Non-physical Damage Business Interruption (NDBI) Innovative Earnings Protection
Agenda Introductions It s a Dangerous World A Framework for Evaluating Corporate Risks Limitations of Traditional Insurance Non-physical Damage Business Interruption (NDBI) Defined Case Studies Clients Asking a Different Kind of Question The Shape of Things to Come 2
Introductions John Ravenna, Head Property Products Americas Leader of the Center of Competence for NDBI David Langman, Alternative Risk Origination, North America 3
It s a Dangerous World Port Closure 10-day shutdown on West Coast ports will cost US economy $2 billion/day Re-routing and carrying costs, another $7 billion to retailers Pandemic/Infectious Disease Risk $8 billion in revenue loss to airlines; casino revenues plunged 50% Regulatory Risk Armed Federal Agencies seized milk products from major cooperative Natural Perils Risk 2010 volcanic ash cloud, disruption to European economy Supply Chain Risk Major EQ/disruption in supply chain, supplier certification loss, bankruptcy 4
It s a Dangerous World Losses are material to earnings, solvency ratings, even ongoing viability of company Indirect loss can be greater, even geometrically greater than direct loss Loss of credit rating/increased cost of debt, loss of market capitalization, impact to reputation (ability to attract outside capital, qualify for approval on acquisitions, licensing, etc.) Significant parts (or all) of these losses don t lend themselves to insurance. Why? No damage to insured property Perils excluded under an all-risk property form Intentional acts Magnitude of the loss as compared to insurance industry capacity Complexity of loss 5
A Framework for Evaluating Corporate Risks Risks fall into 4 buckets Strategic risks Financial price risks Operational risks Insurance risks Risk treatments vary by bucket (different tools are employed) Which risks lend themselves to insurance & why? Can we stretch the definition of insurable loss without requiring equity-like returns? 6
Strategic Risks Disruptors to your business* Examples might include Fundamental changes in the business model (Amazon, Apple) Low-end disruptors; Nucor Steel, Southwest Airlines Difficult to impossible to insure Insurance/Reinsurance is not an excluded class *The Innovator s Dilemma, Clayton Christensen 7
Financial Price Risks Interest rate risk Commodity price risk Currency risk Equity price risk risk treatment usually involves: (1) some form of hedging, and/or (2) entering into long-term predictable price agreements 8
Operational Risks Access to raw materials, qualified labor force Supply chain disruptions Regulatory risks Quality assurance Fraud, security, privacy risks...these risks may/may not lend themselves to insurance treatment 9
Insurance Risk Fortuitous loss Events that are neither expected nor intended (force majeure risk, acts of God) Employ a hedging instrument ; a fixed premium to avoid a large loss potential Insurers avoid the following: Wilful acts Payments that provide more than indemnification on an actual loss sustained basis Acts, errors, or omissions that have no direct impact on your business 10
Limitations of Traditional Insurance Events that cause no direct physical loss or damage, but negatively impact earnings/solvency rating. Events can: Still be fortuitous (unexpected) in nature Have massive economic damages to business, ongoing viability Be difficult to mitigate or hedge through other vehicles Proof of loss Time/effort to capture a recoverable Need for indemnification on an actual loss sustained basis Adequacy of limits versus loss potential 11
Non-physical Damage Business Interruption (NDBI) Understanding what it is, and how it works: Swiss Re Corporate Solutions is taking an industry leadership role to design insurance solutions to cover non-core business interruption (BI) risks resulting from events that may not produce physical damage to insured property. 1. These are black swan events low frequency/high severity that can lead to a material disruption to earnings or the solvency rating of the insured 2. Recoveries can be on an indemnity or formulaic basis 3. Coverage is usually written on a multi-year basis Non-physical damage business interruption (NDBI) is not covered under traditional property damage and business interruption Insurance. 12
Black Swans do Exist! 13
Examples of Potential NDBI Triggering Events Withdrawal of regulatory approval or license to produce (ie, due to quality problems or safety issues) Closure of production facility by order of an authorized regulatory body Contingent business interruption due to non-physical damage affecting a key supplier Financial collapse of a key supplier Failure of Internet access; software errors and mistakes Cyber attacks (malware, virus, denial of access, hacking, etc) Political risks such as strikes, organized blockade, government actions, civil unrest Terrorism affecting trade in a wide area Blackout (no electricity) Product recall Theft, corruption and other criminal acts Environmental contamination Communicable disease Murder/suicide/bad press (Dead man floating) Transportation interruption causing serious delay of delivery of goods or services Natural hazards and other events affecting a wide area, regardless of damage to insured locations 14
