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Press Offices > Short Term Insurers

Centriq Insurance
Press Office Feature : Japan aftermath

Company: Centriq Insurance
Author:Robin Burgess
Email:editor@itinews.co.za
Posted:24 Aug 2012

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A contingent business interruption perspective

From the earthquake induced tsunami resulting in fires in Japan, to the floods in Thailand and Australia - the list of natural catastrophes that hit several countries around the globe these past two years reads like a Steven King novel.

Hard lessons in catastrophe insurance were learned with the top five reinsurers by premium income recording the highest economic losses ever.

Over 300 catastrophic events were recorded in 2011 alone, totalling an economic loss estimated at USD370bn, almost one third of this amount (USD116bn) was covered by insurance.

Robin Burgess, Senior Underwriter at Centriq Insurance discusses the aftermath from a contingent business interruption perspective, with special reference to insurance property losses in Japan, the resulting losses on the reinsurance market, and the importance of this cover in the global market place.

CBI explained

Contingent Business Interruption (CBI) covers a business for its loss of income and other expenses resulting from total or partial suspension of operations because of physical loss or damage to dependent property that is not owned, controlled or operated by the business itself (e.g. damage to a specific supplier's facility), provided the loss is caused by a covered cause or peril.

The above-mentioned scenario was seen in Japan where a single event - the earthquake of 11 March 2011 - triggered global CBI cover as the interruption to manufacturing experienced was wide spread from the major suppliers to the secondary industry.

E.g. Leading motor manufacturer Toyota whose international production, which can be seen as an interconnecting web of components mostly distributed from Japan, was slashed by half, falling from approximately 245 000 units to fewer than approximately 49 000 post the earthquake and tsunami.

However, just as risk managers and claims adjusters thought they had the Japan earthquake and tsunami losses under control, monsoon flooding ravaged the industrial heartland of Thailand - a major supplier of semiconductors, LCD Screens and 50% of the world's hard drives and many forms of plastics to the worlds' leading motor and computer manufacturers - causing further havoc around the globe as many organisations' business operations and supply chains were severely damaged and interrupted. 

Once again, Toyota's dependence on parts supplied by third parties paints a clear picture of how important CBI is in controlling losses.

Japanese manufacturers have long been admired and copied by the world for their just-in-time factory design.

Suppliers send to the assembly line only what is needed for the next few hours. This means manufacturers do not need to spend extra money on stock and only pay when stock is delivered.

This is a fantastic business strategy. However, when Mother Nature steps in there is no buffer stock to continue production. The Thailand floods therefore exacerbated the situation which resulted in a complete halt of many production lines worldwide.

With that said, it is important to note that an insured would need to have earthquake cover to trigger CBI coverage in the event that their Japanese supplier's production line, for example, is damaged or destroyed by an earthquake.

If the Japanese plant was damaged or destroyed solely by a tsunami, however, CBI cover would not have come into play unless the insured had flood cover in force. (Fire cover would have the same outcome.)

Unfortunately, it is difficult for underwriters to properly assess CBI risk before an event, especially seeing that earthquake models typically do not offer any means to assess CBI risk at this stage of the game.

As such, and in light of the huge economic losses that can result from CBI following a natural catastrophe, underwriters need to ensure that policy wordings limit the scope of the cover by e.g. limiting insurance cover to named suppliers and locations where the geographic scope and perils can be assessed.

Reinsurers Reflect

Whilst statistics are continually updated, the latest data released by Swiss Re is sufficient to show that earthquake insured claims for 2011 broke the world record.

Most of the financial losses recorded came from Japan - although insured losses recorded represented only a limited share (between 12% and 17%) of the total cost of the event - making it the most costly natural catastrophe of all time. (See Table 1 - Source: Swiss Re Economic Research and Consulting)

Table 1

1992: Hurricane Andrew
1994: Northridge Earthquake
1999: Winter Storm Lothar
2001: 9/11 Attacks
2004: Hurricane Ivan, Charley, Frances
2005: Hurricane Katrina, Rita, Wilma
2008: Hurricane Gustav
2010: Chile, New Zealand Earthquakes
2011: Japan Earthquake Tsunami, New Zealand Earthquake, Thailand Floods
 
Moreover, whilst property damage to Japan's commercial facilities and disruption to logistics and supply chains were huge - the total damage suffered represented only a fraction of Japan's GDP - showing that the capacity of a country to withstand large earthquakes largely depends on the size of its economy.

(See Table 2 and 3)

Table 2

Date of event

Country

Economic losses

Economic losses as % of GDP

Insured losses

Insurance industry contribution

11-03-2011

Japan

Up to 300

Up to 5.4%

35

Up to 17%

27-02-2010

Chile

30

18.6%

8

27%

22-02-2011

New Zealand

15

10%

12

80%

12-01-2010

Haiti

8

121%

0.1

1%

04-09-2010

New Zealand

6

5.3%

5

81%

06-04-2009

Italy

4

0.2%

0.5

14%

23-10-2011

Turkey

0/75

0.10%

0.03

4%

04-04-2010

Mexico

0.95

0.09%

0.2

21%


 
*Major earthquake events in USD billion at 2011 prices
*Source Acknowledgement: Swiss Re's sigma catastrophe database

Table 3

Interestingly enough, earthquake-prone Japan (as a result of its high seismic activity) has a low earthquake insurance penetration worldwide.

