In any contractual relationship, it’s important for the parties involved to properly allocate their combined risks.
Contractual risk transfer identifies critical exposures and assigns responsibility for preventing and paying for losses — but it’s not always an easy process. However, protecting your organization’s assets and bottom line is worth the effort.
A critical challenge
Managing contractual risk can be challenging, increasingly so as additional insured status has been eroded over time. In 2013, for example, ISO introduced new additional insured endorsements to commercial general liability policies that restricted limits afforded to additional insureds to those specified in a contract. That has made the underlying contract — and the allocation of contractual risk — more important than ever before.
A few reasons why risk professionals should pay close attention to contractual risk:
To build a more effective contractual risk transfer program, organizations should consider the following best practices:
For more on this topic, listen to a replay of the Marsh webcast, Fortifying Your Contractual Risk Transfer Program.
Author: Janice Collins
Financial disaster preparedness begins with a thorough understanding of the risks facing the organization. As an organization grows and its operations become more intricate, its risks change and tend to become more complex. Accordingly, risks need to be assessed continuously, an exercise typically orchestrated by the risk manager with support from throughout the company.
Beyond the many challenges of physical recovery following a catastrophe, additional problems affecting financial recovery often occur because key areas of risk were overlooked or their potential impacts were not fully understood. For example, a real estate services provider had adequate liability coverage for cyber breaches but did not anticipate the potential financial impact of an interruption of its IT systems. The company experienced a cyber intrusion that shut down its servers for 24 hours, resulting in a multimillion-dollar loss that was only partially covered by insurance.
Risks that are not identified or clearly understood in advance are difficult to manage in a cost-effective manner following a catastrophic event. Such risks expose an organization to unexpected and often avoidable financial losses. The process of risk identification, analysis, mitigation and transference is a critical part of the financial preparedness process.
Once risks have been identified and analyzed, seven key areas of financial preparedness must be addressed:
The foundation of financial preparedness, business continuity planning entails understanding how, and to what degree, your organization will be able to service its customers and maintain solvency in the event of a major shutdown of operations or other catastrophic event. This can include a variety of actions, such as fulfilling orders using existing inventory, receiving support from other company locations, outsourcing production and/or services, and setting up a temporary location. These actions help ensure continuity of operations and, in doing so, also help mitigate the loss.
In planning for business continuity, it is important to consider unexpected occurrences and challenges. Catastrophic losses can occur in ways that were not anticipated or previously experienced by an organization. For example, as a result of Superstorm Sandy in 2012, a company lost two of its major data centers, one located in New York City and a backup center located miles away in New Jersey. The company’s management never anticipated the possibility of a hurricane impacting both data centers at the same time. Organizations must explore a wide range of possible causes of loss and the resulting impacts when assessing both the maximum possible and the maximum probable loss.
Retaining key employees and other members of the workforce following a catastrophic event is essential to the continuity and restoration of a company’s operations. Organizations must assess whether or not insurance will be necessary to cover labor costs following a catastrophic loss.
In addition to labor, there are many other costs that will continue following a catastrophic loss. The key to managing these costs is assessing the organization’s (and each facility’s) structure of variable and fixed costs and determining how they will likely be impacted following a partial or complete shutdown of operations.
By understanding and assessing continuing costs, the organization can better plan for mitigation of those expenses and required insurance coverage. The preparation of a simple business interruption values worksheet does not typically go deep enough—the process requires a detailed understanding of operations and related costs, and ways they will be impacted following a loss.
Insurance is typically the first line of defense following a catastrophic loss, but other sources of funding may also be available. For example, if the president formally declares a disaster, state and local government entities, eligible nonprofits (including hospitals, colleges and universities) and Native American tribes may qualify for federal disaster relief, including Federal Emergency Management Agency (FEMA) Public Assistance Program grants, U.S. Department of Housing and Urban Development Community Development Block Grant Disaster Recovery grants, and Federal Highway Administration disaster grants.
In the case of FEMA Public Assistance grants, the documentation and reporting processes can be onerous, with a multitude of eligibility requirements that address the applicant, facilities, work performed and costs incurred. FEMA also has many insurance requirements, particularly for organizations that have received FEMA funding for previous disasters. Developing an understanding of these and other federal guidelines and implementing necessary procedures and controls before a disaster occurs can help ensure that maximum funding is secured in a timely manner, and can also help withstand audits by federal agencies.
It is critical to maintain liquidity following a loss event. A careful assessment of the amount and timing of potential recovery from insurance and other sources of funding, consideration of continuing costs and extra expenses to maintain operations, and the need for capital to rebuild operations can shed light on the requirements for cash reserves and access to credit during an extended operational shutdown. While insurers may provide advances following a catastrophe, final settlement often takes longer than expected. Planning in this area can help avoid unexpected cash shortages that put business continuity at risk.
Before a loss occurs, it is essential to identify and train the team that will support the organization following a loss event. Internal resources should include a broad spectrum of resources spanning the risk, legal, finance and accounting, operations, sales, engineering, and procurement departments. Additional external resources may include debris removal companies, general contractors, engineers, attorneys, accountants and other consultants. Developing your team and outlining their roles before a loss occurs will help expedite the recovery process, increasing its overall effectiveness and saving costs.
