topics schadenspiegel 1/2016 - Munich Re

TOPICS SCHADENSPIEGEL

The magazine for claims managers Issue 1/2016

Man-made disasters A growing number of the largest insurance losses today are man-made. The catastrophe in the Chinese city of Tianjin is just one example of many. PAGE 6

Marine Costly brand protection

Sanctions The science of compliance

Loss prevention Storing hazardous substances at ports

Editorial

Dear Reader, While natural catastrophes continue to account for the majority of large losses, a growing share of the claims burden today results from losses that are at least partly attributable to human conduct. What is more, settlement of these man-made catastrophes is invariably a highly complex and time-consuming process. In light of these developments, this issue of Schadenspiegel takes a detailed look at man-made losses and their impact on claims management. Our attention focuses first and foremost on the explosions which shook the Chinese port of Tianjin in 2015. What were the events leading up to this devastating loss? What is the role of innovative claims management methods such as high-resolution aerial photos taken by satellites and drones to assess losses? What new trends have emerged, for instance with regard to business interruption and brand protection? The growing digitalisation of our lives is also producing completely new loss scenarios. Take “intelligent” healthcare products, for example: wearables and smart implants are not only linked to a whole range of cyber risks, but can also cause serious bodily injury. In D&O liability, the latest trends are highlighting the important role that legal frameworks play in the context of large man-made losses. Along with innovative procedural options for asserting claims, tighter regulations in liability and supervisory law have resulted in a worldwide increase in losses. Meanwhile, it is becoming ever more important to give careful con sideration to embargoes and sanctions when settling claims. Which aspects must insurers take into account to avoid falling foul of government stipulations? Which compliance measures are needed and which tools are available for this purpose? We hope you enjoy reading this issue of Topics Schadenspiegel.

Tobias Büttner Head of Corporate Claims at Munich Re >> For further information visit us on Linkedin www.munichre.com/droneimages-tianjin

NOT IF, BUT HOW

Munich Re Topics Schadenspiegel 1/2016

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Man-made disaster in Tianjin Up to 75,000 brand new high-quality imported cars were being stored at the Chinese port of Tianjin at the time of the explosions. The insured market loss resulting from this accident could amount to between two and three billion euros. For primary insurers and reinsurers, it is proving to be one of the most complex loss events in recent history.

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Editorial1 News4 Column43 Imprint

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Contents

Marine cargo policies in international freight transport only cover property damage. Brand protection clauses go much further.

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MAN-MADE DISASTERS Explosive mixture 6 Improper storage of hazardous substances can be lethal. Storing hazardous substances at ports Special safety regulations apply at ports. Unfortunately, they are not always adhered to.

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Modelling marine risks New methods to quantify loss potential more reliably.

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The high price of brand protection Brand protection clauses cover companies against property damage that could tarnish their brand name.

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Natural catastrophe or man-made disaster? Distinguishing between man-made losses and natural catastrophes is not as straightforward as you might think.

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Embargoes and sanctions require careful handling. Insurers need to comply with the regulations, even in claims settlement.

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SANCTIONS The science of sanctions compliance Complying with sanctions regulations is a major challenge. CASUALTY Digital healthcare products and liability Technologies such as wearables raise many product liability issues.

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D&O LIABILITY EXPOSURE New developments 32 Developments in a number of jurisdictions have seen a rise in the importance of D&O covers. PROPERTY Challenges in the downstream energy sector Claims management following accidents at refineries and other petrochemical facilities. BUSINESS INTERRUPTION Caution: Complex interdependencies How companies with complex business structures can insure themselves against business interruption.


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NEWS

NATURAL HAZARDS IN 2015

AUSTRALIA/NEW ZEALAND

CYBER

A year of climate change

Expect the unexpected

Protecting digital assets

2015, the second year in succession to set a record high for the global annual mean temperature, also saw climate change feature prominently on the political agenda. The breakthrough at the climate conference in Paris allows us to hope that climate change can still be slowed to a level where the risks in most regions of the world remain manageable.

An analysis by Munich Re shows that the number of natural catastrophes in Australia has almost quadrupled since 1980. Global warming is projected to lead to a further increase in extreme weather events. Immense insurance and reinsurance capacity as well as sophisticated risk solutions are required to deal with these changes.

Losses from natural catastrophes were fairly low in 2015. The natural “climate oscillation” El Niño had a marked influence on the patterns of weather-related events. Further analyses and a comprehensive summary can be found in the 2015 issue of our Topics Geo magazine.

In its publication “Expect the Unexpected”, Munich Re’s leading experts share their views on the current situation and future outlook regarding natural hazards and risks in Australia and New Zealand.

Munich Re is cooperating with Beazley, the market pioneer in cyber and data breach response insurance. Beazley is the largest insurer of cyber liability risks in the Lloyd’s market. Together with Munich Re’s Corporate Insurance Partner (CIP), it provides the broadest protection yet for the digital assets and IT infrastructure of the world’s largest companies. Cover will be tailored specifically to the exposures of individual clients, providing up to US$ 100m or €100m of protection for a wide range of cyber risks. This cooperation makes it possible for customers to obtain broad protection, both in terms of perils covered and financial limits.

>> More information is available at: www.munichre.com/ausnz/natcat

>> M ore information is available at: www.munichre.com/topicsgeo2015

Follow us on social media Why not follow us and keep up with the topics that are being talked about in the insurance industry? Check out our extensive range of interesting articles and fascinating videos. Or stay fully up to date with live tweets from company and industry events.

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>> twitter.com/munichre >> facebook.com/munichre >> youtube.com/user/munichrevideo >> linkedin.com/company/munich-re >> xing.com/companies/munichre >> plus.google.com/ 115897201513788995727


>> M ore information is available at: www.munichre.com/ pressrelease-beazley

Protecting reputations: Preparing for a crisis The latest spate of corporate scandals has once again shown that a company’s reputation is key to its success in business. Recent events and the growing number of scandals are heightening companies’ awareness that the potential for financial loss due to a scandal can be much higher than that caused by property damage – or even business interruption. This is because, thanks to the internet and social networks, today’s customers are part of an observant, critical and powerful community. As a result, reputational risks now number among the top ten global business risks (Allianz Risk Barometer 2016), and demand for insurance cover of reputational risk is growing. A company has a much better chance of coming through a crisis with the lowest possible financial damage if it has the right insurance cover. Even a simple analysis of the potential risk scenarios with the insurer often improves risk management. If a claim is made, the funds received from the insurance cover can be used to restore the company’s reputation. The company is free to decide on the action it needs to take to steer its business model back to success. Insurance can also support a company’s directors, as they have a duty to put procedures in place to identify reputational risks and avoid damage, and to ensure that the company is prepared should reputational damage nevertheless occur. Managers should therefore not only provide for risk management, crisis communication and media monitoring, but should also seriously consider taking out insurance against reputational damage.

How is reputational damage calculated? Leaving the panoply of brand valuation theories aside, reputational damage can be calculated on the basis of the fall in turnover when clients go elsewhere. Since the decline in turnover has a direct effect on a company’s cash flow, and hence on the funds it has available to repair the damage to its reputation as quickly as possible, it needs finance. Unplanned expenditure and losses have to be funded from reserves or covered by insurance. Cover generally encompasses loss of profits together with financial support for crisis management and efforts to restore the company’s image. In our solution, the scope of cover and the cover triggers are individually tailored to the company’s needs. Contact us to find out more. >> M ore information is available at: https://www.munichre.com/reputationalrisks-whitepaper/en/homepage/index.html

OUR EXPERT Ulrike Raible is a lawyer at Munich Re specialising in reputational risks. [email protected]


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MAN-MADE LOSSES

Explosive mixture The disaster which struck the Chinese city of Tianjin in August 2015 was certainly not the first of its kind, but it was by far the most devastating. The improper storage of hazardous materials can result in explosions that cause enormous damage over a large radius.

Winrich Krupp, Dieter Ackermann, Michael Klug, Olaf Köberl, Alfons Maier, Klaus Wenselowski

Massive explosions shook the Chinese city of Tianjin in the late evening of 12 August 2015. The two most violent blasts ripped a huge crater in the ground, unleashing energy equal to that of earthquakes with a magnitude of 2.3 and 2.9 respectively. According to the official investigation report by the Chinese authorities, the explosive force was equivalent to that of almost 450 tonnes of TNT. The mushroom cloud rose several hundred metres into the sky. Fire spreads to fertilisers According to the report, the events were triggered by the spontaneous ignition of cellulose nitrate, also known as nitrocellulose or gun cotton. Containers filled with 207 tonnes of the substance were located in the storage area of a logistics firm within the port area of Tianjin. A further 26.3 tonnes were being stored temporarily in the arrival area. The fire then engulfed around 800 tonnes of ammonium nitrate fertiliser, which was being stored nearby, causing it to explode. Cellulose nitrate has a large range of uses, for example as a binder in nitrocellulose lacquers, in the manufacture of adhesives, in pyrotechnics and as a propellant. Because the substance is known to ignite spontaneously, it is stabilised with the aid of humectants (water or alcohol) or a gelling plasticiser during

Tianjin, with a port area of more than 100 square kilometres, is the gateway to the Beijing region. Munich Re Topics Schadenspiegel 1/2016

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MAN-MADE LOSSES transport and storage. For this reason, the chemical must be stored in a cool, dry place. This was evidently not the case in Tianjin. Instead, the resultant crater outside the built-up area indicates that the cellulose nitrate containers were stored out of doors. Daytime temperatures reached 36°C on the day of the accident. Further investigations revealed that the temperature inside the containers had risen to 65°C following exposure to direct sunlight. As a result, the packages of cellulose nitrate in the containers dried out and ignited spontaneously. The investigation report also indicates that the operator of the storage area was holding more than a hundred different hazardous substances there, some in quantities far exceeding the permissible limits. The ten most significant hazardous substances were present in quantities ranging from almost 300 to 2,000 tonnes (see table). All in all, almost 11,400 tonnes of chemicals were located in the dangerous goods warehouse and in the arrival section, plus a further 4,800 tonnes on the site of the logistics firm, including highly toxic and explosive substances. The overriding impression is that of an operation incapable of conducting appropriate risk management and which, according to the investigation report, allegedly offered bribes to officials. According to the report, 49 people were taken into custody and a further 123 charged with negligence and/or corruption. The accumulation of hazardous substances was evidently due to non-compliance with the regulations.

Up to 75,000 brand new cars were being stored in the direct vicinity of the hazardous substances at the time of the explosion.

