Topics Schadenspiegel 2/2016

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unich Re

TOPICSSCHADENSPIEGEL

The magazine for claims managersIssue 2/2016

Business interruptionFire at a memory chip factory

Flash floodsInsurance is the best safeguard

SubrogationWell worth the effort

Devastating wildfires raged out of control in the province of Alberta in 2016, leading to the worst natural catastrophe in Canadian history. PAGE 6

Wildfires in Canada

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PIEGEL 2/2016

Wildfires in C

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1Munich Re Topics Schadenspiegel 2/2016

Editorial

Dear Reader,

Devastating wildfires have plagued California and Australia for many years. However, the firestorm that raged in the province of Alberta in May 2016 was unusually severe for Canada, with the fires in and around Fort McMurray becoming one of the most expensive natural catastrophes in the country’s history. This issue of Topics Schadenspiegel focuses on the cause of the fires, the damage they were responsible for, and the specific challenges that were thrown up for residents, authorities and insurers.

Experience has shown that, in the case of wildfires and bushfires in particular, loss events that initially appear to have been pure acts of God often reveal, upon closer inspection, a significant liability component. We examine from different perspectives the conditions that improve the chances of subrogation and how to proceed in such cases.

An explosion in a semiconductor factory also raised subrogation issues. The case was yet another example of how quickly a seemingly minor mistake can lead to a major loss if important supply chains are interrupted. Examples of losses in the mining industry and damage caused by flash floods demonstrate how indispensable individualised risk assessments and precautionary measures are. Cracks in a multistorey car park in the UK, on the other hand, show the lengthy complications that can still arise from the necessity to distinguish damage from defect based on unclear policy wordings. We hope you enjoy reading this issue of Topics Schadenspiegel.

Tobias Büttner Head of Corporate Claims at Munich Re

NOT IF, BUT HOW

2 Munich Re Topics Schadenspiegel 2/2016

6When a fire broke out in a remote northern forest in the Canadian province of Alberta on 1 May 2016, the perfect conditions were in place. Strong winds drove the flames to engulf the bonedry woodlands around the town of Fort McMurray. The fire destroyed 2,400 homes and affected a total area of 590,000 hectares. By the time it was brought under control some two months later, it had left behind insured losses of between Can$ 3.6bn and Can$ 4bn.


Contents

36 26 Flash floods are an extremely dangerous natural phenomenon. Insurance cover remains the method of choice to protect against loss.

FEATURE TOPIC – WILDFIRESFirestorm in Fort McMurray 6Wildfires raging out of control result in the most expensive natural disaster in Canadian history.

Wildfire – Causes, losses and consequences 14Hazard zones are well known, but wildfires still often cause significant losses in unexpected locations.

Well worth the effort 20Avenues for recovery should be explored, even for nat cat losses.

INTERVIEWSubrogation is often overlooked 22Subrogation expert Todd Denenberg explains what (not) to do when faced with a loss.

BUSINESS INTERRUPTION Fateful mistake by a subcontractor 26A minor assembly error at a memory chip manufacturer results in losses of around US$ 1bn.

MINING Risky dams 32Lumpsum insurance of tailings dams entails major risks for insurers.

FLOODING Flash floods – Unexpected, destructive, deadly 36Insurance is the best safeguard.

PROPERTYCrumbling concrete 40Construction defects at a shopping centre in the south of England spark a lengthy investigation.

Editorial 1News 4Column 44Imprint

A minor yet fateful assembly error on the part of a subcontractor triggered a fire at a memory chip manufacturer, causing damage amounting to some US$ 1bn.


NEWS

BLOCKCHAINInsurers and reinsurers launch B3i initiative

NATHAN RISK SUITEA new dimension in assessing nat cat risks

A major release of Munich Re’s NATHAN Risk Suite (Natural Hazards Assessment Network) will take your risk potential estimates of natural hazards to another dimension. Our NATHAN experts have been working hard to combine geospatial data with deep learning intelligence, making it possible to conduct realtime risk assessment from any device. NATHAN Risk Suite will feature major changes to the platform and new advanced functions.

The new release will be available from February 2017.

>> Further information is available at: www.munichre.com/nathan

Aegon, Allianz, Munich Re, Swiss Re and Zurich have launched the Blockchain Insurance Industry Initiative B3i aiming to explore the potential of distributed ledger technologies to better serve clients through faster, more convenient and more secure services. If blockchain technology proves viable, it could well streamline paperwork and reconciliation for (re)insurance contracts and accelerate information and money flows.

>> For further information please contact your Client Manager

KNOWLEDGE IN DIALOGUE 2017New client seminar programme

We will be offering our international clients an extensive programme of seminars and workshops once again in the coming year. The available courses cover not only all the important classes of insurance but also specialist topic areas such as financial lines insurance and enterprise risk management.

>> For further information please contact your Client Manager

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/munichre >> xing.com/companies/munichre >> plus.google.com/

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Early Loss Detection claims serviceDetecting and reporting fire damage in real time

A new Munich Re service uses big data analysis methods to quickly detect property damage caused by fire, offering many benefits to claims managers.

The Early Loss Detection (ELD) service offers claims managers in the US, UK and – soon – Latin America and Spain fully automated early loss detection and reporting of property damage caused by fire. Further countries and other claim types, for example natural catastrophes, are planned for the coming months. The big data tool and the Loss Scout app enable claims to be managed proactively, allowing all necessary steps to be taken significantly earlier than is currently the case – ideally at the critical moment when it is still possible to make decisions about repair, restoration or replacement.

ELD works as follows. At set intervals, the system scans almost 15,000 public news sources for predefined loss events. If a hit is detected, the system compares the insurer’s geocoded risk data against

the information about the loss, checking whether there is any insured property in the area that might be affected. If this is the case, an email containing all the relevant information can be automatically generated and sent.

The ELD thus not only processes information rapidly and costeffectively, but also delivers valuable information for risk assessment and pricing. In addition, the data provides a solid basis for the early detection of trends.

You can test the web application for free.

>> Get more information from your Client Manager or by emailing [email protected]

WILDFIRE

In the spring of 2016, aided by high temperatures and strong winds, forest fires quickly spread out of control in the Canadian province of Alberta. It would turn out to be one of the costliest natural catastrophes in Canadian history.

Firestorm in Fort McMurray


A town takes flight. In the biggest evacuation in Canadian history, the inhabitants of the town of Fort McMurray abandoned their homes on 3 May 2016.

Markus Klug and Joachim Pawellek

The northern part of the Canadian province of Alberta experienced exceptionally high temperatures in early May 2016. The general weather pattern, featuring a flow of warm, dry air into the region from the south-west, pushed daytime temperatures over the 30 degrees mark, almost twice what was usual for that time of year. On 3 May, the thermometer nudged 33 degrees in the Fort McMurray area, with excep-tionally dry conditions and relative humidity as low as 12% in some places. When a fire broke out on 1 May roughly 15 kilometres south-west of Fort McMurray in an isolated area of forest, the perfect conditions were in place for it to spread rapidly. The city is situated in the middle of a region in which the vegetation was tinder-dry due to low levels of precipitation during the winter. The danger was exacerbated by gusty winds peaking at over 70 km/h, which drove the flames on at a rate of between 40 and 50 metres per minute. On 3 May they reached Fort McMurray, destroying roughly 2,400 buildings.

Opencast mining operations at risk

The fire then moved towards northern Alberta, threat-ening a tar sand mining region there, before moving into the neighbouring province of Saskatchewan. In total, some 590,000 hectares were affected by the flames, equivalent to an area twice the size of Luxem-bourg. It was more than two months before the fire was finally brought under control on 5 July.

Initial loss estimates of up to Can$ 9bn proved wide of the mark. Nevertheless, with insured losses of between approximately Can$ 3.6bn and Can$ 4bn, the wildfires proved to be the costliest natural catastrophe in Canadian history, eclipsing even the enormous losses of the Alberta 2013 floods.

Firestorm in Fort McMurray

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WILDFIRE


Fire probably the result of human activity

According to official sources, the cause of the devas-tating fire is still unknown. Lightning strikes have been ruled out. The fire was most likely the result of human activity.

With the ideal conditions, the forest fire developed its own substantial internal dynamic and “the Beast”, as it was dubbed by local people, rapidly developed into a firestorm. The incredible heat created its own weather system of pyrocumulus clouds. Air masses were driven upwards by the fire, and electrostatic discharge occurred in the smoke clouds as it does in thunderstorms. The resulting lightning bolts can trigger new fires.

In addition to the heat and dry conditions, further fac-tors contributed to the rapid spread of the fires. The timber buildings, firewood stores and wooden fences that are typical in the region all provided perfect fuel for the flames. Many roofs were covered with wood shingles. There was also the fact that Fort McMurray had expanded considerably over the decades in tan-dem with the growing importance of oil sand mining, and housing had been erected without observing the required minimum distance to the forest or other areas at risk from fires. In this context, experience has shown that fire protection recommendations, such as the removal of dry pine needles and branches from housing developments and the clearing of gutters at regular intervals, are not always followed.

Parsons Creek

Dickinsfield

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Stone CreekTimberlea

Wood Buffalo

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Saline CreekPrairie Creek

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Evacuated areas Minor damage Major damage

Source: Munich Re

Fort McMurray neighbourhoods affected by the fire

Fort McMurray

The lower map shows that not all of the neighbourhoods in and around Fort McMurray suffered the same level of damage.

WILDFIRE


Satellite pictures of the region around Fort McMurray (see also the map on the left) show the different directions the fires took.

Although the fire only ranks fourth in Canadian his-tory when measured in terms of its total area, it is the country’s biggest natural catastrophe in terms of assets destroyed. This is largely because of the losses in Fort McMurray, with its 80,000 or so inhabitants, where 10% of the building stock was destroyed by the flames. One person died during the evacuations.