An organization must conduct a review of its coverage at least annually and even more frequently when faced with significant changes in operations. Often, companies discover too late that their insurance policies do not provide sufficient coverage for property damage, business interruption and extra expenses. Many also discover unclear or ambiguous policy language that creates settlement issues.
An annual policy review should provide an understanding of the risks covered, sublimits, exclusions, deductibles, waiting periods and coinsurance requirements. This process can help ensure that risks are covered in the manner intended by management. Following annual renewals, it is also important to determine if any risks need to be further addressed and mitigated due to changes in coverage that may have occurred during the underwriting and renewal process.
The review should include an assessment of the organization’s covered locations and confirmation that the policy lists (or contains appropriate blanket coverage for) all existing locations, especially recently added ones. It should also include an assessment of the statement of values to determine whether property values are current. Property values may need to be updated as companies add, upgrade or sell equipment, invest in new capital, and change physical structures.
The organization’s business interruption values should also be assessed. This means, at a minimum, assessing each location and operation to determine the organization’s exposure to a loss of net income and expenses that would likely continue following a catastrophic event. As your business grows or declines or margins change, business interruption values will likely change as well. Failing to update these values could result in a gap in coverage due to insufficient policy limits, or potentially trigger a coinsurance penalty if designated in the policy.
In assessing insurance, it is important to pay close attention to sublimits, exclusions, waiting periods and deductibles, all of which can significantly impact an organization’s level of financial recovery. As an example, a large entertainment facility experienced a significant loss when an electrical outage led to the cancellation of a show on a busy weekend. Management was surprised to learn that the loss was not covered due to a 48-hour waiting period for “service interruption.”
The period of indemnity specified in a policy may also have a major impact on recovery. Insurance policies typically define the period of indemnity as beginning on the date of loss and extending through the period during which the property can be repaired, rebuilt or replaced, with reasonable speed, to the condition that existed prior to the loss (or, alternatively, the date business is resumed at a new location). Many policies also provide an “extended period of indemnity” of 30 days or more to give the business additional time to restore normal operations. This extended period can provide critical support for financial recovery.
It is also crucial to understand your needs with regard to employee payroll following a catastrophic loss. Business interruption insurance policies may provide full, limited or no coverage for “ordinary payroll” following a catastrophic loss. Ordinary payroll refers to payroll expenses of employees other than executives, department managers, employees under contract and other employees deemed vital to continuing operations. Companies with a critical need to keep such employees after a loss typically require this type of coverage in their policy.
Coverage for extra expense should also be assessed and considered in light of potential actions following an interruption of operations. This coverage generally addresses expenses incurred during the period of restoration to avoid or minimize the suspension of operations at either the current location or temporary locations.
A variety of special coverages are available to cover other areas of risk and may be appropriate for risks specific to the organization, such as insurance for contingent business interruption (to cover losses sustained by your organization as a result of physical damage occurring at your suppliers’ or customers’ facilities), supply chain disruption and cyber incidents.
Source: Risk Magazine
Author: Allen Melton
Author: Michael Speer
Claims digitization will be the over-riding theme for 2017 as these capabilities touch every aspect of the claim landscape. A review of some of the more costly events in 2016 highlights the role of technology and its impact on all areas of claims going forward.
Natural catastrophe events in 2016 dwarfed those from 2015. Per Swiss Re, the first six months of 2015 resulted in a total loss of $46 billion (US) in natural catastrophe events. For the same period in 2016, $68 billion (US) in natural CAT losses were realized — an increase of almost 50 percent. Earthquakes in Ecuador and Japan, wildfires in Canada, and flooding in Europe, all contributed to what will amount to a very large CAT loss year.
From a consumer point of view, overall loss costs from 2010 to 2015 declined by 30 percent for US-based homeowners across a broad number of areas, including wind events (down 50 percent); hail by more than 20 percent; fire (steady decline, no figure available); and theft loss costs, which decreased by 50 percent.
Several factors will impact claims in 2017, ranging from new technology such as autonomous cars and drones to applying analytics to the claims process itself. Among those that will have the greatest influence are:
1. Market trends: autonomous cars
The emergence of self-driving cars will continue unabated into 2017. It raises questions of liability regarding the self-driven car ecosystem — with computers, sensors, software and intelligent infrastructure taking more responsibility for the operation of the vehicle, how will culpability for accidents be determined?
In our current reality, liability accrues to the driver of the vehicle that caused the loss event, however that is determined. With a physical driver relegated to being a monitor of an automated process, this does not seem to be the best way to determine fault going forward.
2. Big data
Our ability to collect and disseminate data has never been more prolific, and that will escalate into 2017 and beyond. Sensors now exist, and the communication infrastructure has evolved to the point where data can be gathered, communicated and analyzed very quickly to arrive at informed decisions/recommendations around potential loss events. This capability can help drive down the severity of the loss event and increase the probabilities of stopping the loss before it occurs.
