The following is an opinion piece written by Andre Martin, head of innovative risk solutions APAC, Swiss Re Corporate Solutions. The views expressed within the article are not necessarily those of Corporate Risk and Insurance.
Technological, economic, demographic, societal and geopolitical macro trends are driving deep changes in the business environment: Over the past 40 years we have witnessed a fundamental shift in the corporate landscape, moving from a sector dominated by physical assets to deriving more value from intangible ones. As such, in 1975, tangible assets such as plant, property, equipment and inventory constituted 83% of the total market valuation of S&P 500 companies. By 2015, that had fallen to 13%, while intangible assets such as intellectual property, networks, platforms, data and customer relationships accounted for the other 87%.
At the same time, globalization has resulted in ever longer and more complex value chains, as many companies have outsourced and diversified their operations, and connected to a myriad of suppliers across the world. For example, one US semiconductor firm has reported it has more than 16,000 suppliers across the world, of which more than half are outside of the US.
These structural changes create massive new opportunities, but also new emerging risks that traditional insurance products are ill-designed to cover. One such exposure that is generating increasing attention is non-physical damage business interruption (NDBI). In other words, financial or economic losses that are not caused by damage of a physical asset, which is generally the trigger for conventional business interruption insurance.
One painful lesson learnt in some of the high-profile natural disasters of the last decade – from the 2011 Thai floods, the Tohoku earthquake and tsunami in Japan to the more recent earthquakes and volcanic eruptions in Indonesia – is that businesses suffered significant revenue losses, even if their physical assets were not directly affected. This could be due to supply chain disruptions, loss of attraction as a tourist destination, wide area damage preventing access or just a general downturn in consumer sentiment.
An example showcasing this exposure was the luxury good sector after the devastating 2011 Tohoku earthquake in Japan. Japan is famously one of the world’s greatest markets for luxury items, representing 11% of global luxury sales. What we saw post Tohoku was that with major disasters such as earthquakes, while not all parts of the country were equally affected physically, such events dampen the consumer mood which has an impact on spending and consequently a significant drop in revenue for businesses. Traditional policies do not indemnify for such “non-damage” economic impact like general consumer sentiment.
But such NDBI exposures are not only limited to nat-cat events. Inclement weather delaying construction projects, regulatory shutdowns or loss of license due to manufacturing irregularities, low river levels disruption supply chains or cyberattacks are all examples causing potential revenue losses without any damage to physical assets.
With the transformation in the corporate landscape and business models deriving value more from intangibles and services rather than tangibles, such NDBI exposures will become increasingly important, shifting the focus of risk managers from asset and balance sheet insurance to protection for earnings and cash flow risks. Both Airbnb and Uber hardly own any physical assets, but a major California earthquake will have a devastating impact on their revenues.
Expanding the limits of insurability
Risk managers are indeed growing more aware and concerned about NDBI and are having active conversations with insurers about how best to protect against such threats.
As risk exposures vary in each case, there is no standard NDBI solution. However, the disconnect of NDBI risk from traditional property risks factors gives rise to asymmetric information and data availability issues, rendering traditional insurance covers inappropriate.
Given the constraints of traditional insurance products, parametric or index-based insurance has proven to be an efficient alternative to transfer such pure economic risk. Unlike traditional BI insurance, index-based insurance is event-based as opposed to damage-based, and therefore completely detached from the underlying physical asset. This makes parametric products an effective instrument to expand the limits of insurability and facilitate NDBI covers. The pay-outs can be used to protect the loss of profits, cover extra expenses needed to keep the business running, contractual penalties and more.
Since every company has different needs and risk profiles, off-the-shelf insurance for NDBI does not really work. As mentioned above, possible trigger events for NDBI losses can be manifold ranging from weather to regulatory or political risks. Parametric insurance offers the possibility to design such bespoke risk transfer solutions. As long as the event is fortuitous, the insurer is able to model the indices used for the trigger, and there is a sufficiently high correlation of the index with the insured’s loss scenarios.
Looking forward, non-physical damage business interruption is the next step in the evolution of providing solutions for exposures which traditionally have been difficult to insure. Advances in data analytics and reporting is leading to a better assessment of risks and allows insurers to refine existing products to match evolving business needs. This – and the innovation in product design – is driving the continuing development of new risk covers for a wider range of threats and perils that businesses face.