Difficulties resuming production

There were limited losses at the oil sands open-pit mine to the north of Fort McMurray. Thanks to the fact that the fire changed direction in time, the pro-duction facilities that process and liquefy the viscous oil sand were spared. Nonetheless, the plants were shut down for roughly a month due to the evacuation of the area. Claims under business interruption poli-cies relating to the shutdown period will in many cases fall within the range of the deductibles, or will not be triggered at all. However, some losses occurred when production restarted because bitumen from the tar sands left in the machinery had cooled down and

solidified during the shutdown. The material was no longer fluid and blocked the pipeline. Given the num-ber of flying embers and the build-up of heat, it was purely a matter of luck that the pipelines above ground and the pump stations remained operational.

The firestorm’s “digital” loss pattern is interesting from an insurance perspective. Whereas some build-ings and abandoned vehicles were completely burnt out, neighbouring houses emerged largely unscathed, apart from minor damage from the heat. The explana-tion for this is that the heat was so intense that flying embers leapfrogged entire rows of houses, setting fire to buildings further away. Because the type of damage varied from one area to the next, case-by-case analy-ses had to be carried out. Total losses were identified via satellites which were able to provide images with sufficiently high resolution for this purpose. The extent to which heat and smoke had affected build-ings with little external damage had to be determined on the ground.

WILDFIRE


Dangerous fire residue

The assessment of damage was delayed because the air was initially contaminated with pollutants from composite materials used in the houses and, in some cases, with toxic ash. The loss adjusters were unable to start work until the authorities had declared the region safe. Binding agents were used to stop the ash spreading further on the wind and thus prevent it con-taminating a wider area.

The local population was heavily involved in repairing the damage. Many people cleaned their homes and furnishings of soot and ash themselves, forgoing pos-sible compensation from insurance companies. In return, they expected claims to be settled quickly.

Consequences from declining oil industry

It is unclear how many of the destroyed homes will actually need to be rebuilt. Because of the slump in the price of oil over recent years, there has been a sharp decline in the importance of oil extraction from tar sands. Residents from other parts of Canada who moved to the region in more prosperous times, attracted by high salaries in the oil industry, may now turn their backs on the city. According to estimates, the population of Fort McMurray could shrink by as much as 10–15%.

The economic downturn that began with the drop in oil prices also affects compensation amounts. Property prices were in decline even before the catastrophe. According to information from the Canada Mortgage and Housing Corporation (CMHC), the average price of a detached house has fallen from Can$ 609,000 in 2014 to Can$ 504,000. If homes are not rebuilt, compensation will be paid based on the current value, which will be less than the original purchase price in many cases. Appropriate estimation of the market value is therefore likely to be a subject of debate. Among businesses, the question of com-pensation could also prove controversial. This not only applies to the length of the business interruption, but also the resulting loss. Hotels, for example, were struggling with lower occupancy rates even before the fires.

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Forest fires in Canada 1990–2015Intensive and limited protection zones

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Increase in construction costs feared

There is further uncertainty as regards post-loss inflation. If there is a sharp, sudden increase in demand, costs of materials and labour could rise sig-nificantly. In the case of Fort McMurray, post-loss inflation will be exacerbated because the city is very remote, and transport capacity limited (transport is essentially only possible via one highway from the south). Added to this is the possibility of new legal regulations being introduced – on fire protection for example – which could drive up construction costs. These costs could increase further still if a decision is taken to boost the local economy by relying solely on local construction firms to rebuild the area, as is cur-rently being considered.

Conclusion

The evacuation proceeded in an orderly manner thanks to excellent organisation. And claims manage-ment on the part of the primary insurers was also exemplary. Indeed, many companies did not wait for claims to be submitted, but instead took it into their own hands to contact customers.

OUR EXPERTS

Markus Klug is a senior consultant in Munich Re’s Claims [email protected]

Joachim Pawellek is a claims engineer in Munich Re’s Claims [email protected]

Demand surge: The great unknown

for these goods and services must be borne either by insurers or those affected by the loss. This needs to be taken into account by insurers when making forecasts relating to catastrophe losses and the reserves required.

Natural catastrophes with significant property damage, as in the case of Fort McMurray, frequently produce a demand surge, also known as post-loss inflation. Sudden spikes in demand for building materials and the labour needed for the reconstruc-tion of buildings and infrastructure drive up prices. The additional costs

WILDFIRE


Binding agents were used to stop ash – in some cases toxic – spreading further on the wind, thus preventing contamination of a wider area.

Pockets of destruction in Fort McMurrayThe fire did not advance in a straight line but made jumps that repeatedly spared individual buildings, helped to a large degree by the strong winds. As a result, roughly three quarters of the town was unscathed despite other areas being razed to the ground. But with approximately 2,400 houses completely destroyed by the fire, insured losses still amounted to between Can$ 3.6bn and Can$ 4bn.

WILDFIRE


Aerial photos illustrate the fire’s “digital loss pattern”. Flying embers leapt over individual rows of houses.

The heat left traces of devastation in and around Fort McMurray.


USA Oct./Nov. 2007Overall losses: US$ 2.9bnInsured losses: US$ 2.3bn(also high insured liability losses)

USA Oct. 1991Overall losses: US$ 2.5bnInsured losses: US$ 1.7bn

WILDFIRE

Markus Steuer

The term wildfire refers to any conflagration that starts in a rural, sparsely populated or largely undeveloped area. In many parts of the world, wildfires form part of the ecosystem and often burn at a safe distance from areas of human settlement. Under dry conditions and when fanned by strong winds, however, fires can spread into heavily populated districts, causing major damage to property. Buildings may be set alight by radiant heat, contact with the flames, or flying embers. The flames themselves are not the only thing that leads to a loss. Smoke can also cause property damage, and indirect losses can result from business interruption.

The wildfire hazard is the result of a complex interaction of highly disparate factors. Wildfire is the only natural hazard that is directly influenced by human behaviour. This is because the majority of fires close to populated areas are the direct or indirect result of human activity, including carelessness and arson. Efforts are made to prevent major fires through rapid fire suppression and the adoption of preventive measures. In sparsely populated regions, most fires are the result of lightning strikes.

A complex interplay of anthropogenic and natural factors make wildfires a risk that is extremely difficult to quantify. Even if hazard zones can be clearly identified, fires can cause significant losses in unexpected locations.

Wildfire – Causes, losses and consequences

Canada May 2016Overall losses: >US$ 3.6bn Insured losses: >US$ 2.7bn (preliminary estimate)

USA Oct./Nov. 2003Overall losses: US$ 3.5bnInsured losses: US$ 2bn


Wildfire – Causes, losses and consequences

Fig. 1: Global wildfire hazard and significant loss events

The map shows the average fire potential of a region. No allowance is made for the impact of wind, for fire suppression, or for the hazard from fires that are started intentionally.

Overall losses and insured losses (in property insurance) are shown in original values.

Source: Munich Re NATHAN and NatCatSERVICE

Portugal July/Aug. 2003Overall losses: US$ 1.1bn

Greece Aug./Sept. 2007Overall losses: US$ 2bn

Russia July/Aug. 2010Overall losses: US$ 1.8bnInsured losses: US$ 0.02bn

China May/June 1987Overall losses: US$ 0.54bnInsured losses: US$ 0.05bn

Indonesia 1997/98Overall losses: US$ 2bn

Australia Feb. 1983Overall losses: US$ 0.3bnInsured losses: US$ 0.16bn

Australia Feb. 2009Overall losses: US$ 1.1bnInsured losses: US$ 0.68bn(also high insured liability losses)

Wildfire hazard

Zone 1: low Zone 2: Zone 3: Zone 4: high

Selection of significant loss events

WILDFIRE


The hazard is especially high in climate zones with enough rainfall to allow vegetation to flourish, but where there are also long periods of warm weather with little precipitation. Under such conditions plants gradually dry out, becoming highly flammable. This type of climate prevails in California, southeastern Australia and the Mediterranean region, all three of which are well known for their high wildfire hazard. Nonetheless, large losses can also occur in other regions, especially during heatwaves and when winds are strong.

Risk models

For the risk hotspots California and Australia, models can be used to estimate potential insured losses from wildfires. Modelling this natural hazard is not easy, however, due to the large number of influencing factors, both anthropogenic and natural. “Event sets” consisting of a variety of simulated wildfires are required for risk models. Data from past events is used for this. The observed frequency of wildfires can be used as a basis to simulate the occurrence of future fires, for example. The spread of the fires can be calculated according to land use and weather conditions. Information on vegetation cover and meteorological data such as wind speed and direction are therefore also used.

Simulating the intensity of the fires is especially challenging because the flammability of the vegetation – which is influenced by meteorological conditions before the fire starts – needs to be factored in. Intensity is also determined by the amount of vegetation and dead plant material available to fuel the fire. The quantity of combustible material can be the deciding factor as to whether a surface fire is able to spread to the treetops. Since this variable can change as a result of natural processes and anthropogenic influences, it is difficult to take into account once the model has been created. Insured losses are calculated with the help of a vulnerability curve and information on the contract terms. A particular challenge here is that frequently very little loss data is available to calculate the vulnerability curve used in the model and, when calculating the loss, allowance needs to be made for different contract clauses.

Insured losses in high-risk regions

Californian wildfires are responsible for greater overall and insured losses than the wildfires of any other region in the world. Large swathes of what is known as the wildlandurban interface (WUI) – areas in which buildings have been erected alongside or in the middle of natural vegetation – are found in highhazard regions. As most buildings in such areas are residential, the lion’s share of insured property losses generally stems from personal lines insurance. Major disasters, such as those in 1991, 2003 and 2007, often occur in the autumn – at the end of the wildfire season. These fires quickly developed into uncontrollable infernos, with winds fanning the flames and helping to spread the fires further and faster.

Firefighters are powerless in the face of a gigantic ball of fire in Simi Valley, northwest of Los Angeles, where an area greater than 400 km2 burned in October 2003. Local fire crews were entirely at the mercy of the forces of nature.