BI Spectrum Pushing the Limits of Insurability Purpose of BI insurance: The indemnity following the interruption is meant to put the insured (as far as possible) into the same financial position as they would have been had the incident not occurred. Generically, any trigger (named peril, hazard, occurrence, claim or event) could be used for a stand-alone insurance product. Cover is always subject to the following minimum conditions: NAMED TRIGGER: we clearly specify when and under what future, unforeseen and unpredictable circumstances insurance kicks in (triggering a damage, physical or non-physical) DAMAGE: The insured, a (named) supplier or an end consumer (client of an insured) suffers a physical or non-physical damage as a direct consequence of one of the defined triggers CAUSAL LINK: There is a causal link between the triggering peril, hazard, claim, occurrence or event, and the damage suffered by the insured, one of its (named) suppliers or one of the insured's clients EXPOSURE QUANTIFICATION: The exposure is quantifiable (we need to be able to quantify the potential exposure based on actual loss history and/or scenario analyses, using Monte Carlo simulations and/or other acceptable methodologies) LOSS DEFINITION: The damage and, as a consequence, our indemnity payment (loss of profit and extra costs) are quantifiable or our "loss payment" can be clearly quantified by a parametric approach ALIGNMENT OF INTEREST: The interest between our client and us is aligned and excludes moral hazard (manipulation) risk corporate core non-transferable risks entrepreneurial risks to be retained by shareholders Traditional BI cover Contingent BI cover corporate non-core transferable risks Classic NDBI: extended CBI cover NDBI Extensions Physical damage Non-physical damage 15
Different Approaches to Indemnity Traditional BI Recovery based on actual loss sustained Loss of Gross Earnings or Loss of Profits Loss based on a complex and lengthy adjustment process Parametric solution Indemnity based on objective measurement and formulaic pay-out Example: Cat-in-box Can be structured as insurance or a derivative Hybrid double trigger Indemnity based on sequence of two or more objective events, for example: 1. Certified act of terrorism as defined under TRIA law, followed by 2. Immediate decline in a publicly available index (airline bookings) that is correlated to the insured s business 16
NDBI Example Hospitality Industry What makes it special? Covers loss of income due to defined events, including transportation interruption, certified terrorism, infectious disease Protects the income statement against several black swan events Double trigger due to defined event and decline in RevPar index Formulaic pay-out in event of loss based on annual drop of RevPar applied against hotels actual experience Basic Details Policyholder: Scope: Term: Coverage: Hospitality REIT Multi-peril, including transportation interruption, certified terrorism, infectious disease 36 months USD 75m with reinstatement pays proxy loss of income due to defined perils and reduction in RevPar 17
NDBI Example Transportation Industry, Railroad What makes it special? Covers loss of income without the pre-condition of a direct damage to physical assets Protects the income statement against several "black swan" type of events (ie, real-life past incidents and key exposures). The cover extends the traditional boundaries of insurability and complements the traditional property cover Use captive as state-of-the art risk management tool and catalyst for innovation in tailored risk transfer Basic Details Policyholder: Scope: Term: Coverage: Railway company Multi-peril, including cyber, nat cat and regulatory ordinances / safety-driven shutdown / reduced operations 36 months USD 50m/100m pays loss of income and extra expenses after nonphysical damage events 18
NDBI Example Transportation Industry, Airline What makes it special? Covers loss of income due to flight cancellation Large quarterly deductible and 10% coinsurance provision. Coverage is intended to protect the income statement against "black swan" type of events Pre-agreed loss payable per flight due to cancellation after deductible has been eroded Various exclusions due to terrorism, pandemic, strike, etc Basic Details Policyholder: Scope: Term: Limit of liability: Global airline Flight cancellation coverage 36 months USD 90m annual aggregate 19
NDBI Example Pharmaceutical Industry What makes it special? Covers loss of income due to withdrawal of regulatory approval at key suppliers and/or credit default of supplier Reinsurance of captive insurance company captive has a large self-insured retention Gross profits coverage for 12 months indemnity period Basic Details Policyholder: Scope: Term: Limit of liability: Pharmaceutical company NDBI world-wide cover 36 months USD 75m annual aggregate 20
Challenges and Limitations with NDBI Tight definition of the triggering events ( all risk versus named perils) Lack of alignment of interest and requests for uninsurable risks with, for example, the following characteristics: Moral hazard (manipulation risk) Ethical doubts Entrepreneurial or core business risks Legal, regulatory, accounting or tax restrictions Lack of transparency into the underlying risks Modelling risk due to lack of information and/or relevant exposure data Difficulty in tracking of (triggering) events 21
Next Steps Brokers and insureds should consider enterprise wide ( black swan ) risks 1. Quantify the impacts of the identified corporate risks to earnings and the balance sheet 2. Focus on low-frequency/high-severity events that could threaten the survival of the company 3. Identify both traditional and non-traditional methods of risk mitigation and transfer Swiss Re Corporate Solutions is eager to work with brokers and insureds to implement cost-effective and creative solutions to mitigate risk, using both traditional and non-traditional solutions 22
Swiss Re Corporate Solutions: Non-standard Solutions 23
Think of We re smarter together 24
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Swiss Re Group at a glance Swiss Re is a leading and highly diversified global reinsurer, founded in Zurich (Switzerland) in 1863 The Group offers traditional reinsurance products and related services for property and casualty, as well as for life and health businesses The Group also offers commercial insurance through Corporate Solutions and manages open and closed life insurance books through Life Capital The financial strength 1 of Swiss Reinsurance Company Ltd is currently rated: Standard & Poor s: AA- (stable); Moody s Aa3 (stable); A.M. Best: A+ (stable) Swiss Re was named as the insurance sector leader in the 2015 Dow Jones Sustainability Indices Armonk, New York Key statistics (USD billions) FY 2011 FY 2012 FY2013 FY2014 FY 2015 Total revenues 28.0 33.6 36.9 37.3 35.7 Net income 2.6 4.2 4.4 3.5 4.6 Shareholders equity 29.6 34.0 33.0 35.9 32.4 1 As at 23 February 2016 27