Adequacy of Sum Insured IMIA Working Group Paper WGP 105 (17) IMIA Conference Munich, 2 nd to 6 th September 2017 Working Group Members: Bhatawadekar, Milind Bhatawadekar Surv/LA India Brault, Eric AXA CS France Eisenberg, Alon Eng-Ins. Surv/LA Israel Forder, John WillisTowersWatson UK Hernandez, Alvaro Qatar General Ins/Reins. Qatar Müller, Sven HDI Global SE Germany Rodriguez Gomez, Javier (Re)Insurance Consultancy Mexico Walters, David Chubb UK Zyuganova, Marina Renaissance Insurance Group Russia Chairman: Frey, Martin MS Amlin Switzerland Sponsor: Cazzaniga, Matia Zurich Insurance Co. Switzerland
The Task: The IMIA EC has proposed the following content: Setting the sum insured is fundamental to most engineering policies. Getting it wrong can cause significant problems. Values can also change during the life of a policy. The working group paper will cover: Difficulties of determining the sums insured initially What can affect adequacy during the life of the project How the matter is handled in policies The implications of getting it wrong Means to make changes Guidance for Underwriters on what to look for - and how to do a rough check when Underwriting Claim Examples involving inconsistencies
The structure of our paper: Theory The reality Project level The reality Wording level Challenges we face Conclusions and recommendations And we tried hard to make it: Practical UW focussed Thought provoking Short Easy to read A few words about the presentation:
Q1 (Test) What do you think about the topic of this Working Group Paper? What exactly was the topic? I could not care less about the Adequacy of the Sum Insured. Let s have a coffe break instead! Extremely important and incredibly sexy topic. I really look forward to this presentation!!
Q2 The theory How do most Policies define how the SI should be represented: as the estimated final total contract price? as the estimated final total contract value? as the estimated final total contract cost?
Q2 The theory Total Contract Value. Defined as the sum of the value (others refer to price) of the contract works inclusive of materials, freight, customs duties, dues and cost of construction plus the value of services, material, machines and labour supplied by the Principal. Caution: Beware of policies on first loss or loss limit basis! Which brings us to the next question:
Q3 The theory How are Price, Cost and Value related? Value > Price Price = Value Price > Cost
Ideally: Value >= Price > Cost Q 3 The theory In reality, the declared SI is often the sum of the prices of the various components quoted, as the true Value is extremely difficult to define. In an ideal world, all parties will quote prices which cover their cost and allow for a sufficient profit margin. Contract conditions will allow them to ask for higher prices in case the conditions of the project change or it is found that original assumptions are not adequate anymore. In reality: Competition, political environment, legal changes and technological developments may lead to situations where contracting parties are forced to do unreasonable things Quote extremely competitive prices (below their cost), accept contracts at unsustainable terms (fix price, penalties) which leads them to cut cost (and corners) beyond what is reasonable Enter into projects which can never be completed at the proposed cost Please also refer to the LEG Paper Project Values and Sums Insured 2011
Q4 Project reality How precisely, in your view, can project values be estimated? Project values should not rise more than 10%. Rises in excess of 20% indicate serious problems! We regularly see rises in excess of 50%.
Q4 Project reality Compared to say 20 years ago: SI of projects have become a lot bigger, they last a lot longer (10 years plus), have become more complex (eg Zuidasdok, Battersea)
Q4 Project reality Environmental impact to be minimized, considerable restrictions Legal framework Innovative financing Constantly pushing the limits of technology Subject to Political influence and corresponding budget constraints The best project management in the world will be required to master such projects, and the insurance protection will have to have the flexibility to accompany such projects and their unforeseen evolution. Projects are living and need constant attention and care You can find a lot of interesting info on reasons why (and for how much) project costs do inflate in Caroline Hairsine s Cost overrun Paper of last year.
Q5 Project Reality How many parties are typically involved in a U$ 100 Mio project? 20 to 30 50 to 70 Considerably more than 100
Q5 Huge number of parties insured, especially contractors and subcontractors, and sub-sub contractors How well are the interests of these parties aligned? Contractual basis may vary considerably Cultural differences on international projects A very complex situation to ensure that values are always up to date! Summary 1: Large, complex risks with many parties, difficult to calculate the SI
Q6 Policy wordings Do the Policies you typically use include: An Average Clause? An Escalation Clause? An Average and an Escalation Clause?
Q6 Are our policies fit for purpose? Until 6 months ago, I thought that most policies include an average clause. Then came this special acceptance Text search for average :
Q6 Are our policies fit for purpose? But there was an Increase Clause (from a Policy for a U$ 360 Mio Power Project) The Risk Details state (amongst other things) : There was no mentioning of additional premium to be paid. But Memorandum 10 may eventually help us?
Q6 Are our policies fit for purpose? What happens here? No Additional premium to reinstate the SI for a loss up to U$ 10 Mio or from an endorsement. In case of really large losses, AP is pro rata temporis, excluding Maintenance No average clause, automatic time extension at max 75% pro rata AP, irrespective of loss ratio, first loss limits reinstated without AP.
