Nick Gurgone of Pinnacle Actuarial Resources and Grant Maxwell of Allianz Global Corporate & Specialty talk to Rebecca Delaney about the impact of the COVID-19 pandemic on the demand for business interruption insurance through captives
Ranked as the number two risk globally in Aon’s 2021 Global Risk Management Survey, business interruption (BI) has exploded as a hot topic on any insurance and risk manager’s priority list over the last few years. As well as highlighting the increasing importance of being able to manage long-tail risks, the COVID-19 pandemic has demonstrated how the interconnectivity of risk means that BI can affect multiple industries and companies simultaneously. During the pandemic, companies were forced to adapt quickly to a virtual world, while increasingly inconsistent government regulations had a significant impact on business continuity plans and the supply chain. From a BI perspective, therefore, resilience is absolutely critical within an organisation.
No longer regarded as a linear risk, the responsibility for resilience and risk transfer has shifted from insurance buyers to risk management teams as their organisation’s visibility in BI and people risk heightens. BI issues can also arise from cyber risk, as the evolving type, volume and success of cyber-attacks has elevated this threat to both an operating risk and an underwriting risk. Airmic’s annual survey names BI following a cyber event as the top front-of-mind risk for risk professionals, which is indicative of the dramatic acceleration in rate increases for cyber insurance.
Grant Maxwell, global head of alternative risk transfer at Allianz Global Corporate & Specialty (AGCS), says: “For most organisations, the biggest fear is not being able to produce and deliver their products or services. BI events can have a very costly and long-lasting impact that can extend well beyond an individual organisation.”
This has created a definitive trend of companies looking to insure against BI. Nick Gurgone, consulting actuary at Pinnacle Actuarial Resources, explains that BI insurance reimburses companies for the lost profits and extra expenses that may be incurred as a result of a BI incident or trigger.
He adds: “A key component of BI policies is how the triggers are defined. Traditionally, the primary BI coverage offered by the commercial insurance market has been for property damage only, included as a piece of the commercial property policy, but does not cover BI resulting from causes other than a property loss — in other words, underlying events causing BI must be covered triggers in the policy in order for the interruption to be covered in the policy.”
Therefore, companies have been seeking to cover a larger amount of triggers as organisations continue to face major world events — such as catastrophic weather events, recessions and the COVID-19 pandemic — that cause BI but are not covered in many commercial policies. Maxwell adds that companies are also experiencing heightened exposure to other unique, non-physical — but nonetheless disruptive — BI events, such as supply chain disruption, loss of key employees, loss of key contracts or customers, reputational damage, cyber risk and labour shortage.
Companies are striving for a more comprehensive awareness of their exposure to these personalised, unique risks that have the potential to cause BI. Gurgone explains this is a result of the growth of enterprise risk management and critical thinking around the planning and managing of risk.
Collectively, these trends have acted as significant drivers for demand and creativity for non-traditional BI coverages. Maxwell notes: “As business becomes more connected, digital and globalised, these non-physical risks are proliferating and companies are increasingly looking to insure against them.”
From a risk management perspective, focus has shifted to risk assessment training to identify business continuity opportunities. Organisations, and particularly the captive industry, thrive on innovation and creativity — there is an opportunity in the increased knowledge surrounding risk to improve risk management strategies and explore potential cost savings.
Gurgone explains that, since BI insurance for certain risks is scarce and often expensive in the commercial market, captives have “effectively become the primary market” for such coverages. For example, small- and medium-sized companies can participate in a quota share arrangement with a reinsurance captive that assumes the majority of risk from several similar captives.
He adds: “The captive approach in general also carries the benefit of being able to craft insurance products to meet the needs of an insured, as long as the policies meet the definitions of insurance, and the risk is insurable.”
The advantages of utilising captives to protect an organisation from BI is affirmed by AGCS’ Maxwell. He notes that since many companies are looking to self-retain a larger share of their BI exposures, those that own a captive and have a holistic risk management approach, are able to absorb some of these risks in their captive.
“As well as an effective form of risk financing, this can mean more focus on the risk to quantify and transfer it internally, which may result in more active and advanced risk management,” Maxwell explains.
