TOPICS SCHADENSPIEGEL 1/2016

TOPICSSCHADENSPIEGEL

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

The magazine for claims managersIssue 1/2016

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an-made disaster in Tianjin · H

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Loss preventionStoring hazardous substances at ports

SanctionsThe science of com pliance

MarineCostly brand protection

1Munich Re Topics Schadenspiegel 1/2016

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 com-plex 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 govern-ment 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

2 Munich Re Topics Schadenspiegel 1/2016

6Man-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.

Editorial 1

News 4Column 43Imprint


26 20

SANCTIONS The science of sanctions compliance 26Complying with sanctions regulations is a major challenge.

CASUALTYDigital healthcare products and liability 30Technologies such as wearables raise many product liability issues.

D&O LIABILITY EXPOSURE New developments 32 Developments in a number of jurisdictions have seen a rise in the importance of D&O covers.

PROPERTYChallenges in the downstream energy sector 36 Claims management following accidents at refineries and other petrochemical facilities.

BUSINESS INTERRUPTION Caution: Complex interdependencies 40 How companies with complex business structures can insure themselves against business interruption.

Contents

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

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

MAN-MADE DISASTERSExplosive mixture 6 Improper storage of hazardous substances can be lethal.

Storing hazardous substances at ports 15 Special safety regulations apply at ports. Unfortunately, they are not always adhered to.

Modelling marine risks 18 New methods to quantify loss potential more reliably.

The high price of brand protection 20 Brand protection clauses cover companies against property damage that could tarnish their brand name.

Natural catastrophe or man-made disaster? 24Distinguishing between man-made losses and natural catastrophes is not as straightforward as you might think.


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 break-through 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.

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 an alyses and a comprehensive sum-mary can be found in the 2015 issue of our Topics Geo magazine.

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

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

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

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

CYBERProtecting digital assets

AUSTRALIA/NEW ZEALANDExpect the unexpected

NATURAL HAZARDS IN 2015A year of climate change

NEWS

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, pro-viding up to US$ 100m or €100m of protection for a wide range of cyber risks. This cooperation makes it pos-sible for customers to obtain broad protection, both in terms of perils covered and financial limits.

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

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.

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

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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 com-munity. 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 there-fore not only provide for risk management, crisis com-munication 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 compa-ny’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 man-agement and efforts to restore the company’s image.

In our solution, the scope of cover and the cover trig-gers are individually tailored to the company’s needs. Contact us to find out more.

>> More information is available at: https://www.munichre.com/reputational- risks-whitepaper/en/homepage/index.html

OUR EXPERT

Ulrike Raible is a lawyer at Munich Re specialising in reputational [email protected]


MAN-MADE LOSSES

Tianjin, with a port area of more than 100 square kilometres, is the gateway to the Beijing region.

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.

Explosive mixture

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 author-ities, 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 humec-tants (water or alcohol) or a gelling plasticiser during


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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 opera-tor of the storage area was holding more than a hun-dred different hazardous substances there, some in quantities far exceeding the permissible limits. The ten most significant hazardous substances were pres-ent 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, includ-ing highly toxic and explosive substances. The over-riding 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 evi-dently 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.

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.

Chemicals stored in the warehouses at the time of the explosion

Chemicals Weight (tonnes)Chloromethylsilane 279.5Butanone 315.8Magnesium 495.5Ammonium nitrate 800.0Potassium nitrate 1,342.8Sodium cyanide 680.5Paraquat dichloride 271.9Formic acid 307.9Sodium sulfide 484.0Sodium hydroxide 1,885.7Potassium nitrate 1,046.0Ammonium nitrate 800.0Sodium cyanide 360.0


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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 dis-tance 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 contain-ers had not buffered the force of the blasts.

Tianjin port occupies a special position as the gate-way 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 build-ings and industries due to this rapid expansion, sev-eral 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.

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 acci-dent. As a result of wind and heat, pollutant concen-trations 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 dis-charged into the Gulf of Bohai. In addition, more than 320 tonnes of sodium cyanide, a highly toxic and environmentally harmful chemical, were subse-quently reported missing, although the permitted storage limit is only ten tonnes. Analyses revealed that 39% of the missing sodium cyanide had dis-solved 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.


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and customs issues also remain unanswered. In addi-tion to value-added tax (17% of the vehicles’ value), 25% import duty and up to 40% luxury tax (depend-ing 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.

