Transurance is a new form of property insurance. The payout is pegged to the amount paid by the primary property insurance policy and is specified as a percentage of the loss paid by a policy. Similar to the beneficiary of a life insurance policy, the policyholder can use Transurance proceeds for anything. All the policyholder has to do is substantiate the amount of recovery that they received from their primary insurance, and Transurance pays the specified percentage of that insurance recovery. The premium for Transurance is the same specified payout percentage--the so-called Transurance Percentage--multiplied by the premium for the referenced insurance.
For example, say a company's property insurance premium is $1 million. A 10 percent Transurance policy referencing this insurance policy would cost $100,000 and pay out 10 percent of whatever amount is recovered. In this case, a $13.5 million insurance recovery would result in a Transurance payout of $1.35 million.
Transurance allows insureds to "supersize" their loss recoveries. If a company wanted to increase their insurance recoveries by 10 percent, as in this example, they would simply pay 10 percent of their insurance premiums to buy a 10 percent Transurance policy.
Transurance is as simple to understand as the problem it solves is obvious and pervasive. For an insured, the total economic consequences of a loss event typically exceed insurance recoveries by a significant and widening margin, no matter how broad the coverage terms or how successful the claims negotiations. We refer to this margin as "collateral damage."
One way of comprehending the impact of collateral damages is to consider specific situations that cause them. While the following are just a few examples, they prompt serious consideration of this issue. In each of these examples, the collateral damage was at least 15 percent of the insurance recovery:
* A large fire temporarily disrupted a manufacturer's ability to fulfill its contractual commitments. The company offered its best customers price concessions to keep them happy. Insurance paid for the factory to be rebuilt but not for the price concessions.
* A cosmetics company spent significant amounts of money advertising its product to prepare for the year-end holidays, its prime sales period. Several of its trucks, loaded with merchandise, were stolen. Insurance paid for the trucks and the merchandise, but it did not pay for the money the company spent on advertising or for the loss of profits it experienced.
* A records-retention company had a fire at one of its facilities and could not readily identify its cause or origin. Suspecting possible terrorism and wanting to reassure its customers, it increased security at all of its facilities. The insurance company was only willing to pay for increased security at the affected facility.
* A plant explosion caused the local community to be concerned about the potential for environmental damage. Although the company was certain that there was no reason for local residents to be concerned, it was forced to conduct ongoing environmental tests of the local air, water and soil and to hire lobbyist and public relations experts to reassure the community. The company also found it needed to dedicate a senior executive to manage the crisis, to study what the public and shareholders perceived to be a risk management failure, and to devise a plan so that it would never happen again. Insurance paid for the plant to be rebuilt but not for the community outreach.
* A tornado ripped off the roof of a major retailer's regional distribution center for the Southeast. Inventory and rebuilding efforts were reimbursed by the company's insurance, but many of the ancillary costs required for the company to work around this problem were not covered.
* A large telecom company's employees worked overtime for many months after Hurricane Katrina. Given that many of their homes were destroyed, the company needed to create a "tent city" to house and feed them and their families. While insurance covered a large portion of the company's property damages, it did not cover the extra costs the company spent on its employees and their families, nor did it pay for the lost revenues that the company experienced from losing so many of its customers.
Although there will always be some collateral damages when there is an insurable property loss, it is difficult to say precisely what they will consist of until after the loss. The most obvious collateral damages are those losses that are covered by insurance but not reimbursed by the insurer because of deductibles and limits. There is no dispute about the amount of these losses or whether they are covered, but they are not paid due to the contractual limitations of the insurance policy.
Amounts that are claimed but ultimately not deemed to be covered by insurance make up the next class of collateral damages. Collateral damages of this sort arise because of disagreement between insured and insurer as to what constitutes a covered loss or how much is covered.
Finally, there are many losses that are too difficult to define, prove or measure to be included in a traditional insurance policy. A special case of this occurs where business-interruption coverage either does not work at all or its performance is so uncertain that the coverage is not purchased. While these collateral damages might be significant, they are often almost invisible to risk managers. No one attempts to keep track of them because everyone knows that they are not covered by insurance. For large losses, a significant amount of collateral damage might manifest itself in the form of lost revenues, unidentified expenses or opportunity costs. Even for seasoned business managers, it is impossible to understand the full extent of these losses.
One of the best ways to comprehend the potential for collateral damages that fall into this least visible category described above is to consider the impact a large loss would have on a particular company in the context of its business environment.
THE BUSINESS ENVIRONMENT
Businesses can be thought of in terms of their internal and external environments. The internal environment consists of a company's physical property, plant, equipment, employees, financial capital, intellectual capital and other types of property. The external environment consists of the physical and social environment in which the company operates--the company's customers, suppliers, business partners, financial capital suppliers, competitors, community, politicians and regulators.
When a large loss occurs, every aspect of the company's business environment could be affected. In the internal environment, property might be damaged that is not fully covered by insurance. A large loss could place undue strains on employees or make competing job offers seem much more inviting. It might also impair the value of the company's brand, its contracts and its intellectual property.
In the external business environment, a large loss could prompt an intense review of the company and its prospects. The community could become concerned about the impact of the loss, and politicians and regulators might decide that they need to make their presence felt. Customers, suppliers and joint venture partners could become concerned about the company's ability to make good on its commitments to them, while competitors might find that it is the perfect opportunity to expand their market share. Debt covenants may be breached, and shareholders may be concerned that the loss has significantly impaired the business.
In short, everyone and everything in the internal and external environment could be affected by the company's loss, and the company would need to expend significant financial and operating resources to stabilize things. In effect, the company that just suffered a large loss would be both struggling to recover and called upon to make every other party whole or take actions to ensure that whatever happened will not recur.
In a business environment that is increasingly leveraged and interdependent, collateral damages are ubiquitous and increasing in significance. Loss recoveries from traditional insurance are diminishing as a percentage of the total economic damages that companies sustain when they have insured loss events.
Covering collateral damage with traditional insurance is impossible or at best problematic because of the need for definition (preloss) and proof (post-loss), or it is uneconomic in cases where selection or imposition of deductibles and limits reduce the recovery.
Transurance makes collateral damage insurable by defining it as anything not covered by the referenced insurance, and by valuing collateral damage as a percentage of the loss paid by the referenced insurance.
Moreover, unlike traditional insurance, Transurance is hassle free. Insurance buyers do not have to waste time and energy gathering underwriting information, negotiating complex coverage definitions, or working through a long and involved claims settlement process.
Conceptually, Transurance may be applied to any type of insurance as a way for insureds to supplement their recovery to pay for collateral damages and for insurers to earn additional premium for taking a risk that is a mathematical function of one they already know. And it is easy for both parties.
At present, insurers seem most receptive to offering Transurance on commercial property exposures due to the relatively large premiums and the relatively short claims settlement time required for this line of insurance. However, we suspect it will only be a matter of time before it is also offered on other lines of insurance.
The beautiful thing about Transurance is that both the insurer and the insured can assess its costs and benefits in terms of something that they already know and understand. The insured gets some additional percentage of what they already bought and thought was a good value at a competitive, market-clearing price. The insurers writing Transurance get the opportunity to sell more coverage at a price deemed attractive by the market.
Both sides of the Transurance transaction stand to gain by making the insurance pie bigger with less additional effort. In effect, Transurance makes more things insurable while making insurance work better.
BRUCE B. THOMAS is co-managing director of Transurance Services LLC.
L. WARE PRESTON III
is co-managing director of Transurance Services LLC.
April 15, 2007
Copyright 2007© LRP Publications