Contingency Clouds Business Interruption
Broadly speaking, capacity across the U.S. for business interruption insurance (BI) is ample, and terms and conditions are far from onerous.
That said, brokers report that the utility sector as well as a few others have experienced unexpected high losses, both in frequency and in value.
A few carriers have reduced their exposure to BI coverage in general, or to specific sectors or sub-segments.
As a result, there have been several situations where insureds were in the uncomfortable position of having to file and pursue a claim or claims, and simultaneously seek new placements after underwriters declined to renew or sought smaller positions in the owners’ programs.
On top of those tactical concerns for owners and their brokers, there are also more strategic shifts taking place in BI and more generally in the property and casualty market, driven by the realization by underwriters that contingent coverage is far less quantified than had long been thought.
Overlooked Supply Chain Risk
The trends of outsourcing, just-in-time delivery, and electronic orders and billing have been highly effective in reducing costs and boosting profitability. But that same evolution leaves even the most stable companies vulnerable to small disruptions in the physical supply chain or the internet.
Several of this year’s Power Brokers earned their laurels sorting complex BI claims compounded by short-notice renewals.
Michael J. Perron, senior vice president for the northeast region and property placement leader in the energy and engineered risk group at Willis Towers Watson, has made something of a cottage industry out of slicing through Gordian knots in BI claims.
“In general, BI capacity and coverage are available,” said Perron, a Power Broker® in the Utilities-Alternative category.
“Some carriers have seen losses in the power sector, and a few other places, but generally P&C remains soft. Still, carriers are being especially careful these days on contingent coverage. They are finding they did not realize the full exposures they had. They are finding it difficult to get their arms around all the exposures.”
Part of the problem, Perron suggested, is modeling, especially in the catastrophe market. “For the most part insurers do a good job of monitoring CAT risk. But for the most part those models do not include supply chain.”
Even those that do can cause further complications for insureds. Perron recalled that recently one client wanted to increase its coverage. Based on limits, that should not have been a problem.
“But their carrier, which is one that is particularly good with contingency and with supply chain, also writes for several of their suppliers, so the carrier was concerned about aggregation risk,” he said.
That situation was resolved by going back to the market, but for other clients it hasn’t been that straightforward.
Solving Complicated Claims
In one instance, the owner of a hydropower plant had a failure in one of twin turbines. The second unit continued to operate normally, albeit under more careful watch.
The property insurer decided not to renew because they feared the second unit could suffer the same failure as the first. Only one of the units could be dewatered at any given time, so it was impossible to open the operating unit to inspect until the disabled turbine was back in operation. A real Catch 22.
It is difficult to compile traditional best practices for unique situations.
Several insurers would not write the risk. One offered to write the risk but excluded BI and equipment breakdown (boiler and machinery).
“That approach would render the policy effectively useless against common failures very different than what impacted the disabled turbine,” noted Perron.
Another insurer offered coverage, including BI and equipment breakdown, but with a deductible of $20 million for the turbines until the operating unit was inspected and found to be free of the problems that seemed to have damaged the other.
For a permanent resolution, Perron said he and his group “worked with several insurers to provide coverage that was not perfect, but better than the coverage offered by the first two to bid.
Two carriers offered coverage similar to the client’s expiring coverage with one key exception: They would exclude an event emanating from a failure similar to what had occurred.
Another insurer charged a higher premium, but provided coverage without this limitation.”
In another case, a gas-fired power generator sustained three very different losses: one involving turbine failure, another involving a generator breaker failure, and a third involving a transformer failure.
“In any loss, in any claim, you want to show that you are working to maximize recovery and minimize losses.” — Michael Perron, senior vice president, Willis Towers Watson
“The incumbent carrier recognized that the client had taken appropriate steps to address lessons learned from each of these events, and actually had taken steps to minimize the carrier’s claim payments with savvy negotiations with providers and others,” said Perron.
“Still, the carrier chose to take a reduced line on the renewal.”
It is difficult to compile traditional best practices for unique situations, but Perron does suggest some guidance.
“Together the broker and the client have to convince the underwriters that the owner is managing the situation,” he said.
“Losses happen. That is why you have insurance. It helps for owners to understand that if they have multiple losses, their carrier is going have internal questions from management about the situation and the insurability of this client.”
Just as Perron spoke with underwriters and the carriers’ engineers to understand their take on the loss, he urges owners to do everything they can to help insurers understand that the owner can manage and mitigate the loss.
That may seem counterintuitive; BI by definition is for events out of the owner’s control.