As such, government, corporations and individuals absorb a large percentage of catastrophic losses the country suffers.

Table 4 illustrates the higher the ratio of insured to economic losses, the greater the insurance industry's contribution to reconstruction efforts within the country.

Table 4

Country

Number of events

Insured losses

Economic losses

Insured losses / Economic losses

New Zealand

3

17

22

80%

United States

13

25

64

38%

Chile

5

9

34

26%

Mexico

11

1

11

10%

Japan

24

40

373 to 463

9% to 11%

Turkey

26

2

30

5%

Italy

8

1

50

2%

*Insured and economic losses are indicated in USD bn at 2011 prices.
*Source Acknowledgement: Swiss Re's sigma catastrophe database

As the above-mentioned tables clearly illustrate, it would be foolish to think that governments or funding from relief organisations can absorb economic losses from massive earthquakes such as the ones experienced in the last two years alone.

Pre-disaster funding mechanisms such as widespread insurance coverage can significantly lessen the post-disaster financial impact of earthquakes in terms of reconstruction and recovery.

This can be done by:

a.) Using earthquake models to predict and measure earthquake shock losses or anticipate the difference in building resistance to ground shaking for example
b.) spreading the risk among policyholders across geographic boundaries and across international reinsurers;
c.) charging risk-base premiums that encourage pre-disaster risk mitigating behaviour (e.g. lowering the cost of protection by linking premiums to the presence of stringent building codes).

However, to successfully increase the uptake of earthquake insurance, the public's low perception of earthquake risk needs to be addressed.

(Before the catastrophe of 2011, the frequency of earthquakes compared to other natural disasters was fairly low even in places with highly destructive seismic occurrences. This, many insurers believe, attributed to the public's low uptake of earthquake insurance coverage.)

This is where governments come in. By increasing public awareness on earth quake risk and encouraging businesses and individuals to better manage the risk through the uptake of earthquake insurance, governments can help to increase insurance protection.

A larger uptake of earthquake insurance will in turn help the insurance industry to lower premium rates, making it more affordable for a larger percentage of businesses and individuals.

Look what these governments have done:

- The government of Mexico put a public-private funding solution in place in 2006 to provide emergency relief for earthquakes of certain predefined magnitudes in specific regions.
- Following two major earthquakes in 1999, Turkish government made earthquake insurance coverage mandatory via the Turkish Catastrophe Insurance Pool (TCIP) for residential buildings that fall within municipal boundaries. Residential earthquake insurance coverage is also mandatory in New Zealand.

With that said, we are pleased to say that we are indeed seeing some of the governments investing in disaster prevention and management public awareness campaigns.

We are also seeing governments' investing in making infrastructure more resilient, hence lowering expected property losses, e.g. stringent building codes, making new buildings more earthquake resistant.

Without compromising effective underwriting risk management, the insurance sector on the other hand needs to simplify its product structure in terms of (a.) the (number of) exclusions that apply; (b.) its wide range of deductibles and loss limits to make it less complex for the consumer to understand.

Secondary loss agents (i.e. losses that do not directly result from ground shaking, including tsunamis, soil liquefaction, business interruption and contingent business interruption, aftershocks etc.) also need more attention as these factors - which significantly contributed to overall losses in New Zealand, Chile and Japan - are not sufficiently considered in earthquake risk models currently available.

The fact that losses due to tsunamis are not yet included in the existing earthquake insurance models for Japan is another urgent aspect that needs to be addressed (especially in the light of global warming and considering that the Japanese coast line is frequently affected by tsunamis.)

Although weather technology has evolved in leaps and bounds - with man launching 50 weather satellites in the 1960's using what was said to be the most advanced 'modern-standards' for its time; today the latest super computers processing power provides us results based on historical data going back a few decades, allowing us to 'predict' weather patterns.

That said, Mother Nature's catastrophes, however, still remain as unpredictable as ever for man.

Lloyd's of London recorded a £516m loss in 2011 after paying out the largest catastrophe claims on record.

The insurance market paid out £4.6bn in disaster claims after earthquakes in Japan and New Zealand, storms in the US, and floods in Thailand and Australia hit.

Total catastrophe claims for the global industry reached $107bn (£67bn) last year (Source: Aon Benfield)

The unprecedented series of natural disasters forced up the total Lloyd's payout to £12.9bn, or £1.07 for every £1 paid in premiums last year.

The Thai floods, in October, were the biggest disaster for Lloyd's in term of payouts last year, with total claims estimated at £1.4bn.

Robin Burgess is a Senior Underwriter with Centriq Insurance

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