Floods, Tsunami May Dent ‘Black Box’ Supply-Chain Insurance

Insurers and reinsurers may limit the coverage they offer for supply-chain disruptions and negotiate higher prices after record claims from natural disasters in Japan and Thailand.

Most of its 1.5 billion euros ($2 billion) of net claims related to the earthquake and tsunami that hit Japan in March stem from commercial covers that include business interruption insurance, said Munich Re, the world’s biggest reinsurer. Insured losses from the Thai floods that disrupted factories in Japan could be as much as $11 billion, rival Swiss Re Ltd. said.

Contingent business interruption policies, which protect automakers and other manufacturers when a catastrophe in one part of the world halts production in another, rose over the past 10 years as reinsurers helped insurers shoulder the risks, said Jochen Koerner, a member of the executive board in Germany and Austria at insurance broker Marsh & McLennan Co. (MMC) This year’s “perfect storm” boosted claims and undermined risk assumptions, he said.

“Contingent business interruption insurance is not straightforward and can be seen as a massive black box,” said Koerner. “If a factory burns down, that’s only one claim in property insurance, while the same incident could potentially disrupt the supply chains of hundreds of companies if the factory supplies essential goods to other companies.”

Swiss Re, the world’s second-largest reinsurer, this week estimated its own insured claims from the Thai flooding at $600 million, while declining to say what proportion of the losses came from contingent business interruption coverage. Munich Re estimates its net claims from the flooding at about 500 million euros before taxes.

Important Link

“The disasters in Japan and Thailand this year were the worst hit that CBI coverage ever took,” said Volker Muench, head of corporate underwriting property at Allianz SE’s industrial-insurance unit. “Japan is a very important link in the global supply chain and basically Thailand is its backup for some industries.”

Japanese companies such as Toyota Motor Corp. and Honda Motor Co. are the biggest foreign investors in Thailand, which is also the world’s second-largest producer of hard disk drives for computers.

“For weeks, factories were under several meters of water and have been unable to produce and supply key parts to global carmakers or digital- and electrical-goods manufacturers,” said Brian Gray, chief underwriting officer at Zurich-based Swiss Re.

‘Wake-Up Call’

The disaster, after northern and central regions experienced their highest rainfall in 50 years, flooded about 1,500 industrial facilities in Thailand, which Swiss Re says is a “significant” link in the global manufacturing supply chain.

Standard & Poor’s earlier this week lowered the long-term counterparty credit and financial strength ratings of Thai Reinsurance Public Co. (THRE), the country’s biggest domestic reinsurer.

“We no longer consider the market to be low catastrophe prone,” the ratings firm said, adding that international insurers and reinsurers would likely pick up the largest share of the flood losses.

“The Thailand floods are another wake-up call, so that the industry as well as the relevant manufacturers would be well advised to tackle this issue now,” said Torsten Jeworrek, who heads Munich Re’s reinsurance business.

‘Full Transparency’

To limit future losses from this type of coverage, Munich Re is requesting more information on its customers’ supply chains, especially in the semiconductor and automotive industries, Jeworrek said.

“If after 18 months there is no full transparency, or plans for replacing key suppliers of the insured to make it possible for us to budget for these CBI exposures, we will limit or even exclude the coverage under the reinsurance treaties,” he said. “The scope of coverage will certainly shrink.”

Some reinsurers may cut their contingent business interruption risk, said Bryon Ehrhart, chief executive officer of Aon Benfield’s analytics unit. He estimates the size of the global market for these policies at $10 billion to $12 billion.

“The experience this year has been fairly exceptional, but I don’t think it will result in a substantial cutback of the product,” said Ehrhart. “These losses might actually stimulate more demand for the product.”

‘No Models’

HDI-Gerling Industrie Versicherung AG is holding talks with reinsurers about possible changes to its contingent business interruption coverage, said Christoph Groffy, a spokesman for the industrial arm of German insurer Talanx AG.

“The main problem is that there are no models to calculate the claims potential in this area,” he said, adding that the firm has increased policy prices this year in some loss-affected areas.

This year’s disasters revealed the interdependency of global production, said Muench of Allianz. Measuring potential losses for insurers is made more complicated as extensions to contingent business interruption policies also cover the loss a supplier may face because physical damage has put a customer out of business, he said.

Over the past 12 months, business was disrupted at 85 percent of 550 companies surveyed by the Caversham, U.K.-based Business Continuity Institute. About 20 percent of firms, based in 18 different countries, were affected by the earthquakes in Japan and New Zealand this year.

Supporting Prices

“For 17 percent of respondents the financial costs of the largest single incident totaled a million or more euros,” according to the survey, which was sponsored by Zurich Financial Services AG.

Coming after record insured losses of about $70 billion from natural disasters in the first half, the Thai floods may push up premiums for business interruption insurance, which is sold by Allianz, American International Group Inc. (AIG) and other firms as an add-on to business-property coverage.

“We expect a market and worldwide review of underwriting routines and pricing levels regarding business interruption risks both in the industry and reinsurance industry,” said Christian Muschick, a Frankfurt-based analyst with Silvia Quandt Research. “This should support pricing levels going forward.”

To contact the reporter on this story: Oliver Suess in Munich at osuess@bloomberg.net; Carolyn Bandel in Zurich at cbandel@bloomberg.net

To contact the editors responsible for this story: Frank Connelly at fconnelly@bloomberg.net; Edward Evans at eevans3@bloomberg.net

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