“In any loss, in any claim, you want to show that you are working to maximize recovery and minimize losses,” said Perron.
In one recent situation a client needed a replacement transformer. Rather than order a new one with a longer lead time from the manufacturer of the original equipment, the owner was able to rent a transformer. That enabled them to accelerate the recovery time, and also saved the carrier a million dollars.
That little maneuver also expanded the owner’s supply chain. Ultimately, the insured ordered a new replacement transformer from the rental supplier, rather than from the maker of the initial unit, thus broadening its portfolio of suppliers.
In the end, maximizing recovery and minimizing loss is not just a sound strategy for expediting claims and mitigating for renewal after the claim. It is enlightened self interest.
“Companies often underestimate the tremendous impact that business interruption has,” Perron said. “It is not just the loss of revenue. It can be loss of prestige in the industry. It can be loss of customers.” &
Crumbling Infrastructure: Day Of Reckoning
For decades, government watchdog groups and engineering associations warned that the nation’s infrastructure was grossly underfunded and on the brink of collapse, but those warnings, for the most part, went unheeded by authorities.
Now a day of reckoning is upon us. The dereliction of North American infrastructure is a catastrophe in slow motion.
For four months, natural gas spewed from a leaking well in southern California — the largest recorded natural gas leak in history. The amount of methane released was the equivalent of running half a million cars for a year. Residents of the area were sickened and more than 10,000 of them needed to be relocated.
For more than a year, the residents of Flint, Mich., suffered lead exposure when the city changed its water source. Water from the Flint River interacted with aging water pipes, resulting in thousands of children being exposed to heavy metals for extended periods. The city is in a federal state of emergency.
Dozens more health and environmental debacles are certain to take place.
“U.S. infrastructure is in a dire state of disrepair,” said Michael Sillat, president and CEO of WKFC, a managing general underwriter in the Ryan Specialty group handling excess and surplus lines.
“The roads, bridges, schools, airports and power grids of the U.S. will take something like $3.5 trillion to bring them up to an acceptable, safe and manageable standard.”
Despite events like the huge Northeast blackout in 2003 that affected seven states and the Province of Ontario, and the collapse of the Interstate 35 Bridge in Minneapolis, he noted that “funding for public infrastructure is deficient.”
Operational Risk Challenges
The continuing problem in Flint underscores the challenge of operational risk and risk management. Municipalities all over the country are facing water main ruptures and sewage overflows daily. The costs of repairs and cleanup have to be calculated against any perceived savings in operational or maintenance expenses.
“The onus is on the insureds, especially on government entities for shoring up the infrastructure in the country.” —Michael Sillat, president and CEO, WKFC, managing general underwriter in the Ryan Specialty group
“We write governmental entities that are water and wastewater authorities and municipalities that treat and provide their own water and collect or treat their own sewage,” said Kathy Adamson, lead underwriter for government entities at CivicRisk, a division of WKFC.
“Prior loss history and infrastructure condition/maintenance is a major factor in determining our attachment and premium.”
Addressing infrastructure shortcomings lies at the feet of owners.
“The onus is on the insureds,” said Sillat, “especially on government entities for shoring up the infrastructure in the country.”
Grace Hartman, director at Aon Infrastructure Solutions, noted that the “contraction in [public] spending … does not mean that existing bridges don’t need maintenance and that new ones don’t need to be built.”
“The question is how to get that done if public entities are not going to pay up-front. There are alternative project delivery methods, notably public-private partnerships (P3s).”
Use of P3s in the U.S. varies with state law. “So called ‘mini-mega’ projects, in the $750 million to $1 billion range have been identified as the correct economy of scale and cost of capital for P3s so far,” Hartman added.
For all the signs of progress, it is unlikely that full infrastructure restoration can be accomplished before another major failure.
Risk professionals in the public and private sectors are asking about worst-case scenarios — bridge collapses that cut off major highway arteries; dam failures that flood vast areas and prevent manufacturing and trade. There are not yet a lot of answers to those big questions.
“We see some agencies in the U.S. that do not even know what their assets are,” said Terry Bills, global transportation industry manager for Environmental Systems Research Institute (Esri). “If I were an insurer, I would have concerns about asset management and would be very engaged in the process.”
In starting to assess the effects of a major infrastructure failure or natural disaster, Adrian Pellen, also a director at Aon Infrastructure Solutions, said the costs “have to look beyond frequency and severity of losses to include litigation costs and issues. Property insurance is not intended to pick up things that are already in disarray, but liability can still play a big role.”
The Insurance Response
Aging infrastructure puts a spectrum of industries and even the economy as a whole at risk, said Lou Gritzo, vice president and manager of research at FM Global.
