Suffering losses from 2005’s Hurricane Katrina was bad enough for many businesses and individuals, but to make matters worse for many, certain losses were not covered by their insurance policies.
So said several Marsh experts during a June 17 webinar entitled, “Lessons from Hurricane Katrina, Looking Back, Planning Ahead,” which outlined ways in which Hurricane Katrina, which devastated New Orleans almost 10 year ago, impacted insurance underwriting, business interruption and claims handling.
The first lesson learned: businesses should thoroughly read their commercial property policies before they purchase them, said Duncan Ellis, leader of Marsh’s U.S. property practice. However, far too many find out the hard way what’s in their policies — or not in them — after sustaining major losses from catastrophes and other events.
“That’s the wrong time to find out that you are not covered for something, or that certain conditions do not apply,” Ellis said.
“After Katrina, many of our clients were sorely surprised to learn that despite having windstorm coverage, they weren’t covered for storm surge. Understanding what you are buying really can pay off.”
Ellis and Paul McVey, leader of Marsh Risk Consulting’s property claims consulting practice, outlined a number of “tripwires” in property policies that occurred after Katrina, for business owners to now be mindful of in case of future events.
The goal when dealing with major catastrophes is for insurers and policyholders to work as allies, McVey said. As part of a policyholder’s loss management plan, they should meet with their carrier and agree upon communication protocols and upon each party’s roles and responsibilities after an event. They should determine the appropriate carrier representative with the authority to make decisions on claims.
“After Katrina, many of our clients were sorely surprised to learn that despite having windstorm coverage, they weren’t covered for storm surge. Understanding what you are buying really can pay off.” — Duncan Ellis, U.S. property practice leader, Marsh
“What we see after Katrina, when decisions had to be made as to reinstatement, replacement, mitigation, there weren’t a lot of people involved at [carriers’] mid-management level to make those decisions,” he said. “That put the process on hold to a degree, and some of the things became confrontational. Insureds should make the effort to establish a relationship with an empowered senior claims representative.”
Other policy tripwires that caught businesses by surprise in Katrina that all businesses should now be aware of include:
- Determining the exact definition of special high-hazard flood zones, such as a 100-year flood plain, and how damage within those zones can impact sublimits. Typically within policy sublimits are further internal sublimits for these special zones. For example, if a business has a $200 million sublimit for flood, it is probable that there is a further internal sublimit of $50 million for high-hazard flood.
- Understanding policy definitions that determine whether an event was a named windstorm or a flood, which can impact whether the policy excludes surges from wind-driven water.
- Determining how coverage is typically triggered by civil or military authority and ingress/egress. There have been disputes about whether Katrina claims regarding ingress/egress issues should be paid after politicians told people to stay away from New Orleans, as carriers have argued that those politicians were actually not acting with civil or military authority.
- Determining how “wide area impact” or “idle period” impacts claims.
- Determining whether contingent business interruption coverage extends not only to suppliers or customers, but also to suppliers of suppliers and customers of customers.
- Determining the scope, time limits and corresponding disappearing deductibles within contingent business interruption coverage due to local utility companies’ service interruptions.
- Determining whether deductibles apply by occurrence and/or by location, and whether there are separate deductibles for property damage and “time element.”
- Determining whether costs, such as overtime for contractors rebuilding properties, fall under sublimits or “expediting expenses.”
- Determining what is — and is not — covered under business interruption, and how claim costs may be calculated.
“The property damage piece is very easy to figure out, but business interruption is probably the most misunderstood coverage and probably the most difficult in settling claims,” Ellis said.
“It’s not replacing revenues — it’s replacing profits lost and continuing expenses that the property generates when it’s not operational. For example, a continuing expense could be taxes and non-continuous expenses could be heat, light and power.”
Also often misunderstood is the indemnity period for contingent business interruption claims, McVey said. The timeframe is typically defined as the time to replace, reinstate or repair the property, but businesses should be aware that many variables could impact payment of claims. That’s why it’s so important to discuss these issues ahead of time with their broker or claims representative — particularly before renewal.
Texas Flooding Highlights Auto’s New Complexity
It will take some time to arrive at a hard number, but indications are that the automobile claims from the Texas flooding in May will exceed $250 million, with overall losses at close to $1 billion.
This is a serious issue for automobile insurers. Reports indicate that some auto insurers may have to rely on reinsurance to pay off their Texas claims before all is said and done.
