a fire occurring and the consequences if one does. The Regulations apply to all types of workplace, including those that possess fire certificates. Employers with five or more employees must record the results of the fire risk assessment.

Fire risk assessments need to examine not only intrinsic hazards, such as those resulting from trade processes, but also hazards such as arson, the spreading of fire from neighbouring sites, and contractors working on the premises. It also makes sense to focus on the main causes of fires.

According to the Fire Protection Association (FPA), arson remains the biggest problem. The FPA says that more than a third of the fires which lead to claims over £50,000 are started deliberately. This rises to over 60% for fires in the construction industry, schools, community centres and churches.

A recent Home Office study also shows arson to be a fast-growing crime, with incidents increasing as enforcement declines. Arson has one of the lowest clear-up rates of any major crime. The Arson Prevention Bureau reports that a conviction follows only 1% of the deliberately-started fires recorded by the fire service.

Arson prevention strategies are often limited to improving physical security, reducing the presence of combustible waste and managing the layout of the premises to limit the potential for fire spread. These measures can reduce the likelihood of an external attack, but may be ineffective where an arsonist has legitimate access to the premises. Nearly a fifth of arsonists suffer from mental disorders. Unless these people have been screened out during the recruitment process, they may be employees of the firm, ready to wreak their vengeance if they feel they have a grievance.

Electrical faults are the second biggest cause of fires. The FPA says that 70% of such fires occur at night, and the largest ones start in production areas. All types of premises are vulnerable, but some of the biggest losses have been in the metal industry, furniture factories, vehicle repair workshops, pubs, clubs and restaurants. Regular maintenance, inspection and testing could have prevented many of these fires.

Fires caused by carelessly discarded smoking materials and by heat and sparks (usually by contractors) vie for third and fourth places. Both of these categories of fire are preventable if the risks are recognised, and if employees and contractors are properly supervised.

For many companies, a serious fire means the end of their business - studies show that 30% of companies fail in the first year after a serious fire. Having adequate material damage insurance to reinstate the premises and replace damaged machinery and stock is not enough. Effective business recovery planning and adequate business interruption insurance are also vital.

Plan to recover
One recent survey showed that the awareness of the need for business recovery planning is high, but often the task is put on the back-burner. Of those companies that do have a plan, around 60% either fail to test it, or consider its effectiveness doubtful. Business recovery plans can quickly go out of date, so they need to be regularly revisited.

The plan should identify the hazards affecting the business and then assess the potential impact. Bottlenecks and critical areas of the business should be identified. A scoring system helps to calculate the degree of risk and to plan the appropriate response. The plan should then be audited and tested to ensure it is effective, both in the crisis-management phase and later during the recovery phase.

Business interruption insurance tends to be regarded as an add-on cover to which many smaller companies give little thought. After a major incident the cover may not meet their needs. Additionally, the length of the maximum indemnity period needs careful consideration. Many companies opt for a 12 month period. However, this is unlikely to be adequate after a major loss.

Even when the business is fully operational, it is unlikely that its gross profit will speedily revert to its pre-loss level. Trained workers and key staff may have gone; major customers will certainly have done so, and the reputation of the business may have suffered long-term damage. It could take several years for the firm to regain its market position.

In modern business, a partnership approach with suppliers is common, often with single sourcing of components. The just-in-time delivery system reduces the need for warehousing, but greatly increases a firm's dependence on its suppliers. Few businesses insure against their suppliers having a major loss, even though this could be just as disastrous as an incident affecting their own premises.

Similar considerations apply to customers' premises. If a major customer has a large fire and stops ordering supplies, few companies would be able to replace that customer quickly.

As well as insuring against loss of profit, businesses should think about covering additional increased costs of working. Most policies provide limited cover for additional costs, but it applies only if the gross profit from the additional sales generated at least matches the increased costs incurred. Because customers are not renowned for their loyalty, businesses need to maintain their sales at any price, and need cover for additional costs which is not subject to this so-called 'economic limit'.

Few businesses will suffer a total loss, however. Some underwriters will agree to provide cover on a first loss basis. Here, the policyholder calculates the amount of gross profit in the normal way, but then selects a lower sum insured based on an assessment of the loss potential. As market capacity is limited, this is a good way of achieving effective cover at an economic cost.

With losses rising, premiums soaring and market capacity running low, businesses can no longer afford to rely on crudely arranged insurance programmes. Greater sophistication is needed, both to reduce the risks of fire and to select those covers which are essential to the firm's survival.

Fire claims are spiralling out of control. According to figures released by the Association of British Insurers (ABI), the cost of this year's fire and business interruption claims are up by a massive 80%, on last year.

These figures come on top of horrendous results in 2001, when fire claims topped £1bn for the first time in 10 years. Including lost production and uninsured losses, the cost to British industry was nearer £7bn. Analysts are now expecting 2002 to be even worse.

This could not come at a worse time. Between 1998 and 2000, UK insurers incurred an underwriting loss of over £500m. Last year's terrorist attack on the World Trade Center wiped out $80bn (£50bn) of worldwide capacity and caused reinsurance costs to increase by an average of 25%. This year, the wild fluctuations in world stock markets have hindered insurers from rebuilding capital.

Capacity is therefore in short supply, and, with fire losses increasing so rapidly, insurers are hiking up their prices and being very selective in the risks they accept. The ABI says that UK commercial property insurance premiums are up by an average of 50% compared to last year's prices.