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WILDFIRE


The state of Victoria accounts for a large proportion of insured losses in Australia. In the last major event, the Black Saturday bushfires of 2009, residential buildings and contents insurance accounted for around three quarters of the insured property loss, with commercial, industrial and agricultural policies responsible for the remaining quarter.

The Black Saturday fires highlighted the problem of underinsurance: an estimated 80% of insured households affected were not adequately covered. If the sum insured for a destroyed house is less than the cost of reconstruction, the loss is not fully covered and the owners have to make up the difference themselves. Approximately 13% of the homes destroyed in the Black Saturday fires were not insured at all.

Winds fanned the flames

Besides the dry weather conditions, strong winds that changed direction were the main reason why the 1983 and 2009 fires were so destructive. Fires spread by a strong, steady wind are generally long and narrow. If the wind direction changes, however, the long side of the fire can suddenly become the new fire front.

The probability of power lines igniting a fire increases with higher wind speeds because trees can come into contact with the lines, for example. The 2007 Southern California wildfires and the Black Saturday bushfires in Victoria in 2009 illustrate the high loss potential of such events for liability insurers. Class actions were filed against utilities and other parties. It was thought that some of the fires were caused by deficiencies in the distribution network. In the USA and Australia, the parties involved agreed on settlements that did not include any admission of liability on the part of the defendants. In total, the compensation payments amounted to almost US$ 3bn. Since the utility companies concerned in both countries had liability insurance that specifically included liability for wildfires, the insurance industry bore a significant share of the costs.

Catastrophes in unexpected locations

In 2016, a wildfire affecting the remote Canadian town of Fort McMurray caused the Canadian market’s costliest insured wildfire loss ever. Until then, losses of this magnitude had only ever happened in California, where the hazard is much greater. The fire, dubbed “the Beast” by locals, proved so destructive because it experienced the perfect 303030 conditions: temperatures above 30°C, relative humidity under 30%, and wind speeds of over 30 km/h.

Fig. 2: Losses from wildfires worldwide 1980–2015

Overall losses (in 2015 values) Insured losses in property insurance

(in 2015 values)

Adjusted for inflation using national consumer price indices and on the basis of fluctuations in exchange rates against the US dollar.

Source: Munich Re NatCatSERVICE

WILDFIRE


Following serious peat fires near Moscow in 2010, local inhabitants were affected by a blanket of smoke containing toxic gases and large quantities of particulate matter. As a result, there was a spike in the frequency and intensity of illnesses, as well as a significant rise in mortality.

WILDFIRE


An exceptional heatwave also favoured severe fires around Moscow in 2010, as a direct result of which 130 people lost their lives. High temperatures over a long period, extreme dryness and smog caused health problems for many. As a result, the number of deaths in July and August 2010 was 56,000 up on the same period the previous year.

Recurring events

The El NiñoSouthern Oscillation (ENSO) natural climate phenomenon has an impact on the average hazard situation. In El Niño years, the probability of droughts and wildfires in Indonesia and Australia increases because the prevailing, warmerthanaverage water temperatures in the tropical Pacific alter the atmospheric circulation patterns. Indonesia’s major wildfires in 1982/83, 1997/98 and 2015 all coincided with strong El Niño conditions and drought. Most of the fires were started deliberately: large forestry companies and plantation owners took advantage of the dry conditions to rapidly clear land illegally with the aid of fire, and the local population used fires for their traditional slashandburn farming practices. Many fires spread out of control because of the dry conditions, causing major damage to timber and estate crops. The largescale vegetation fires that burned for a long time produced a giant cloud of smoke which caused health damage and business interruption in Indonesia and neighbouring countries. The tourism sector also suffered heavy losses.

Successful prevention A number of wildfires were caused by careless behaviour during a drought in the Chinese province of Heilongjiang in May 1987. The fire service struggled to reach the remote region due to the limited number of access roads. Difficulties in fighting the fires and insufficient prevention efforts meant that it was not possible to extinguish the fires before strong winds fanned the flames, spreading them further. More than

10,000 homes were destroyed, and 213 people lost their lives. Following the disaster, China expanded its preventive measures and sought to ensure more effective firefighting. Public awareness of the risk of fires was raised through targeted information and education programmes. Fires can now be tackled more professionally and effectively thanks to better firefighting equipment and improvements in early detection. As a result, there has been a sharp reduction in both the number and size of wildfires in China.

Conclusion

Many wildfires close to densely populated areas can be extinguished before they are able to cause high property damage. But major fires that develop under the right conditions can be virtually impossible to control. Preventive measures help to reduce the frequency of such events, but not all wildfire catastrophes can be averted. Insurance cover remains the optimal solution to protect against the financial impact.

OUR EXPERT

Markus Steuer is a consultant in Munich Re’s Geo Risks Research unit. [email protected]


SUBROGATION

Hendrik Schulten

If an insurer has covered a loss, it has a right of recourse against responsible third parties. The pur-pose of this rule is to avoid the injured party being compensated twice for the loss (by both the insurer and the party that caused the damage). In addition, it prevents the at-fault party from benefiting from the fact that the injured party has insurance that covers the loss. Subrogation thus ensures that the indemnity insurer does not unwittingly also become a liability insurer for the party responsible for the damage.

Not every natural catastrophe is an act of God

The fact that subrogation is a ubiquitous issue, appearing even in the most unlikely of contexts, is exemplified by the California wildfires that caused over US$ 1.5bn in damage in San Diego in 2007. Whereas some insurers assumed that the long drought leading up to the fires had been exclusively to blame, others retained counsel to investigate possible avenues of recourse. The investigation found that the fires had not in fact been pure acts of God but were caused, among other things, by sparks from poorly maintained power lines. With the aid of legal counsel, significant amounts were recovered by sub-rogation.

Another case revolved around water damage to a school in Arizona caused by a flash flood. During an investigation, it was determined that the school had been built on a site onto which surface water was

channelled after heavy rainfall. A diversion gully had been built for this reason, but it was evidently not big enough to contain such large volumes of water. The case went to court, and the contractor respon-sible was held liable for 90% of the loss.

Establishing the injuring party is key

These two examples show that subrogation issues should even be considered in the area of nat cat damage. The benefits of subrogation are more evident for man-made losses but, even here, insurers face certain pitfalls. Firstly, the question of the at-fault party should be investigated as a matter of routine.

If this party can be established, the next step is to examine whether culpable conduct can be proven and consider the chances of actually recover-ing the loss. It may involve a sole trader – or a multi-national conglomerate with revenues in the billions. Sometimes several parties are involved and are jointly and severally liable. This avoids the risk of winding up in hopeless legal battles that last for years and entail fees that are out of all proportion to the subrogated claims. This is an especially great risk given that the party responsible need not necessarily disclose if and to what extent it has liability insurance or sufficient other financial means.

In daily life it is normal to hold liable a person who causes you damage. Yet some insurers forgo this recourse all too easily. Opportunities for subrogation exist even in seemingly hopeless cases such as natural catastrophes, provided the proper provisions have been made.

Subrogation – Well worth the effort


SUBROGATION

a certain management level. If doubts arise on the market about whether a company handles such conflicts of interest in an ethical manner, its participa-tion in future insurance programmes is sure to be affected. Demonstrating transparency vis-à-vis one’s co-insurers is therefore recommended in such situa-tions, as is the appropriate resolution of the conflict of interest.

Such conflicts can be resolved, for example, by the insurer’s taking a more observational role within the panel. But unilaterally waiving all recourse is not the answer in many cases. Indeed, the insurer will often even harm itself if it does not subrogate, since the co-insurers who are not in conflict will certainly want to take recourse and, if successful, will pocket the reluctant company’s share for themselves.

Sometimes certain exclusions are acceptable

Interests of another kind can conflict if the at-fault party is closely associated with the policyholder. This party might be a subsidiary or an official agency that the policyholder depends on for certain permits. Or it might be a key supplier, which then revokes the poli-cyholder’s status as a prime client, thus jeopardising the policyholder’s supply chain. Since subrogation is optional, it can be contractually waived at any time.

Difficult conflict-of-interest issues

Even if it is clear that the injuring party has sufficient insurance cover or financial strength, it may not always be beneficial to pursue the recourse. This is the case if a multi-line insurer offers property and third-party liability (TPL) covers and both lines are affected by the same insured event, but for different policyholders. This situation could potentially lead to a conflict of interest. For example, if the injuring party’s liability policy provides significantly more cover than the share of the claim to be paid by the insurer, subrogating the claim would be disadvan-tageous.

This simple arithmetic approach becomes problem-atic, however, if the insurer is part of a market in which the other insurers are not faced with the same dilemma. The lead carrier is required to (co)represent the interests of the entire market and thus subrogate even when this would be against its own interests. It is thus better not to let such situations come into being in the first place. All insurers must take the relevant compliance measures to create ethical walls to ensure that information about indemnity limits in the property and TPL lines remain confidential below

Excerpt from Munich Re’s Industrial All Risks (IAR) Policy:

7.10 Subrogation

7.10.1 If the insured, or any other person or organisation to or for whom the insurer makes payment under this policy, has rights to recover damages from another, those rights are transferred to the insurer to the extent of the insurer’s payment.

7.10.2 In the event of subrogation recovery, any monies recovered (including, but not limited to, fees, expenses, or interest) shall be distributed to the insurer and the insured in the following order:

7.10.3 To the insured and/or the insurer for amounts they paid as an expense neces-sary to obtain the recovery;

7.10.4 Any further recovery shall be divided between the insurer and the insured in the same proportion as each has borne or paid for the underlying loss.

For the purposes of this clause 7.10.4, the portion of the loss borne or paid by the insured shall only include the insured’s deductible or self-insured retention as agreed within this policy.

7.10.5 To the insured for any remaining recovery.


Indeed, insurance policies often contain a partial exclusion of recourse. These exclusions are accepted by insurers because, as partners in risk, they are not blind to their customers’ business interests. However, waivers of subrogation require that the scope of eligi-ble parties be clearly defined in the exclusion clause. Universal waivers and clauses conditioned exclusively on the policyholder’s consent are not recommended.