Chemicals stored in the warehouses at the time of the explosion Chemicals

Weight (tonnes)

Chloromethylsilane 279.5 Butanone 315.8 Magnesium 495.5 Ammonium nitrate

800.0

Potassium nitrate

1,342.8

Sodium cyanide

680.5

Paraquat dichloride

271.9

Formic acid

307.9

Sodium sulfide

484.0

Sodium hydroxide

1,885.7

Potassium nitrate

1,046.0

Ammonium nitrate

800.0

Sodium cyanide

360.0

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Please note that some chemicals (highlighted in colour) were stored both in the dangerous goods warehouse and further amounts in the arrivals section of the logistics warehouse.

MAN-MADE LOSSES

The report further states that the explosions and the fire released 129 chemicals which contaminated the air, water and soil in the surrounding area. The air in particular was heavily polluted shortly after the accident. As a result of wind and heat, pollutant concentrations decreased considerably during the next 13 to 18 hours. Extensive chemical contamination was found in a lake some 2.3 km from the scene of the accident; contaminated water also accumulated in the explosion crater and was subsequently discharged into the Gulf of Bohai. In addition, more than 320 tonnes of sodium cyanide, a highly toxic and environmentally harmful chemical, were subsequently reported missing, although the permitted storage limit is only ten tonnes. Analyses revealed that 39% of the missing sodium cyanide had dissolved in water, while 58% evaporated during the explosion or escaped into the atmosphere. The deployment of large amounts of hydrogen peroxide after the accident helped to neutralise the remaining sodium cyanide. The rest was rapidly oxidised by atmospheric oxygen and thus rendered harmless. One of the largest man-made losses in Asia Munich Re has estimated that the insured market loss could amount to between two and three billion euros, making this one of the largest ever man-made losses in Asia. For insurers and reinsurers, it could also become one of the most complex losses of recent times. According to official reports, 173 people, including 99 firemen, lost their lives or remained unaccounted for and around 800 were injured.

The fireball and shock wave from the explosions destroyed containers and caused major damage to warehouses, production facilities and residential buildings. 304 residential, commercial and industrial buildings were damaged, many of them seriously. 7,533 containers and 12,428 imported vehicles were total losses. Windows were shattered, even at a distance of several kilometres. The nearby Donghai metro station was also severely damaged. Even more people would have been killed if the explosions had not occurred in the late evening, and stacked containers had not buffered the force of the blasts. Tianjin port occupies a special position as the gateway to the Beijing region and its facilities have expanded to more than 100 square kilometres in recent years. It is not only the most important terminal in the Beijing region, but also the world’s third largest port in terms of tonnage. In light of this rapid growth, precautions to ensure compliance with the regulations on hazardous goods may well have been neglected. As a result of the heterogeneous collection of buildings and industries due to this rapid expansion, several interim storage facilities for up to 75,000 brand new cars – mostly high-quality imports – had sprung up in the immediate vicinity of the chemical store. They account for the lion’s share of the insured loss.


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MAN-MADE LOSSES

An explosion at a fertiliser warehouse in the Texan town of West in April 2013 resulted in tremors equivalent to a magnitude 2.1 earthquake.

The overall loss to the stored goods and containers remains unclear. Around 30,000 containers are believed to be affected. It is unclear whether they contain goods and – if so – what the value of these goods may be. It is likely that many of the containers destroyed and catapulted through the air were empty and stacked in depots.

and customs issues also remain unanswered. In addition to value-added tax (17% of the vehicles’ value), 25% import duty and up to 40% luxury tax (depending on the cubic capacity of the engine) are also levied on high-end foreign cars. Exactly which sums apply here in the case of a total or partial loss still has to be established with the Chinese authorities.

Property insurance or marine insurance?

Tianjin is not an isolated case

Due to the complexity of the subject matter, it will take a long time for the insurers to settle the claims. The first issue to be clarified is whether the damaged vehicles are covered by property insurance or marine insurance. This will depend above all on how the transfer of risk has been defined in the respective policies (quayside or up to the first customer). Correct assignation to property or marine insurance will also determine whether and to what extent deductibles apply, as well as the degree to which any agreed brand protection clauses apply (see the related article on page 20). Predominantly found in marine insurance, these clauses may allow policyholders to claim a total loss in order to protect their brand name, even if damage to insured property is only assumed. Precise determination of the loss is also made more difficult by the fact that the authorities removed thousands of vehicles from the centre of the explosion area immediately after the event and had them destroyed before the loss adjusters were able to start work. Tax

Numerous incidents, some of them many years ago, have highlighted the dangers associated with negligent handling of ammonium nitrate. In 1921, 561 people lost their lives when 4,500 tonnes of ammonium nitrate exploded in a chemical factory in the German town of Oppau. In 1947, a ship carrying ammonium nitrate exploded in the port of Texas City, claiming 581 lives. An industrial accident occurred more recently in Toulouse on 21 September 2001. Around 300 tonnes of ammonium nitrate detonated in a chemical factory there, killing 31 people and injuring more than 2,300. Dozens of windows, doors and roofs in the area were shattered, leaving 5,000 people homeless. It has still not been possible to establish the cause of the accident. The prosecutors’ official theory is that contaminated ammonium nitrate became degraded over the course of many years of exposure to various environmental influences until it finally ignited spontaneously in a container.

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MAN-MADE LOSSES

Events leading up to the explosion of a fertiliser warehouse in the small Texan town of West in April 2013 are well documented. The force of the blast was so great that seismologists classified it as a 2.1 magnitude earthquake. The warehouse was completely destroyed and more than 150 buildings in the Texan town were severely damaged. 15 people died and more than 260 were injured. Explosion in West The investigation report issued in January 2016 by the US Chemical Safety and Hazard Investigation Board (CSB) lists a whole series of errors. The structural design of the warehouse and the fact that a sprinkler system was not installed were mentioned as contributory factors leading to the explosion. The Board also criticised the low training standard of West’s volunteer firefighters, the lack of coordination on site, the firefighters’ inadequate knowledge of how to deal with hazardous substances, particularly ammonium nitrate, and consequently their lack of risk awareness when fighting the fire. What is more, there had been no disaster response exercises prior to the accident. No buffer zone around the hazardous substances One issue raised by the accident is why a potentially dangerous fertiliser warehouse was located in the town of West. The report comes to the conclusion that, over the years, the town of West actually expanded in the direction of the fertiliser factory. A buffer zone had not been set up, since there were no regulations requiring that residential areas remain physically separate from areas in which hazardous substances are handled. According to the CSB, West is not an isolated case. It seems that many towns and cities in Texas and throughout the US are far too close to potentially dangerous industrial areas. It was also established following the explosion that the ammonium nitrate in stock had not been duly and completely reported to the relevant authorities. Generally speaking, storing large amounts of hazardous substances in this way frequently constitutes a risk. Following the events in West, US President Barack Obama issued the Executive Order “Improving Chemical Facility Safety and Security”. This Executive Order authorises the Administration and supervisory authorities to jointly introduce measures improving the safety of chemical facilities. A first step in this direction was taken in August 2013 with publication of the document “Chemical Advisory: Safe Storage, Handling, and Management of FGAN”. It summarises the best procedures for handling ammonium nitrate (fertiliser-grade ammonium nitrate, FGAN) and lists the lessons learned from previous accidents.

Further examples of blasts involving hazardous substances The same risk is also present in other parts of the world, as an explosion at a firework factory in the Dutch town of Enschede shows. On 13 May 2000, more than 100 tonnes of fireworks detonated there. The disaster killed 23 people, injured more than 950 and damaged over 200 buildings and homes. The Roombek district in which the factory was located was devastated by the shock wave. Even today, it is still not known what caused the fire that triggered the fatal chain reaction on the factory site. Possible causes mentioned in the final report include arson and technical defects. Industrial and commercial operations are not the only sources of danger, as demonstrated by events in Cyprus in July 2011. Military material en route from Iran to Syria confiscated by the Cypriot government for breach of United Nations sanctions had been stored on the Mediterranean island since early 2009. In total, nearly 100 containers of munitions and explosives were stored in the open on a military base. Although the authorities were aware that improper storage, and particularly exposure to heat, could lead to deterioration of the explosive material within the containers, nothing was undertaken by the officials responsible. Construction of a roof over the containers was dismissed as too costly. Fire broke out on 11 July, causing the containers to detonate, killing 13 people and injuring more than 60. Some 150 homes were damaged in the nearby village of Mari and industrial buildings up to three kilometres away were affected to varying degrees. The hardest hit was the island’s largest power plant located directly next to the explosion site which was severely damaged and led to an insured loss of €133m. The total insured loss from the event was estimated at more than €350m. The power plant’s insurers reportedly settled the loss with the power plant operator for €132.5m and exercised their rights of subrogation against the government. After lengthy negotiations insurers agreed to a subrogated settlement of €99m. There are numerous national and international regulations governing the storage and transport of hazardous goods. The model regulations of the “Recommendations on the Transport of Dangerous Goods” issued by the United Nations establish an international basis for provisions governing hazardous goods. The International Maritime Organization (IMO) has prepared binding safety regulations governing the transport and storage of hazardous goods in ocean shipping; these are recognised to a greater or lesser degree, depending on the country concerned. The International Maritime Dangerous Goods Code (IMDG Code) is a central guideline in this context. However, its regulations remain ineffective if they are disregarded and adequate controls are not enforced.


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MAN-MADE LOSSES

Loss-driving factors These cases show that the accidents and their magnitude were attributable to a relatively small number of factors: −−Inadequate risk awareness in the handling and storage of explosive, combustible and environ mentally harmful substances −−Inadequate marking of the type, quantity and location of the hazardous substances in storage and hence possible exceeding of the maximum storage quantities permitted −−Inadequate knowledge of the facility and training of the firefighters −−Insufficient physical separation of dangerous facilities and settlements, no special zones

Business interruption – An underestimated risk As Enschede, West and Tianjin show, high losses can also occur outside the area directly exposed to an explosion. Scenarios similar to that in Tianjin are also conceivable for other port facilities which have grown rapidly and in an unstructured manner over recent years. The risks in “old” ports, such as Los Angeles, are much lower by comparison. The parties responsible there have learned from past accidents and located potentially dangerous sites in less exposed areas. Tianjin could lead to a change of thinking as regards accumulation risks. It is not only natural catastrophes like the floods in Thailand or the 2011 quake in Japan that can give rise to considerable accumulated losses and lead to significant disruptions in supply chains – disasters due to human error can have the same effect. Tianjin should serve as an example, prompting close scrutiny of accumulation risks not only in the case of large port facilities, but also for large warehouses and industrial parks. This applies with regard to the concentration of very different types of freight in a narrowly circumscribed area, as well as in respect of the risks presented by industrial enterprises or infrastructure in the surrounding area.