In addition, companies with captives or higher self-retentions are able to access higher capacities in the traditional insurance market, as well as form a better understanding of their own risks to develop an advanced approach to risk management.
“Using the captive may allow diversification with other risks that are ceded to the captive. Combined with a structured reinsurance solution behind a captive, a company has a much better grip on reducing and managing the volatility that is inherent to such BI risk in a capital-efficient manner.”
Challenges
As with any form of self-insurance, providing BI insurance presents challenges. Maxwell points out that, although property and BI insurance is a traditional insurance product, it is a highly sophisticated one. Assessment of BI risks and identification of the most urgent BI scenarios is a complex process, exacerbated by the frequency of disruptive events and global interconnectedness of production and supply chains. With this globalised perspective in mind, insurers must carefully manage any potential aggregation in their portfolios, as single events, such as natural catastrophes, can cause business and supply chain interruption for multiple companies, causing multiple claims from policyholders globally.
Maxwell adds that greater awareness of risk brings the realisation that not all BI risks are easy to insure and to find meaningful capacities, particularly for large and contingent BI risks. This means there is a lack of transparency, which generates uncertainty, around the realistic BI exposure of an organisation after specific events.
“The better the transparency and data, the more meaningful capacity insurers are able to provide,” Maxwell summarises. “We still see clients whose mapping of supply chain risk is not as detailed as it should be. It is critical to understand the value chain and identify the most important exposures in order to mitigate the risks and create solutions to transfer or reduce the risk.”
Full steam ahead
Despite these challenges pertinent in providing BI coverage, the road ahead for the captive industry looks optimistic. Spurred by the COVID-19 pandemic, the unprecedented level of BI over the last two years has inspired companies, brokers and insurers to examine how they can manage this risk more effectively and proactively.
AGCS’ Maxwell affirms: “There is now a desire and willingness among top management to bring greater transparency to supply chains and to work with data to better understand the risks. Momentum has been building and increasingly businesses see resilience as a competitive advantage.
He adds that with this increased focus, the next 12 months is likely to see new developments in risk assessment, risk mitigation, risk retention and risk transfer, with the latter increasingly leveraging a combination of traditional insurance products and alternative risk transfer solutions and captive involvement.
In addition to growing demand for BI coverage, the captive market is likely to see an increasing list of triggers that companies are interested in insuring, adds Pinnacle’s Gurgone.
He explains: “Many more companies will have a newfound interest and awareness of these types of risks, and demand for related coverages will increase, especially from the captive market, which is currently the primary market for most of these risks.”
Captive managers in charge of reinsurance programmes that impact multiple captives will have fluctuating responses to this charge in demand, Gurgone anticipates. While some may offer more BI coverages that explicitly include pandemic risk, others will not want to risk solvency to their reinsurance pools.
“Overall, it seems likely that the captive industry will continue to be the primary market of non-property BI, and that general demand for this insurance will continue to increase,” he concludes.
Beware the pitfalls
Pinnacle’s Gurgone outlines two major challenges in providing BI insurance:
Appropriately defining the coverage — in order for a BI risk to be insurable, there are some key requirements. Fundamentally, it must be possible to calculate what a BI loss is when one has occurred, which can be a tricky process. In addition, the risk of loss must exist and result from a fortuitous event.
A timely example is the challenge of defining a BI coverage trigger for pandemic. Can COVID-19 BI losses be covered on a go-forward basis when COVID-19 is an event that is already occurring? In other words, would losses stemming from the pandemic be fortuitous at this point? It is important to word the policy language so that a loss is only covered if something fortuitous and unknown occurs after the effective date of the policy date.
Determining an actuarially-sound premium — while common pricing approaches for traditional coverages rely heavily on databases of claims and exposures large enough to have acceptable statistical credibility, past BI losses, or the lack thereof, do not tend to correlate with or be as predictive of future losses to the extent of traditional coverages.
Consequently, analysing historical claims is not nearly as useful for determining an actuarially-sound premium for BI coverages. Actuaries need to turn to less traditional and more creative ratemaking techniques. Another actuarial challenge is that policy language tends to be more unique and personalised with BI coverages than with traditional coverages. Policies with the same name might not cover the same exposures or have the same exclusions, so the actuary may not be able to build a one-size-fits-all pricing model for their BI rating.