Tianjin is not an isolated case

Numerous incidents, some of them many years ago, have highlighted the dangers associated with negli-gent 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.

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.

Property insurance or marine insurance?

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 insur-ance, 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. Pre-cise determination of the loss is also made more diffi-cult 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

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.


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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 explo-sives 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 contain-ers 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 exer-cised their rights of subrogation against the govern-ment. 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 hazard-ous goods. The International Maritime Organization (IMO) has prepared binding safety regulations gov-erning 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.

Events leading up to the explosion of a fertiliser ware-house 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 magni-tude 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 contribu-tory factors leading to the explosion. The Board also criticised the low training standard of West’s volun-teer 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 ammo-nium nitrate in stock had not been duly and com-pletely reported to the relevant authorities. Generally speaking, storing large amounts of hazardous sub-stances in this way frequently constitutes a risk.

Following the events in West, US President Barack Obama issued the Executive Order “Improving Chem-ical 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.


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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 respon sible 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 ware-houses 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.

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 explo-sives. 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 assess-ing the risks. In future, all parties will have to play their part in making major risks and their interde-pendencies (supply chains) more transparent, so that such critical risks can be assessed more effec-tively 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 acci-dent. A more violent blast would likely have brought the assembly lines to a standstill for longer, with correspondingly higher 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 loca-tion 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 facil ities and settlements, no special zones

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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 near-est residential area was considerably less.

terrabella.google.com

terrabella.google.com

1 Storage area

2 Xingang 7th Rd

3 Car depots

4 Donghai Road rail station

5 S11 motorway

6 Residential buildings

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Klaus Wenselowski is Head of Property Loss in Claims Manage-ment & Consulting for Global Clients/North [email protected]

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

Winrich Krupp is a senior claims manager for property and engi-neering losses in the MENA and APA [email protected]

Michael Klug is a senior consult-ant in Corporate Claims and a key-case manager with global responsibility for cross- divisional management of very large [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 [email protected]

OUR EXPERTS

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

Airborne assessment of the loss

A completely new approach was pursued in the claims handling for Tianjin, where drones and satel-lites 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 pro-duced 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.


Alfons Maier

Port facilities not only handle ordi-nary goods, but are also a hub for hazardous substances. The goods delivered by ship are stored tempo-rarily in special warehouses for dan-gerous goods from which they are then collected for further distribu-tion. 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 unnec-essary. After all, the construction of a warehouse for hazardous substances costs two or three times that of an ordinary warehouse, due to the spe-cial requirements imposed for the building. Such considerable invest-ments 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 sam-pling, fine commissioning, filling and cleaning containers, supply and dis-posal of packaging materials, and stowage of sea containers.

As the following summary shows, special precautions are needed when handling hazardous substances.

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 regu-lations which normally also call for separate storage. Special require-ments must also be observed when handling larger quantities of com-bustible and explosive substances.

Strict compliance with the statutory rules and regulations is consequently the most important way of prevent-ing 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 Environ-ment 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 Danger-ous Goods Code (IMDG), which gov-erns marking and packaging during stacking, storage and handling activ-ities on board ships or in port, as well as the International Management

Loss prevention through compli-ance with statutory requirements

The challenge when building danger-ous goods warehouses in port areas is to connect a whole range of laws and directives on building construc-tion, hazardous substances, water protection, explosives, epidemics, etc. The complexity of these legal standards makes it necessary to involve the authorities in an all- embracing, interdisciplinary planning process at an early stage. Both national and international standards must be observed.

Different systems are applied world-wide 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 trans-port 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 cri-teria 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 indus-trial plants which handle, store or

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.

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Munich Re Topics Schadenspiegel 1/201616

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Code for the Safe Operation of Ships and for Pollution Prevention (ISM), which sets general safety standards for maritime traffic, and the Interna-tional Code for the Construction and Equipment of Ships Carrying Dan-gerous Chemicals in Bulk (IBC). Other codes include the International Code for the Construction and Equipment of Ships Carrying Lique-fied Gases in Bulk (IGC Code) and the International Code for the Safe Carriage of Packaged Irradiated Nuclear Fuel, Plutonium and High-Level Radioactive Wastes on Board Ships (INF Code). These codes gov-ern the structural design and require-ments 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 spe-cific risk conditions, certain mini-mum distances must be maintained in relation to residential and indus-trial areas, public traffic infrastruc-ture and other storage facilities when storing or transporting hazardous substances in large quantities. This must be assured through suitable

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

observation and surveillance meas-ures 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 atmos-phere. The reason for this is that hazardous substances must be pre-vented from leaking into the environ-ment 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, foun-dations and doors must be resistant to fire and the different hazardous substances must be separated by permanently installed isolating bulk-heads. The floor must be sealed in such a way that hazardous sub-stances 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 extin-guishers, smoke and gas detection systems as well as explosion-proof devices.

