In contingent business interruption, the same sort of claims appear again and again and yet it seems the sector continues to use CBI as a sweetener. Is this the year the profession learns the lessons of the past?
Thanks to a series of natural catastrophes worldwide -- from the Atlantic hurricanes to mudslides and typhoons -- it seems at least part of the global insurance industry has had a wake-up call.
The figures speak for themselves -- last year the cost of 315 catastrophic events was calculated at $210bn, with just $54bn of that insured. This year, in the period up to 25 August, Swiss Re said natural catastrophe losses were $44bn -- the next month alone saw some $120bn of losses.
And it appears much of what was insured was not necessarily paid for in terms of premium collection.
Reinsurer after reinsurer admitted they face losses in the wake of one of the costliest months ever in terms of insurance claims. And it seems the premium income has not kept pace.
Figures suggest some reinsurers saw losses of two and half times their 2016 premium income -- hardly a sustainable model.
However, with so much capacity floating around the market it has been hard for the insurers and reinsurers in particular not to chase business down to its lowest pricing. Terms and conditions have been easier than ever before for insurance buyers to negotiate, and sweeteners abound.
One of those that has proved particularly costly has been business interruption. While business interruption itself is usually paid for as part of the bundle, many insureds have been offered contingent business interruption (CBI) almost as a throwaway.
It seems some lessons have not been learnt.
After Hurricane Katrina in 2005, in what became a defining case (Orient Express v Generali), a hotel owned by Orient-Express Hotels (OEH) suffered significant damage during Hurricane Katrina and was closed until it partially reopened on 1 November 2005.
The local authority in New Orleans imposed a mandatory evacuation of the city, which was not lifted until the end of September. OEH suffered significant business interruption (BI) losses due to both the damage caused to the hotel and the evacuation of the surrounding area. The case set the standard for CBI claims.
Back in 2011, after the Japan earthquake and tsunami, just one motor manufacturer, Mazda, which was not even directly hit by the catastrophe, claimed about $65m alone for CBI losses because its supply chain was disrupted.
Again, in 2011, floods in Thailand proved immensely costly with some unexpected CBI claims. Lloyd's alone put the overall claims at more than $2.2bn. At the time, insurers admitted they had not necessarily appreciated the aggregation of having so many insureds vulnerable to the same catastrophe, while the onward impact to the global supply chain had also been largely underestimated.
As one risk organisation admits when discussing CBI with insureds: "Your insurer may not have contemplated such claims when writing the policy." Surely the question is: why not?
There are some broad areas in which CBI may be a factor, as US-based Hill and Hamilton Insurance and Financial Services explains to its customers:
- There are a variety of ways in which business work flow could be interrupted. An example from the cyber liability world is if the insured customer database or computer production line is hacked and causes the business a loss of income due to a loss of service until systems are restored and security is back up and running. Similarly, if a business relies on the systems of a third party, the business could suffer a loss if that system were hacked.
- Another example is if a neighbouring business acts as a 'leader property' by serving to attract customers to a business. If something were to happen to their company, for example a fire, the business may suffer significantly as well.
- What would happen to the business if the largest supplier stopped supplying their products for a month? These kinds of incidents can easily happen due to factory property damage, cyber attacks, transportation disruption, etc. Insureds are encouraged by brokers to place a business interruption policy on the main supplier.
For the insurance sector, it can be hard to quantify the CBI exposure. As a recent PwC report states: "Part of the challenge is that cyber risk isn't like any other risk insurers and reinsurers have ever had to underwrite. There is limited publicly available data on the scale and financial impact of attacks.
While underwriters can estimate the likely cost of systems remediation with reasonable certainty, there simply isn't enough historical data to gauge further losses resulting from brand impairment or compensation to customers, suppliers and other stakeholders."
It is hard enough for the insureds themselves as another survey, this time from KPMG, reveals. It found 87% of respondents citing supply chain risk as a major threat to achieving their growth agenda.
Worryingly, only about 42% had visibility of the risk down to tier one suppliers and less than one in 10 had such visibility to tier two suppliers.
There is constant talk now of a changing landscape globally and the probability that the major reinsurers will look to force premium rates up -- only time will tell if that can happen and if there is an increased focus on CBI and its true cost to the sector.
Contingent business interruption insurance and contingent extra expense coverage is an extension to other insurance that reimburses lost profits and extra expenses resulting from an interruption of business at the premises of a customer or supplier. The contingent property may be specifically named, or the coverage may blanket all customers and suppliers. CBI insurance is also known as contingent business income insurance or dependent properties insurance.
HOW BUSINESS INTERRUPTION WORKS:
For example, a company with yearly revenues of $730m generates $2m of revenue per day on average ($730m/365 days). If a major earthquake hit the facility and it was down for one week, then its lost revenue would effectively be $14m ($2m x 7 days). Note that this calculation is a simplified approximation that assumes all days are equally important and does not account for seasonality (such as when retailers ramp up production in anticipation for the holidays).
How CBI works
Let's say one of your clients has a production facility in Japan that assembles cars. This manufacturer has a supplier in Florida that makes engines (this immediate supplier is often referred to as a tier one supplier), and the engine maker has its own supplier in Italy (a tier two supplier) that produces a custom gasket. If the Italian supplier is hit by a major earthquake that results in three days of downtime, this event could ultimately prevent the final production facility in Japan from being able to make cars. It is this disruption in Italy that flows through the chain of sub-suppliers to the production facility that is the CBI risk. Of course, many companies will have multiple suppliers, reserve inventory and other resiliency measures in place to mitigate CBI risk. But in this example, the company in Japan may end up having anywhere from zero to three days of downtime, depending on its supplier network.
Source: AIR Worldwide