Bad Things Do Happen to Good Insurance Customers
How hidden gaps in coverage can crater an organization’s global property protections and business resilience.
Insurance is a critical tool for managing risk—when it works. Let the insurance buyer beware, however, that it doesn’t always work equally well everywhere. Coverage problems regularly surprise multinational companies that require property insurance in remote locales around the world. Cynics have compared global property insurance to cell phone service: Depending on where you are, your experience may vary. By a lot.
Worse, bad choices in global insurance coverage may remain hidden until a remote location suffers a fire, flood, hurricane, earthquake, cyberattack, or other catastrophe. Only in such a crisis scenario does the company discover how many strings are attached to the insurer’s promise to pay. The insured business may unexpectedly face not only coverage gaps, but also unanticipated taxes, regulatory scrutiny, delays in claims payments—and, ultimately, extended business interruptions.
These problems can often stem from a conventional global insurance structure called the “controlled master program,” under which a corporate insurance client signs a master contract with an insurer and the insurer arranges coverage for the company in each country where the company operates. Coverage under such a contract may vary from country to country. The result may be a mishmash of conditions and limits in coverage across the company’s different locations—and, potentially, nasty surprises if the company suffers a loss in a remote country.
Well, consider the following scenario: An American company has a plant in Southeast Asia that burns down, incurring a US$150 million loss. The company’s local policy in Asia covers only US$100 million, because when the policy was purchased, the local insurer had insufficient capacity to cover the full value of the plant. In other words, the local insurer didn’t have enough capital to insure the plant for US$150 million. The company’s primary insurer may then agree that its master policy should cover the balance. However, settling that claim would require a US$50 million cash transfer from the insurance company’s U.S. headquarters to the insured’s affected overseas operation.
Here are some problems that such a cross-border transfer could create:
• Unexpected taxation. Cross-border transfers might be subject to taxes levied in the receiving jurisdiction since the transfers might be considered unearned income. By contrast, the portion of the claim settled locally—US$100 million in this case—is legally considered to be an insurance payment, so it doesn’t get taxed. A local policy with broader coverage and higher limits would have been a better idea, because in the event of a US $150 million loss, the entire US$150 million settlement would be tax-exempt.
• Regulatory scrutiny. Major cross-border funds transfers are likely to catch the attention of regulators, who may be concerned about foreign exchange advantages accruing to one party or the other, and about having their jurisdiction flooded with foreign currency. This scrutiny could complicate the transaction.
• Delays. There are two types of delays that a multinational might face in receiving insurance payouts abroad. The first is the normal red tape that arises as the primary and local insurers determine who will cover which portion of a claim, and at what amount—decisions that are often disputed and take time to resolve.
The second type is a third-party delay, such as the cap that a receiving country’s central bank may enforce on large cross-border transfers. If the receiving country’s central bank imposes a transfer cap of US$5 million per month, for example, a US$50 million cross-border settlement will take the primary insurer 10 months to execute, assuming the insurer doesn’t need to transfer any other funds from the U.S. to the same country during that time. Thus, the affected operation may lay idle for nearly a year, which could cause massive disruptions in the company’s order-to-cash cycle in the region and might permanently reduce its market share.
‘Pay Me Here, Now, and Completely’
These expensive and time-consuming hassles are just a few of the potential problems that a multinational company may face after suffering an insured loss overseas.
The best case in such a scenario would be for the insurer to pay claims fully, immediately, and at the local level. However, paying fully for a major loss requires the local insurer to be well-capitalized—that is, to have enough cash on hand to cover big potential losses. In our example of a manufacturing-facility fire in Southeast Asia, the local insurer did not have sufficient capacity to pay in full.
Another potential cause of a coverage shortfall is for the insurer to inadvertently underinsure the company’s remote operations. For example, a factory that would take US$4 million to rebuild if destroyed by an earthquake may actually be worth US$20 million to its parent company because of the pivotal role it plays in the parent’s supply chain. It would be prudent for the parent company to insure the factory for US$20 million, to cover the full extent of losses should a disaster take the factory offline for an extended period of time.
Occasionally, a local policy may have a gap in coverage that leaves entire events uncovered. Some countries’ insurance regulators limit property insurance to a list of specific events, such as: fire, lightning strike, explosion, and aerial impact. In the event of an earthquake, a foreign company would have to rely on its master policy to pay for the entire loss, with all the attendant delays and tax penalties. What’s challenging for the multinationals buying insurance abroad is that these problems—coverage gaps, red tape, disputes, delays, and tax burdens—typically do not become apparent until long after the insurance contract is signed.