Yet even in such cases, opportunities for recourse are not completely lost, provided the policyholder still has an own interest in holding the perpetrator respon-sible. This may be the case if the relationship with a supplier is ruined or the policyholder would be putting its reputation at risk if it continued to work with the supplier. Other situations are also conceivable, such as if the policyholder has to pay a high deduct ible or the loss exceeds the acceptance limit. In such cases, the insurer and policyholder can agree to drop the exclusion of subrogation at any time.

Ideally, the parties would do this with the help of a specialist law firm which they have chosen together, and in the context of a subrogation agreement in which they set out their binding rights and obligations and all other important aspects of their common objective. This includes the sharing of litigation costs and a precise description of how any recovered pro-ceeds are to be distributed. Stock phrases such as “pro rata” or “proportionally” are often not specific enough in this regard, since the basis for performing this proportional distribution needs to be clear. This is particularly relevant where there is a high level of uncovered damage, either due to deductibles, acceptance limits being exceeded, or losses not being insured at all. Indeed, the greater the amount of such damage, the lower the insurer’s share of the gross total loss and, accordingly, the lower its share if the recourse is successful.

SUBROGATION

When it comes to large losses, identifying human influence and ascertaining whether a third party could be responsible for damage are not always high on the list of priorities. Todd Denenberg, US subrogation expert, explains what insurers need to look out for when attempting to recover from others.

“Subrogation is often overlooked”

Schadenspiegel: When should an insurer retain counsel to review subrogation potential?

Todd Denenberg: It’s best to retain counsel on any loss – but certainly those that could exceed US$ 100,000. Experienced subrogation counsel may well find recovery potential where the insurer or adjuster sees none. And since they often work on a contingency fee basis, their expertise costs the insurer nothing.

Not only do subrogation specialists know what to look for regarding causation and potentially respon-sible parties, they also know which experts to bring in on a loss. If counsel – rather than the insurer – retains and directs the expert, this provides a level of

attorney-client privilege protection to the expert’s loss investigation that would otherwise not exist. Sub-rogation counsel can also ensure that important evidence is preserved, avoiding spoliation.

Why is it so important to react immediately after a loss event?

The first ten days after a loss occurs are critical. In fact, counsel should be retained while the loss is still occurring whenever possible. The delayed or incomplete investigation of a loss can result in over-looked avenues or theories of recovery and spoliation of evidence. This reduces the chances of successful subrogation.


Wording such as that found in the model clause of Munich Re’s Industrial All Risks Policy can provide the necessary clarity, even in the context of an agreement made after the loss has occurred. In addition, the con-tract needs to stipulate in whose name a potential suit against the injuring party would be filed and who would take the final decisions in settlement negotia-tions – whether in or out of court. One can also stipu-late that policyholders cede all their recourse rights. This means that they will not appear as parties and their names will not be included in the proceedings.

If the parties can agree on these key points early on, they can create a greater sense of trust and coopera-tion and avoid potential conflicts further along in the proceedings. The insurer and policyholder can thus also work more purposefully towards developing a common strategy to prevail against the injuring party. After all, proving guilt is not often easy – it takes time and resources.

Systematic review of subrogation options

In certain lines of business in which subrogation issues often arise, such as motor or health insurance, insurers will typically have a department or a number of specially-trained staff whose job it is to routinely investigate recourse options. However, in property and especially industrial insurance, such systematic investigation is not yet standard. Insurers who baulk at the high costs and effort involved in subrogation, despite the great potential, should consider the possi-bility of cooperating with an external law firm. This works best on the basis of a framework agreement with a specialist subrogation firm which would review possible claims against third parties as early as possi-ble – ideally as soon as the loss is reported. If this review is delayed until the later stages of the overall claims process, the chances of proving cul-pability are typically much smaller. It is better to secure evidence early on, using photographs or expert opinions, and to interview witnesses before their memories fade.

SUBROGATION

Loss scenes are inherently chaotic. The insured’s primary concern is to figure out how to clean up and/or repair the damage, and critical evidence is often thrown out with the rest of the debris or damaged property. As far as coverage is concerned, adjusters and insurers are more interested in what caused the loss than who caused it. As a result, key evidence may be destroyed and/or responsible parties deprived of a meaningful opportunity to view the loss scene for themselves.

In what ways can loss adjusters support subrogation investigations?

First and foremost, a good rapport must be estab-lished with the insured. Given that the loss site needs to be preserved, cooperation is essential. The insured can also facilitate interviews with employees and others who may have witnessed the loss. In addition, if the insured has an ongoing business relationship with the party responsible for the loss, it may be of assistance in obtaining information from that party.

Second, the condition of the property after the loss has to be documented. If a possibly defective product is involved, serial numbers and any other information found on the product should be recorded.

Statements should then be taken from the insured, employees, eyewitnesses, and police or fire depart-ment officials on the scene.

Finally, one has to determine if there are any time constraints on the loss investigation. It is essential that the loss site be preserved long enough for the retained experts to determine the cause of the loss and identify key evidence to be preserved. The longer it takes to clear the loss site, the larger the insurance claim. The adjuster must therefore determine if there are any business interruption time constraints on pre-serving the loss site and notify subrogation counsel accordingly.

Wildfires, earthquakes and lightning strikes are gen-erally caused by nature. How is subrogation possible in such cases?

Perhaps the most overlooked areas in terms of subro-gation recovery are natural catastrophe events that damage many properties covering a very large area. Wildfires, earthquakes, floods, hurricanes and storms are the most prominent examples in this context.


Keeping an eye on costs

Framework agreements should stipulate the parties’ rights and obligations, and how costs and proceeds are to be divided. They also include the key processes, thus enabling the tasks outsourced to the lawyers to be integrated as seamlessly as possible into the insur-er’s claims procedure. The agreement should also set out, at key junctures, who must inform whom about what, when, and in what form, and stipulate the loss amounts beyond which the law firm’s assistance will be called upon. If the parties can agree on fees that depend on the amount of indemnification (contin-gency fees), the financial risk to the insurer is kept to a minimum. If performance-related fees are legally not an option – which is the case in much of Europe – the insurer can provide the firm with a set budget per case to initially assess possible avenues of subroga-tion. Further steps would then be considered only where there were realistic chances of recovery.

It is clear that insurers who are aware of these issues and who have set up structures to deal with them increase their chances of recovering damages. It cer-tainly does not make good business sense for an insurer to flatly reject all claims it assumes have little prospect of success. Smaller insurers in particular quickly reach the limits of their capacity in this regard. Specialist firms and reinsurers such as Munich Re can provide valuable services thanks to their vast experience. They have built up the neces-sary networks and have the long-term stability required to weather disputes that could go on for years.

Munich Re has drawn up a best-practice clause in its Industrial All Risks Policy that aims to equitably reconcile the various interests in subrogation pro-ceedings. The clause addresses two decisive ques-tions: firstly, who are the main stakeholders and, secondly, how are the costs divided? It stipulates that the insurer will initially advance the costs of the

The problem with this is that it ignores the fact that third-party action or inaction may have exacerbated or even caused the damage. In such cases, there is still a basis for subrogation. For an act of God to truly bar recovery, there must be no human involvement whatsoever in the loss. Accordingly, insurers need to determine whether a third party caused – or contrib-uted to – the loss in question.

How do you look for possible human involvement in a wildfire, rainstorm or windstorm?

As commercial and residential areas have expanded into what was formerly wilderness, the risk of wild-fires has increased. A “human” component is often overlooked. In cases of arson or campers failing to properly extinguish a campfire, there may be little recovery potential. But in other cases, the loss might be caused in part by a highly insured or very collect-ible third party.

In October 2007, three related wildfires occurred near San Diego, California, causing significant and widespread damage. The first occurred when improp-erly maintained overhead power lines swung into each other during high winds, arcing and creating sparks that ignited dry vegetation. The second was caused by communication lines coming into contact with power lines. The third fire occurred when the branches of a tree extending over power lines broke and fell on the lines, causing them to come down and ignite dry vegetation. The insurance companies were able to recover tens of millions of dollars.

Local heavy rains causing flooding are often referred to as “the storm of the century” by the media, leading adjusters and other insurer representatives to quickly dismiss subrogation. While natural forces dictate the amount of rain that falls, human factors play a significant role in what happens once it hits the ground. Topographical changes due to land develop-ment, for example, can impact the flow and direction of surface-water run-off, as can drainage systems and culverts. As a result, insurers should not disre-gard the possibility of recovery from neighbouring landowners, designers of drainage systems, or other third parties where insured property has been flooded.

SUBROGATION


litigation. If the suit is successful, these advance payments are then reimbursed before the sum paid by the injuring party is split on the basis of a consid-ered and clearly defined system: a win-win situation that creates value for both sides.

In conclusion, anyone who still has doubts about whether it pays to thoroughly consider subrogation might reflect on a final, simple piece of arithmetic: successful subrogation always constitutes a risk-free net gain. In somewhat simplified terms, this means that successfully recovering €100,000 through subro-gation is equivalent to writing a premium (given a 95% combined ratio) of €9.5m.

Hurricanes and tornadoes are seen as archetypical acts of God. Yet wind speeds at any given location in a hurricane fluctuate continually, so one area ex -periencing very high winds does not necessarily mean another did as well. Accordingly, before reaching any decisions regarding subrogation, the insurer must first obtain accurate data on wind speed, say, from government authorities. A meteorologist can also be retained to look at radar and satellite data and con-struct post-storm wind speed calculations if the mag-nitude of the loss justifies this expense. The insurer can then examine whether a third party could have played a role in the cause of the loss. Improper design, construction and/or maintenance of buildings may indeed be a more significant cause of the loss than the winds themselves.

SUBROGATION

Todd Denenberg is a Managing Partner at Denenberg Tuffley, PLLC, a law firm based near Detroit that specialises in subrogation cases.