But a substantial problem will remain long after the flood water has gone and the Texas claims and those in neighboring Oklahoma are paid.
The average new vehicle contains more than 100 million lines of code. Compare that to the early space shuttles, which possessed a mere 400,000 lines of code.
That problem is the dilemma of increased automobile claims complexity due to the technology that is now embedded in cars.
While collision accident frequency numbers may fall — due to such things as sensors that can tell you if you’re about to ram into the car behind you as you back up — this new complexity foretells a real risk of an increase in average repair costs.
That’s because cars have essentially become computers on wheels.
The average new vehicle contains more than 100 million lines of code. Compare that to the early space shuttles, which possessed a mere 400,000 lines of code.
With more than 2,000 functional parts, some of them comprising multiple hybrid alloys, even the average car of today is much more complicated than the most expensive cars of previous generations.
The implications for the motor repair process are not insignificant.
At the very least, this complexity creates issues around who does the repair, especially if the vehicle is to continue to remain under warranty.
New questions start to emerge: Who is competent to do the work, where can it be done, and is there adequate capacity in the supply chain to meet claims volumes, especially in a period of surge?
Will the consumer be faced with possible delays due to supply/demand imbalances caused by this added complexity, and if they do face substantial delays, how will that impact their purchasing decisions?
We may already have reached the point where new vehicles with the latest technologies aren’t available for sale in places where the ability to repair them doesn’t exist.
If these are issues for manufacturers and customers, aren’t they also matters of concern for repair centers, which will increasingly need to invest in new technologies and train their staff to use them?
Won’t higher investment by suppliers need to be complemented by longer term commitment from insurers? Beyond this, the need for more advanced capabilities may mean that the selection of competent car repair services will become limited, and insurers will have fewer choices in repair service providers.
Auto assessors will also need additional training. Damage to circuitry is much more problematic to find and resolve than a good old-fashioned dent, especially where the problem is one of water damage and corrosion.
With the Texas flooding giving auto insurers a major pain point, they would be well advised to use this opportunity to gain as much insight into this new car repair/ technology dynamic as possible.
Pathogens, Allergens and Globalization – Oh My!
In 2014, a particular brand of cumin was used by dozens of food manufacturers to produce everything from spice mixes, hummus and bread crumbs to seasoned beef, poultry and pork products.
Yet, unbeknownst to these manufacturers, a potentially deadly contaminant was lurking…
What followed was the largest allergy-related recall since the U.S. Food Allergen Labeling and Consumer Protection Act became law in 2006. Retailers pulled 600,000 pounds of meat off the market, as well as hundreds of other products. As of May 2015, reports of peanut contaminated cumin were still being posted by FDA.
Food manufacturing executives have long known that a product contamination event is a looming risk to their business. While pathogens remain a threat, the dramatic increase in food allergen recalls coupled with distant, global supply chains creates an even more unpredictable and perilous exposure.
Recently peanut, an allergen in cumin, has joined the increasing list of unlikely contaminants, taking its place among a growing list that includes melamine, mineral oil, Sudan red and others.
“I have seen bacterial contaminations that are more damaging to a company’s finances than if a fire burnt down the entire plant.”
— Nicky Alexandru, global head of Crisis Management at AIG
“An event such as the cumin contamination has a domino effect in the supply chain,” said Nicky Alexandru, global head of Crisis Management at AIG, which was the first company to provide contaminated product coverage almost 30 years ago. “With an ingredient like the cumin being used in hundreds of products, the third party damages add up quickly and may bankrupt the supplier. This leaves manufacturers with no ability to recoup their losses.”
“The result is that a single contaminated ingredient may cause damage on a global scale,” added Robert Nevin, vice president at Lexington Insurance Company, an AIG company.
Quality and food safety professionals are able to drive product safety in their own manufacturing operations utilizing processes like kill steps and foreign material detection. But such measures are ineffective against an unexpected contaminant. “Food and beverage manufacturers are constantly challenged to anticipate and foresee unlikely sources of potential contamination leading to product recall,” said Alexandru. “They understandably have more control over their own manufacturing environment but can’t always predict a distant supply chain failure.”
And while companies of various sizes are impacted by a contamination, small to medium size manufacturers are at particular risk. With less of a capital cushion, many of these companies could be forced out of business.