Loss prevention through informa-tion and tracking systems

A transparent logistics chain is essential in order to maintain a con-stant overview of the type of hazard-ous substances in any one place and their quantities. With this informa-tion, the substances can be stored safely and without dangerous accu-mulations as well as without exceed-ing permitted storage levels. In the context of port storage logistics, a distinction is often made between “packaged hazardous goods in dock-side facilities for temporary storage during transport”, “transit and direct transshipment of packaged hazard-ous goods” and “hazardous goods as bulk goods”. The goods’ location and transport are best recorded and man-aged with the aid of an information and tracking system.

When using telematic systems, it is advisable to distinguish between port telematics and forwarding tele-matics in the port facilities. Port telematics might combine a com-munications interface and special appli cation 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 forward-ing management. The most impor-tant 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 consign-ments of hazardous goods becomes more transparent.

Loss prevention through increased controls

In the majority of cases, public authorities are responsible for moni-toring compliance with the relevant regulations governing hazardous substances and particularly their marking. Incorrectly declared car-goes, which could result in danger-ous 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 manage-ment 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 find-ings that 25% of the accidents are attributable to incorrect declarations underscore the need for stringent controls.

Conclusion

There is an urgent need for port stor-age facilities specialising in hazard-ous 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 regula-tions, particularly as regards the dis-tances 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 hazard-ous substances in port areas more transparent and permit identification of dangerous levels or cases of com-bined storage. In addition, such sys-tems also make it possible to check and verify compliance with the required marking and approved stor-age 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’ loca-tion, type and quantity, as well as on the safety precautions taken to pro-tect 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 scenar-ios which also take account of expo-sure 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 [email protected]


MAN-MADE LOSSES

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 quantify-ing the loss potential of such facilities.

Modelling marine risks

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 consider able losses on a number of cargo insurers.

Four years later, the US eastern seaboard was hit by Hurricane Sandy, its storm surge flooding port facil ities 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.

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

OUR EXPERT

Christoph Masius has seven years’ experience in accumulation risk [email protected]

What is it that makes accumulation control so diffi-cult 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 sce-narios? 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 con-stantly 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 attrib-utes such as occupancy type or year of construction into vulnerability functions. The modelling takes account of a portfolio’s features with increasing speci-ficity as localisation becomes more precise and the database more complete.

Marine insurance has a fundamental problem in this context: localising the insured risks is often impos-sible or involves major uncertainty, as they are con-stantly 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.

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 model-ling. 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 Man-agement Solutions (RMS) has developed an initial module for specifically modelling marine risks to be launched in 2016. This establishes the technical func-tionality for more accurate simulation of loss scenar-ios. It remains to be seen whether the quality of the exposure data successively improves as a result.


MAN-MADE LOSSES


MARINE

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 sev-eral disasters involving car carriers in recent years, although natural catastrophes have also played a part. The explosion at the port of Tianjin is a particu-larly noteworthy case. The explosion affected some 68,000 vehicles of different makes which were stored in the port area. Some were covered by property poli-cies, 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 manu-facturers to declare seemingly undamaged vehicles as a total loss on account of suspected chemical con-tamination, for example. This is because manufactur-ers 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 repercus-sions 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 out-ward 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 addition-ally cover the manufacturer against liability claims

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.

The high price of brand protection

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 man-ufacturer’s sales to plummet.

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. Depend-ing on the type of goods concerned, such costs can be substantial.

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 hail-storm 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 mini-mise the loss. Such a procedure may also depend on the prevailing economic circumstances.

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.

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 com-pletely immaterial. The mere assumption of damage is sufficient, for instance if a ship was listing for sev-eral days. The policyholder can decide whether the goods may be salvaged in order to minimise the loss, acting completely independently and without consult-ing an expert. In individual cases, this can be a sensi-ble option for highly specialised products that could only be inspected by rival companies with the requi-site expert knowledge. On the other hand, such clauses can also result in policyholders being given “carte blanche” with regard to loss adjustment.