[email protected]

OUR EXPERT

Hendrik Schulten is a lawyer and an expert on large industrial insurance losses. He heads a team specialising in coverage issues and the wording of property insurance [email protected]


BUSINESS INTERRUPTION

A seemingly minor assembly error was all it took to trigger an explosion and subsequent fire at an Asian semiconductor factory. The fire then swept through the clean room area and the ventilation system to the roof of the building.

Catastrophic error


Winrich Krupp, Hendrik Schulten, Mark Jeong

A small but fateful assembly error on the part of a subcontractor triggered a fire at an Asian manu-facturer of memory chips that resulted in losses totalling almost US$ 1bn. Costs were driven up by damage to special equipment and the highly techni-cal production facilities. Covers for contingent busi-ness interruption (CBI) were also triggered because of disruption to supply chains.

It all started in August 2013 when additional process gas lines for the production area were being laid and connected in the semiconductor factory. The subcontractor responsible for this work mixed up the nitrogen and hydrogen connections to a distribution cabinet. As a result, the control unit in the distribution cabinet, located beneath the clean room production halls, was rinsed with highly explosive hydrogen instead of being rendered inert with nitrogen. When the production machine supplied by the distribution cabinet was commissioned over a week later on 4 September, an explosion occurred which caused a fire. The fire spread to the clean room area and onto the roof via the gas ventilation system. The fire was extinguished by the sprinkler systems and the fire service in just under four hours.

Air cleaner than in an operating theatre

Even though only small areas of the clean rooms were directly affected by the fire, smoke and soot damaged extensive areas of the manufacturing systems and production area. The highly technical production process for manufacturing these chips comprises numerous steps where special machines are used (see diagram on next page). Since even the slightest impurity can affect the production yield and reliability of the chips, the air is kept virtually dustfree.

Catastrophic error



Support from external experts

In view of the complex production process, it quickly became apparent that valuing the loss and exercising any lossminimisation options could only be achieved by bringing in external specialists. It needed to be established which machines and equipment could be cleaned or repaired, and which needed to be replaced with new purchases. Special expertise was required in this area on account of the precision machinery and the extremely low errorrate tolerances for the final product. The views of insurers and policyholders often differ significantly with regard to such assessments. A further aspect was that help from the external specialists would make it easier to estimate when production could be ramped up again to achieve the normal level.

The two clean rooms contained a total of more than 1,400 special machines and appliances, many of which were destroyed by the fire or damaged by smoke, soot and the resulting corrosion. There was also the risk that the abrupt power cut that followed the explosion could have damaged the sensitive electronics in the devices. For this reason, even machines and equipment that displayed no outward signs of damage had to be checked for errorfree functionality within extremely narrow tolerances. An additional concern was that – aside from the direct consequences of the fire – the large number of expensive wafers that had remained in the production process might be lost because of uncontrolled exposure time to chemical substances (see diagram below). Despite the localised impact of the fire, property damage to equipment and buildings and the costs for the business inter ruption in the semiconductor factory amounted to US$ 860m.

How a memory chip is produced

Whether processor or memory chip, all manufacturers produce their semiconductors using the same basic technology: photolithography. The starting point (1) is the cylindrical, single crystal made of pure silicon. This single crystal ingot is cut into thin slices (wafers) using ID saws or wire saws and then polished smooth in several steps. Oxidation on the surface takes place at high temperatures, during which a thin layer of insulating silicon dioxide is formed (3). In the next step, the wafer is coated with a photoresist layer and a template

attached with the pattern of the circuits that are to be transferred to the wafer (4). The photoresist changes as a result of exposure to light and can be removed with the help of a solvent. In this way, silicon oxide surfaces are obtained with the structure of the circuits. There are subsequent steps such as doping, stripping and etching to permanently transfer the circuit structures to the wafer (5). The unexposed photoresist is then removed and the individual chips are finally sliced from the wafer.

1. Wafer with material layer 2. Coating with photoresist, drying 3. Exposing with mask

4. Developing and stripping the exposed photoresist

5. Etching of the material 6. Removal of the photoresist



Whenever chip production is started, a certain period of time is required before it has warmed up to the point where the yield of errorfree chips has reached an acceptable level. This rampup process can take up to two months and, under certain circumstances, extend the phase covered under a business interruption policy.

Because there are only a small number of memory chip manufacturers worldwide, the production stoppage affecting this one producer had massive ramifications around the world. Immediately after the loss became known, the price of memory chips rose sharply in line with the reduced supply, as the facilities affected by the fire were responsible for a substantial portion of global memory chip production. In addition, OEMs (original equipment manufacturers) who had concluded longterm contracts to purchase the memory chips from the manufacturer concerned had to fall back on other means of supply at very short notice. Not only was this difficult to do, since every OEM affected immediately began looking for alternatives, but it also involved high costs on account of the increased prices for memory chips.

Bottleneck threatens Christmas business

Memory chips are not only used in computers for dynamic random access memory (DRAM) functions, but also as flash memory chips which store data permanently. A large number of electronic devices, such as mobile phones, cameras, navigation systems and USB sticks, cannot operate without these components. The situation was particularly dire at one US customer in the IT sector. At the time of the fire, it was in the critical phase of bringing out a new game console in time for the lucrative Christmas market. The justintime production at the contract manufacturer had already started when the supply of memory chips suddenly stopped. Given the time pressure involved, the company saw no alternative but to purchase the relevant components on the spot market at significantly higher prices. There were also air freight costs in the tens of millions to launch the game consoles on schedule despite the delay.

Unprepared for a breakdown in supply

Because the console segment was not part of the group’s core business, not enough attention was paid to the risks emanating from globally networked supply chains. For example, the company had omitted to split procurement of critical components like the memory chips between at least two suppliers in order to reduce or eliminate any potential bottlenecks. Particularly in the case of memory chips, which as bulk products feature no special specifications, it is very easy to fall back on different suppliers. Ultimately, the loss from the contingent business interruption came to almost US$ 500m, although the insurers had to pay a much smaller amount thanks to the agreed sublimit of US$ 150m and the policyholder’s deductible of US$ 25m.

A further problem arose at a different OEM, which had also concluded a longterm supply agreement with the semiconductor manufacturer concerned. This OEM was still not being supplied with chips by the manufacturer even as late as the following January, despite production being up and running again by this point. One could speculate that the chip manufacturer had seized the opportunity and preferred to sell its chip components on the spot market at a higher price, rather than sticking to the longterm supplier agreement (at lower prices). The ultimate losers were the insurers, who had to refund the price difference to the OEM under the CBI cover. They would only have been freed from the obligation to indemnify if there had been a break in the causal chain that led to the financial loss. However, there was no evidence for this.

In the production of memory chips, filter systems keep the air free of dust particles.



Lessons to be learned from the loss

Once again, a seemingly minor slip triggered a major loss that cost insurers dear. This was not only due to the special production conditions in the industry, but also because risk managers have not yet fully grasped the significance of CBI – despite the large number of losses. CBI losses resulting from the globalisation of supply chains pose a particular threat if a specific component is used in a variety of products and that component is made by just a few manufacturers. This could be memory chips, as in this case, or even unbreakable glass for mobile phones, which is only produced by a handful of companies around the world. In the automotive industry, drive technology, tyres and electronic components are likely causes of bottlenecks.

Using sublimits to reduce exposure

For underwriting, the challenge is to identify critical weak points and to make allowance for these in the contract design. The problem here is that underwriters depend on the information provided to them. They can never hope to know more than the customers themselves, and it would be an illusion to believe they could identify all the different cogs and wheels that intermesh in complex production processes. For this reason, CBI losses can never be completely ruled out given today’s international division of labour. The location, date and extent of CBI losses cannot be controlled, something they share in common with natural catastrophe risks.

Global demand for a tiny product: microchip on a fingertip.



In such a case, sublimits are the most effective way of limiting exposure. In this context, it is sensible to distinguish between named suppliers and secondtier unnamed suppliers. The named suppliers are expressly listed in the policy. Since it can be assumed that named suppliers apply higher standards to avoid production breakdowns, higher sublimits can be agreed for them than for unnamed suppliers. Furthermore, for risks involving complex supply chains, the underwriter should form a clear picture of the quality of continuity management.

Do not needlessly relinquish recourse claims

Following a loss, the topic of recourse should be examined since, in the area of CBI, it is usually third parties (in this instance the subcontractor responsible for the gas connection) who trigger the loss. However, policyholders often agree to waive recourse action under the policy against their named suppliers because they do not want to put a strain on future business relations, and because the insurer will pay for the loss anyway. In this situation, the insurer has no means of taking action against the party responsible for the damage without the consent of the policyholder. Insurers should therefore take care not to needlessly surrender their rights to recourse claims. When assessing the loss, insurers should also make a realistic assessment of their expertise and options, as was done so successfully in this case. External expertise was expensive but worth every penny. After all, it made it possible to significantly reduce the loss amount and also shorten the overall settlement process.

Last but not least, underwriters should consider what options the policyholder has in terms of alternative production sites. For example, the Asian semiconductor manufacturer operated facilities in other countries that also produced memory chips. Ideally, the extent to which a breakdown in one factory could be made up for by other production sites should have been specified when drafting the policy conditions.

OUR EXPERTS

Winrich Krupp is a senior claims manager for property and engineering losses in the Middle East and AsiaPacific. [email protected]

Hendrik Schulten is a lawyer and an expert on industrial insurance. He heads a team specialising in coverage issues and the wording of property insurance [email protected]

Mark Jeong is Head of Claims at Munich Re, [email protected]


MINING

A typical dammed basin for tailings at a copper mine in Tahtsa Reach, British Columbia.

Waste can be found wherever there are mining operations. Non-solid waste is collected in basins called tailings ponds, which are contained by dams. The failure of such a dam can have catastrophic consequences. If structures like these are to remain insurable, their individual risk situation must be analysed.

