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Traditional insurance products are increasingly coming under pressure, not only from policyholders demanding more innovative and simpler coverages, but also from insurers who are looking for new ways to serve the insureds’ demand to cover new risks and to optimize their portfolios.
In the property insurance landscape in Germany, interest seems to be particularly focused on innovations in the business interruption area. On the one hand, as a result of legal, regulatory and societal requirements, policyholders are increasingly exposed to liability claims, which seriously affect the balance sheets and financial resources of policyholders’ companies. This pressure results in policyholders pushing for extensions of existing insurance that will enable them to cover financial losses. At the same time, insurers are striving to safeguard their own profitability and trying to grow their portfolios – while facing fierce competitive pressure due to declining demand and lower profit margins in traditional Property and business interruption insurance.
After a brief review of the traditional business interruption insurance, this article discusses the changes that are currently taking place and what can be expected in the future.
Business interruption (BI) insurance is a type of insurance that provides cover for loss of revenue due to an interruption or impairment in the economic performance of the insured business.
In the event of a BI claim, the profit loss, as well as the unearned ongoing (fixed) costs during the so-called indemnity period of the insurance policy, are usually reimbursed. The indemnity period starts with the occurrence of a material damage (not the interruption of the insured’s operations), the consequences of which lead to a business interruption in the insured company. In general, a business interruption may impact more than one company’s business; it may affect a group of related companies that have losses because of their interdependency – e.g. branches of the same company.
The basic prerequisites for an insured BI loss include all of the following elements of property damage that occurs in the following situations:
In this context, a BI loss is defined as any impairment of a business unit that affects profit and costs.
Nowadays, different covers for BI losses are available, including:
Every year, experts and companies worldwide are asked what risks they consider to be the most critical for their companies.1
Since 2013, business interruption has been cited as the most problematic risk, being assessed as even greater every year.
The number of causes for a BI loss is growing every year. They range from traditional risks such as fire, natural hazards or supply chain interruptions, to new triggers caused by ongoing digitisation. While the latter typically does not cause damage to property, it can lead to high financial losses.
These risks were listed as the main triggers for a BI (multiple answers were possible)
According to a 2015 study, the costs of a BI loss are often significantly higher than those of property damage: The average BI loss was about USD 2.4 million, more than one-third higher than the average property damage (USD 1.75 million).2
A similar risk survey carried out in 2017 paints a similar picture, with BI among the most frequently cited risks for a company.3
Overall, it can be said that BI insurance in commercial and industrial business has developed from a formerly rather neglected area of insurance to a necessary standard cover.
Statistical analyses of incurred losses show that the average BI loss is approximately 36% higher than the average property damage. One reason for higher average BI losses is that they increase faster than property damages. Another reason is that BI losses are considerably more volatile. For example, in the event of a business interruption, the customers of a company look for alternative supply options and oftentimes do not return to their former supplier after the restoration of the impaired business.4
In order to counter this potential threat, the industry is increasingly demanding cover for unusual risks in property BI insurance; for example, non-damage BI, which means compensation for a financial loss, even if the damage that caused the financial loss is not covered.
BI insurance in its current form no longer seems to be able to keep up with the changes in exposure caused by new economic/risk management lessons – e.g. centralization, patenting, specialization, infrastructure in “industrial parks” – as new risk scenarios are constantly emerging.
A typical problem in today’s BI insurance arises with the determination of the necessary insurance sum and indemnity period. The calculation of the insured sum does not follow the existing business principles of income calculation (i.e. IFRS), but takes into account other criteria, such as definition of operating profit, which can often lead to confusing results in the calculation of the insured amount, the sum insured and the actual financial loss. In addition, a change in business models – such as outsourcing, globalization, new production methods, and more complex assessments of the resulting consequences – increases the risk of not taking significant loss potentials into account, so that the actual loss for policyholders and insurers is higher than expected. In addition, new types of risks arise as causes of damage; for example, interruption of operations due to disruption of transport routes, exchange rate fluctuations, insolvencies in the supply chain and failure of the infrastructure.
When analyzing losses, it becomes apparent that today’s BI claims are considerably more cost-intensive than they had been in the past.5 Examples of causes of losses due to globalization include:
But there are still players in the market who see BI insurance as an annex to property insurance (among other things, the property premium calculation triggers the BI premium, e.g. small business interruption insurance in conjunction with property insurance), so that there is no individual assessment of the BI risk.
In addition, other problem areas are emerging that call for changes in today’s approach to BI insurance:
Current BI insurance appears to no longer meet today’s requirements of a global and shared economy. In addition, risk assessment and underwriting, which are mainly driven by the property perspective, must be looked at even more closely.
It seems necessary to consider and assess the future BI scenario independent of property risk. As a result, business interruption will gain significantly more weight in underwriting decisions on capacity, premium and reinsurance placement. In particular, the following questions should be considered:
It is to be expected that – especially considering the changes in production and administrative processes and the associated specialisation (Industry 4.0) – the number of BI losses will continue to increase and dominate the total exposure of a risk. Expanding networks can lead to more incidents resulting in a greater accumulation loss for existing BI policies.