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.


salvage proceeds. This much greater risk of a total loss must be taken into account by insurers and rein-surers in risk assessment, premium pricing and loss accumulation cover. The events at Tianjin have dem-onstrated the importance of premiums commensu-rate 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.

MARINE

OUR EXPERT

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

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 protec-tion 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 trans-ported. The clauses do not always adhere to the prin-ciple 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.

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 dam-aged 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


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NOT IF, BUT HOW


MAN-MADE DISASTERS

Wolfgang Kron

Natural catastrophes can cause immense eco nomic 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 exam-ples show.

Landslide at the Vajont Dam

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 with-stood 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 mountain-side stopped moving. In April 1963, the filling of the basin was resumed – until the side of the mountain sud-denly 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.

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.

Natural catastrophe or man-made disaster?


Forest fires in Indonesia

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 rav-aged 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 conse-quences were dire: people had seri-ous 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.

Yet it would be too simple to attrib-ute 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 combina-tion of man and nature.

Landslide in Shenzhen

On 20 December 2015, a massive landslide in southern China destroyed 14 factory buildings and more than a dozen office and residential build-ings. 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.

According to the authorities, an arti-ficial 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 with-out the authorities taking any action. Even if heavy rains ultimately trig-gered the disaster, it was clearly a man-made incident.

Dam breach in Tesero

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.

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.


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 interna-tional 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 meas-ures (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.

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 sanc-tions contains several hundred entries, including sev-eral 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 cor-porate structures: the decisive regulations are those which apply in the country where an insurance com-pany, 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 inde-pendent 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 aid-ing and abetting. Employees abroad must additionally ensure that they comply with the requirements speci-fied 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.

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.

The science of sanctions compliance

COMPLIANCE


Consequences for the insurance industry

For a long time, insurers and reinsurers were not explicitly mentioned in the directives imposing sanc-tions. This situation changed in 2009, with the result that the insurance industry is now under a much greater obligation. The existence of potential touch-points 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 pri-mary insurance client are another important factor in reinsurance. If both insurers are governed by Euro-pean law, it may normally be assumed that the client will act in conformity with the sanctions, as it oper-ates in the same legal environment. Despite this, how-ever, the reinsurer should ensure through its own due diligence processes that the client is aware of the reinsurer’s approach to sanctions. Further due dili-gence 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.

COMPLIANCE

Additional diligence must be exercised if claims pay-ments are to be made at a later date within the frame-work 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 chal-lenges 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

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

Source: Group Compliance, Munich Re

Fig. 1: Decision tree for underwriting

PH/Insured person domiciled in an embargoed country?

Iran, Syria, North Korea?

Check against EU embargo list

Contact Group Com-pliance or MH CU for further guidance

Geographical scope includes sanc-tioned countries?

Sanctions clause

Treaty/Policy must not be written

OK

Yes

Yes

Yes

No

No

No

Listed

Not listed


COMPLIANCE

the European reinsurer. Since there were no sanctions on Russia in force at the time, a review by the under-writing 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 situ-ation.

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 pos-sible 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 domi-ciled 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. Com-panies and individuals inside the EU, on the other hand, may neither directly nor indirectly make eco-nomic resources available to sanctioned individuals or companies.

Where possible, shareholder structures must also be considered when investigating whether or not a com-pany 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 sanc-tions 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.

Fig. 2: Points to check in marine insurance

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 impor-tant for insurance companies.

Source: Group Compliance, Munich Re

Shipping company Ship name Cargo

Charterer

Shipbroker Beneficiaries

Destination

Cedant (incl. address)

Currency Flag

Bank Policyholder

(incl. address)

Countries

Payer

Origin

Business partner’s shareholders

Insurance broker


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 regula-tions. 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.

OUR EXPERT

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

Conclusion

Companies will find it more and more difficult to comply with sanctions clauses, not least because such programmes are becoming increasingly preva-lent and comprehensive. In addition, the regulations governing individuals, goods and services are con-stantly being supplemented and updated, which makes it even more difficult to keep track of require-ments. 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. Special-ists are needed to establish such aspects as the pre-cise 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.


CASUALTY

Smart watches allow patients to access digital healthcare products.

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 consid-erable potential for new technical solutions, but also by public projects. For example, the British govern-ment has stipulated that 95% of National Health Service patients treated by general practitioners must have access to e-consultation and other digital prod-ucts 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 under-taken 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. Prod-ucts with higher risk classes need more time before they can be launched. In many cases, questions con-cerning 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 prod-ucts are still under development or in clinical trials.