Risk-prone dams


MINING

Günter Becker

In contrast to water reservoirs, the retention struc-tures for tailings disposals are either made from crushed rocks or, in the worst case, from dried waste residue. In order to seal the dams, they are given a core made from clay and in some cases plastic liners as well. Since the mine life of many operations is longer than originally planned because of increasing raw material prices, the dams may also need to be raised. Depending on the extraction method used, this can be done with either waste rock or dried tailings, which sometimes contain toxic chemicals from the treatment process.

Dams as a risk factor

Unlike reservoirs, which can be drained for mainte-nance, tailings dams must remain reliable over their entire operational life. In principle, they are built to last for ever, and ideally will be revegetated after a mine has closed down. While the mine is in operation, they must be stable enough to withstand the pressure from the tailings they hold. Unfortunately, this is not always the case. Canada‘s Mount Polley dam burst in 2013 and in 2015 the Samarco dam in Brazil failed.

The most frequent causes for incidents in tailings storage facilities (TSF) are earthquakes, overflow and landslides. In the case of quakes, either the dam itself can become unstable, or it can fail as a result of what is known as liquefaction. The maximum volume of a TSF can be exceeded by high precipitation, with the result that tailings escape from the basin. The dam itself is often damaged in the process. If the slopes of tailings dams are not flat enough, or not sufficiently compacted during construction, landslides occur that significantly compromise the stability of the dams.

The more expensive alternative technique is “dry stacking”, in which the processing residue is com-pletely dried before being deposited. The material is piled up and compacted. This removes the need to construct large dams.

New standards for tailings basins

The highest dams today are up to 240 metres tall, and will grow even higher in the future. By way of compar-ison, the Hoover dam in the south-west of the USA measures 221 metres in height. TSFs are therefore among the largest man-made structures in the world. In the light of this trend and the aforementioned inci-dents, the mining industry has recognised the need for action. In December 2015, the International Coun-cil on Mining and Metals, a consortium of the world‘s 23 largest mining and metal companies, announced that it intended to review standards for the storage of tailings.

A rethink has also begun in the insurance industry after dam failures over the last few years triggered several major losses. The objective is to be able to estimate the risks more accurately, to ensure that tail-ings dams remain insurable in the future. It would be sensible in this context to separate the insurance of mining, and the special risks it involves, from stand-ard property insurance. Munich Re has already adopted this approach in its Corporate Insurance Partner (CIP) unit. Unlike with the oil and gas sectors, there has traditionally been no separate line of busi-ness for mining in the insurance industry. Insurance policies are simply adapted from the policy forms for “standard” property risks in other industries by adding specific amendments for mining. As a result, product development has failed to keep pace with the indus-try’s needs and risks.

Lump-sum agreements and higher limits

The shortcomings become apparent in the area of business interruption. Loss of revenue due to busi-ness interruption is only covered if triggered by an insured property-damage loss. But tailings from min-ing operations are a product of no value, and thus cannot be covered under generic property insurance. This means that mining companies actually have no way to insure against business interruption if the dam on a sludge basin fails. On the other hand, it is impos-sible to operate a mine without a functioning TSF, since operations would have to close down if the processing residue cannot be disposed of.

Mining companies were assisted in their search for a solution to this dilemma by the soft market conditions of the last few years. This made it possible for them to conclude lump-sum agreements with insurers which also covered losses from business interruption with-out property damage triggers. The limits for these have steadily increased as market conditions have become softer.

Individual risk assessment necessary

What is needed, however, is a different approach: risks must be correctly assessed if they are to be insured commensurately. This requires experts in the field of mining who can work closely together with the respective clients. Munich Re has developed a questionnaire for this purpose, which forms the basis for the individual risk assessment. This should help calculate the critical risk scenarios, based on which the scope of cover and limits of indemnity can then be determined. The relevant factors include the age of

1


MINING

conditions. Some of the important factors here are the material the dams are made from, the method in which they have been raised, and the properties of the soil on which they were built. In this evaluation pro-cess, Munich Re has the advantage that it has been supporting individual mining projects for decades and can draw on the expertise gained in this area.

the TSF, its probable service life, and the expected output of the operations. One exclusion criterion, for example, would be if the level of the sludge in the retention basin was just below the top of the dam. That would pose a substantial risk of the dam over-flowing in the next heavy rain event.

If the questionnaire produces no exclusion criteria, the next step is for the underwriters to individually determine the stability of the tailings dams based on geotechnical reports. This is because each of these structures is different due to the varying geological

Extraction of the waste rock

Sludge basin

Waste rock is ground down

Addition of water and chemical solution

Waste sludge

Built up and out

With the upstream design, the top layer of the wash residue is dried and used as the foundation for the next-higher earth barrage.

2

3


MINING

Conclusion

Lump-sum covers for risks emanating from tailings dams harbour substantial risks for insurers because clients are requesting ever-larger sums insured. Insurers will have no option but to separate mining from general property insurance, and to find individ-ual solutions in the same way as is customary in oil and gas business. In Corporate Insurance Partner, Munich Re has already adopted this approach with an experienced team of experts for various industries, and has also created a successful model for technical underwriting with its experienced mining team.

In order to get at valuable minerals, mining companies extract large quantities of rock. This first has to be ground down, and is then generally processed with the addition of chemical solutions. The lower the concen-tration of valuable materials, the higher the proportion of waste sludge that accrues. These tailings, as they are called, are some-times contaminated with chemicals and are pumped into large sludge basins. The basins are generally contained by earth works. Since the period during which a mine can be operated at a profit is usually extended by increases in raw material prices, the sludge basin frequently needs to be expanded. The companies manage this problem by successively raising the retain-ing dam.

Tailings dams are of varying stability, depending on their design. With the popu-lar upstream design, the upper layer of wash residue is dried and used as the foun-dation for the next-higher earth barrage (see the diagram on the left). This variant has the advantage that the dam can be erected with little effort and therefore at a low cost. However, earthworks like these are the least stable, particularly if raised too quickly, i.e. before the top layer of waste has dried sufficiently. Much more solid struc-tures are obtained if the original dam is raised centreline (2) or downstream (3).

OUR EXPERT

Günter Becker heads the section for mining risks at Corporate Insurance Partner, Munich Re. He has an industrial background as a mining engineer, and over 20 years’ expertise as an under-writer of mining [email protected]

Different types of tailings dams

Upstream Centreline Downstream

1

2

3

How sludge basins are formed

Built up and out

Built out

A relatively solid design is to raise the orig-inal dam centreline (2) or downstream (3).


FLOODING

On 1 June 2016, vast quantities of water swept through the Bavarian town of Simbach. Following a thunderstorm and torrential rain lasting several hours, parts of the Rottal-Inn district in southern Germany were completely inundated.

Flash floods are among the most dangerous of all natural hazards. Because structural preventive measures have only a very limited effect, flood insurance should be the method of choice to protect against loss.

Unexpected, destructive, deadly: Flash floods


FLOODING

Wolfgang Kron

A hot summer’s day: a stream runs murmuring in its bed. But then a thunderstorm moves in. All of a sudden, vast quantities of rain pour down from the skies, accompanied by thunder and lightning. The murmuring of the brook builds to a roar. In the space of a few minutes, the water level rises and the stream becomes wild and turbulent. Twigs, branches, entire trees and other debris, sometimes as big as cars, are swept along as the flash flood charges through. The water pours into cellars and underground garages and, not long after, into people’s houses. There is no time to rescue belongings. The priority here is to save your life.

People often underestimate the hazard posed by flash floods. In 2015, there were more than 120 events worldwide in which at least five people lost their lives, and over 95 in the first ten months of 2016. Many of these fatalities could have been avoided. While it may be perfectly understandable to want to rescue your car from an underground garage, it is an extremely risky undertaking during a flash flood. The water often arrives suddenly, sweeps everything before it, and develops incredible force. The potential material loss is simply not worth the danger involved. Since most vehicles are insured anyway, owners can expect to be compensated for the loss of their car.

Topography determines the flow path

Flash floods occur in conjunction with high precipita-tion intensity, in other words, when there is a lot of rain within a short period of time. They mainly occur as a result of thunderstorms, tropical cyclones or monsoon rains, but also with advective and orograph-ically intensified precipitation events.

They can occur virtually anywhere and there are thousands of them each year. Many have a moderate impact, while others are life-threatening and highly destructive. Virtually all events involve losses, because the water is unable to infiltrate the soil quickly enough or find designated run-off paths, even when the soil remains absorptive. As a result, it flows over the surface in an erratic fashion, rapidly concen-trating on flow paths determined by the topography. These can be watercourses and ditches, but also nat-ural troughs and roads. The result is rapidly growing flood waves that in next to no time can reach areas which have not even had any rain.

Besides torrents of water, flash floods can affect flat terrain in the form of standing water. Since there is no gradient, the water is unable to flow away quickly enough and therefore fills any depressions in the terrain. The height of such floodwaters can range from just a few centimetres to several metres. Under-passes, underground garages and cellars are at risk, as are basements in department stores and subway tunnels. The only positive side to this type of flash flood is that the water masses are stagnant, or only flow very slowly, which means they cannot develop much erosive power or carry considerable amounts of solids.

Debris flows and mudflows

The opposite is true with debris flows and mudflows. Here the water sweeps along with it vast quantities of solid materials, which can even constitute the majority of the flow in terms of volume (up to 60%). These types of flash flood are more destructive than just water. Driftwood can become trapped in narrow locations (e.g. under bridges) and block the flow, pro-ducing backwater.

In built-up areas, obstacles to the flow and the drain-age capacity of the stormwater drainage systems (sewage system) are a major factor. If the drainage capacity is exceeded, water streams out of the man-holes onto the road, and from there into buildings. If there are no backwater valves, water from the sewage system can also enter homes via house drains.

Because flash floods can occur anywhere, objectively speaking, all property is at risk. People are not even safe on the top of a hill, and even less so on a hillside. Although flash floods are invariably localised events, they can also affect much larger areas. This is fre-quently the case with tropical storms.