In this respect, BI insurance might continue to evolve from property damage cover to a model of compensation for the financial consequences of unexpected business interruptions. For example, the German industry and its stakeholders are already demanding cover for financial losses without a property damage having occurred (non-damage BI) in order to protect the balance sheet.8 These coverages are already being offered by some insurers, but – as far as we know – are only rarely requested.
In my opinion, this development will almost inevitably take place, as the insureds’ risk management nowadays is more and more geared towards safeguarding the financial situation of a company. This specifically includes the protection of the following:
In addition to the traditional insurance of material assets (property line of business) and the claims of third parties (casualty line of business), the protection of intangible assets is becoming even more important, as can be seen in Figure 1.
In the past, the value of a company was mainly measured by the tangible/material assets (buildings, facilities and equipment, inventory). This has now shifted in favor of intangible assets – predominantly intellectual property, networks, platforms, data, customer relationship or the company’s reputation.
Changes in the five largest corporations in the world illustrate a shift from the largest manufacturing companies to technology and service companies, driven, in particular, by digital transformation:
For this reason, the comprehensive collection and analysis of data, and the interconnectedness of all parts of the company with the manufactured goods, are regarded as imperative for successful risk management. This allows detailed risk identification, risk assessment and more targeted information on risk protection. This enables insureds to make a more targeted decision as to which risks can be borne by themselves and which ones are to be transferred to third parties, i.e. insurers or the financial market.
More recent BI losses, which are increasingly being caused by non-traditional risk exposures – such as data theft or compromised technology services without property damage – confirm this development. The following will inevitably cause companies to look for new ways to hedge income and cash flows:
As a result, the demand for insurance products might change in the future, as the gap between economic and insured losses continues to widen. Currently, for example, in the case of natural catastrophes, at best 30% – 50% of losses are insured; in developing countries the percentage is significantly lower.11 Companies are increasingly looking for new forms of risk coverage, because the rapid and partly disruptive technological change caused, for example, by autonomous systems and artificial intelligence (AI), will lead to new legal, regulatory, social and ethic requirements, risks and liabilities for companies.
A company’s main motivation in connection with risk mitigation and the transfer of financial risks has been and will continue to be:
The focus will therefore be on safeguarding the financial stability of the company in the event of a loss by providing financial resources.12
In the future, insurance might serve as an economic alternative to risk financing in order to provide for sufficient liquidity or a capital increase, which can take the following various forms, depending on a company’s point of view:
Parametric insurance, in particular, may serve to cover additional protection gaps. Insurance cover is triggered by facts. The sum insured is paid out as soon as the conditions/thresholds or measured values specified in the contract are exceeded, such as defined magnitude of an earthquake or a certain wind speed. The challenge for the parties will be to establish a link between the triggering measured value and the actual risk exposure. If this should work, further innovative insurance solutions will be developed to protect income and cash flow instead of assets and balance sheets. First signs can already be seen in new coverage concepts tested in the market; e.g. cyber-, non-damage BI and supply chain.
Parametric insurance solutions therefore can be the result of a consistent extension of insurance cover from pure property damage, complimented by cover for business interruption and retroactive claims, to income and cash flow losses.
The beginnings of this development can already be seen in non-damage BI and cyber insurance policies. For example, depending on the agreed insurance terms and conditions in a predefined loss scenario, the financial consequences for the company are covered, even without prior traditional property damage to the insured’s or third parties’ property. The compensation payment can be based on any of the following:
It is a problem that both types of cover are subject to considerable uncertainties with regard to frequency and severity of losses, and that it is difficult to establish a correlation between the risk exposure and the respective risk situation as a result of constant changes in the risk situation.
Both examples are associated with an enormous accumulation problem for insurers/reinsurers that is very difficult to quantify and to assess using today’s methods and models.
With the introduction of Artificial Intelligence (AI) and further automation – such as Industry 4.0 and Blockchain – this problem will exacerbate. These technologies might give rise to additional new, as yet unknown risks that will require more far-reaching solutions.
The new challenges are increasingly pushing the boundaries of insurability. New markets, new risks and innovative risk transfer solutions are constantly expanding and in some cases even exceeding the limits of insurability.
In order to maintain the criteria for insurability and provide a targeted and adequate capacity, it will probably become indispensable to do the following:
In my opinion, traditional non-life insurance solutions will change because the demand from insurance buyers will change substantially in the future.
The significance of current insurance products will decrease with the changing risk management approach of companies and their need to hedge identified risks, while new forms of cover will develop and be in demand.
The goal of the new forms of cover will be to – at least financially – offset the potential threat to earnings and cash flow, and to stabilize the company’s situation irrespective of the occurrence of a negative event. These new or expanded forms of risk transfer will require risk modelling and risk assumption on the basis of statistically relevant data sets. Existing loss scenario analysis models and methods will evolve, or new risk models will have to be developed if such risks are to be insurable.