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.

31

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 prod-ucts 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 chal-lenge 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.

CASUALTY


The European Commission is also working on new recommendations

At present, attention is primarily focused on regula-tory principles governing development and market access. In light of more frequent use and longer peri-ods 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 net-working with consumer devices or “more open” net-works 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 prod-uct 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 vul-nerability of systems also depend on user behaviour.

Cyber crime is another problem which must be taken seriously. Hospitals and medical devices are targets for hackers. Attackers exploit the considerable poten-tial 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


LIABILITY

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 compa-nies also contributed to the overall increase. Another factor in 2015 were the elevated levels of US securi-ties 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 secu-rities 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.

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 aver-age 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 law-suit 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 insur-ance 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 finan-cial 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 approxi-mately 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.”

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.

D&O liability exposures: Developments in the US and globally


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 rep-resented 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 cor-rect underwriting conclusions may be drawn.

The most important additional element to be consid-ered 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 compa-nies. The elevated securities litigation frequency for non-US companies during 2015, and indeed for the past several years, has largely been a factor of height-ened 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 availabil-ity 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 col-lective redress for investment losses.

Securities class action activity is now a well- established 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 coun-tries, 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 proceed-ings 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 foun-dations in proceedings based on the events surround-ing Fortis’s participation in the acquisition of ABN AMRO in 2007. The settlement is subject to approval by the Amsterdam Court of Appeals.


LIABILITY

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 [email protected]

If approved, the Fortis settlement would represent by far the largest settlement ever under the Dutch collec-tive 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 connec-tion 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 proce-dures are built, the Dutch procedures could prove to be of interest to the corporate defendants as well as to prospective claimants.

Whether or not the Dutch collective settlement proce-dures emerge as a preferred mechanism to resolve collective investor claims, there is no doubt that activ-ity 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 underwrit-ing 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.

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.

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



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

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 manage-ment, a number of different aspects and special characteristics of this industry must be given careful consideration.

Challenges in the downstream energy sector

PROPERTY


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 underestimat-ing 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 under-standing 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 challeng-ing, especially as a number of different parties are involved. Substantial differences in valuations fre-quently lead to delays in loss adjustment. Ideally, the insured will have provided pretty accurate asset valu-ation 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 dam-aged, 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 aver-age, sufficient consideration needs to be given to the realistic valuation of insured assets prior to conclu-sion 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 busi-ness 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 economi-cally 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 agree-ment 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, fre-quently a substantial proportion of the required mate-rials 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 pol-icy. There are a number of ways to deal with such an issue. Regardless of the method chosen, it is impor-tant that insured and insurer establish a clear under-standing 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 sanc-tions lists, which may be subject to change during the claims process.

But these are not the only rules that could make pay-ment 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 immedi-ately 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.


PROPERTY

Even a small, theoretical over-optimisation compared to the actual production of the facility can have a rela-tively large impact on the loss calculation. The analy-sis 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 govern-ment influence. In Argentina for example, refineries operate in a regulated market where the government can state that a refinery must supply a specific mar-ket 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 mar-ket. 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 permit-ted 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 sur-prises, insurers must acquire a sound understanding of the rules and regulations governing operation of the insured property.

Maintenance during the interruption period

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 mainte-nance 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 respon-sibility, in whole or part, for the loss. This general prin-ciple 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 sub-rogation at the beginning of the claims process is

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.

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.

(a) Upstream

Midstream deals with transportation and storage of crude oil, natural gas, natural gas liquids and similar raw materi-als. Many midstream companies have gas plants, liquefac-tion or regasification plants.

(b) Midstream

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).

(c) Downstream

Evaluating the business interruption

For indemnifying the business interruption loss, the critical question is how the insured would have oper-ated had the loss not occurred. The insured is gener-ally 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 refin-ery 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 deter-mine its accuracy, i.e. whether the refinery can actu-ally 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.


PROPERTY

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 evi-dence 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 con-flicts 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 pro-moting open and structured communication of this kind and anchoring it contractually is to draw up a claims protocol. A claims protocol stipulates the dif-ferent steps involved in the claims process, communi-cation and responsibilities at the time the policy is concluded and before a loss has occurred.

Linear optimisation or linear programming (LP)A refinery purchases a specific raw material (crude oil) at the lowest pos-sible 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 mathemati-cal 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 nor-mal operation, giving consideration to such things as changes or sea-sonal swings.

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 [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]


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.