Precise forecasts virtually impossible

The total amount of rainfall is often a secondary factor. What is decisive is the “suddenness” of the pre-cipitation, and the rapid time sequence involved with flash floods. Specific warnings usually give just a few minutes’ notice. Early warnings of flash floods (sev-eral hours in advance) are based on little more than the general weather forecast. Although such fore-casts have become more reliable and precise in recent years, it will remain impossible in the foreseeable future to predict exactly where and when a flash flood will occur, or how extreme it will be. Flash floods are also much shorter in duration than river floods; most of the water disappears again after a few hours.


FLOODING

As a rule, effective protection requires permanent measures. Emergency measures (for example, clear-ing sections of buildings at risk) are not a viable alter-native given the very short warning periods. Never-theless, responding appropriately to flash floods can help to reduce losses, especially in extreme events where the structural measures mentioned no longer suffice.

Threat to life often underestimated

An onrushing stream can erode channels and railway embankments and undermine bridge pier and abut-ment foundations. Sediment and flotsam carried along by the flood pose an additional risk for people. The force of flowing water is also frequently under-estimated. Studies have shown that lighter people can no longer stay on their feet in water that is ankle-deep (0.2 m) and flows with a velocity of approxi-mately 3 m/s (11 km/h). In this instance, the flow velocity v (in m/s) multiplied by the water depth D (in m) is 0.6 m2/s. Almost everyone would be knocked over when v • D becomes greater than 1.3 m2/s, a value that is reached with 3 m/s and knee-deep water (0.45 m).

Driving a car through flowing waters can also prove to be a fatal mistake. If the water is more than a few deci metres deep, it is the stream, not the driver, that determines the direction of the vehicle. Once the vehi-cle is partially submerged, and perhaps subject to a stronger current, it becomes extremely difficult to escape unharmed. Many lives have been lost in such situations. In the USA, more lives are lost from flash floods than from any other natural hazard: around 60 fatalities per year, with more than half of the victims dying in their vehicles.

Generally speaking, areas on the windward side of mountains are more prone to flash floods, as moist air masses are forced upwards and produce more inten-sive rainfall. Naturally, water will flow much more powerfully on such sloping and steep terrain.

Structural measures of little practical use

It is not easy to make provisions against extreme flash floods, and the potential for loss reduction is very lim-ited. The main priority is clearly to save lives. Their rarity (in terms of a particular location), in conjunction with their great destructive force, virtually precludes meaningful structural precautions. Protective meas-ures such as those along rivers cannot be adopted over a wide area, either because they are too costly, or for aesthetic, structural or technical reasons.

The most important and most effective precaution is to avoid erecting a building in the immediate vicinity of potential flash flood flow paths. This includes watercourses of any size, depressions, hollows or terrain at the foot of a slope. In a new building, the ground floor, and all entrances to the building through which water can enter, should be raised a few deci-metres above ground level. It is also advisable to raise the cover plates on basement shafts, to place protec-tive walls around the outside steps leading to base-ments, and to incorporate flood barrier humps at the entrance to underground garages. While these offer little protection in extreme events, structures at least remain free of damage during moderate flash floods. Waterproof basement windows are a further helpful measure. Back-pressure flaps help prevent water entering from the public sewage system.

Noteworthy flash flood losses since 2000 Year Location Topography Cause Why noteworthy2000 Southern Alps Mountainous Adv/oro Losses: 8.5bn/480m (Italy, Switzerland) 2001 Houston (USA) Flat Trop. storm Large city. Losses: 6bn/3.6bn2001 Algeria Mountainous Adv/oro 750 fatalities. Losses: 300m/–2002 Central Europe Highlands Adv/oro Large area affected 2005 Mumbai (India) Flat Monsoon Megacity. Rain: 944 mm/24 h 1,150 fatalities. Losses: 5bn/770m2009 Jeddah (Saudi Arabia) Mountainous Thunderstorm >120 fatalities. Losses: 930m/200m2011 Copenhagen (Den.) Flat Thunderstorm Large city. Losses: 1.5bn/900m2012 Beijing (China) Flat Thunderstorm Megacity. 79 fatalities Losses: 1.8bn/160m2012 Krasnodar (Russia) Mountainous Thunderstorm 172 fatalities. Losses: 400m/32m2012 Northern Pakistan Mountainous Monsoon 455 fatalities. Losses: 2.5bn/–2013 Buenos Aires (Arg.) Flat Thunderstorm Rain: 300 mm/2 h. 89 fatalities Losses: 1.3bn/800m2013 Uttarakhand (India) Mountainous Monsoon 5,500 fatalities2015 Atacama (Chile) Flat, hilly Adv/oro Desert Losses: 1.5bn/500m2016 Southern Germany Hilly Thunderstorm Various locations Losses: 2.8bn/1.4bnAdv = advective; Oro = orographic; Losses in US$ (original): overall/insured

Flash flood events come in many shapes and forms. They can occur in any terrain and have various potential meteorological causes. As the table shows, the consequences can be dire.


FLOODING

Insurance is the solution of choice

Structural precautions and many other measures have only a limited effect in preventing losses from extreme flash floods and therefore make little eco-nomic sense in many cases. Consequently, this is an area of great interest for the insurance industry. And because structural measures are very expensive in relation to the monetary risk involved, an insurance policy offers the most efficient means of covering that risk. Since flash floods are not confined to waterways and can occur anywhere, they present little problem in terms of insurability, as there is no issue with adverse selection. The fact that there is a very low probability of any specific insured being affected by a flash flood also helps to keep the risk-commensurate premium at a modest, and therefore affordable, level.

The more people that buy insurance against flash floods in any given market, the greater the geographi-cal balancing of risks – a favourable situation for everyone involved. For the government and society, because they save significant amounts in tax-funded financial aid following such events. For the people affected, because they have a contractually agreed financial basis to replace or rebuild what is damaged, an important aspect from a psychological perspective too. And for the insurance industry, because it improves premium income.

This is why authorities in many countries have launched extensive campaigns in cooperation with the insurance industry. These are intended to convince homeowners, businesses and companies of the real advantages of flood insurance and therefore increase insurance density. Some of the campaigns have been very successful. The Organisation for Economic Co-operation and Development (OECD) has also backed this solution and is promoting it worldwide.

Climate change exacerbating the problem

In a warmer climate, the potential water vapour con-tent in the atmosphere will increase by 7% for each rise in temperature of 1°C. Evaporation from the world’s oceans climbs in tandem with the higher tem-peratures of surface water. In the future, these pro-cesses will not only generally increase the quantities of precipitation, they will also lead to more frequent extreme rainfall from local storms. In particular, the more intense convection over heavily built-up urban areas with high concentrations of values may lead to severe and extremely abrupt local weather events.

It is therefore highly probable in future that we may expect more frequent and more intensive flash floods to occur. The risks involved in loss events like these will also rise because of the growing value of assets. At the same time, we cannot assume that adaptation measures will be able to compensate for these devel-opments. If at all, this will only happen over the very long term as a result of widespread structural adapta-tion of those buildings that might be affected.

In light of this, a greater awareness of the risks posed by flash floods must be created, raised and main-tained at all levels: in the government, among those at risk, and in the insurance industry. While it is impos-sible to prevent extreme flash floods, many losses can be avoided by taking relatively simple structural and organisational measures. Insurance can take care of the rest.

OUR EXPERT

Wolfgang Kron is a hydraulic engineer and senior consultant in Geo Risks Research. He is responsible for issues relating to water as a natural [email protected]

Minimum protection against rainwater entering the building.

Elevated buildings prevent major losses resulting from moderate events, but not from extreme events.


PROPERTY

Michael Gibbons

In late 2003, a large shopping centre on England’s south coast opened for business after two years of construction at a reported cost of approximately £65 million. Yet even before the grand opening, prob-lems had begun to emerge: in the development’s 3,000-space, multi-level car park, structural concrete beams and supports had begun to crack and flake. The affected areas were cordoned off and temporary supports and netting put in place, presumably in the hope of achieving a speedy remedial solution. How-ever, the cracking and flaking concrete worsened over the next two years, necessitating closure of the entire shopping centre and car park for several weeks shortly before the busy Christmas season in 2005.

It was reported that the design of the concrete beams and supports was at fault. Drawn-out negotiations between the owner, contractor, tenants and insurers regarding their respective rights and obligations ensued. In December 2014, 11 years after original completion of the project, local authorities approved a plan to demolish and rebuild the car park in five phases over the course of four years.

In cases where insured physical damage arises from construction defects, project insurers clearly have an important role to play. The loss, its purported causes and its long tail, highlight the effect of the complex web of contracts, insurances and stakeholders that often characterise large construction projects. In this case, it appears that the parties resolved their differ-ences behind closed doors and did not turn to the courts, leaving the details of the final agreement to the imagination. At the same time, this loss demon-strates many aspects that deserve the attention of project insurers when conducting risk assessments, particularly in relation to how the policy should respond to widespread damage across supporting infrastructure resulting from construction defects.

Crumbling concrete

The period of cover is fundamental

In cases such as this, with the gravity of damage gradually emerging, a clear definition of the coverage period of the project policy is essential. Without clearly defined time frames, it would be impossible to ascertain with any certainty which of the project, property or liability policies respond to which occa-sions of physical damage and/or their directly result-ing economic losses. Frequently, the period of cover in standard project policies focuses more on the practi-cal elements or preconditions for handover, including general concepts that are open to interpretation such as practical completion, final completion or handover.

How do construction defects become insured losses? The example of a shopping mall in southern England shows just how complex claims settlement can be and what pitfalls lie in wait for insurers.


PROPERTY

ally contained exclusions for damage caused by defects but write back ensuing losses, which are losses to other parts of the insured property that fol-low the original damage and are often required to arise from a separate peril. In this case, it is doubtful whether US-style write-back would have been trig-gered due to the lack of an apparent ensuing loss to non-defective property.

Different covers and exclusions

In the London market and elsewhere, two suites of wordings known as the DE and LEG clauses have become a standard feature of project policies, offering differing levels of exclusion (or coverage depending on which way they are viewed). The clauses differ but generally begin by excluding coverage for damage caused by defects, or costs they render necessary, fol-lowed by a narrowing of the exclusion to only exclude, for example, betterment.

