Less is more to ensure BI claims certainty, says Swiss Re

A broadening of coverage in business interruption (BI) insurance due to price pressure and competition is leading to concerns about claims certainty, according to Swiss Re Corporate Risk Solutions (SRCS).

The BI proportion of Property Damage claims continues to grow and in some cases eclipses physical loss to assets by more than double. It is not uncommon for BI losses to exceed $100m and the very largest can reach upward of $1bn. This trend is due to a number of factors such as just in time inventory, interdependency risks and increased costs and complexity of supply chains and production equipment.

As a result, it is no surprise that corporate risk and insurance professionals, as well as board-level executives, are scrutinising their Business Continuity Plans and BI coverages to avoid nasty surprises. BI losses are largely originated from fires and explosions, which at a global level, account for almost two-thirds of losses. Storms, machinery breakdown, strikes and riot, malicious damage and flood are also main causations of BI losses. However, in Asia, storm and flood losses dominate causation.

Findings from a recent Swiss Re Institute sigma publication illustrate that there were 327 catastrophes worldwide in 2016, of which 128 took place in Asia. There were 191 natural catastrophes and 136 man-made disasters. While the numbers were down from 356 in 2015, the insurance industry covered close to $54bn – less than one third – of the economic losses from natural and man-made disasters in 2016. These figures illustrate that insurance cover is not universal and a large protection gap exists.

Asia Pacific in particular has long suffered from a protection gap – driven largely by a lack of insurance penetration.

There is no exception when it comes to BI, with the protection gap getting larger and in some countries penetration is estimated at just 5%, says Alex Howell, head property SEA, at Swiss Re Corporate Solutions (SRCS). “Part of that is down to difficulties in fully understanding all the exposures that could impact business and lead to an interruption. This can be a complex and very involved process, factoring in internal operational aspects, such as fixed and variable costs, revenue growth and calculating gross profit, as well as external factors, such as customer supply, denial of access, wide area damage and exchange rate fluctuations.

“Across Asia-Pacific we also continue to see a wide array of Business Continuity Plans where, in some cases, awareness to vulnerabilities is well-understood, yet on the other hand cases where only a limited number of interruption scenarios have been explored and stress tested. What is key is for corporations to work with external parties, including brokers and insurers, to get as much of a handle on possible disruption and then decide on the mitigation actions, as well as the appropriate level of insurance purchase and setting adequate indemnity periods.”

At the same time, the protection gap is likely to continue as Asian countries expand in both industrialisation and urbanisation, says Peter Newall, Director and Senior Claims Manager, (SRCS). In Thailand, for example, there has been more building on floodplains, creating more exposure. At the same time, the effects of climate change have seen a rise in the number and severity of natural catastrophes.

Another trend that SRCS highlights is the broadening of BI coverage to the point where it is creating a level of ambiguity and claims uncertainty.

“Business interruption is a type of cover developed along largely formal lines,” says Mr Newall. “It is well honed, well documented and virtuously circular – for every dollar of sales that is lost, and incorporating fixed overheads and net profit, the policy would pay out. It is a beautiful piece of insurance wording.”

To rectify the situation and take the mystery out of BI coverage, adopting a ‘back to basics’ approach and clearly explaining how the policies are designed to respond would benefit all parties. “A lot of work went into making BI a well thought-through line of insurance,” says Mr Newall.

This is not to say that there is no room for development and forward-thinking. Insurers have become more creative in terms of the scenarios they are willing to underwrite. Further, Business Interruption is no longer merely focused on losses at the premises.

But, says Mr Howell, whether a company is small, large, domestic or global, the message is the same: “The standard BI policy is very good but you have to make sure you have the coverage you need or that your CFO is aware of any gap in BI protection and is comfortable holding it on the balance sheet.”

The critical feature of a BI policy is that the calculation for payment is indexed to turnover, with each dollar of turnover reflecting proportions of fixed and variable costs as well as net profit.
This model was widely adopted by international insurers and still stands today as a solid template and Mr Newall is warning companies that if they start altering wordings it can have grave repercussions. “In some situations we have seen that altering a policy has led to it only responding to include certain fixed costs, rather than gross profit. In turn, this results in a claims settlement figure well below what was expected.”

Mr Newall does however concede that the policy needs to adapt to a changing risk environment, and to reflect new digital and emerging exposures where assets are often non-physical. However, he goes on to say: “There is no need to reinvent the wheel. Keep the simple BI formula based on turnover with fixed costs and net profit and then discuss with your underwriter the different circumstances under which a policy would pay out.”

Traditional BI cover is triggered by property damage, however we have seen an increase in cases where businesses are disrupted even though there was no physical damage at their premises. Mr Newall gives the example where an important supplier suffers physical damage, however your own premises have none. In these circumstances you could potentially be left uninsured.

In response to this, SRCS is expanding cover to allow clients to deem the damage to the supplier’s premises to be equal to damage to their premises. This can expand to instances such as infectious diseases and cyber. Mr Newall says: “This is something very simple to do and was done back in the 60s, 70s and 80s. However we’ve now got a hybrid version that tries to extend the cover but can result in claims uncertainty. Sometimes it’s better to go back to a simple tried-and-tested version that is clear and transparent for all parties.”

Similarly, if there is a risk due to a natural catastrophe for wide area damage, then consulting with your broker and insurer is key, rather than adding extensions to the base policy. In the case of wide area damage, what is not easy to estimate is the loss amount and indemnity period. For example, if you own a business that remains undamaged on a deserted industrial estate, which was evacuated after a flood, you will not be able to recommence trading for a number of months while the water level recedes – then there is a business interruption that needs to be covered.

The industry is coming up with new solutions such as parametric, index-based products that are attempting to fill some of these gaps. These solutions provide cover based on an event rather than the actual damage. For example, the magnitude of an earthquake or wind storm or typhoon. This creates more certainty for corporations, which benefit from a quick claims settlement based on pre-defined amounts.

Parametric solutions would solve many of these issues but the main lesson for insureds is to study their BI policies in detail before it comes to an actual loss and the discussions end up in a courtroom, says Mr Newall. “A lot of insureds have a BI policy in place but don’t have a good grasp of the intricacies. Similarly, they don’t look at the wording until they have a loss.”
SRCS ran a series of masterclasses in the past 12 months to encourage risk managers to look at their BI coverage without the pressure of dealing with a loss and to consider different disaster scenarios and where gaps in coverage might exist. And while the scenarios and the triggers have become more complex, the mantra from SRCS remains the same, according to Mr Newall: “Keep it simple.”