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What is new is that, in addition to stationary values, attention must increasingly focus on mobile goods and perils. This includes valuable mobile goods, such as cars, and hazardous mobile goods, such as explosives. For underwriting purposes, they must be assessed while in motion. This is a demanding task when considering the accumulation risk, for it entails a change of paradigm from purely static modelling to mobile modelling. Efficient information and tracking systems have been developed in the field of tele matics to assist the insurance industry when assessing the risks. In future, all parties will have to play their part in making major risks and their interdependencies (supply chains) more transparent, so that such critical risks can be assessed more effectively and prices calculated more efficiently by underwriting teams. The largest manufacturing facility operated by a Japanese carmaker in China is located roughly 2 km from the scene of the explosion. Production there was interrupted for around two weeks following the accident. A more violent blast would likely have brought the assembly lines to a standstill for longer, with correspondingly higher losses.

MAN-MADE LOSSES

1 Storage area 2 Xingang 7th Rd

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3 Car depots 4 Donghai Road rail station 5 S11 motorway

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3

6 Residential buildings

4 1 3

5

6

terrabella.google.com

2

3

3

4 1 3

5

6

terrabella.google.com

Aerial view of the Tianjin port area before and after the explosion: the approved minimum distance between the storage area for hazardous substances and the neighbourhood was 1,000 m. At roughly 700 m, the actual distance from the nearest residential area was considerably less.


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MAN-MADE LOSSES Airborne assessment of the loss A completely new approach was pursued in the claims handling for Tianjin, where drones and satellites were used for the first time to ascertain the extent of this man-made catastrophe. Fearing further detonations and possible contamination risks, the authorities had set up an evacuation zone around the scene of the accident covering a radius of three kilometres, which was only gradually reduced. Four days after the explosions, orbital images were produced and compared with images taken only a few days before the disaster. The satellite data captured all affected cars, containers and buildings, offering valuable information about the extent of the damage. Information provided by satellites was complemented by spatial data captured by copter drones with a resolution (depending on the altitude) of just a few centimetres. Combining this spatial knowledge with data mining and web-crawling methods made it possible to establish the link to the individual insureds affected. Data from satellites and drones revealed that the Tianjin explosion crater, measuring 100 metres in diameter, was situated outside the built-up storage areas. This led to the conclusion that the chemicals responsible for the explosion must have been stored in the open. Thanks to increasingly high-resolution imaging and greater amounts of satellite data available, a first swift assessment of the loss from the air will now probably become standard procedure for large losses of all kinds.

OUR EXPERTS Dieter Ackermann is a claims manager in Europe/Latin America at Munich Re. [email protected]

Olaf Köberl is a master mariner and a lawyer, and has ten years’ professional experience as a deck officer on tankers and container vessels. [email protected]

Michael Klug is a senior consultant in Corporate Claims and a key-case manager with global responsibility for crossdivisional management of very large losses. [email protected]

Winrich Krupp is a senior claims manager for property and engineering losses in the MENA and APA markets. [email protected]

Dr. Alfons Maier is a senior loss control consultant in Munich Re’s Corporate Claims Division. [email protected]

Klaus Wenselowski is Head of Property Loss in Claims Management & Consulting for Global Clients/North America. [email protected]

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MAN-MADE LOSSES

Storing hazardous substances at ports – Challenges for loss prevention The disaster in Tianjin raises the question of how hazardous substances should best be managed at port facilities. A number of fundamental conditions must be met in order to prevent losses.

Alfons Maier

Port facilities not only handle ordinary goods, but are also a hub for hazardous substances. The goods delivered by ship are stored temporarily in special warehouses for dangerous goods from which they are then collected for further distribution. This applies to dangerous cargo as well as to pier-to-pier container services (transport of loading units from the terminal in the port of loading to the terminal in the port of unloading). The advantages are obvious. Costs are significantly reduced, as the users of these single points of contact do not require their own warehouses for the hazardous substances, and transport from one storage facility to another is unnecessary. After all, the construction of a warehouse for hazardous substances costs two or three times that of an ordinary warehouse, due to the special requirements imposed for the building. Such considerable investments are only worthwhile if certain dimensions are achieved, but this is normally only the case for specialist cargo handling firms. In addition to storage, they provide a number of other services. These include sampling, fine commissioning, filling and cleaning containers, supply and disposal of packaging materials, and stowage of sea containers. As the following summary shows, special precautions are needed when handling hazardous substances.

Loss prevention through compliance with statutory requirements The challenge when building dangerous goods warehouses in port areas is to connect a whole range of laws and directives on building construction, hazardous substances, water protection, explosives, epidemics, etc. The complexity of these legal standards makes it necessary to involve the authorities in an allembracing, interdisciplinary planning process at an early stage. Both national and international standards must be observed. Different systems are applied worldwide for classifying and marking chemicals. As a result, a substance or mixture of substances may be classed and treated as hazardous in one country but not in another. This causes problems, not only for transport and trade, but also with regard to safety at work. To remedy the situation, a uniform global system for classifying chemicals has been set up under the aegis of the United Nations. The Globally Harmonised System (GHS), as it is known, was first presented in 2003 in the form of a “Purple Book” which is normally updated every two years. Classifi cation according to harmonised criteria means that the same symbols, warnings and safety instructions can be used on labels and in data sheets across the world to draw attention to the dangers associated with chemicals. National regulations must be observed at all times when building and operating port facilities or industrial plants which handle, store or

process hazardous substances. These regulations specify which facilities require mandatory licensing and consequently must meet certain requirements. Explosive, radioactive and infectious substances are often governed by more far-reaching regulations which normally also call for separate storage. Special requirements must also be observed when handling larger quantities of combustible and explosive substances. Strict compliance with the statutory rules and regulations is consequently the most important way of preventing losses. In this context, loss prevention begins outside the port, in maritime traffic: hence the global relevance of Maritime Safety Conventions (IMO– IMDG/ISM/IBC). International safety regulations governing the transport of dangerous sea freight in maritime shipping – acknowledged with more or less binding force, depending on whether they have been adopted on a national level – are prepared by the Maritime Safety Committee (MSC), Marine Environment Protection Committee (MEPC) and Legal Committee (LEG) of the International Maritime Organization (IMO). The central guideline is the International Convention for the Safety of Life at Sea (SOLAS) and the International Maritime Dangerous Goods Code (IMDG), which governs marking and packaging during stacking, storage and handling activities on board ships or in port, as well as the International Management


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MAN-MADE LOSSES

Chinese workers remove containers damaged by explosions in the port of Tianjin.

Code for the Safe Operation of Ships and for Pollution Prevention (ISM), which sets general safety standards for maritime traffic, and the International Code for the Construction and Equipment of Ships Carrying Dangerous Chemicals in Bulk (IBC). Other codes include the International Code for the Construction and Equipment of Ships Carrying Liquefied Gases in Bulk (IGC Code) and the International Code for the Safe Carriage of Packaged Irradiated Nuclear Fuel, Plutonium and HighLevel Radioactive Wastes on Board Ships (INF Code). These codes govern the structural design and requirements for ships carrying dangerous goods. They are part of the SOLAS Convention. The entire system is part of the Global Integrated Shipping Information System (GISIS). Loss prevention through physical separation In order to take account of the specific risk conditions, certain minimum distances must be maintained in relation to residential and industrial areas, public traffic infrastructure and other storage facilities when storing or transporting hazardous substances in large quantities. This must be assured through suitable

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observation and surveillance measures when planning, licensing and subsequently operating such facil ities. Loss prevention through structural measures and plant engineering Dangerous goods warehouses are designed and built according to a simple principle: the warehouse must be sealed in all directions, i.e. in relation to the soil and groundwater, as well as in relation to the atmosphere. The reason for this is that hazardous substances must be prevented from leaking into the environment following an accident and emergency services must be able to reach the scene of the accident safely. In particular, this means that, where possible, the roof, walls, foundations and doors must be resistant to fire and the different hazardous substances must be separated by permanently installed isolating bulkheads. The floor must be sealed in such a way that hazardous substances cannot escape into the ground. Leakages, for instance, are diverted into sumps from which the fluids can be removed by external pumps. Equipment also includes forced ventilation, fixed fire extinguishers, smoke and gas detection systems as well as explosion-proof devices.


Loss prevention through information and tracking systems A transparent logistics chain is essential in order to maintain a constant overview of the type of hazardous substances in any one place and their quantities. With this information, the substances can be stored safely and without dangerous accumulations as well as without exceeding permitted storage levels. In the context of port storage logistics, a distinction is often made between “packaged hazardous goods in dockside facilities for temporary storage during transport”, “transit and direct transshipment of packaged hazardous goods” and “hazardous goods as bulk goods”. The goods’ location and transport are best recorded and managed with the aid of an information and tracking system. When using telematic systems, it is advisable to distinguish between port telematics and forwarding telematics in the port facilities. Port telematics might combine a com munications interface and special application software. The interface (Electronic Data Interchange or EDI system) allows information to be exchanged via a direct link between

MAN-MADE LOSSES the customer, handling firm and port management. In combination with special software systems, it can be used for such industry-specific tasks as customs documentation, port administration, ship data or forwarding management. The most important job of forwarding telematics is to ensure a transparent transport process. Close-range delivery can be planned in good time by providing consignment data in advance. At the same time, the goods can also be located during transport. The entire distribution business is simplified by using suitable wireless data systems, and management of the consignments of hazardous goods becomes more transparent. Loss prevention through increased controls In the majority of cases, public authorities are responsible for monitoring compliance with the relevant regulations governing hazardous substances and particularly their marking. Incorrectly declared cargoes, which could result in dangerous accumulations, or combined storage in warehouses for dangerous goods, can thus be identified in this way. IT-based controls can also be performed using a cargo management screening process. In 2014, Hapag-Lloyd’s watchdog system raised the alarm in 162,000 cases, including 2,620 cargoes which were identified as incorrectly declared hazardous goods. Another possibility is the Cargo Incident Notification System (CINS) set up by container carriers to exchange information on cargo-related accidents. CINS findings that 25% of the accidents are attributable to incorrect declarations underscore the need for stringent controls.

Conclusion There is an urgent need for port storage facilities specialising in hazardous substances to keep up with the rapid growth in global trade. Given their large capacities and the range of potentially hazardous substances they contain, such warehouses are governed by special safety regulations, particularly as regards the distances to be maintained and the loss prevention measures required in respect of both structural and plant engineering measures. Provided that such measures are enforced, they can prevent losses and limit the magnitude of a loss. Information and tracking systems help to make movements of hazardous substances in port areas more transparent and permit identification of dangerous levels or cases of combined storage. In addition, such systems also make it possible to check and verify compliance with the required marking and approved storage quantities. In an emergency, it is essential to have fast access to data on all relevant hazardous substances (for instance in material safety data sheets) to ensure that emergency services have all the information they need regarding the substances’ location, type and quantity, as well as on the safety precautions taken to protect people and the environment. Suitable emergency and business continuity plans permitting a swift resumption of operations are just as important as compliance with the regulations on dangerous goods. The decisive factor is to develop scenarios which also take account of exposure to multiple risks, such as fire/ explosion, natural hazards, terrorist attacks and cyber risks.

