Staying afloat during the recent UK floods

by Neil Hodge

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26 Mar 2014

  • Financial Director
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Flood by Bill McConkey

THE FLOODS that have devastated large swathes of the UK since December are still hitting the headlines three months after they struck, and they serve as a timely reminder to all finance directors that their organisations should have contingency plans in place to mitigate business disruption.

So far, it seems that the vast majority of businesses – save the tourist industry in the south-west, and Network Rail with its ongoing repairs to the lines – have come out of the ordeal relatively unscathed, compared to householders.

Business lobby group the Confederation of British Industry (CBI) says that up until mid-February, there had been no signs that factory output or orders have suffered from the flooding and extremely wet weather that occurred during the survey period, though it admits that it could perhaps show up in following months’ data.

Two of the UK’s biggest water companies – Pennon, owner of South West Water, and Severn Trent, the UK’s second-largest water supplier – have said that the floods would have no material financial impact on their bottom line, despite the increased maintenance work they have had to carry out.

Furthermore, construction work related to flood relief work and infrastructure maintenance has helped civil engineering activity reach its highest level since 1997, according to a survey by business analysts Markit (though house-building slowed).

The general consensus seems to be that UK business has largely dodged a bullet. Research by Bank of America Merill Lynch indicates that insured losses are likely to be less than in 2007, when parts of the UK received a month’s worth of rain in 24 hours, resulting in 55,000 households and businesses being flooded across the country. The latest estimates, published on 13 February, show that fewer than 6,000 properties (residential and commercial) have been flooded this time around, and that there has been a greater concentration in south-east England, rather than a national spread. As a result, at the beginning of March, ratings agency Fitch said that the floods will cost insurers about £1.2bn, which is “manageable”, and that significant damage to commercial property was “limited”.

“The concentration of flooding has been limited to just a couple of areas, and the rainfall has been steady over a number of weeks, rather than torrential,” says Simon McGinn, general manager of commercial insurance at insurer Allianz.

“This has meant that organisations have had more warning than in the 2007 floods to limit the potential damage to their own premises, and make alternative arrangements with suppliers and customers. As a result, we do not expect to see huge company losses this time around.”

Good fortune?
Despite such ‘good fortune’, experts are quick to warn that the floods should prompt organisations to revisit their flood risk management and business continuity plans, as well as their insurance arrangements. The Environment Agency estimates that businesses that take effective action in response to a flood warning – given at least eight hours in advance of a flood – can make up to 90% savings on damage to moveable equipment or stock.

Flood graphThere are three types of flood risk. Coastal and river (fluvial) flooding, caused by higher tides and rain, is the most well known, but flooding can easily occur in inland areas that are well away from major rivers. Surface water (pluvial) flooding – a major contributor of the 2007 floods – is caused because excess rainwater cannot drain away quickly, while groundwater flooding occurs where the geology of the area is predominantly chalk and excess rain flushes out water that can stand for weeks or months.

Mary Dhonau, chief executive of Know Your Flood Risk, an organisation that promotes greater flood risk awareness and disaster preparation, says that “flooding is the biggest natural risk that organisations face in the UK and it is surprising how few are prepared to deal with its impact on property, stock, the workforce, the supply chain and the bottom line”.

Organisations tend to have very short-term memories about how destructive flooding is, she points out, and businesses will look back at these recent floods and think that – unless they are based in these badly affected areas – their exposure to flood risk and business disruption is low. “In a bizarre way, the fact that only relatively few businesses have been affected directly by the latest flooding may lead many organisations to think that they do not need to do anything – how wrong they are,” Dhonau adds.

Indeed, floods can give finance directors a series of logistical nightmares: the premises may be cut off or unusable, meaning that products, supplies, and employees cannot gain access. Furthermore, the workplace may be effectively out of bounds for weeks or even months, meaning that an alternative location that can be used on a rolling basis needs to be arranged quickly. Added to that, customers and suppliers may be equally disadvantaged, which can lead to product shortages and a drop in cashflow at the worst possible time.

As a result, organisations should check that they can at least take control of two key issues – supply chain management, and insurance cover. Roy Williams, managing director at Vendigital, a supply chain consultancy, says that the key to successful supply chain management is to “keep it simple”.

“There is a tendency for supply chains to become increasingly complex over time, and the more complex it becomes, the more difficult it is to remain agile and to know what the impact will be to the business if part of the chain goes wrong,” says Williams. “Organisations should try to keep their list of suppliers as lean as possible.”

Williams says that another common pitfall of which organisations often fall foul is failure to review their supply chain contingency plans.

“Most organisations say that they have a plan and that they have had it for years – and that is just the point. It has never been reviewed, revised or refreshed, and the contingency arrangements have never been tested. It’s therefore useless as a working document. Furthermore, most organisations don’t bother to ask their customers and suppliers if they have similar contingency plans in place. This means that there is absolutely no visibility about what actions can be taken if anything goes wrong,” he says.

Find the fault
Williams recommends that organisations – led by the finance director – should stress test their arrangements to see where faults lie.

“I know companies that send a team of people into the warehouse who simply remove entire ranges of items without warning and wait to see how long it is before the operational managers know there is a problem, and watch how they react. It may be crude but it can be very effective, and it can highlight major flaws in the procurement process,” he explains.

One of the biggest risk management tools that finance directors rely on is insurance, but again – organisations can mismanage the process very easily. McGinn at Allianz says that companies need to check if they have the right sort of insurance coverage – as well as the appropriate limits – to ensure that key assets as well as stock, plant and machinery are accurately valued so that they can be replaced quickly if they are damaged. He also recommends that companies use a broker to get the best level of coverage available.

“Brokers will know that companies will get better rates and wider coverage if they can demonstrate that their clients have developed business continuity and flood risk plans, so brokers are also useful in making sure that management refresh these plans regularly,” says McGinn.

“Added to that, brokers can arrange a more customised offering from insurers so that clients are getting a tailored insurance product rather than an off-the-shelf policy that may not completely suit their needs. For example, basic business continuity cover may provide for six months, but in many cases business disruption from an event such as flooding can last longer than a year, so a 24-month policy would be better.”

Policy wordings should also be thoroughly checked, he says: organisations should make sure that flood damage has not been removed from their property damage cover during the renewal process.

Most at risk
The Statement of Principles agreement between insurers and the government in the wake of the 2007 floods offered flood cover as standard on low-risk properties built before 1 January 2009 but it expired in June 2013. There is now no obligation for insurers to offer cover against flood risk for property built after 1 January 2009, despite the fanfare behind the Association of British Insurers’ launch of Flood Re which is aimed at providing flood risk cover to those homes and businesses (primarily SMEs) most at risk.

“Insurers are going to be wary of offering competitive terms – or cover at all – if a company is located next to a river that constantly floods year on year,” says McGinn. “As a result, it is important to check the terms of the policies. It is a buyers’ market at the moment, so coverage is available at competitive rates, but companies should always check that they are getting the necessary protection.”

Organisations may have averted disaster in this latest instance – but for many it is through luck, rather than design. More proactive risk management will help identify how exposed the business could be to severe flooding, and will provide contingency plans for how the company will stay afloat in a crisis rather than sink. ■

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Financial Planning and Performance AnalystCabinet Office-Greater London-Competitive

 
 
 
 
 
 
 
 

 

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