Caution: Complex interdependencies

BUSINESS INTERRUPTION

Markus Heiss

Vertical integration allows companies to optimise their value and their supply chain’s value by integrat-ing upstream and downstream production processes into their operations. This frequently involves moving production facilities abroad in order to take advan-tage 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 manage-ment. For example, when evaluating business inter-ruption 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 assess-ment and evaluation. However, smaller companies with just a few manufacturing locations will fre-quently 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.

The added value of the entire value chain is often only known by the insured’s head office. In order to calcu-late the appropriate sum insured, it is vital that under-writers fully understand the structure of the company and how goods and services are sold between the dif-ferent 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 independ-ent companies making finished products. These prod-ucts 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 sell-ing company takes a mark-up of about 30% for its own fixed costs and profit margin.

A business interruption loss at a manufacturing facil-ity based on the transfer prices would thus produce an indemnity value less than the true business inter-ruption 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 manufac-turing facility will be materially affected.


Factories, warehouses and sales out-lets 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 insur-ance terms and conditions.


In conclusion, the individual financial accounts of various group entities may not reflect the true busi-ness 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 respec-tive local and global business interruption policy coverages, the risks to upstream and downstream operations can be addressed by way of an interde-pendency extension. This ensures that cover for a loss resulting from business interruption is extended to other related entities in the production chain. A typi-cal interdependency extension may read as follows:

“Where the insurance provided by Section 2 – Busi-ness Interruption of this Policy insures Gross Profit, such insurance shall also apply in the event of inter-ruption 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 depend-ency on output at the printing company not taken into account, a considerable gap in cover will exist.

Today’s complex world of business interruption



OUR EXPERT

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

The official and even internal financial statements of the individual locations frequently do not reflect the financial exposure of the group resulting from a busi-ness interruption event at one location. The risk for the group can be a multiple of the risk at any individ-ual 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 reserv-ing. 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 verti-cal integration, the more difficult it is to determine the actual risk profile in the event of business interrup-tion. It is therefore essential to establish absolute clar-ity regarding transfer pricing and interdependency, as this helps to identify the need for business interrup-tion cover. It also aids early and accurate assessment of the loss for reserving purposes. Close cooperation between everyone involved throughout the entire pro-cess 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 satis-faction.


COLUMN

Tobias Büttner, Head of Corporate Claims at Munich Re [email protected]

Man-made disasters versus natural catastrophes

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 disas-ters, the first scenarios that usually spring to mind are explosions, envi-ronmental disasters such as Deep-water Horizon, aircraft crashes caused by pilots, and terrorist attacks such as that on the World Trade Center in 2001 – still one of the cost-liest insured losses of all time. In recent years, disaster scenarios associated with cyber risks have also taken on greater significance. Dam-age caused by events such as com-puter viruses, mass data abuse on a global scale or the carefully targeted manipulation of software in power plants, dams and traffic control sys-tems is no longer limited to pure economic loss but can also lead to serious property damage and per-sonal injury.

On top of this, we are seeing a grow-ing number of cases in which the substantial role played by human conduct in the occurrence and mag-nitude of a loss only becomes appar-ent 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 ramifica-tions is generally a much lengthier process when dealing with wide-spread pollution than with storm damage. While losses due to earth-quakes or hail are usually regional in scope, legal action by shareholders or consumer protection organisa-tions may involve numerous jurisdic-tions across the world, with all the complications that come with a variety of applicable legal frame-works. 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 inten-sity of media coverage or political considerations. Efforts to cover up the loss can also make it more diffi-cult 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 par-ticularly 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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© 2016Münchener Rückversicherungs-GesellschaftKöniginstrasse 10780802 MünchenGermanyTel.: +49 89 38 91-0Fax: +49 89 39 90 56www.munichre.com

Münchener Rückversicherungs-Gesellschaft (Munich Reinsurance Company) is a reinsur-ance 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 Reinsur-ance 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 consti-tute an offer to sell or a solicitation of an offer to buy any product.

Responsible for contentChristine Angerer Dr. Tobias BüttnerDr. Paolo BussoleraProf. Dr. Ina EbertDr. Achim EnzianProf. Dr. Peter HöppeDr. Stefan KleinArno Studener Dr. Eberhard Witthoff

EditorCorinna MoormannGroup Communications(address as above)Tel.: +49 89 38 91-47 29 Fax: +49 89 38 91-7 47 [email protected]

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TOPICS SCHADENSPIEGEL 1/2016