The Potential Impacts of COVID-19 on Measuring Manufacturing LossesMarch 23, 2020
Impacts of COVID-19
The ongoing COVID-19 pandemic and resulting international response has created uncertain times for individuals, businesses and governments. Governments from various countries have reacted differently to control the spread of the virus: earlier this year, China enacted mass quarantines in some provinces, and today the US and Canada are currently ramping up quarantine measures while encouraging “social distancing”. States and provinces are shutting down businesses where people gather in larger numbers, such as bars and restaurants and even instituting ‘shelter in place’ measures in particularly hard-hit areas. While the exact trajectory of this pandemic is unclear, additional measures will likely need to be taken around the world as more information becomes available.
Regardless of the containment measures mandated and their corresponding effects on viral spread, COVID-19 will inevitably affect businesses in the US and globally. In a matter of weeks, the US stock market has fallen 30-40%. The travel industry, which employs millions of people directly and tens of millions of people indirectly, has essentially ground to a halt. A Federal Stimulus Bill is currently being negotiated in Congress that may include forgivable loans to small and mid-size business and provisions that include emergency funding for the travel and medical sectors of the economy. This all leads to the most probable scenario that the US, and most likely the world, is entering into a recessionary period not seen since 2008. These unprecedented times will undoubtedly have an effect on the insurance industry; whether it be challenges faced evaluating new claims arising from the COVID-19 virus, difficulties managing ongoing claims for businesses that experienced events prior to COVID-19 and future claims and coverage disputes that have not yet occurred.
As businesses and insurers are working to manage the constantly evolving threats and challenges posed by this pandemic, we’ve developed a hypothetical case scenario that illustrates the various factors at play for global manufacturing companies around the world which we hope may be of some assistance as we all begin to handle these complex and unprecedented losses:
COVID-19 Hypothetical Case Study
Background: Beer Glasses, Inc. is a company domiciled in Anytown, USA that supplies glassware and apparel to bars and microbreweries. They are a boutique manufacturer that purchases glassware primarily from China and prints logos on the products. Prior to the arrival of COVID-19 in the US, Beer Glasses, Inc. was operating at capacity and most orders were taking two to three weeks to fulfill. Existing business was good and the company was routinely gaining new customers as the US microbrewery market continues to expand. In fact, Beer Glasses had just completed a multi-million-dollar expansion to add capacity and keep up with demand, doubling production output and storage space. Two new, high-speed ink printers and curing ovens to dry the ink were also purchased for several million dollars, allowing the company to produce the intricate, multi-colored glassware that customers desired.
March 2020: Due to the mass quarantines instituted by China in January, manufacturers in the country were shuttered for multiple weeks and as a result, there is a supply shortage of glassware. While the mass quarantine in China was recently lifted and manufacturers are again producing, a one to two-month backlog on glassware exists. Beer Glasses has run through most of its stock of pint glasses and only has enough stock for an additional two weeks of production. Beer Glasses does, however, have an ample stock of 64-ounce “growlers” for “carry out” beer, but growlers have recently been a low-volume product. As you would expect, Beer Glasses is contacting their customers to let them know glassware shipments may be delayed, but cannot give specifics regarding when orders will be fulfilled. Some customers, even long-standing ones, are beginning to seek alternative companies to supply their glassware.
To make matters worse, with many states mandating the shutdown of bars and restaurants for several weeks, the company’s customers are now cancelling existing orders and current production is down 25 percent of where it was prior to the COVID-19 outbreak. Sales staff sit idle, as customers shut down their businesses concerned that their operations may not survive the required closures.
Beer Glasses must now decide whether they should close operations for several weeks to save on variable costs. While they are concerned about the impact of this decision on employee morale, they are also extremely concerned about the long-term viability of the company, particularly after significantly increasing their fixed costs and debt with the recent expansion. During this decision-making process, Beer Glasses suddenly gets an unexpected influx of orders for 64-ounce growlers. Because microbreweries and bars cannot host customers in their tap rooms, but in some cases can sell beer for “carry out,” sales of growlers have increased rapidly as customer demand has not slackened. The company decides to remain open and re-focus their production on growlers.
March 19, 2020: Early the morning of March 19, 2020 a fire at the company’s production facility damages some manual ink machines, as well as the newly purchased automatic ink presses (the non-functional and functional) and two curing ovens.
The Impacts of a Global Supply Chain on Manufacturing Losses: Due to ongoing travel restrictions, the French manufacturer of the ink printers cannot send service engineers to the US to repair the equipment and there are no trained service personnel in the US, so the printers cannot be repaired until travel restrictions between the US and Europe are lifted. The curing ovens were manufactured in the US and field service engineers are available to repair the equipment, but the company is not located within driving distance and has banned all employee air travel for the time being. The oven manufacturer will not give a firm date on when they can send out service engineers, as they are waiting to obtain more information from Federal and State agencies about the virus spread. As such, Beer Glasses’ automated glassware printing lines are inoperable for the foreseeable future and a timeframe to begin the repair process is unknown.
Challenges with Calculating Manufacturing Losses: All of the factors discussed above serve to complicate business interruption and extra expense calculations involved with the claim. When evaluating any business interruption claim, you must first determine the probable experience, or expected operations, of the facility during the period of indemnity had the covered peril not occurred. While many policies indicate that due consideration of the business before the date of loss must be considered, during uncertain and changing economic times in which the economic climate before the date of loss does not reflect the economic climate during the period of indemnity, historical operating results may not reflect the probable experience.
In the hypothetical scenario, there are a number of uncertain factors that would need to be considered in order to determine the expected operations during the period of indemnity, such as:
- How has the government mandated shutdown of bars and restaurants impacted the company’s customer base and expected revenue had the fire not occurred?
- When the mandated shutdown of bars and restaurants finally ends, how quickly does the market for Beer Glasses’ product return and how fast would customer buying habits return?
- When would sufficient raw materials from China be available for Beer Glasses to make all product lines available?
- Had the fire not occurred, would Beer Glasses have shut down operations for a period of time despite the recent, and potentially temporary, influx of Growler orders?
- Will the company be able to access funds, when the Federal Stimulus bill is passed, that will reimburse the company for certain continuing operating expenses (ie employee payroll and rent)?
While the above scenario is hypothetical, an actual case like this is not out of the realm of possibility. In fact, we already have businesses experiencing delays in sourcing repair parts, particularly with equipment manufactured in the US but relying on parts sourced from China and Europe. Each claim will need to be closely reviewed and monitored as every company will be affected differently by the current economic situation. This will undoubtedly lead to disputes and disagreements on the measurement of business interruption and business income claims that arise during the COVID-19 period and thereafter.
In the end, we can hope that the impact of COVID-19 will be minimal, particularly in regards to people’s health, and that government agencies can quickly, but safely, lift restrictions to minimize the health, social and financial impacts on people and business.
About the Authors
Over the past 10 years at Meaden & Moore, Stephen has specialized in providing investigative accounting services to the insurance industry including the following areas, business interruption losses, extra expense claims, property damage claims, financial condition of analyses of businesses, financial statement audits, fraud analysis, employee dishonesty, dispatch and demurrage claims, loss of income claims and various litigation support assignments including consultant to attorneys in damage claim analysis, preparation for depositions and information requests for discovery.
An electrical engineer with over 24 years of experience investigating electrical incidents and equipment failures, determining origin and cause, scope of damage, and valuation of equipment. He has extensive experience performing large scale electronic restoration and emergency response in high technology catastrophe losses across the marine, medical and manufacturing/industrial industries.