“The key issue is protecting industry from water, a risk that continues to change with rising sea level. Now, there are exposures that were previously unrealized. That directly affects coastal development and urbanization.”
There have been efforts by the industry to adapt business-interruption policies to accommodate indirect disaster and infrastructure risks. Results have been mixed. Underwriting is complex, and uptake among owners has been spotty.
Where there are clear and present dangers, such as indicated on new flood maps, homes and businesses are being moved, but refineries and chemical plants can’t be.
“The most important protections in any case are those that are fit for purpose,” said Gritzo. “Anything that can be moved or elevated should be.”
Risk managers must make a plan based on current exposures, and then address the greatest vulnerabilities, he said.
Bills of Esri said that public agencies are focusing on traffic levels as they decide what to repair and what to abandon.
“What to keep and what to let go is a very different political issue now,” said Bills. “Infrastructure used to be nonpartisan. But the gridlock at the federal level has forced states to be creative in their own directions.
“One option is P3s, which are growing fast in some places,” he said.
According to the U.S. Army Corps of Engineers, there were about 3,000-plus P3 projects in the works as of September 2015, with a value of about $268 billion.
Part of the problem, said George Spakouris, director of infrastructure advisory at KPMG, is that “governments have not been building things in a long time. The booms were in the ’50s and ’60s. That expertise is not within cities and states anymore. Even utilities don’t seem to know how to plan and build anymore.”
That brings the problem full circle, Spakouris noted. “There are many old assets out there where failure could cause great damage,” well beyond the immediate loss of the structure. &
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Speed and Savings
The dilemma of limited public sector budgets and crumbling infrastructure may have found a cure. The state of Pennsylvania took advantage of recent developments by surety bond underwriters to help secure an aggressive program to replace bridges around the state.
Surety bonds are required for work done by government entities, but this is a public-private partnership, so letters of credit were an option. But the sponsor, the state Department of Transportation (PennDOT), decided to use a surety bond program using new elements that included a fixed claims-determination process, and also liquidity provisions to ensure that work could continue during a claim.
The Rapid Bridge Replacement Project (RBR) is addressing 558 structurally deficient bridges across the commonwealth under a design-build-finance-maintain public-private partnership (P3) arrangement between PennDOT and Plenary Walsh Keystone Partners — the joint venture concessionaire, owned 80 percent by Plenary Group USA and 20 percent by Walsh Investors.
“This feature, which is more seen with contractor performance bonds in Europe, reduces the period of uncertainty in relation to a claim from a surety and for that reason it is assessed in a positive way from rating agencies and lenders.” — Michael R. Bonini, director, Public-Private Transportation Partnership Office, PennDOT.
Plenary Walsh is responsible for demolishing the existing bridges, maintaining traffic during construction, and then maintaining the new bridges for 25 years following construction. PennDOT will retain ownership of the bridges throughout.
It is the largest road project in Pennsylvania history.
Most of the bridges included in the program range from 40 to 75 feet in length and are located in rural regions on the state highway system.
The RBR is the first project to be completed under Pennsylvania’s 2012 P3-enabling legislation.
PennDOT said it chose the P3 structure to accelerate the replacement of the bridges and facilitate efficiencies in design and the construction of bridge components. This has resulted in a 20 percent cost savings over the life of the concession period, compared to PennDOT’s replacing the bridges itself, according to the agency.
Substantial completion of the project is expected on Dec. 31, 2017. Total cost is $1.119 billion; the design-build contract is for $899 million.
PennDOT said the batching of the projects will allow the bridges to be replaced and maintained at an average cost of $1.6 million each versus $2 million each if completed by PennDOT.
Commercial close occurred on Jan. 9, financial was March 18. Construction on the first bridges began this summer, and the bridges will be completed in batches. Substantial completion of the project is expected on Dec. 31, 2017. Total cost is $1.119 billion; the design-build contract is for $899 million.
“The key feature of the performance bond used for the Rapid Bridge Replacement project that is different from more traditional ones is that it spells out a specific process about accepting claims, dispute resolution and how long such a process can take,” said Michael R. Bonini, director of the Public-Private Transportation Partnership Office at PennDOT.
“This feature, which is more seen with contractor performance bonds in Europe, reduces the period of uncertainty in relation to a claim from a surety and for that reason it is assessed in a positive way from rating agencies and lenders.
“For PennDOT, this means a more streamlined process in relation to timely completion of the project and access to this mechanism if the contract is terminated and the design-build contract is assigned to PennDOT.”