Q6 Are our policies fit for purpose? Or what about this one? What happens in between 5% and 15%? TSI >U$ 10 000 000 000
Q6 Are our policies fit for purpose? A word on parties insured:.xv) This is the 15 th item on the list of Insured Parties. Including Directors and Officers? In summary, I think this is pretty close to
Q7 Policy wordings Assume there is an Average clause and an Escalation clause in the policy. How do you apply Average? (multiple answers possible) Before consideration of the Escalation clause? After (in excess) consideration of the Escalation Clause? Can I have a beer please?
Q7 The TSI is usually described as an estimated final TCV Most policy wordings are silent about how Average would need to be applied. and in what intervals the estimate needs to be reviewed. Sometimes, it is stated that the premium is How and when can you apply Average?
Q8 Policy wordings Assume there is an Average clause in the policy. How do you apply it when 2 Subcontractors have different levels of underinsurance? Split it proportionally Apply the average of the Average clause We always negotiate payments anyway
Q8 Are our policies fit for purpose? Average/Underinsurance clauses are often not included in policies anymore especially in large and international projects. Escalation/Increase clauses typically in the range of 10% to 20% of SI are always included - but what do they actually do when there is no Average clause?? They are sometimes twisted to avoid payment of additional premium in case the project value rises. Consequences in case true values are larger are unclear. If Average clauses were to be applied, practical difficulties (e.g. the attritional nature of the large majority of Engineering losses, the combination with an escalation clause, the timing of the increase of the SI or the number (and the many changes) of parties involved) often render the application unfeasible. Summary 2: Complex projects with clauses which don t work? So, is there anything we can do to improve the situation?? Yes, we can! Let s continue to play..
Q9 What can we do better? In your organization: wo is responsible to check the Adequacy of the SI? The Risk Engineers The Underwriters/Brokers The Claims guys
Q9 What can we do better? The easy answer is: The Broker. But someone in your organization has to get in contact with the Broker to ask for updates. Does not really matter, as long as it s being done by someone!! The separation of powers between UW and Claims may lead to difficulties in this respect. The Claims teams may not have access to updated information about the details of the Sum Insured. Risk Engineers may only focus on safety and security aspects during their visit not so much on the values and changes to the project. So it is up to the UW to make sure SI and documentation are adequate! Extreme coinsurance and complicated fronting or reinsurance arrangements reduce your chances to get it right! Here are some statements we have collected during our interviews which illustrate our reality and the room for improvement.:
Q9 What can we do better? Quotes: A waiver of underinsurance is regularly agreed We are not aware of any case where compensation has been reduced due to underinsurance proof of underinsurance is too complex and very unlikely successful. There is no chance to check the final SI if the insured is not willing to submit it. The accuracy of the SI is not considered in the loss adjustment process it is not requested by the insurance company or the loss adjuster. If we become aware that the SI is not declared correctly after a loss happened, we try to hide this.
Q10 What can we do better? Be strong, we are almost at the end of this presentation! What is the difference between an Average clause and a UFO? Oh my god, he has gone nuts!! Give me a break!! WTF!!
Q10 What can we do better? No difference: Some believe in it but nobody has seen one in reality. Average Clauses are either not in the Policy, or we often can not apply them Don t rely on clauses to deal with the (Non-)Adequacy of SI of risks, invest more time in ensuring it! After all, this is the basis for all we do!! The issue is not: is there enough cover. It is: is there enough premium! Or: is the umbrella we provide bigger than we thought?? Ask (the right) questions, be clever, make use of all the info we can get. We have to become more active before losses happen, own our business more!, regular interaction with relevant parties, get closer to the risk! Clarify responsibilities in your organization. Raise awareness, support and encourage our UW to get it right. Identify projects where the Adequacy of SI is potentially an issue:
Q10 What can we do better? Use your AoSI-meter: aka: common sense meter : Size and Complexity: the larger and more complex a project gets, the more difficult it is to estimate the final contract value and the more effort is required to keep track on this throughout the project. Owner controlled projects with a large number of contributing contractors and subcontractors may be more challenging than Contractor controlled projects. Degree of Proto-typicality Degree of Political interest (and influence). Can result in too optimistic budgeting in order to get the project supported. Cost over-run as well as difficulties in case of losses are to be expected.
Q10 What can we do better? Use your AoSI-meter: cc Experience and reputation of Contractors, Developers and Risk Managers involved. Do the parties involved have experience in the country in which the project is located and are they familiar with the cultural and legal environment? Is the project financially viable? Is the contractual basis defined and is it meeting your standards? Is the Principal/the Risk management organisation of the project willing to constructively engage with the insurance representatives? Is the legal situation of the project location stable? Is the local currency stable or are you working in an environment of high inflation?
Q10 What can we do better? The more of these factors apply to a project you underwrite, the more effort to confirm the Adequacy of the SI is required (or the more prudent your UW approach should become. Watch the size of your umbrella and the weather conditions!!! Don t rely on UFO clauses on SI (and others.) Read our Working Group Paper again and again.. Back to the Quiz and the scores. IMIANAIRE status requires a score of: Since you are all IMIANAIRES by now. Make good use of that - Play the right cards!