OUR EXPERT Dr. Alfons Maier is a senior loss control consultant in Munich Re’s Corporate Claims Division. [email protected]


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MAN-MADE LOSSES

Modelling marine risks International trading hubs have become centres of high value concentration, with the larger ports handling goods worth several billion euros every day. The catastrophe at Tianjin highlighted the insurance industry’s difficulty in reliably quantifying the loss potential of such facilities.

Christoph Masius

This is not a new issue. Past major events have frequently caused considerable losses for marine insurers. In 2008, a hailstorm struck the port of Emden, a leading export hub of the German auto motive industry. A rare event in meteorological terms, the storm not only caused significant damage to vehicles parked on the dockside, but also inflicted considerable losses on a number of cargo insurers.

View of the storage area for Volkswagen cars in Emden, Germany.

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Four years later, the US eastern seaboard was hit by Hurricane Sandy, its storm surge flooding port facilities in New York and New Jersey. The magnitude of the losses took insurers by surprise and underscored the need for better control over liability accumulations.

MAN-MADE LOSSES What is it that makes accumulation control so difficult in marine insurance? And why are insurers still so far from the quality standards achieved in property insurance and its ability to model extreme loss scenarios? The problems are partly of the insurers’ own making, but they are also due to the specifics of marine insurance and the many special risks it covers. The methods used to control accumulation are constantly being further developed. Falling hardware prices and higher computing power have led to the development of complex probabilistic catastrophe models capable of simulating the losses from tens of thousands of potential events. The models combine liability distribution and insurance terms with para meters specific to the event, such as wind speed or the intensity of an earthquake. Like the models and their technical capabilities, the quality and granularity of exposure data have also matured. Many property insurers today are not only able to assess their portfolios at individual address level, they also store a wealth of other data in their systems on the individual risks. Aided by this mass of data, the models assign individual locations to the simulated scenarios and translate risk-relevant attributes such as occupancy type or year of construction into vulnerability functions. The modelling takes account of a portfolio’s features with increasing specificity as localisation becomes more precise and the database more complete.

In addition to the lack of information on liability, the models themselves can only meet the specific requirements of marine insurance to a limited extent, as they were traditionally developed for property insurance. The vulnerability of marine risks is more varied and, for a long time, the available loss data were too few and their granularity too poor to permit adequate validation of the results obtained by modelling. The industry only recognised the need to improve accumulation control tools following the enormous losses caused by Sandy. In cooperation with Munich Re and other selected insurers and brokers, the model provider Risk Management Solutions (RMS) has developed an initial module for specifically modelling marine risks to be launched in 2016. This establishes the technical functionality for more accurate simulation of loss scenarios. It remains to be seen whether the quality of the exposure data successively improves as a result.

Marine insurance has a fundamental problem in this context: localising the insured risks is often impos sible or involves major uncertainty, as they are constantly moving. Although they often follow routes laid down by logistics, the insurer cannot know where an insured object is located at any given time; in other words, its location cannot be established precisely for an individual risk. This applies in particular to ports where goods are regularly transshipped without delay. While this lack of transparency makes loss appraisal following an event much more difficult, it becomes almost impossible to model loss potentials on the basis of detailed exposure.

OUR EXPERT Christoph Masius has seven years’ experience in accumulation risk management. [email protected]


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MARINE

The high price of brand protection In their standard form, the marine cargo policies used in international freight transport only cover property damage. While brand protection clauses offer extended cover, loss potential for insurers has increased as some of these clauses considerably restrict insurers’ rights when settling claims.

Corinna Göke

Brand protection clauses (BPC) are found above all in automotive policies, protecting policyholders against the risk that actual or assumed property damage could tarnish the brand name. There have been several disasters involving car carriers in recent years, although natural catastrophes have also played a part. The explosion at the port of Tianjin is a particularly noteworthy case. The explosion affected some 68,000 vehicles of different makes which were stored in the port area. Some were covered by property policies, others by marine cargo policies. It has not yet been decided what will happen to these vehicles. We can assume that the majority of marine cargo policies include brand protection clauses allowing the manufacturers to declare seemingly undamaged vehicles as a total loss on account of suspected chemical contamination, for example. This is because manufacturers baulk at the risk of bad publicity and subsequent liability claims. This was also the case with the Cougar Ace, which capsized in the Bering Sea in 2006 with over 4,000 vehicles on board and continued to list severely for more than two weeks. Unable to gauge the repercussions of this disaster and fearing possible liability claims, the manufacturer decided to write off the vehicles as a total loss even if they showed no outward signs of damage. This is because in order to protect consumers, product liability legislation makes it at times impossible to exclude liability claims. Mainly cars and other luxury goods affected Normally, the costs of such a declaration must be borne by the manufacturers themselves if a brand protection clause has not been agreed. The German Freight Forwarders’ Standard Terms and Conditions, the DTV Cargo Insurance Conditions and the Institute Cargo Clauses (ICC) all agree on this point. Only physical damage is covered, and not the damage to a brand name caused by an actual or assumed property loss. BPCs protect manufacturers of pharmaceutical products, timepieces, cars, electronic devices and general luxury goods from possible reputational losses. Control of damaged goods clauses additionally cover the manufacturer against liability claims

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Brand protection clauses protect manufacturers of luxury goods from possible reputational losses.

and prevent damaged goods from making their way onto the market. The value of a brand can suffer if high-end luxury goods are sold at a fraction of the original price or if defective brand products enter circulation. One conceivable scenario would be that new mobile phones suffer water damage during transportation by sea. A loss adjuster brought in to assess the damage concludes that the mobile phones can be repaired and marketed with a markdown and arranges for them to be sold through a wholesale dealer in order to realise the salvage proceeds. However, over the course of time the phones’ status as damaged goods “fades

MARINE

from view” and consumers never find out that the devices have sustained water damage and have been repaired. Naturally, the phones begin to malfunction after some time. Reports of quality defects circulate and damage the brand’s reputation, causing the manufacturer’s sales to plummet.

A different situation applied in 2012 when Hurricane Sandy flooded a storage area near the port of Newark in the US, damaging around 14,000 vehicles. Most of the vehicles were scrapped in a move that was no doubt partly prompted by the desire to pre-empt liability claims.

Had a BPC been concluded, the manufacturer could have insisted on the removal of its logo from the devices and could have established whether this was a case of a total loss, either acting alone or basing its conclusion on an expert’s evaluation or possibly even without consulting the insurer, depending on the wording of the clause. If a control of damaged goods clause had been agreed, then it would also have been able to decide whether the phones should be placed on the market at all. An agreement can also be made to the effect that the insurer will cover the costs of scrapping/disposing of the goods affected. Depending on the type of goods concerned, such costs can be substantial.

As already mentioned, there are various forms of brand protection and control of damaged goods clauses. With comprehensive cover, the question of whether goods have actually been damaged is completely immaterial. The mere assumption of damage is sufficient, for instance if a ship was listing for several days. The policyholder can decide whether the goods may be salvaged in order to minimise the loss, acting completely independently and without consulting an expert. In individual cases, this can be a sensible option for highly specialised products that could only be inspected by rival companies with the requisite expert knowledge. On the other hand, such clauses can also result in policyholders being given “carte blanche” with regard to loss adjustment.

The clause must be viewed critically, scrutinised and priced by the insurer, as the insurer’s rights can be restricted to different degrees, depending on the wording of the clause. Risks in storage areas Natural catastrophes can also cause problems where brand protection clauses are involved. In 2008, a hailstorm in Emden, Germany, damaged some 35,000 vehicles on the factory grounds and storage areas of a major German car manufacturer, triggering the BPC included in the insurance policy. Extensive remedial measures were undertaken to minimise the loss, such as the dents being removed from vehicle bodies. In this way, the vehicles were restored to mint condition, even though the agreed brand protection clause meant that the policyholder was not obliged to minimise the loss. Such a procedure may also depend on the prevailing economic circumstances.

In diluted forms, the policyholder must consult an expert to assess the condition of the goods. It can then decide on the goods’ further use, sometimes in consultation with the insurer. Should the goods be salvaged in any form whatsoever, the insurer is entitled to the salvage proceeds. The salvage and further utilisation of damaged goods can, however, be fraught with problems in cases where no BPC has been agreed. Although the insured has an obligation to minimise losses, a fear of liability claims might make a carmaker much less likely to supply spare parts for vehicles which have been involved in a loss.


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MARINE The vehicle serial numbers, which must be quoted when ordering spare parts, would identify the vehicles concerned. This would make further utilisation of the vehicles virtually impossible. In order to prevent dispute about who should ultimately bear the costs of the resulting (total) loss, the obligation to minimise losses and the procedures for further utilisation of damaged vehicles definitely need to clarified prior to conclusion of the contract. Conclusion Insurers’ loss potential resulting from brand protection clauses has risen due to the growing sizes of ships and storage areas, the increasing value of the goods carried, the sometimes sensitive technology involved, and the rising volume of goods being transported. The clauses do not always adhere to the principle that the injured party must prove the amount of loss and that a loss has occurred at all, often to the detriment of the insurer. As a result, the insurer now has little influence over the size of a claim and pos sible loss mitigation measures.

salvage proceeds. This much greater risk of a total loss must be taken into account by insurers and reinsurers in risk assessment, premium pricing and loss accumulation cover. The events at Tianjin have demonstrated the importance of premiums commensurate with the risk prevailing in the market. In the case of comprehensive brand protection clauses, it is therefore particularly important that the clause be handled responsibly by the policyholder. Variations of the clauses which completely reverse the burden of proof for the occurrence of a loss and its magnitude to the detriment of the insurer and place the question of utilisation entirely in the hands of the policyholder should be avoided or amended. At the very least, the parties should jointly decide in consultation with a loss adjuster whether the loss can be minimised without diminishing the reputation of the brand.

If a control of damaged goods clause has been agreed, a total loss is a great deal more likely, as the policyholder can decide for itself whether the damaged goods may be salvaged and utilised further. In other words, the policyholder can determine at its own discretion whether a product involved in a loss may be marketed so that the insurer can realise the

OUR EXPERT Corinna Göke is a lawyer and qualified forwarding agent. She works for Munich Re as a senior legal counsel in Marine Claims. [email protected]

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23

MAN-MADE DISASTERS

Natural catastrophe or man-made disaster? Not all natural catastrophes are the work of fate – some are man-made. However, the distinction is not always straightforward, particularly in the case of floods, landslides or wildfires.

