Business interruption losses on the rise, clear role for ILS

With interconnectivity increasing, the negative and costly economic impact from business interruption (BI) risks is a growing concern for many firms. Again bringing to light the potential for ILS and alternative risk transfer structures to provide much-needed coverage for BI exposures.

In an increasingly interconnected world the effects natural catastrophe, or man-made catastrophe events can have on the day-to-day operations of companies around the globe is substantial, and growing, according to Allianz Global Corporate & Specialty (AGCS).

That signals an increasing threat to insurance and reinsurance companies, that they could be at risk of suffering bigger than expected losses due to business interruption from catastrophes, or man-made disasters.

As that threat grows the need to secure sources of contingent insurance and reinsurance capital grows, sources that may need to be significant in size in the future as this under-appreciated risk grows, suggesting a clear role for the capital markets and ILS as BI capacity provides in the future.

This notion is underlined by predictions from insurance, reinsurance, and insurance-linked securities (ILS) market analysts and participants that climate, and weather-related catastrophe events are on the rise, both in terms of severity and frequency, and the fact that technology has enabled companies to be closely connected, regardless of geographical location.

“The growth in BI claims is fuelled by increasing interdependencies between companies, the global supply chain and lean production process.

“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,” said Chris Fischer Hirs, Chief Executive Officer (CEO) of AGCS.

In a new report AGCS explains that now, the average BI insurance claim is beyond the $2.4 million (€2 million) mark, some 36% higher than the average, corresponding property damage claim.

Underlining that while the physical damage from natural or non-natural disasters can be significant for firms, the “economic impact from BI is often much higher than the cost of the actual physical damage.”

Of the 1,800 sizeable BI claims that AGCS analysed for its report, which totalled claims of beyond €3 billion between 2010 and 2014, from 68 different countries, the majority of claims were from non-natural disasters, such as human error, technical issues and so on, as opposed to weather-related events.

However, this did vary by region, explains the report. Fire and explosion accounts for roughly 59% of BI losses globally, topping the bill in Europe, the Middle East, North America, and South America.

But in Asia the picture is very different, as fire & explosion accounts for just 10% of BI losses, with flooding and storms representing a similar portion, at 13%, and 9% respectively. Furthermore, in the Caribbean and Central America storms account for a staggering 33% of the regions’ BI losses.

“Both severity and frequency of BI claims is increasing,” states the AGCS report, an admission that highlights the need for adequate risk transfer solutions to protect businesses from the growing threat of potential BI losses from events like cyber-attacks, and human error, to the persistent and also increasing threat of weather-related perils, like flood, storms, hurricanes, and earthquakes.

A recent example of BI losses can be seen with the Tianjin port chemical explosion, where disruptive effects, such as the closure of the port, impacted companies around the globe, leaving businesses that are geographically far from the actual physical damage of the event unable to operate due to a supplier being affected, for example.

BI claims have risen in recent times as the Internet and technological advancements have improved and enabled greater interconnectedness, resulting in a vast, and complex global supply chain.

But as noted earlier this year by Marsh, ILS, or alternative risk transfer structures, in particular ones that utilise a parametric trigger, an element to the solution that ensures rapid payout post-event, can be widely used to protect businesses against BI losses due to natural disaster events.

By value, notes AGCS, average BI losses are the highest amongst the energy sector, and with heightened interconnectedness across the energy industry and the threat of increased extreme weather events, weather risk financing products are vital to provide companies with financial support when disaster, natural or not, strikes again, and this can be adopted and tailored across various sectors.

While the structures, capacity and willingness of the growing ILS market is well-suited to protecting against BI claims, the markets evolution and expansion into new business lines, such as specialty, could mean their exposure to BI claims grows, as is the same with any diversified re/insurer, or ILS player.

BI coverage is an area that ILS and the catastrophe bond market could become a provider of insurance products to the world’s most interconnected corporations and companies, augmenting the capacity of the traditional insurance or reinsurance market.

Add to this that the report suggests the majority of companies and industries, ILS included, are likely more exposed to BI losses than they’re currently aware, owing to the complex and inherently difficult to predict knock-on effect from events and its resulting impact on the global supply chain, the need for adequate risk transfer and protection against BI risks is clear.