The only sure thing about underwriting contingent business interruption risks in today's fast-paced business climate is that it's all about unknowns.
And in a global economy with heightened productivity demands, more frequent outsourcing and intricate manufacturing supply chains, the job of the commercial property underwriter handling this complex risk isn't getting any easier. Insurers frequently find themselves groping for basics--such as corporate names, locations and other rudimentary details--when they try to write this cover for their corporate clients.
"It gives everybody nightmares," says Jamie Miller, senior vice president and chief property underwriter for the Americas at XL Insurance America in Stamford, Conn., referring to contingency risks that are not scheduled. That means the insured's suppliers are not identified on the policy. "It's a crap shoot and you don't know exactly what you are underwriting."
Unlike the traditional business interruption coverage that is part of a commercial property policy and contains the soothing specifics that underwriters crave, contingent business interruption cover heads out into unknown territory. It covers corporations against some of the same named perils--such as fire or earthquake--that can force a company to lose income and file a business interruption claim.
The so-called CBI coverage goes a step further and covers a corporation for the loss of income that stems from business interruption losses suffered by its suppliers. An auto manufacturer, for example, may have to temporarily shut down its manufacturing plant if its seat belt supplier experiences a fire at its production facility and can't ship the seat belts.
CBI cover also protects a corporation against income losses incurred if a major customer experiences a damaging fire, for example, and is temporarily out of business and can no longer buy the corporation's products, be it cars, refrigerators or semi-conductors. But since the risk manager of a corporation can usually identify its customers, underwriters don't worry too much about this contingency risk.
It is the risks associated with suppliers--especially the unnamed suppliers that are labeled "unscheduled risks" or "an unnamed contingent time element"--that can cause sleepless nights.
"The supplier usually is not named and the risk manager isn't aware of all suppliers," says Robert Bean, senior vice president of underwriting and reinsurance at FM Global in Johnston, R.I. "The risk manager could identify key suppliers, but it can be time-consuming and changes over time."
And the void doesn't end with unnamed suppliers operating in unspecified locations that may be halfway around the planet. Underwriters and their fussy engineering staffs may be in the dark about the quality of construction of the supplier's manufacturing facility. And they may not know anything about the supplier's commercial property insurance coverage and whether it includes adequate business interruption limits that will let the supplier absorb the loss and get back to work turning out the seat belts, for example, for the U.S. auto manufacturer.
"Not only may I not be able to name the location, but I also can't tell in precise terms what the construction standards were for the supplier's manufacturing site, what the building is made of and how it is protected against potential losses," says John Gallagher, senior vice president of global property, at Ace USA Global Property in Philadelphia.
Compounding matters, says Gallagher, is a lack of information about the financial health of the supplier's insurer and whether the insurer is solvent. "We don't know the financial stability of their insurer. If there is a problem with their carrier and obtaining compensation, it can exacerbate the situation," he says.
Ratcheting up the loss potential for insurers is the increasingly competitive business environment as countries and companies compete for foreign investment, contracts and suppliers. As industries consolidate and companies merge, an industry may be dependent on a few key suppliers--which creates a great risk for insurers if one of those suppliers suffers a big loss.
MANY INDUSTRIES IMPERILED
As companies pare down costs and boost productivity by using complex inventory management techniques, their executives also may be unknowingly increasing their vulnerability to a property loss suffered by themselves or a supplier.
"Years ago, companies had multiple plants in different locations that made the same product. Now with the pressure for increased operating efficiency, they may have only one plant to improve their margins," says Bob Howe, managing director, global property, at Marsh Inc. in New York City. "But if there is only one plant, what will be the loss to the brand or the market share of the company if that plant or their supplier's plant shuts down?
"With more efficiencies and greater productivity comes greater risk. CEOs, CFOs and risk managers need to understand their supply chains and their vulnerabilities. They need to be aware of their exposures." And nearly every industry--from the auto sector with its regular sourcing of components from around the globe to pharmaceuticals dependent on a specific chemical to electronics--is vulnerable.
Service industries, such as a catalog company that fills its customer orders through a third-party call center, are also at risk.
But it is corporations reliant on a single source, such as a semiconductor maker who obtains its chips from a specific Taiwanese factory, or a process industry like petrochemical that is dependent on a variety of products to complete the manufacturing process, that are especially exposed, industry experts say.
"Generally, the more complex the business process is, the larger and more complex is your supply chain," says Gary Marchitello, managing director of national property syndication at AON in New York City. "And the loss of a supplier could shut you down entirely as if it were your own loss."
That makes risk identification--pinpointing the critical products used in the manufacturing process and the sources of these products--a vital process for corporations. The second step is risk measurement: measuring the financial impact of losing the products obtained from any of those suppliers.
Bean says that underwriters work with corporate risk managers to analyze the company's manufacturing process so they can understand the company and the risk before they issue a policy. And if a corporation can't identify its suppliers, its CBI cover will include smaller limits.
"When the underwriters write a CBI risk, they want to know the location of the supplier and the protection at the location," says Suzanne Douglass, managing director, property, at Willis Risk Solutions in New York City. "The underwriter is going to say, 'If you can't tell me who the supplier is, I'm going to put a limit on the risk.'"
So if the limit for business interruption cover on a commercial property policy for a large multinational is $500 million for a 12-month period, for example, the CBI coverage for an unnamed supplier would be limited to $25 million. CBI coverage for a loss suffered by a named supplier would be greater at about $150 million--if the insurer is not writing risks for other corporations dependent on that same supplier, Douglass adds.
But in some cases, the risk manager simply doesn't have the answers for their insurer. "In a big firm, the risk manager doesn't necessarily know what deals the various business units are cutting with their suppliers," says Miller of XL. "And the deals with suppliers are changing all the time. The risk manager has a credible problem because the business side is moving fast."
In addition to writing smaller limits, underwriters are handling the unknowns of CBI coverage with contracts that contain more specific language. Since the hardening of the property market that began in the late 1990s, commercial contracts frequently include language that excludes any losses claimed by unnamed suppliers. The cover for unnamed suppliers has to be added on.
And underwriters limit their exposure by not writing too much CBI cover for companies in one industry that may be dependent on the same supplier. "CBI in today's world is an unplumbed exposure for many, many people. So many companies are changing so rapidly to respond to the demands of the global economy that it's a tough risk to write," says Douglass of Willis. "CBI will be a significant risk going forward."
PAULA L. GREEN,
a staff writer with a New York-based finance magazine, is a frequent contributor to Risk & Insurance®.
April 15, 2005
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