Wolfgang Kron

Landslide at the Vajont Dam

Natural catastrophes can cause immense economic and human losses. Floods, storms, earthquakes, droughts, forest fires and volcanic eruptions are among the most devastating types of natural catastrophe. But some disasters are man-made. These include explosions, major fires, aviation, shipping and railway accidents, and the release of toxic substances into the environment. However, the distinction between natural and man-made catastrophes is not always as clear cut as you might think. Some events are wrongly assumed to be natural catastrophes, as the following examples show.

On 9 October 1963 in the Italian Alps, 270 million cubic metres of rock and earth collapsed from the side of Monte Toc into the reservoir below, triggering a 150 metre tsunami which overtopped the dam. 25 million cubic metres of water rushed through the narrow canyon towards the village of Longarone at the bottom. This village and four others were almost completely destroyed and nearly 2,000 people were killed. The 262 m high concrete dam withstood the wave and still stands today virtually unscathed. Construction of the dam had been completed in 1960. During the filling process in 1962, the adjacent hillside began to move. Filling was immediately halted and the water level lowered. This seemed to work and the mountainside stopped moving. In April 1963, the filling of the basin was resumed – until the side of the mountain suddenly collapsed. Normally, a landslide into a lake and the resultant tsunami are entirely natural processes. However, the Vajont disaster was clearly a result of the filling of the basin destabilising the mountainside. Without the dam, the mountain would not have started to slide and even if it had, there would have been no flood wave.

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Dam breach in Tesero

Forest fires in Indonesia

Landslide in Shenzhen

Two mine-tailing basins were located near Tesero in the Trento region of Italy. The 34 m high dam of the upper basin collapsed on 19 July 1985. A torrent of debris and mud poured into the lower basin, causing its dam to fail as well. A 200,000 cubic metre mudflow rushed through the Stava valley at high speed, burying 268 people.

In 2015, devastating forest fires raged across parts of Indonesia. Weather conditions there and in large parts of the world were heavily influenced by the climate phenom enon known as El Niño. Conditions were especially dry in the western Pacific region. In Indonesia, fires ravaged forests and bushland over tens of thousands of square kilometres. A dense mantle of haze covered large parts of Southeast Asia, in some cases for months on end. The consequences were dire: people had serious health problems, airports and schools had to be closed and public life suffered in general. Economic losses amounted to billions. Property losses alone are likely to exceed a billion US dollars.

On 20 December 2015, a massive landslide in southern China destroyed 14 factory buildings and more than a dozen office and residential buildings. Sludge and debris some six metres deep buried parts of the Hengtai industrial area on the edge of the Shenzhen Special Economic Zone. Around 70 people were killed.

Some databases list the event as a flood disaster. Yet the disaster was not due to extreme precipitation. The dam had been constructed to very low safety standards and was known to constitute a high risk. The collapse is believed to have been caused by a poorly installed drainage pipe.

Yet it would be too simple to attribute this catastrophe exclusively to the El Niño phenomenon. The fires were started deliberately – to clear the forest. Due to the extremely dry conditions, however, the actual area burned was many times larger than originally intended. The catastrophe was therefore caused by a combination of man and nature.

According to the authorities, an artificial dump of excavated soil and rubble had been brought down by heavy rains. The debris had evidently been piled up too high and too steeply and over the years had grown to a height of over 100 metres without the authorities taking any action. Even if heavy rains ultimately triggered the disaster, it was clearly a man-made incident.


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COMPLIANCE

The science of sanctions compliance Embargoes and sanctions restrict freedom in foreign trade. Insurance companies must ensure they comply with sanctions regulations not only on the underwriting side but also in claims settlement. IT-based solutions provide a sound basis but are no substitute for a detailed review of each individual case.

Urs Alexander Mayer Not only the United Nations, but also the European Union and individual countries can impose trade restrictions on goods and services, as well as international capital transactions and payments. Sanctions imposed by the EU automatically apply in all member states. The Deutsche Bundesbank lists 25 countries (as at April 2016) against which the EU has imposed sanctions on capital transactions and payments. In addition to the restrictions which apply to individual countries, it also lists restrictive anti-terrorism measures (so-called personal sanctions not related to a specific country) targeting individuals, institutions or organisations. Depending on their objective, sanctions can have manifold consequences. They can range from the total cessation of trade relations to restrictions for certain branches of industry (such as offshore ex ploration and oil drilling in regions north of the Arctic Circle). As a rule, the aim of financial sanctions is to prevent money and other economic resources from being directly or indirectly made available to listed individ uals or organisations. Sanctions lists provide an overview The insurance industry must apply internal pro cedures and guidelines to ensure compliance with the applicable regulations imposed by sanctions and embargo rulings. Non-compliance entails a high reputational risk, as it can give rise to substantial monetary fines or even prison sentences and may result in the loss of market access in certain regions.

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Sanctions lists provide an overview of the individual parties affected by restrictions. These official lists identify the individuals, groups, organisations or assets against which or whom economic and/or legal restrictions have been imposed. Here we have the first challenge, for the consolidated list of EU sanctions contains several hundred entries, including several with different spelling. Another problem is that the UN, the EU and the US refer to different sanctions lists and directives which are not always congruent. Moreover, the lists do not directly specify whether they refer to individual assets or branches of industry; this is something which must be established from the respective directives. Which sanctions apply depends on a company’s corporate structures: the decisive regulations are those which apply in the country where an insurance company, for example, has its head office. However, they also affect the foreign branches and subsidiaries of major corporations, for these are part of the legal entity under company law and are therefore bound by the imposed sanctions. On the other hand, while independent foreign subsidiaries are excluded from the imposed sanctions in purely legal terms, they are still governed by the regulations of the country in which they are located. In their case too, however, the type of business can provide an indication as to whether or not sanctions apply. Attention must also be paid to the possibility of such criminal acts as evasion or aiding and abetting. Employees abroad must additionally ensure that they comply with the requirements specified for their respective nationalities. A German employee working in Singapore, for instance, must comply not only with the sanctions in force there, but also with the requirements specified by the EU.

COMPLIANCE

Consequences for the insurance industry For a long time, insurers and reinsurers were not explicitly mentioned in the directives imposing sanctions. This situation changed in 2009, with the result that the insurance industry is now under a much greater obligation. The existence of potential touchpoints with sanctions regulations must now be checked at the underwriting stage (Fig. 1). As the marine insurance example in Fig. 2 shows, this check can prove fairly complex due to the large number of parties involved. The regulations governing the primary insurance client are another important factor in reinsurance. If both insurers are governed by European law, it may normally be assumed that the client will act in conformity with the sanctions, as it operates in the same legal environment. Despite this, however, the reinsurer should ensure through its own due diligence processes that the client is aware of the reinsurer’s approach to sanctions. Further due diligence processes and above all more in-depth checks are needed if the primary insurer is located outside the EU. Appropriate exclusion clauses must be agreed if there are any doubts concerning compliance with the imposed sanctions. The business must not be written if this is not possible.

Additional diligence must be exercised if claims payments are to be made at a later date within the framework of the insurance contract. For the insurer’s claims management, this means that due diligence checks are obligatory during claims handling and above all immediately prior to settlement of the claims. This is because the sanctions regime may have changed considerably in the meantime. The currency of the insurance contract may also play a part here. Since all payments in dollars pass through a US clearing house, US sanctions law must also be observed. The same also applies in cases in which payments are remitted in a different currency but are handled by a US bank. Challenges for operative business The following fictitious example illustrates the challenges that may arise in day-to-day business. In 2013 a Russian cedant requests cover for a project in its country. The cedant has more than 30 original insured parties and is promised cover following a review by

Fig. 1: Decision tree for underwriting

Yes

Iran, Syria, North Korea?

Yes

PH/Insured person domiciled in an embargoed country?

No

No

Source: Group Compliance, Munich Re Yes

Check against EU embargo list

Not listed

The diagram illustrates the procedure when checking a business deal with regard to sanctions. The actual process is even more complex in practice.

Geographical scope includes sanctioned countries?

Sanctions clause No

Listed

Contact Group Compliance or MH CU for further guidance

Treaty/Policy must not be written

OK


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COMPLIANCE Fig. 2: Points to check in marine insurance

Charterer

Cargo

Ship name

Shipping company

Business partner’s shareholders

Insurance broker

Shipbroker

Beneficiaries

Cedant (incl. address)

Countries

Flag

Payer

Currency

Policyholder (incl. address)

the European reinsurer. Since there were no sanctions on Russia in force at the time, a review by the underwriting team was not required. The situation changed when the EU imposed sanctions against Russia in March 2014. When the project suffered a loss in 2015, the reinsurer had to take account of the changed situation. For a complete review within the framework of due diligence, it is not sufficient to limit the investigation under sanctions law to the cedant alone, although it is the only other party in the contractual relationship. On the contrary, the reinsurer is obliged to vet all possible beneficiaries (insofar as they are known) who might profit from a payment by the cedant in order to ascertain whether any relevant sanctions are in force. This applies in particular because the cedant is domiciled outside the EU and is therefore not bound by EU regulations. The cedant is consequently free to remit payments to individuals or organisations against whom or which the EU has imposed sanctions. Companies and individuals inside the EU, on the other hand, may neither directly nor indirectly make economic resources available to sanctioned individuals or companies.

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Source: Group Compliance, Munich Re

Origin

Destination

The underwriting team must first establish whether regulations have to be observed and, if so, which. These are then interpreted in the context of the business written and the risks covered. Since sanctions are increasingly imposed as a means of enforcing political goals, this topic will become more and more important for insurance companies.


Bank

Where possible, shareholder structures must also be considered when investigating whether or not a company is subject to EU sanctions. For instance, one or more shareholders may be named in the sanctions list, but not the company itself. If the shareholding exceeds a threshold of 50%, the company must be treated as though it was also the subject of a sanctions regime. Indemnities actually accruing to the company as a result of the loss must not be disbursed. This can be achieved by commensurately reducing payments to the cedant or alternatively by agreeing on a settlement with the cedant ensuring that the sanctioned company does not receive any payments. Screening with special software Special screening tools are useful when analysing complex shareholder structures. With these tools, scheduled payment transactions and customer data can be checked for violations of embargo regulations and financial sanctions. The market offers innumer able software products which allow a company’s own data to be compared with those on the sanctions lists. Execution of a payment order must be stopped if the screening tool reveals that a sanctioned individual or organisation could benefit from the payment.