Historically, manufacturing executives were hindered in their risk mitigation efforts by a perceived inability to quantify the exposure. After all, one can’t manage what one can’t measure. But AIG has developed a new approach to calculate the monetary exposure for the individual analysis of the three major elements of a product contamination event: product recall and replacement, restoring a safe manufacturing environment and loss of market. With this more precise cost calculation in hand, risk managers and brokers can pursue more successful risk mitigation and management strategies.
Product Recall and Replacement
Whether the contamination is a microorganism or an allergen, the immediate steps are always the same. The affected products are identified, recalled and destroyed. New product has to be manufactured and shipped to fill the void created by the recall.
The recall and replacement element can be estimated using company data or models, such as NOVI. Most companies can estimate the maximum amount of product available in the stream of commerce at any point in time. NOVI, a free online tool provided by AIG, estimates the recall exposures associated with a contamination event.
Restore a Safe Manufacturing Environment
Once the recall is underway, concurrent resources are focused on removing the contamination from the manufacturing process, and restarting production.
“Unfortunately, this phase often results in shell-shocked managers,” said Nevin. “Most contingency planning focuses on the costs associated with the recall but fail to adequately plan for cleanup and downtime.”
“The losses associated with this phase can be similar to a fire or other property loss that causes the operation to shut down. The consequential financial loss is the same whether the plant is shut down due to a fire or a pathogen contamination.” added Alexandru. “And then you have to factor in the clean-up costs.”
Locating the source of pathogen contamination can make disinfecting a plant after a contamination event more difficult. A single microorganism living in a pipe or in a crevice can create an ongoing contamination.
“I have seen microbial contaminations that are more damaging to a company’s finances than if a fire burnt down the entire plant,” observed Alexandru.
Handling an allergen contamination can be more straightforward because it may be restricted to a single batch. That is, unless there is ingredient used across multiple batches and products that contains an unknown allergen, like peanut residual in cumin.
Supply chain investigation and testing associated with identifying a cross-contaminated ingredient is complicated, costly and time consuming. Again, the supplier can be rendered bankrupt leaving them unable to provide financial reimbursement to client manufacturers.
“Until companies recognize the true magnitude of the financial risk and account for each of three components of a contamination, they can’t effectively protect their balance sheet. Businesses can end up buying too little or no coverage at all, and before they know it, their business is gone.”
— Robert Nevin, vice president at Lexington Insurance, an AIG company
Loss of Market
While the manufacturer is focused on recall and cleanup, the world of commerce continues without them. Customers shift to new suppliers or brands, often resulting in permanent damage to the manufacturer’s market share.
For manufacturers providing private label products to large retailers or grocers, the loss of a single client can be catastrophic.
“Often the customer will deem continuing the relationship as too risky and will switch to another supplier, or redistribute the business to existing suppliers” said Alexandru. “The manufacturer simply cannot find a replacement client; after all, there are a limited number of national retailers.”
On the consumer front, buyers may decide to switch brands based on the negative publicity or simply shift allegiance to another product. Given the competitiveness of the food business, it’s very difficult and costly to get consumers to come back.
“It’s a sad fact that by the time a manufacturer completes a recall, cleans up the plant and gets the product back on the shelf, some people may be hesitant to buy it.” said Nevin.
A complicating factor not always planned for by small and mid-sized companies, is publicity.
The recent incident surrounding a serious ice cream contamination forced both regulatory agencies and the manufacturer to be aggressive in remedial actions. The details of this incident and other contamination events were swiftly and highly publicized. This can be as damaging as the contamination itself and may exacerbate any or all of the three elements discussed above.
Estimating the Financial Risk May Save Your Company
“In our experience, most companies retain product contamination losses within their own balance sheet.” Nevin said. “But in reality, they rarely do a thorough evaluation of the financial risk and sometimes the company simply cannot absorb the financial consequences of a contamination. Potential for loss is much greater when factoring in all three components of a contamination event.”
This brief video provides a concise overview of the three elements of the product contamination event and the NOVI tool and benefits:
“Until companies recognize the true magnitude of the financial risk and account for each of three components of a contamination, they can’t effectively protect their balance sheet,” he said. “Businesses can end up buying too little or no coverage at all, and before they know it, their business is gone.”
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Lexington Insurance. The editorial staff of Risk & Insurance had no role in its preparation.