3. Cyber liability
Cyber liability continues to be an area of increased focus for insurers, and most offer cyber liability products to policyholders that are primarily aimed at the loss of data due to an intrusion. However, there were developments during 2016 that suggest loss of data and the costs to recover it may be far from sufficient.
For example, recent losses in the Iranian oil fields due to orchestrated cyber attacks need to be examined closely. These cyber attacks resulted not only in data loss, but also in physical buildings and contents lost through fires and explosions proximately caused by the intrusion.
This is a whole new realm in the cyber liability arena, and one that most insurers are not including in their products for this space. This claim and loss issue will command significant attention going forward.
4. Claims core systems: Ready for a comeback?
Pivoting to the technology front, although claims enterprise system replacement or augmentation dominated in 2005–2012, the focus by insurers more recently has been on policy and billing administration systems. However, claims-driven technology capabilities are again receiving attention, primarily in the areas of digital capabilities. While the prior activity resulted in a significant increase in claim process automation, there remain significant gaps in analytics, augmentation of internal insurer data with third-party data, and collaboration amongst the eco-system players in claims.
First Notice of Loss (FNOL) processes and the collection of information by the claims adjuster still involves significant time and entry of data. One clear trend addressing this is the increasing use of robotic process automation (RPA) to automate data entry activities. If done correctly, RPA replicates the activity of a human in standard data entry by gathering data from multiple sources, standardizing and formatting the data for ingestion, and applying it to the appropriate aspect of the workflow.
5. Applying predictive analytics and AI to claims
There are also many opportunities in the claims process for the use of predictive analytics, although adoption has been slow. There are clear use cases for specific areas — including claim fraud and loss and reserve forecasting — and clear areas of opportunity such as loss forecasting. The benefits of quickly assessing a claim’s severity, forwarding it to the proper claim expert, involving all applicable claim services, and coming to a fair and expeditious settlement to avoid litigation are clearly understood. One key area enabling accurate loss forecasting analytics is the incorporation of sensor-driven data — such as from boilers or related energy-producing vessels where heat, pressure, load and other key data elements can be monitored.
Predictive analytics can also help to prevent fraud. These predictive tools are used to identify data elements likely to or potentially leading to fraud, e.g., auto collision claim coming in from New York City from areas with high congestion; late model sports cars; accident types that suggest fraud (such as rear-end accidents with neck injuries). All these factors tell a story, and predictive tools can help analyze that information.
6. Artificial intelligence
Another technology enabler in claims that will receive increased focus in 2017 is artificial intelligence (AI). Coupled with image and video analytic tools, AI can “learn” how to provide increasingly accurate loss estimates based on a picture or video. Of course, AI has other areas of application in the claims value chain. Subrogation and salvage are two technical areas within claims that will benefit from having AI applied to the existing analytical models; subrogation, specifically, is an area that many insurers feel is under-utilized and sub-optimized.
7. Prioritizing process optimization and customer engagement
Optimizing the overall claims process for policyholders will be another key focus for 2017. Automation efforts in the past decade focused on automating and consolidating internal claims activities. Now, providing smart, easy-to-use and intuitive capabilities for external audiences, like policyholders and claimants is being addressed.
One of the key touch points with customers is in paying their claims, an area critical to customer satisfaction and policy renewals. Start-ups in the insurance space are using automation to address the claim payment process (as well as the quote and purchase process).
Lemonade and Trov are both making the claims process as painless as possible for their insureds. Trov is using text messages to provide a basic “First Notice of Loss” channel. Lemonade accepts a picture or video of the damage, and attempts to adjudicate the claim based on that information and a series of algorithms, as well as information from the policyholder.
Drone use is another utility that is going to make a significant difference in commercial claim processing for instruments that are difficult, expensive or even dangerous to perform damage assessment upon. This includes: bridges, oil well derricks, cell towers, tall smokestacks, and radio and TV towers, which are difficult to access for direct observation and measurement of damage due to hail, wind, precipitation and the like.
Drones provide highly detailed images that can be used for image analytics to assess damage. Having both pre- and post-loss imagery will provide for better damage estimates. The images also can be used to estimate other parameters such as height, distance from other physical objects like bodies of water adjacent to properties. With FAA regulatory clarification, the use of drones in commercial insurance will increase significantly and use cases for personal lines will emerge as well once FAA regulations are fully implemented and understood.
Finally, the reverberations from the blockchain technology wave will be felt in the claims process. At a minimum, the potential for reducing fraud in fine arts, classic cars, and related high-value insured objects sector will be significant. If blockchain can be leveraged to create public ledgers where high-value objects are identified and tracked, the occurrence of forged items should diminish over time. There are also potential benefits in areas such as title insurance, where title information can be shared in a public ledger available to multiple parties of the insurance and real estate transaction.
Adopt a test-and-learn approach
There were many opportunities in 2016 to apply digital capabilities to the claim process, and that will only increase in 2017. As with any investment, keeping the business case in mind is always important; however, insurers should take a “test and learn” approach and not expect immediate returns on their investment. The learning aspect will be valuable, and should be recognized as a “benefit” too.