COMPLIANCE Individual checks are often required additionally, as sanctions lists do not contain all details relating to sanctions (such as relevant shareholdings) and the automated comparison may deliver erroneous results. Munich Re has set up the “Central Unit Sanctions” for this purpose. The unit is part of Group Compliance and is staffed by specialists who have considerable experience in analysing sanctions clauses and in operative business. The Central Unit Sanctions investigates whether a payment order does indeed violate sanctions regulations. Another conceivable case, in addition to the aforementioned analysis of shareholder structures, would be one in which the beneficiary of the payment is not the same as the sanctioned individual – in other words, both have the same name, but a different address or date of birth. The Central Unit Sanctions is also responsible for documenting every decision for auditing purposes.

Conclusion Companies will find it more and more difficult to comply with sanctions clauses, not least because such programmes are becoming increasingly prevalent and comprehensive. In addition, the regulations governing individuals, goods and services are constantly being supplemented and updated, which makes it even more difficult to keep track of requirements. Insurers must keep an eye on developments, initiate suitable compliance measures and scrutinise the legal situation in individual cases. This will help them to avoid violations which could have consider able consequences. It is no longer enough to simply review the sanctions lists with the aid of IT-based screening tools. Specialists are needed to establish such aspects as the precise shareholding structures or the exposure of covers, and to carefully analyse the sanctions clauses. The only possibility for small and medium-sized insurance companies is to call in an external service provider if they cannot manage the task themselves. In all cases, however, responsibility for correct compliance with the regulations remains with the company itself.

OUR EXPERT Urs Alexander Mayer is a com pliance officer at Munich Re and advises the company on all matters related to sanctions. He has 15 years’ experience as a lawyer in insurance and reinsurance. umayer @munichre.com


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CASUALTY

Digital healthcare products and liability Intelligent new technologies in the field of medical devices are being developed at a phenomenal pace. Many medical device manufacturers, software firms and pharmaceutical companies are working on new products that are increasingly based on digital integration and mobile applications.

Matthias M. Schweiger

The development in the field of healthcare products is fuelled not only by a receptive market and the considerable potential for new technical solutions, but also by public projects. For example, the British government has stipulated that 95% of National Health Service patients treated by general practitioners must have access to e-consultation and other digital products by 2020; it is also the government’s intention that by then 95% of tests can be digitally exchanged between healthcare providers. Since October 2015, the US Food and Drug Administration has undertaken a public consultation regarding the use of smartphones, tablets and wearables to recruit people for and conduct clinical studies. Different stages of development The possible applications are currently at different stages of development. Digital healthcare products will become increasingly complex and effective. Products with higher risk classes need more time before they can be launched. In many cases, questions concerning clinical trials and validation of the products have not yet been definitively answered. The “app on prescription” already exists. Caterna is one example worth mentioning in this context: several public health insurance providers in Germany already cover the costs of this online vision training for patients with poor functional eyesight (amblyopia). Many other products are still under development or in clinical trials.

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Smart watches allow patients to access digital healthcare products.

Many questions do not need to be clarified just yet The legal questions reflect the product cycle. Court rulings are to be found in the context of patents and intellectual property. Wearables are known to have been recalled in the non-medical sector. In several lawsuits, the US Federal Trade Commission has imposed fines against providers of health apps on the grounds of deceptive advertising. A product’s legal classification is an important issue for many providers. In the case of wearables and apps, the distinction is not always clear. Whether or not a medical device is involved is an important matter in connection with the regulatory requirements for market access, product safety and recalls, as well as liability. Various institutions have issued guidelines on the classification of apps as medical devices, such as the German Federal Institute for Drugs and Medical Devices or the British Medcines and Healthcare Products Regulatory Agency.

CASUALTY

The European Commission is also working on new recommendations At present, attention is primarily focused on regulatory principles governing development and market access. In light of more frequent use and longer periods of use, it is already clear that safety measures and recalls, product compliance and duties in respect of instruction and product observation will become increasingly important in future. Challenges posed by digital products Technical advances, ever larger dimensions and networking with consumer devices or “more open” networks give rise to new questions in the context of product liability. At first glance, the questions raised under product liability law are the same as those in the past. What’s more, not all applications are really new: telemetry, telemedicine and the integration of medical devices in networks have existed for many years. The digital dimension raises additional questions. The growing use of digital applications has changed product risk profiles. To a certain extent, being networked with consumer devices not only makes the products dependent on consumer behaviour, but also and above all on the software and hardware supplied by third parties. Safety updates, compatibility and network availability are just a few of the challenges to be addressed. In many cases, the software and the vulnerability of systems also depend on user behaviour.

Conclusion It remains to be seen which new aspects need to be clarified in the context of product liability law. The small number of court rulings do not yet provide any indications. Further decisions will follow as new products are introduced. Software and consumer products not destined for use in the medical sector often have a risk profile and error tolerance different to those of medical devices. Cyber security is also a major challenge for healthcare products – particularly when consumer devices and open networks are used. Preventive risk identification and assessment help to address the new issues in this field.

Cyber crime is another problem which must be taken seriously. Hospitals and medical devices are targets for hackers. Attackers exploit the considerable potential for extortion here, due to the associated danger to patients’ health. Data security may become an issue under liability law, as bodily injury cannot be ruled out. Damages may also be claimed for violations of privacy, for instance if health data are stolen and published. Collecting data may also influence the standard of care expected of those involved. Not only can more data be collected more quickly, they are also constantly avail able and can be analysed. The owner of the data may be aware – or due to (gross) negligence unaware – of circumstances imposing duties of care. One question that arises particularly in the medical sector concerns the extent to which available data need to be analysed, for instance in the case of real-time data from clinical observation. Moreover, such data are often only avail able in anonymised form.

OUR EXPERT Dr. Matthias M. Schweiger is a lawyer at Hogan Lovells in Munich. matthias.schweiger@ hoganlovells.com


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LIABILITY

D&O liability exposures: Developments in the US and globally The liability arena for corporate directors and officers has long been characterised by a dynamic claims environment. In the past, the highest-profile developments in this arena have taken place primarily in the United States, due to long-standing patterns of litigiousness there. However, in the last few years changes in applicable laws and in the regulatory environment, as well as a series of high-profile scandals, have increased the significance of D&O insurance across the world.

Kevin M. LaCroix

The most significant D&O liability severity risk for US-listed publicly traded companies is the possibility of a class action lawsuit under the US securities laws. According to NERA Economic Consulting, the average and median US securities class action lawsuit settlement in 2015 was US$ 52m and US$ 7.3m respectively, with defence costs representing millions more. For that reason, US securities class action lawsuit filing trends represent an important indicator of aggregate D&O claims frequency and severity and are very closely watched in the domestic US D&O insurance industry. Several of the 2015 securities litigation filing trends may be of particular concern to insurers. Specifically, the number of securities class action lawsuit filings during 2015 (189), while consistent with the annual average during the period 1996–2014 of 188, represented the highest annual number of securities class action lawsuit filings since the financial crisis year of 2008. These filing figures take on an even greater significance when considered relative to the number of US-listed companies, which has been steadily declining since the early 1990s (although there has been a slight upward increase in recent years owing to increased IPO activity). Overall, there are nearly 40% fewer US-listed companies than there were in 1996. The upshot of all of this is that the likelihood of any US-listed company getting hit with a securities class action lawsuit – which during 2015 stood at approximately 4% – is at its highest level in years. By way of comparison, the annual average securities litigation frequency for US-listed companies during the period 1996–2014 was 2.9%. As Cornerstone Research said in its annual report about US securities class action activity, “In 2015, companies listed on US exchanges were more likely to be the target of a class action than at any time during the period 1996–2014.”

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Reasons for the increase in securities class actions There are a number of factors driving this increased US securities class action litigation frequency. For example, heightened levels of IPO activity on the US securities exchanges have led to an increase in IPO-related litigation. In addition, a greater frequency of securities litigation involving life sciences companies also contributed to the overall increase. Another factor in 2015 were the elevated levels of US securities litigation activity involving companies domiciled or based outside the US with listings on US exchanges. For many years, about 16% of all US-listed companies were domiciled or based outside the US. Historically, these non-US companies have experienced US securities litigation less frequently than US-based com panies. During the period 1996 to 2014, securities litigation involving non-US companies represented only about 11% of all US securities litigation filings.

LIABILITY

However, in recent years, and despite the longer-term historical trends, the non-US companies have been more likely than US-domiciled companies to be involved in US securities litigation. Thus, in 2015, though non-US companies represented slightly less than 17% of all US-listed companies, securities lawsuits involving non-US companies represented nearly 19% of all US-securities class action lawsuits. Indeed, even though the annual likelihood of any US-listed company being hit with a securities lawsuit (4%) was at its highest level for years in 2015, the likelihood of a non-US company being hit with a securities lawsuit was at an even higher level (4.1%). This greater likelihood of US securities litigation activity for non-US companies might be interpreted to suggest that all non-US companies represent a greater securities class action litigation risk than would comparable US-based companies, and that D&O insurance for non-US companies should be rated and priced accordingly. However, the data need to be scrutinised a little more closely before the correct underwriting conclusions may be drawn. The most important additional element to be considered is the fact that of the 35 securities class action lawsuit filings involving non-US companies during 2015, 15 of them involved US-listed Chinese companies. The elevated securities litigation frequency for non-US companies during 2015, and indeed for the past several years, has largely been a factor of heightened levels of securities activity involving Chinese companies. Once the impact of the Chinese-related litigation activity is factored out, the US securities litigation activity involving non-US companies looks much more consistent with the proportion of non-US companies listed on the US exchanges.

Significant developments outside the US While securities class actions continue to be more frequent and more costly in the US than elsewhere, there are indications that such lawsuits are gaining ground outside the US as well. As a result of changes in the applicable laws, a number of countries have seen increased levels of securities litigation activity. In addition, the increased levels of regulatory scrutiny both during and after the global financial crisis have bolstered these trends, as has the increased availability of litigation funding. The significance of these trends has been heightened by the emergence of a number of high-profile scandals that have motivated many investors and their representatives to seek collective redress for investment losses. Securities class action activity is now a wellestablished part of the litigation environment in Canada and Australia. More recently, a combination of changes in the legal environment and revelation of alleged corporate misconduct has led to a number of litigation initiatives in a variety of different countries, including the UK, Brazil and Germany. Dutch collective settlements All of these developments will be interesting to watch, but of all the recent developments perhaps the most significant and most interesting is the recently announced settlement of the Fortis investor proceedings under the Dutch collective settlement pro cedures (WCAM). On 14 March 2016, Ageas, as Fortis is now known, announced that it had reached a €1.2bn settlement with a number of shareholder foundations in proceedings based on the events surrounding Fortis’s participation in the acquisition of ABN AMRO in 2007. The settlement is subject to approval by the Amsterdam Court of Appeals.


