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Allianz Risk Barometer 2016 - Top risks in focus: Business interruption

Business interruption (incl. supply chain disruption) ranks as the top peril in the Allianz Risk Barometer for the fourth year in succession with 38% of responses rating this as one of the three most important risks for companies. Although the share of responses is down year-on-year (46% in 2015), this is mitigated by the fact that many of the other top 10 global risks such as natural catastrophes, fire and explosion, cyber incidents and political risks can also have severe business interruption (BI) implications.

AGCS insurance claims analysis shows that BI losses are increasing, typically accounting for a much higher proportion of the overall loss than a decade ago.
According to AGCS' Global Claims Review 2015: Business Interruption In Focus  the average large BI property insurance claim is €2.2m ($2.4m), more than a third higher than the average direct property damage claim of just over €1.6m ($1.75m).

"The primary driver behind increasing BI losses is that interconnectivity of risk is growing day-by-day, as technology, globalization and social change create a complex web of relationships and interdependencies with 'just-in–time' and 'lean' manufacturing now standard practices,” says Hugh Burgess, Global Head of Mid-Corporate and Head of Corporate Lines North America, AGCS. “It is also evidenced in the impact of financial crises, as well as in cyber space, with the rise of social networking and the so-called 'Internet of Things'” (see here).

At the same time, the global impact of natural catastrophes is well documented, with increasing concentration of production and economic value in natural catastrophe hazard-prone areas such as South East Asia for example, a continuing trend.

According to Risk Barometer responses, the major causes of BI that businesses fear the impact of most are natural catastrophes (51%), closely followed by fire, explosion (46%). Supplier failure ranks third (32%).

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“It’s not surprising that natural catastrophes top the causes of BI that global businesses fear most as these events always lead to business interruption,” says Volker Muench, Global Practice Group Leader, Property, AGCS Property Underwriting.

Major loss events such as the Japanese earthquake and Thailand floods in 2011 saw hundreds of businesses file such insurance claims, with the majority of these
notifications coming from companies based outside of the affected areas.

The impact of fire and explosion

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Claims analysis shows a significant fire, explosion incident costs around €1.7m in business interruption losses on average. Photo: Shutterstock.

It is also not surprising that fire and explosion is the second top cause of BI businesses fear most. AGCS analysis of more than 1,800 large BI insurance claims over the past five years shows that this peril is actually the top cause of BI loss around the globe, accounting for around 59% of the value of such claims. Each fire and explosion incident costs around €1.7m ($1.8m) in BI losses on average.

Whereas a large fire or explosion may once have only impacted one or two companies, today such losses can impact multiple companies in different locations. This was evidenced both during 2013, when a fire at a semiconductor plant in China stopped delivery to many electronic equipment manufacturers in North America, and, more recently, by the explosions at the port city of Tianjin in China in August 2015, where there have been a number of BI losses as a result of the subsequent interruption of flow in stock and production when the port was closed by authorities.

Addressing and minimizing exposure

“Five years on from the Japanese earthquake and Thailand floods many companies have taken steps to address and minimize their BI exposure. Supply chain management and business continuity plans have become more robust,” says Thomas Varney, Head of Allianz Risk Consulting Americas. Some large companies have shifted from a predominantly procurement-driven view of supply chain risk to one that brings together management disciplines to overcome the risks. Businesses are also using a much broader array of early indicators to pick up on supplier problems. These include looking for inconsistencies in product quality as a warning signal of financial problems rather than just monitoring a company’s financial strength rating. Companies are also monitoring their suppliers’ competitors in order to identify the development of any potential problems within the industry environment in question.

However, while there are obviously lessons to be learned from past BI experiences and large losses, as the world becomes increasingly interconnected, there needs to be a more proactive steering of risk management policy in order to actively manage the BI risks of the future that are emerging from the fast-changing environment in which businesses are now operating, according to Muench.

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More BI claims resulting from events such as cyber incidents and technical failures (see here), interruptions caused by import/export restrictions, disrupted production due to strikes, political violence, terrorism, war or the actions of authorities, and loss of reputation due to various environmental, social and governance activities are expected to result in sizable financial losses in future. Insurance can provide protection from such disruptive forces but swift crisis communication and response management are also crucial to mitigate the loss impact.