The message to businesses is therefore clear: if they want insurance at an affordable price, they must put more effort and resources into reducing the risk of fire. John Parker, the ABI's Head of General Insurance says, "All businesses need to ensure they have comprehensive risk management programmes to identify the fire dangers they face, and implement measures to minimise the risks. Costly disruption, lost productivity, higher operating costs, more expensive insurance premiums and the risk of business collapse all follow from the failure to treat the risk of fire seriously."

Disregarding the risks of fire could also result in prosecution. Since the Fire Precautions (Workplace) Regulations came into force in 1997, employers have been required to carry out a fire risk assessment of their workplace. The aim is to identify fire hazards and the control measures needed to deal with them, thus reducing the likelihood of a fire occurring and the consequences if one does. The Regulations apply to all types of workplace, including those that possess fire certificates. Employers with five or more employees must record the results of the fire risk assessment.

Fire risk assessments need to examine not only intrinsic hazards, such as those resulting from trade processes, but also hazards such as arson, the spreading of fire from neighbouring sites, and contractors working on the premises. It also makes sense to focus on the main causes of fires.

According to the Fire Protection Association (FPA), arson remains the biggest problem. The FPA says that more than a third of the fires which lead to claims over £50,000 are started deliberately. This rises to over 60% for fires in the construction industry, schools, community centres and churches.

A recent Home Office study also shows arson to be a fast-growing crime, with incidents increasing as enforcement declines. Arson has one of the lowest clear-up rates of any major crime. The Arson Prevention Bureau reports that a conviction follows only 1% of the deliberately-started fires recorded by the fire service.

Arson prevention strategies are often limited to improving physical security, reducing the presence of combustible waste and managing the layout of the premises to limit the potential for fire spread. These measures can reduce the likelihood of an external attack, but may be ineffective where an arsonist has legitimate access to the premises. Nearly a fifth of arsonists suffer from mental disorders. Unless these people have been screened out during the recruitment process, they may be employees of the firm, ready to wreak their vengeance if they feel they have a grievance.

Electrical faults are the second biggest cause of fires. The FPA says that 70% of such fires occur at night, and the largest ones start in production areas. All types of premises are vulnerable, but some of the biggest losses have been in the metal industry, furniture factories, vehicle repair workshops, pubs, clubs and restaurants. Regular maintenance, inspection and testing could have prevented many of these fires.

Fires caused by carelessly discarded smoking materials and by heat and sparks (usually by contractors) vie for third and fourth places. Both of these categories of fire are preventable if the risks are recognised, and if employees and contractors are properly supervised.

For many companies, a serious fire means the end of their business - studies show that 30% of companies fail in the first year after a serious fire. Having adequate material damage insurance to reinstate the premises and replace damaged machinery and stock is not enough. Effective business recovery planning and adequate business interruption insurance are also vital.

Plan to recover
One recent survey showed that the awareness of the need for business recovery planning is high, but often the task is put on the back-burner. Of those companies that do have a plan, around 60% either fail to test it, or consider its effectiveness doubtful. Business recovery plans can quickly go out of date, so they need to be regularly revisited.

The plan should identify the hazards affecting the business and then assess the potential impact. Bottlenecks and critical areas of the business should be identified. A scoring system helps to calculate the degree of risk and to plan the appropriate response. The plan should then be audited and tested to ensure it is effective, both in the crisis-management phase and later during the recovery phase.

Business interruption insurance tends to be regarded as an add-on cover to which many smaller companies give little thought. After a major incident the cover may not meet their needs. Additionally, the length of the maximum indemnity period needs careful consideration. Many companies opt for a 12 month period. However, this is unlikely to be adequate after a major loss.

Even when the business is fully operational, it is unlikely that its gross profit will speedily revert to its pre-loss level. Trained workers and key staff may have gone; major customers will certainly have done so, and the reputation of the business may have suffered long-term damage. It could take several years for the firm to regain its market position.

In modern business, a partnership approach with suppliers is common, often with single sourcing of components. The just-in-time delivery system reduces the need for warehousing, but greatly increases a firm's dependence on its suppliers. Few businesses insure against their suppliers having a major loss, even though this could be just as disastrous as an incident affecting their own premises.

Similar considerations apply to customers' premises. If a major customer has a large fire and stops ordering supplies, few companies would be able to replace that customer quickly.

As well as insuring against loss of profit, businesses should think about covering additional increased costs of working. Most policies provide limited cover for additional costs, but it applies only if the gross profit from the additional sales generated at least matches the increased costs incurred. Because customers are not renowned for their loyalty, businesses need to maintain their sales at any price, and need cover for additional costs which is not subject to this so-called 'economic limit'.

Few businesses will suffer a total loss, however. Some underwriters will agree to provide cover on a first loss basis. Here, the policyholder calculates the amount of gross profit in the normal way, but then selects a lower sum insured based on an assessment of the loss potential. As market capacity is limited, this is a good way of achieving effective cover at an economic cost.

With losses rising, premiums soaring and market capacity running low, businesses can no longer afford to rely on crudely arranged insurance programmes. Greater sophistication is needed, both to reduce the risks of fire and to select those covers which are essential to the firm's survival.

FIRE RISK ASSESSMENTS
How does you go about conducting a fire risk assessment? Frazer Argyros-Farrell, assistant training manager of the Fire Protection Association, suggests breaking down the process into five simple stages.