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LIABILITY If approved, the Fortis settlement would represent by far the largest settlement ever under the Dutch collective settlement procedures. The settlement could also boost several other pending initiatives in which organisations representing other shareholder groups are seeking to use the Dutch procedures in connection with the current scandals. Of course, there would be a host of issues that would have to be sorted out before the Dutch procedures could be used to resolve any of these other procedures. But there is no doubt that with the Fortis settlement, the Dutch procedures arguably have emerged as a possible preferred way to secure resolution of initiatives for collective investor relief. Indeed, because a judgment of the Dutch courts in support of settlement would presumptively be enforceable throughout the EU, and because of the opt-out basis on which the Dutch settlement procedures are built, the Dutch procedures could prove to be of interest to the corporate defendants as well as to prospective claimants.

Conclusion Recent developments and claims filing trends mean that D&O insurance underwriters face a complex and challenging environment. Heightened claims activity, particularly with respect to collective investor redress actions, represents both a frequency and severity risk for D&O insurers. In the past, US securities class action litigation represented the most significant D&O exposure. However, developments in a number of jurisdictions suggest that this type of exposure is now more widespread.

Whether or not the Dutch collective settlement procedures emerge as a preferred mechanism to resolve collective investor claims, there is no doubt that activity on behalf of investors will continue to emerge, to the point that the risk of collective investor litigation arguably is no longer exposure-concentrated in the US, Canada and Australia. The initiatives on behalf of investors in other jurisdictions, and in particular the emergence of the Dutch collective settlement procedures as a possible preferred mechanism for collective investor redress, arguably present the D&O insurance community with an altered risk underwriting atmosphere. Along those lines, it should not be overlooked that at least €290m of the €1.2bn Fortis settlement will be funded by Fortis’s D&O insurers.

OUR EXPERT Kevin M. LaCroix is an attorney and Executive Vice President at RT ProExec, a division of R-T Specialty, LLC. RT ProExec is an insurance intermediary focused exclusively on management liability issues. [email protected]

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How good is your claims management ?

Changing weather risks are having a major impact on the insurance industry. Insurers today need to find ways to manage major losses and expedite recovery. Two new publications from our Knowledge Series can help you find the answers to these questions. In “Claims management following natural catastrophes” we examine the major weather-related natural catastrophes of recent years and present conclusions that help insurers to optimise their contingency planning and claims management. “Severe weather in Eastern Asia” presents an in-depth analysis of the changed exposure situation in East and Southeast Asia. These two publications are available in English as a download from our client portal connect.munichre.com or from your Client Manager. For further information, please contact your Client Manager. NOT IF, BUT HOW


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PROPERTY

Challenges in the downstream energy sector Numerous accidents have occurred in recent years at refineries and other petrochemical facilities, leading to extensive property damage and costly business interruptions. To ensure optimum claims management, a number of different aspects and special characteristics of this industry must be given careful consideration.

The time needed to repair damaged facilities also plays a role in claims management.

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PROPERTY

Matthias Meyer and Robert Schmid

For many insureds, a loss event in excess of US$ 100m is an entirely new experience. Losses of this magnitude can lead to the insured underestimating the time and effort that must be dedicated to the claims process. The insured will be reliant on the support of insurers, brokers and loss adjusters to fully understand the claims process and what information needs to be provided for a swift adjustment. An active dialogue between insurer and insured regarding each stage of the claims process is key. Ideally, an understanding of the claims process should be established before any loss event takes place. Differing asset valuation As soon as a loss has occurred, the question arises as to its magnitude. Retrospectively determining the precise value of the damaged assets can be challenging, especially as a number of different parties are involved. Substantial differences in valuations frequently lead to delays in loss adjustment. Ideally, the insured will have provided pretty accurate asset valuation figures to the insurer prior to the conclusion of the insurance contract. Unfortunately, when a loss occurs it sometimes transpires that this information was not given in sufficient detail or accuracy. After a loss, insurers generally appoint adjusters, who in turn may seek assistance from firms specialising in estimating the value of the damaged property. Once experts have determined exactly what has been damaged, they need to evaluate how much it will cost to repair or replace the affected property, taking into account local labour and production costs. To avoid unwelcome surprises, such as the application of average, sufficient consideration needs to be given to the realistic valuation of insured assets prior to conclusion of the insurance contract. Naturally, this is equally important for the business interruption part of the policy. Cost and schedule of rebuild For insurance policies that provide coverage for business interruption in addition to the property damage, it is important to determine how long the repair or rebuild of the damaged property should take. This time estimate can be used to judge whether the insured has carried out repairs as quickly as economically reasonable. In some cases, the insured is entitled to indemnification regardless of whether the insured property is repaired or replaced. In such cases, it is essential to create a hypothetical rebuild schedule that realistically reflects the time it would have taken the insured to repair or replace the damaged property.

It is important that insurer and insured reach agreement over the length of the hypothetical rebuild schedule, as this has a direct impact on the business interruption calculation. Once both parties have agreed on the scope of damage, cost and schedule of the rebuild, a number of potentially contentious issues will have been resolved. Exchange rate effects The policies of refineries are often denominated in US dollars. When a loss occurs outside the US, frequently a substantial proportion of the required materials and labour will be sourced locally, and the costs incurred in the local currency. If it is subject to strong fluctuations in relation to the US dollar, this can have a significant impact on the indemnity under the policy. There are a number of ways to deal with such an issue. Regardless of the method chosen, it is important that insured and insurer establish a clear understanding as to how the exchange rate will be applied. Otherwise, conflicts and delays are likely. Complying with statutory provisions Insurers must consider potential restrictions that may apply to indemnity payments, preferably before any interim payments become due as part of the claims process. The first potential hurdle could be capital controls and financial sanctions, i.e. restrictions on the free movement of capital and payments. To make sure they do not breach any of these regulations, insurers must continuously monitor the various sanctions lists, which may be subject to change during the claims process. But these are not the only rules that could make payment to the insured difficult. Some countries have specific taxes that apply to payments made into the country, which can potentially add a substantial sum to the indemnity payment. The question will immediately arise as to whether these costs are covered under the policy. To avoid conflict, insurer and insured should understand the applicable laws regarding taxes and address these in the policy.


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PROPERTY

Downstream energy sector Onshore oil and gas business is normally divided into (a) upstream, (b) midstream and (c) downstream sectors, whereby the delineation between the three categories is flexible. (a) Upstream Upstream or exploration and production (E&P) refers to generation of the raw material. This means drilling of bore holes, the collecting network of pipelines between hole and separation, separating water, oil and gas; jetties.

(b) Midstream Midstream deals with transportation and storage of crude oil, natural gas, natural gas liquids and similar raw materials. Many midstream companies have gas plants, liquefaction or regasification plants.

(c) Downstream Downstream consists of traditional refining with products like fuel (diesel, gasoline, autogas, LPG), lube oil, asphalt, and the petrochemical industries, including all types of polymerisation (plastics).

Even a small, theoretical over-optimisation compared to the actual production of the facility can have a relatively large impact on the loss calculation. The analysis of the LP model is an integral part of the business interruption calculation. As it is an expert discipline, it is important for insurers to retain a specialist who understands the insured’s business. Special aspects of regulated markets Depending on where the insured plant is situated and the regulations to which it is subject, a part of the business interruption loss may depend on government influence. In Argentina for example, refineries operate in a regulated market where the government can state that a refinery must supply a specific market share of gasoline, for example. If the refinery is not in a position to do so as the result of a loss, it is required to import the shortfall from the world market. After having suffered a loss, such circumstances would expose the refinery to world market prices determined by supply and demand, which could be higher than the price at which the refinery is permitted to sell the product in its home market. This could lead to a claim under the insurance policy. This brief example illustrates the type of complications that can arise in a regulated market. To avoid unpleasant surprises, insurers must acquire a sound understanding of the rules and regulations governing operation of the insured property. Maintenance during the interruption period

Evaluating the business interruption For indemnifying the business interruption loss, the critical question is how the insured would have operated had the loss not occurred. The insured is generally able to provide historical operation data, but these need to be analysed and extrapolated. The extent to which these data can be used to calculate the impact of the damaged property on the business must then be determined for the duration of the agreed interruption period. In the case of larger refinery losses, the insured and insurer usually rely on the insured’s linear programme (LP) to calculate the basis of the claim. One key consideration here is to determine its accuracy, i.e. whether the refinery can actually perform as the LP had predicted. By comparing the LP prediction with the actual performance, it is possible to estimate the LP’s deviation from actual.

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After a downstream loss that has caused substantial damage and leads to a prolonged interruption period, the insured often uses this time to carry out maintenance work in undamaged areas of the plant. If this maintenance work was originally planned for a later period, the insured obtains a financial benefit from bringing it forward as a result of the loss. The insurer can deduct this benefit from the insured’s loss. To avoid dispute, the insured should be made aware of this issue at an early stage. Subrogation Once an indemnity payment has been made by the insurer, the insurer may have a claim for the amount of this payment against a third party bearing responsibility, in whole or part, for the loss. This general principle also applies in the downstream energy sector. As a rule, the insured’s and insurer’s interests are aligned, because the insured normally retains an uninsured portion of the loss which could also be recovered from the third party. Nevertheless, raising the issue of subrogation at the beginning of the claims process is

PROPERTY

Linear optimisation or linear programming (LP) A refinery purchases a specific raw material (crude oil) at the lowest possible price and produces a variety of products (gasoline, diesel, asphalt, etc.). The products are then sold on the market at a specific price. The goal of the refinery is to optimise its production. The lowest possible raw

material purchase costs, lowest possible production cost and highest sales price lead to the maximum margin. Linear programming is a mathematical approach that starts with a set of linear equations which describe cost,

throughput and profit, which are then evaluated using an arithmetic model. It allows the refinery to achieve maximum profit during normal operation, giving consideration to such things as changes or seasonal swings.

sometimes met with resistance by the insured, pos sibly due to concerns that matters could become legally complicated, with lawyers reviewing contracts between the insured and the third party. However, it is important that subrogation is investigated at an early stage of claims handling to ensure that the issue is appropriately considered and to preserve any evidence that may prove that a third party is at fault. Conclusion The aspects outlined here represent only a selection of those recently encountered in downstream energy losses and is by no means a complete list of all the problems that can lead to conflict during the claims management process. It is the responsibility of all stakeholders in this process to address potential conflicts and delays as soon as they have been identified as relevant. Ultimately, open communication between all parties is the key to success. One good way of promoting open and structured communication of this kind and anchoring it contractually is to draw up a claims protocol. A claims protocol stipulates the different steps involved in the claims process, communication and responsibilities at the time the policy is concluded and before a loss has occurred.

