Interdependency fuels business interruption claims

The Increasing interconnectivity of global supply chains is driving an increase in business interruption (BI) risk and losses, reports Allianz.

The German insurance group’s specialist business and industrial risks insurer Allianz Global Corporate & Specialty (AGCS), has issued its latest report, entitled ‘Global Claims Review 2015: Business Interruption in Focus’.

“Collapsed buildings, damaged factories or destroyed shipping containers: whenever natural catastrophes or man-made disasters strike the physical damage is often devastating for companies,” the report notes.

“However, the less obvious economic impact from BI) is often much higher than the cost of the actual physical damage and presents a growing risk to operating in an increasingly interconnected world.” This is evidenced by figures showing that the average large BI property insurance claim is now €2.2m (US$2.4m, £1.6m), which is 36% higher than the corresponding average property damage claim of just over €1.6m.

Both severity and frequency of BI claims is increasing, with incidents mostly caused by non-natural hazards such as human error or technical failure rather than from natural catastrophes. The top 10 causes of BI loss account for over 90% of such claims by value, with fire and explosion being the top cause, accounting for 59% of all BI claims globally.

In the UK, fire and explosion claims heads the largest risk table with 77% of BI claims made. By comparison the second highest – faulty design, material and manufacturing claims – represents no more than 11%. Each fire and explosion incident analysed globally averaged €1.7m in BI costs alone.

“The growth in BI claims is fuelled by increasing interdependencies between companies, the global supply chain and lean production processes,” says Chris Fischer Hirs, chief executive (CEO) of AGCS. “Whereas in the past a large fire or explosion may have only affected one or two companies, today, losses increasingly impact a number of companies and can even threaten whole sectors globally. With our experts researching this topic, we are well positioned to respond to this evolving risk.”

Clusters and catastrophes

As manufacturing production continues to shift to Asia, so too have large BI claims. AGCS says that there is an increasing concentration of production sites and logistics hubs in certain areas. When clusters are hit by natural catastrophes, or by other events such as a fire or explosion – as per the blast at the Tianjin port in China in August – disruptive effects can quickly multiply resulting in contingent business interruption (CBI) losses around the globe. In such cases a business may be unable to operate as one of its suppliers is affected. “BI exposures are largest for sectors with high levels of interconnectivity and technological values, as well as concentrations of risks in single locations such as automotive, semi-conductors and power and petrochemical plants,” says Alexander Mack, chief claims officer of AGCS. “While modern supply chains may be flexible and cost-efficient, they are also more vulnerable to disruption.”

Following the earthquake and tsunami in Japan and Thailand floods in 2011, which triggered many global BI and CBI losses, companies have taken steps to reduce supply chain risks. “We observe that many global businesses are rapidly maturing in terms of BI and supply chain risk awareness and management, but there is still room for further improvement”, says Volker Muench, property specialist, AGCS.

The report finds that interdependencies between suppliers can be a big unknown and many businesses are dependent on key suppliers. Business continuity planning should therefore not only be part of a company’s own supply chain risk management programme, but should also be extended to all of its critical suppliers. Supply chain management should be treated as a cross-functional task involving at least functions such as procurement, logistics and finance.

Industry trends

AGCS’s report analyses more than 1,800 large BI claims totalling over €3bn from 68 countries in the period 2010 to 2014, where it acted as lead or as co-insurer. Average BI losses are highest by value for claims originating from energy (€3.96m) and property (€2.21m) lines of insurance, followed by engineering (€0.9m) and entertainment (€0.3m).

The cost of large energy claims has risen; BI now accounting for a higher proportion of loss totals, as exposures have increased due to larger onshore energy facilities and growing interdependencies between companies resulting in regional CBI claims if one plant is disrupted. At the same time BI insurance demand has risen as new buyers from Russia purchase BI cover for the first time while existing buyers in the US and Europe seek higher insurance limits.

In the entertainment sector, illness or an accident of a cast member is the most prevalent cause of interruption: Injury to a major star can delay the production, leading to multi-million dollar claims. This so-called ‘cast loss’ is responsible for 60% of such claims received in the sector and almost three quarters of claims by value. The proliferation of costly visual effects in film production, which often require contractual commitments with third party specialists, can cause more expensive claims through production delays. BI and CBI are significant drivers behind the increasing severity of major property losses, where non-physical damage causes of BI could become more significant. Perils such as cyber-attacks, political violence, strikes, pandemics and power outages could potentially cause large losses for companies without damage to property.

Other non-damage events include actions taken by civil or military authority such as access restrictions or air space closure. Several losses following the Tianjin explosion resulted from the subsequent interruption of flow in stock and production as the port was closed by authorities. Such losses would only be covered by emerging non-damage BI policies, which only a few companies have purchased to date but which more are becoming interested in.

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