New Delivery Method
Surety bonding is “in a state of rapid development,” said Michael Bond, head of surety for Zurich, which was a participating surety in the RBR. “This is a new delivery method in the U.S.
“The enabling legislation for P3 programs does not necessarily specify surety as opposed to letters of credit or other forms of performance security. Letters of credit have been used worldwide to provide liquidity to a project, but they don’t protect subcontractors.
“Performance bonds also cover payments for labor and materials. That ensures workers and suppliers are covered.”
“The Pennsylvania program is a very creative example of how the public works and surety industries are responding to current needs.” Michael Bond, head of surety, Zurich
Bond said that the innovations in the RBR program address some of the prevailing concerns about surety, namely the uncertainty of the claims process, and the possibility of untimely payments, that could cause a liquidity problem for the project.
“The Pennsylvania program is a very creative example of how the public works and surety industries are responding to current needs,” said Bond.
To be clear, the surety bonds are different from the public-works bonds or funding bonds that are issued by the state authority and actually pay for the project.
The surety bonds provide performance security that the concessionaire, Plenary Walsh in this case, will complete the project satisfactorily. If there is a default, there would be a call on the bond and the surety would step in to work with the authority and the contractors to complete the project.
“What is new and different is that in a traditional public-works project the government is the owner and counterparty to the contractor,” said Bond. “In the P3 model, the counterparty is a private entity created to execute the project.”
He added that while such a special-purpose entity has some advantages over traditional public-works operations, it also has some proscriptions. Notably, the project is funded on a limited-recourse basis, so if there are cost escalations or unforeseen expenses, the concessionaire cannot dip into the government pockets to cover. There is some contingency, but it is limited.
“This is the next level in construction [risk management],” said Doug Wheeler, regional managing director for construction services at Aon Infrastructure Solutions. Aon was the broker for the contractor.
A European Model
“This alternative project delivery model came out of Europe and into Canada, then into the U.S. There is more legwork up-front, but there are dozens of projects already on board. Pennsylvania is a big proponent, New Jersey is almost there [with enabling legislation], but Governor Christie vetoed the most recent proposal. In New York, there has been a push.”
This is a very exciting time in public works and surety, said Aon’s Grace Drinker, senior analyst of infrastructure.
She stressed that even though the P3 process is different than the traditional design-bid-build approach, “there are still checks and balances aplenty in P3. There have been P3 contracts cancelled because of oversight and scrutiny.
“There is no risk to public safety or the public purse in the P3 process,” Drinker said. “What it does is bring operating efficiency to infrastructure.”
With the P3 approach, she said, “it is possible to have a higher initial cost, but the operating efficiency over the 30-year lifecycle of a project is a net savings. There is a real value for money in this.”
Drinker added that “contractors prefer to use surety capacity to letters of credit capacity to meet lender requirements on projects.”
Wheeler concurred that contractor preference is a big piece of the puzzle. “Surety is more efficient for the construction industry.” He added that capacity in surety is finite, but not a concern.
“Bundling the bridges allows them to be replaced faster and cheaper,” said Steve T. Park, senior associate with Ballard Spahr in Philadelphia, the bond counsel to PennDOT.
“The typical design-bid-build process would have taken longer. They selected bridges that could be easily bundled, designs that were similar, so they could fix the most in one program.”
There was equal diligence on the other side of the table.
“We spent a lot of time de-risking the program,” said Sarah Roberts, president of Intech Risk Management, insurance advisers to the concessionaire.
“We spent a lot of time de-risking the program.” — Sarah Roberts, president, Intech Risk Management
“When people hear 558 bridges, the initial perception is that they were not certain it could succeed. But the project is actually easier to manage with a lot of bridges than it would be for a single project of the same size.
“With a single project, if there is a delay, the whole timeline is thrown off. With so many bridges, it is possible to swap out one for another and work around delays to keep the whole project on schedule.”
She is sanguine about the growth potential for P3 projects in the U.S., at least in the long term.
“I don’t think we are there yet in P3 in the U.S.; there is still a lot of coming of age to do. In this case, the P3 model had a direct benefit to the owner, PennDOT, and indirectly to the taxpayers of the state.”
Lynn Schubert, president of the Surety & Fidelity Association of America, confirmed that P3s, and most public construction in Europe are protected by letters of credit.
“In the U.S., our public construction prefers performance bonds for completion and payment. But the concern of the ratings agencies is the speed with which surety bonds are called upon.
“In the Pennsylvania [project], the contracts include a quick-resolution process. It is a little extra piece, but it is very exciting.”