OUR EXPERTS Matthias Meyer is a section head in Munich Re’s Special & Financial Risks unit and has worked in claims management for 14 years. His responsibilities include handling oil and gas losses worldwide. [email protected] Robert Schmid has been with Munich Re for 23 years, working in various areas involved with oil and gas companies. He supports underwriting by analysing energy losses. [email protected]


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BUSINESS INTERRUPTION

Caution: Complex interdependencies As business structures become more complex, companies often need more sophisticated insurance products to properly manage their business interruption risks. Narrow vertical integration makes risk management more difficult and increases the demands placed on insurers regarding correct risk assessment and loss evaluation.

Markus Heiss

Vertical integration allows companies to optimise their value and their supply chain’s value by integrating upstream and downstream production processes into their operations. This frequently involves moving production facilities abroad in order to take advantage of lower labour costs or tax incentives. However, the financial benefit of such a move is tempered by the increased complexity it brings to risk management. For example, when evaluating business interruption risks, intercompany transfer pricing systems and interdependencies need to be taken into account. This is true for pre-loss risk assessment, post-loss reserve setting and ultimate loss evaluation. The issues of transfer pricing and interdependency are equally relevant, regardless of whether the loss stems from a physical loss within the insured company or from damage to a supplier or customer resulting in a contingent business interruption loss. Determining transfer prices Many large international companies purchase global insurance cover, and transfer pricing only becomes relevant when losses occur requiring accurate assessment and evaluation. However, smaller companies with just a few manufacturing locations will frequently make do with local policies. In this case, the profit and loss account of an insured entity in one country will reflect the profit and loss earned on the basis of the transfer pricing structure in place. The transfer pricing will not take into account the actual business risk of the overall company, i.e. the lost gross profit generated along the entire value chain right through to the sale of the finished products to the end customer. Profits that the affected entity earns upstream and downstream are not included.

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The added value of the entire value chain is often only known by the insured’s head office. In order to calculate the appropriate sum insured, it is vital that underwriters fully understand the structure of the company and how goods and services are sold between the different legal entities of that company. Take as an example an international company that manufactures food products for sale to retailers. The company owns several meat and milk-processing plants across Europe, which are all legally independent companies making finished products. These products are first supplied on the basis of an intercompany transfer price to various distribution centres, which then sell the product to the retailer. The intercompany transfer prices are based on the full manufacturing costs, which consist of about 85% variable costs and 15% fixed manufacturing overheads plus a small profit margin of 2% for the production plant. Each European location is insured separately. The final selling company takes a mark-up of about 30% for its own fixed costs and profit margin. A business interruption loss at a manufacturing facility based on the transfer prices would thus produce an indemnity value less than the true business interruption exposure, as a significant portion of the actual gross profit is achieved through sales to retailers. If this risk is not adequately insured through coverage of the interdependency risks or a global master policy, the overall financials of the group and the manufacturing facility will be materially affected.

BUSINESS INTERRUPTION In conclusion, the individual financial accounts of various group entities may not reflect the true business interruption exposure of the whole production chain resulting from the failure of an individual entity. Only a detailed understanding of how products and services are accounted for within the same group, and how and where the gross profit is generated, can bring meaningful risk and loss evaluation. Problems involved with interdependencies In cases where not all entities of a group, or potential joint venture partners, are insured under the respective local and global business interruption policy coverages, the risks to upstream and downstream operations can be addressed by way of an interdependency extension. This ensures that cover for a loss resulting from business interruption is extended to other related entities in the production chain. A typical interdependency extension may read as follows:

“Where the insurance provided by Section 2 – Business Interruption of this Policy insures Gross Profit, such insurance shall also apply in the event of interruption of or interference with the Business carried on by the Insured in consequence of loss or destruction of or damage to property at any other premises owned, leased or occupied by the Insured or any company standing in the relationship of subsidiary to parent to the Insured or subsidiary to parent to any company who are themselves a subsidiary of the Insured for the purpose of the Business (i.e. those not stated as Premises in the Schedule) and such loss, destruction or damage shall be deemed to be Damage at the Premises.” Take for example a printer who produces labels for an affiliated company that is insured under the same policy and acts as the trading company to the end customer. In this example, the printer’s margin is low but the trading company earns a considerable gross profit which is taxed at a lower rate in the country where it is based. A business interruption loss at the printing company will also affect the financial results of the trading company. If the trading company’s gross profit is not adequately insured and its dependency on output at the printing company not taken into account, a considerable gap in cover will exist.

Today’s complex world of business interruption

Factories, warehouses and sales outlets around the world are linked and depend on each other to survive. This interdependency results in complex

financial and accounting processes that need to be reflected in the insurance terms and conditions.


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BUSINESS INTERRUPTION The official and even internal financial statements of the individual locations frequently do not reflect the financial exposure of the group resulting from a business interruption event at one location. The risk for the group can be a multiple of the risk at any individual location. This creates problems for the insurers in conducting a proper risk and loss evaluation and in their efforts to achieve early and accurate loss reserving. Ideally, they should work in close cooperation with the insured and possibly other external advisers to establish how the various group entities depend on each other and how a loss at one location can impact on the whole group. An interdependency extension, common in some markets, is a good idea for businesses with a high degree of vertical integration and thus a high level of internal interdependencies. Furthermore, such an extension can close a possible gap in cover in cases where a global master cover is not available or desired. Some interdependency extensions even insure the upstream and downstream losses of group companies which are themselves not insured under a local or global policy cover.

The more complex the structure is as a result of vertical integration, the more difficult it is to determine the actual risk profile in the event of business interruption. It is therefore essential to establish absolute clarity regarding transfer pricing and interdependency, as this helps to identify the need for business interruption cover. It also aids early and accurate assessment of the loss for reserving purposes. Close cooperation between everyone involved throughout the entire process is essential. This allows insurers to work through general loss calculation methodologies, explain what is needed, address potentially difficult loss evaluation areas and manage expectations to everyone’s satisfaction.

OUR EXPERT Markus Heiss is a partner in the London office of MDD (Matson, Driscoll & Damico) UK LLP, Forensic Accountants, and specialises in BI and stock losses as well as other economic consequential losses. His main area of activity is the EMEA region, plus Latin America and Russia. [email protected]

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COLUMN

Man-made disasters versus natural catastrophes Tobias Büttner, Head of Corporate Claims at Munich Re [email protected]

Traditionally, most major losses have tended to involve natural catastrophes: storms, earthquakes, floods and droughts regularly head the list of the insurance industry’s costliest losses. However, recent years have repeatedly highlighted the importance of the human factor in major losses. When it comes to man-made disasters, the first scenarios that usually spring to mind are explosions, environmental disasters such as Deepwater Horizon, aircraft crashes caused by pilots, and terrorist attacks such as that on the World Trade Center in 2001 – still one of the costliest insured losses of all time. In recent years, disaster scenarios associated with cyber risks have also taken on greater significance. Damage caused by events such as computer viruses, mass data abuse on a global scale or the carefully targeted manipulation of software in power plants, dams and traffic control systems is no longer limited to pure economic loss but can also lead to serious property damage and personal injury.

On top of this, we are seeing a growing number of cases in which the substantial role played by human conduct in the occurrence and magnitude of a loss only becomes apparent at second glance. For instance in the case of devastating forest fires caused by inadequate maintenance or safety precautions on the part of utility companies. Or more frequent or more extreme droughts and floods as a result of climate change. Even such classic natural catastrophes as earthquakes are in some cases associated with oil and gas drilling using fracking methods. What’s more, claims settlement is often more complex for man-made major losses than for natural catastrophes. Clarifying all the various ramifications is generally a much lengthier process when dealing with widespread pollution than with storm damage. While losses due to earthquakes or hail are usually regional in scope, legal action by shareholders or consumer protection organisations may involve numerous jurisdictions across the world, with all the complications that come with a variety of applicable legal frameworks. In addition, it often takes years to form a more or less accurate picture of how the loss came about in the first place. Not uncommonly, the extent of a loss also depends on such barely calculable factors as the intensity of media coverage or political considerations. Efforts to cover up the loss can also make it more difficult to establish the cause, as was the case following the explosion at the port of Tianjin.

On the coverage side, man-made losses also regularly give rise to particularly complex legal issues. The age-old problem of distinguishing between damage and defect, or the question of who knew what when, and who can be blamed with which degree of fault – issues important in D&O cases – are good examples of that. All in all, it is becoming clear that not only are primarily man-made losses gaining in importance, but it is becoming more and more difficult to maintain the classic distinction between natural catastrophes and man-made losses. Virtually every loss can have (major) repercussions in terms of liability. The associated increases in time input and costs must be factored into the risk calculation.


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Picture credits Cover: picture alliance/ZUMAPRESS.com p. 1: Gerhard Blank pp. 2, 3 left, 20, 25 left: picture alliance/AP Photo p. 3 right: Shutterstock.com p. 4 left: Beawiharta Beawiharta/Reuters p. 4 middle: Christoph Hoppenbrock p. 4 right: Getty Images/iStockphoto p. 5 top: Getty Images/Uppercut p. 5 bottom, 14, 17, 22, 29, 39: Blende 11 Fotografen pp. 6/7: VCG via Getty Images pp. 8/9: Getty Images AsiaPac p. 10: Getty Images p. 13: terrabella.google.com pp. 16, 25 right: picture alliance/dpa p. 18: picture alliance/ZB/euroluftbild.de p. 23: NASA p. 24 left: Wolfgang Kron p. 24 middle: Rick Wilking/Reuters p. 25 middle: picture alliance/ Stringer – Imaginechina p. 30: Getty Images p. 32: Getty Images p. 36: Lloyd Warwick International Ltd. p. 43: Kevin Sprouls

© 2016 Münchener Rückversicherungs-Gesellschaft Königinstrasse 107 80802 München Germany Tel.: +49 89 38 91-0 Fax: +49 89 39 90 56 www.munichre.com Münchener Rückversicherungs-Gesellschaft (Munich Reinsurance Company) is a reinsurance company organised under the laws of Germany. In some countries, including in the United States, Munich Reinsurance Company holds the status of an unauthorised reinsurer. Policies are underwritten by Munich Reinsurance Company or its affiliated insurance and reinsurance subsidiaries. Certain coverages are not available in all jurisdictions. Any description in this document is for general information purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any product. Responsible for content Christine Angerer Dr. Tobias Büttner Dr. Paolo Bussolera Prof. Dr. Ina Ebert Dr. Achim Enzian Prof. Dr. Peter Höppe Dr. Stefan Klein Arno Studener Dr. Eberhard Witthoff

Printed by Gotteswinter und Aumaier GmbH Joseph-Dollinger-Bogen 22 80807 München Germany Additional copies are available at a nominal fee of €8. Please send your order to [email protected]

Editor Corinna Moormann Group Communications (address as above) Tel.: +49 89 38 91-47 29 Fax: +49 89 38 91-7 47 29 [email protected]

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ISSN 0941-0805

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NOT IF, BUT HOW