Crucially, the clauses attempt to draw a line between defect and damage by explicitly providing that defec-tive property is not damaged merely due to the exist-ence of the defect. In addition, there is the argument that damage “caused by” a defect requires the damage to be something different from the defect itself, thereby excluding mere manifestations of defects. The DE clauses in most cases write back coverage for “non-defective” property, requiring a distinction to be made as to what is “defective” property (although the DE5 betterment clause may or may not contain this). The LEG clauses do not require such a distinction and focus on the border between defect and damage.

In the car park, were some cracks mere manifesta-tions of a defect? Had others developed to an extent that they were clearly damaged? Is the whole car park “defective property” as a result of the design, despite perhaps being correctly installed by the subcon-tractor, but to faulty specifications? At the time of dis-covery of the first cracks was the clock stopped in that the rest of the property was merely defective and had not yet suffered damage? Are insurers responsible only for remedying the cracked areas themselves and not replacing the entire car park? These questions, coupled with those surrounding the period of insur-ance mentioned above, likely occupied a prominent place in the discussions between project insurers and the car park’s contractor.

It further complicates matters when only one element of a larger project is affected by construction defects, as appears to have been the case here. The final com-pletions or handovers, as defined, may have occurred long after the complex went into operation. This inevi-tably raises questions on the extent to which the pro-ject policy will respond to ongoing losses. There are, however, possibilities to narrow the scope for dis-putes. One way is to ensure that the policy contains hybrid definitions of the period of cover that combine the general concepts mentioned above with finite time periods as a fall-back. On a general level, under-writers are urged to explore the often standardised project policy wordings and verify whether they require manuscript amendments which better fit the characteristics of the project being insured and are flexible enough to apply as predictably as possible to unforeseen changes.

Damage vs. defect

Cracking beams and flaking concrete raise questions regarding the legal separation of defect from damage. When does cracking constitute a mere manifestation of a defect? When does it cross the line to damage? Can a snapshot taken at the time of discovery define the extent to which insurers are liable for the dam-aged areas only? Which defect clause is present in the policy to attempt to draw the line?

Traditionally, policies have not unequivocally defined the concept of damage, leaving the courts to forge their own legal definitions. In many jurisdictions, there is a general consensus that damage requires a physical alteration or change that diminishes the value or usefulness of the insured property. At face value, the cracking and flaking in the concrete would appear to satisfy this, but the enquiry does not end there.

Project insurers are generally reluctant to take on a construction company’s business risk of having to rectify own defects, and the older jurisprudence on the manifestation of inherent defects bears this out. For these reasons, clauses have been developed to attempt to draw a line between what is considered insurable risk and what is left as the contractor’s busi-ness risk. In the US, for example, policies have gener-

The damage to the car park had a major impact on business at the shopping centre. Where there is advance loss of profit cover for the principal, prolonged negotiations or the intervention of local author ities regard-ing approvals, the amount of lost business can be exacerbated.


PROPERTY

Repair, replacement and betterment

It is not clear how much debate took place on whether the car park could be repaired in situ. If there was such a debate, project insurers were likely to have been heavily involved. Insurance policies are consid-ered contracts of indemnity. In other words, insurers will pay to return the insured property to its condition prior to the loss. This concept seems simple enough, but runs into difficulty when the property was defec-tive to begin with, as rectification or replacement can necessitate a completely different design and ma -terials. Where this is the case, determining the extent and actual costs of improvements or “betterments” is nearly impossible.

As mentioned above, there is also the issue as to what insurers are actually responding to: the actual in stances of cracks and their hypothetical repair, or replacement of the entire car park in which the dam-age permeates the entire structure. To overcome these difficulties, a hypothetical repair or replacement is often used to determine the amount indemnifiable under the policy. It is not surprising that these discus-sions can take time, as the parties interact in the domain of the theoretical. Perhaps the introduction of standard clauses on the hypothetical repair process could minimise the scope for disputes.

Cover of economic losses

The damage to the car park had an appreciable effect on the business being conducted at the shopping cen-tre. Where there is advance loss of profit coverage for the principal, prolonged negotiations or the interven-tion of local authorities regarding approvals, the amount of lost business can be exacerbated. In the case in question, the temporary measures appeared to have allowed business to continue relatively un -interrupted, with the exception of the several weeks of closure during the busy December period in 2005. Where a dispute between the principal and contractor is ongoing and affecting progress, insurers are right to limit the indemnity for economic losses to those necessarily incurred to the extent this is supported by the wording of the policy. For this reason, under-writers would be wise to understand how the advance loss of profit section would respond in such a situa-tion and whether the issue of ongoing dispute between parties other than the project insurers needs to be specifically addressed.

Also, the ongoing tension between an open definition of damage in the insuring clause, fortuitous physical damage and the concept of guaranteeing the fitness of delivered work are clearly felt here. It remains to be seen whether project insurers and their insureds can find the balance between insurable and entrepreneur-ial risks. In order to do so, it will be be necessary to more clearly define and examine the concept of insur-able damage, or even whether differing defect cover (or exclusions) can be applied to different aspects of the project.

Temporary remedial measures

The principal and certain experts were reportedly convinced that demolishing and rebuilding the car park was the only viable permanent solution to the design problems. During the decade of discussions with various stakeholders that preceded agreement on this position, significant costs were clearly in -curred to prop up the failing structure and continually assess its viability. An issue for project insurers would have been the extent to which such temporary meas-ures were covered under the project policy, and spe-cifically which heads of damage they would fall under.

Project policies often specifically cover and sublimit temporary measures before a definitive solution is found. The policy period definition, including the beginning and end of extended maintenance cover-age, may also have been relevant here. Difficult ques-tions arise, however, when the principal and the main contractor are in disagreement as to what remedies the main contract offers for failure to provide the agreed structure and ultimately who must carry the cost for the failure. Where these discussions artifi-cially prolong the ultimate solution, insurers may incur a larger loss for temporary measures or expedit-ing expenses and have arguments that proportions of these expenses are sublimited or not covered at all. Time limits, sublimits and specific duties to mitigate loss can be of great value in finding certainty in these situations.


PROPERTY

Avoid double indemnity

Indications are that two different subcontractors were responsible for the design and building of the car park. Project policies will often define the “insured” as all those parties intervening on the site, meaning that subrogation is not generally available for project insurers against the negligent subcontractors. There are good reasons for this, as fixing the project can be delayed by suits and counter-suits between contrac-tors and subcontractors. Despite this, it can be impor-tant for project insurers to understand who has been held responsible and what measures are being taken against those parties. For example, a supplier of defective material may not have the benefit of the pro-ject policy due to a lack of insurable interest where title to the goods was passed to a subcontractor upon delivery. It may also be worth verifying how con-tractual damages, and corresponding recoveries from liability insurers, have been claimed to avoid double indemnity.

Conclusion

The car park saga is not the first drawn-out construc-tion claim involving questions of insured damage aris-ing from defective work, and it will certainly not be the last. It is important, however, for insurers and insureds to take lessons from these cases and con-sider solutions that specifically deal with damage, or a lack of it, arising from defective work, whether sud-den or gradual. The main lesson from defect claims is perhaps that standard wordings and even the spe-cifically designed defect exclusions leave too much room for discussion and are seldom adjusted to deal with the peculiarities of the project in question. Re -designing a project cover to better deal with cases of damage resulting from defects goes to the heart of fundamental issues: the purpose of insurance in cov-ering fortuitous loss and not providing performance guarantees, the nature of indemnity and the business efficacy of comprehensive and clear risk sharing.

OUR EXPERT

Michael Gibbons is a lawyer specialising in major industrial and liability claims at Munich Re. mgibbons @munichre.com


COLUMN

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

Fort McMurray: Claims handling challenges

Six months after the devastating wildfires that tore through the Canadian province of Alberta in the spring of 2016, the rebuild of Fort McMurray is in full swing. Residents are now returning to the town that was largely destroyed by the fires, and reconstruction work has begun. Yet a number of factors are prevent-ing claims from being settled quickly.

For one, not all former residents of Fort McMurray are expected to return home. The tar sands industry, one of the major employers in the region, had been suffering as a result of low oil prices even before the wild-fires hit. Because of this, real estate prices in Fort McMurray had already started to drop. Those residents who do not return will be claiming reim-bursement of the current market value of their homes instead of hav-ing them rebuilt. However, calculat-ing this market value is complicated by price erosion prior to the fires. In many cases it will be difficult to determine the extent to which the current low prices are due to the dis-aster as opposed to simply being a continuation of the longer-term trend. To make matters worse for the former residents, the resulting mar-ket value may well be below the price they originally paid for their homes.

Other residents do want to rebuild their homes in the town, just no longer on the floodplains of the river or in areas contaminated by the fire. As a rule, rebuilding on a different site is more expensive. Despite this, the increased costs are usually cov-ered, provided the move is the result of mandatory official regulations. Things look different, however, when claimants decide of their own accord to build on a different site. Additional costs will then only be reimbursed in very special cases where there are humanitarian reasons for doing so. Disputes about whether such rea-sons exist can significantly delay reconstruction.

The fact that parts of Fort McMurray have been temporarily closed off by officials due to contaminated ash is causing additional delays. Moreover, local authorities have been faced with significant challenges in clear-ing the debris, examining and issuing planning permissions, and setting up the infrastructure necessary for reconstruction to begin. In many cases, the result has been that con-struction could not be completed before winter. Since work is usually impossible while the ground is fro-zen, many claims will not be settled until well into next year.

All in all, the Fort McMurray wildfires demonstrate once again the impor-tance of close cooperation among all those involved following a natural disaster. Getting claims settled quickly and avoiding unnecessary costs after such major losses is only possible if local and national author-ities, insurers and aid organisations work together seamlessly.

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Münchener Rückversicherungs-Gesellschaft (Munich Reinsurance Company) is a reinsu-rance 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 Reinsu-rance 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

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