the value and limitations of business interruption insurance for technology companies – and a few...
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The Value and Limitations Of Business Interruption Insurance
ForTechnology Companies –
And A Few Ideas On How To Improve It
Urs Nussbaum, Swiss Re
Marsh 2005 Technology Conference
Page 2
Purpose
"Not everything that is faced can be changed, but nothing can be changed until it is faced." -- James Baldwin
Critical review of present practices
Provide ideas to develop alternatives
Win a few people to pursue the discussion after the conference
Empower all stakeholders to take a leap of faith
"Not everything that is faced can be changed, but nothing can be changed until it is faced." -- James Baldwin
Page 3
Select General Thoughts On The Nature Of Insurance
Historic Dimension
– Insurance laws hardly change (x finite)
– Products essentially the same
– Broadening/tightening of coverage cycle-driven
World around insurance has changed
– Tangible to intangible (services, Intellectual Property)
– Analogue to digital
– Specialization and value chain focus, outsourcing
– Significant progress in financial risk management (hedges)
– Capital markets as a potent and capable risk taker for all kinds of risks
-> How could insurance survive?
Page 4
Select General Thoughts On The Nature Of Insurance
High level of abstraction – some level of self-adjustment
– Not specific to industries and consumers
– Broad definitions and descriptions (event, insured interest/activities)
– Contains hidden options – previously inexistent events
Semi-finished product – continuously applied
– Risk manager/broker: exposure evaluation & effectiveness of protection
– Underwriter: exposure evaluation and pricing
– Loss adjuster/lawyer: claims settlement process
Page 5
Summary of Pros and Cons Of Insurance
Pros For Insured– Broad coverage incl. hidden risks – “luxury” option
– No basis risk between actual loss and payout
Cons For Insured– Needs specifying and applying to individual circumstances
– Ex-post loss quantification
– Continuous negotiation process
– (No liquid market no price transparency)
Pros For Insurer– Ability to sell “same” service to variety of different
consumers
– Low product cost
Cons For Insurer– Hidden options
– Settlement value determined by third party
– Moral risk management needed
Page 6
Implications For Business Interruption
Exposure Assessment
– Information about business process
– Values
– Limits
Loss Settlement Issues
– Extra Expense/Increased Cost of doing business -> Interest alignment & moral risk management, collaboration Insured with Insurer (overtime, repair, use of other facilities)
– Overcompensation -> exclude: variable expenses, making up for lost production
– Basis of comparison: 12 months before
Page 7
Summary Of Issues
Uncertainty and imprecision remain even ex-post
Judgement and interpretation inherent in implied service/process
Implied Joint Venture between Insured and Insurer (exposure evaluation and loss settlement). Note, interests are not always aligned
Continuous process of negotiation necessitates third party, carries risks of disagreement
Slow, expensive and possibly leads to mutual disappointment
Page 8
Features Of A Solution
Address the disadvantages of the status quo
Specific industry and individual business needs must be reflected in the structure and in the policy to a higher level
Continued negotiation and resulting unpredictability and high level of judgement must be replaced with pre-determined processes/agreements
Post-event loss quantification must be replaced with pre-determined payments under defined conditions to the extent possible
Recoverable must be booked and paid quickly
Page 9
Comparable Product ELPRO
Example Contingent Price Option for power utilities
Payment In case of production shortfall due to occurrence of NERC/FERC triggers
Min(Max (Shortfall- Deductible,O) * Max(Price-Strike,0), or Limit
Effect Reimbursement for production shortfall under market price and production cost calculation/projections
Sample Peak Prices US PJM West
0
100
200
300
400
500
600
700
800
6.1 6.15 6.29 7.13 7.27 8.10 8.24
Date
$ / M
Wh
Unplanned Outage
Strike Price
Page 10
Application of the ELPRO Model
Trigger events
Defined list of acceptable “named perils” including non-physical damage reflecting risk retention level and industry-specific issues
Loss payments (per time unit)
Determination of fixed operating cost, deductible based on risk retention level and available accounting information
Determination of profit component beyond fixed cost (a) capital market projections (stock market index or ratio) or (b) historic profitability based on available accounting information
Loss settlement
Upon verification of trigger event
Specificity,
Pre-determined events
Pre-determined amounts
Faster, cheaper settlement
Page 11
Example Of Alternative Structure Semiconductor Company
Trigger Event (replace FERC/NERC definitions)
– Fire and other key hazard risk, additionally, key supplier credit default and/or information system breakdown at specified locations under consideration of present characteristics
Loss Payment (Replace electricity volume and market price risk)
– Fixed cost – deductible
– Gross profit pegged to historic performance but determined by Philadelphia Semiconductor Index
– Strike Price: Index exceeds defined value (e.g. Phlx > 399)
– Payment: $x for each point that Phlx > 399, per day
Assumption: Correlation between Phlx and BI value
Page 12
Summary of Pros and Cons Of Alternative Structure Exposure and accounting information provide proxy.
Accuracy of pre-loss estimate not significantly inferior to post-loss estimate. Reliability will vary with industry
Tech world is too intangible and too unpredictable to quantify the “true” BI loss
Loss settlement process faster and cheaper
Insurance recovery can be booked fast
Service performance generally more predictable
Basis risk - Danger of under/overcompensation
Underwriting process may take longer
Adverse selection, unprofitable business may find undue attraction
Regulatory muster
Page 13
Open Questions
Regulation/Accounting (insurance vs derivative, SOX)
Quantifying and getting comfortable with the basis risk (Ability to evaluate/model the scenarios)
Internal
Market demand
Page 14
Questions For Discussion
Value of certainty of BI payments
Ability to book insurance recovery quickly
Comfort level with basis risk – ability to (reliably) quantify BI ex-ante
Regulatory comfort level
Value of extending BI cover beyond physical damage
Value of “hidden options”
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