Reverse-Engineer the Process
How can a multinational CFO or treasurer ensure that any local losses will be paid fully, locally, and immediately, and that the transfers will be classified as insurance payments and not unearned income? By scrutinizing every local policy that the company purchases and reverse-engineering a hypothetical claim.
Here are seven steps treasury and finance teams can take along the way to better understand coverage in each country where their company does business, and to help avert problems with claims.
1. Identify your company’s critical operations. Conduct a business impact analysis with key managers—and suppliers, if appropriate—and look at all your properties collectively. Determine which are the most critical to your business continuity, production, and profit.
2. Sort properties by vulnerability. Review the resulting list of critical operations, and identify the properties that are most vulnerable to a catastrophe, such as fire, flood, wind, earthquake, cyberattack, or failure of large industrial equipment.
Examine the worst-case scenarios. Engineers, insurers, and facilities and risk management teams should assess fire and natural hazard protection with both eyes-on inspections and the help of flood, wind, and earthquake maps. Data is also available on the failure histories of every major model of industrial equipment, and your risk manager can look at each machine’s age, operating history, safety conditions, and operator training.
Next, look beyond the brick and mortar to the total financial loss your business could incur. In addition to the costs of rebuilding and potential lost sales, which are typically covered by insurance, a disaster abroad could create instability in the supply chain. Your organization could also lose market share and growth opportunities, or it could suffer from negative investor sentiment, leading to a rising cost of capital.
Finally, take a broader view of the business risk inherent in the countries where your properties are located. Governments, non-governmental organizations (NGOs), and some private companies rate geographies on risk/resilience factors such as natural hazards, fire risk management capabilities, building code quality, building code enforcement, infrastructure quality, economic strength, cyber risk, corruption, supply chain visibility, oil dependence, corporate governance, and more. (FM Global aggregates 12 risk/resilience drivers for 130 countries and territories here.)
In short, understand the full extent of your risk.
3. Shore up as many vulnerabilities as you can. When you fully understand your vulnerabilities and the true role of each property in your global business performance, prioritize your investment in risk mitigation according to the likelihood and severity of potential losses.
On a property-by-property level, that can mean securing roofs, installing automatic fire sprinklers, investing in flood barriers, and patching software. Pay special attention to digital threats. Sweep offices for physical cyber vulnerabilities (e.g., unlocked doors and unattended laptops) and address shortcomings in your information governance, IT security, insider threat management, disaster recovery, and networked industrial controls.
4. Scrutinize coverage options. In each country and for each prospective insurer, go over coverage details. Make sure you understand all exclusions, including excluded disruption types and causes, duration limits, dollar limits, etc.
Warning: It’s common for local insurance carriers to overlook threats that have not yet significantly affected their geographies, even if those threats could have a future impact. For example, if a small country hasn’t experienced any terrorism, it may exclude this threat from standard insurance policies.
Another painful and common exclusion is what we call “fire following.” Let’s say a cyberattack causes a turbine to speed up and break, and that triggers a fire. Some policies will cover the cyberattack and equipment failure but not the fire following it. The fire can be more expensive than the triggering event, so it’s best to know whether this type of event is covered. The goal is to learn exactly what you’re buying.
5. Resist the controlled master policy, if possible. If you can find it, choose a standard high-capacity underlying policy that’s replicated verbatim in every country where you need coverage. Ask each local insurer to prove that it has enough capital to pay any foreseeable claim, and pay it—locally—to avoid unnecessary taxes and delays.
6. Evaluate the capacity of your primary insurer. As part of your due diligence on your primary global insurer, challenge the provider to show it has enough capacity (often through reinsurance). Start by confirming the provider’s ratings from A.M. Best, Fitch, Moody’s, and S&P. Understand that capacity is largely a function of reinsurance treaties. Most prominent companies will have best-in-class treaties with the world’s major reinsurers.
Proof that the insurer has adequate capacity doesn’t mean your main corporate carrier will stand behind local policies in every country, however, nor that every local insurer will be able to pay a claim. Confirm in writing that your carrier guarantees the financial security of its entire worldwide network of insurance partners. Locally affiliated partners should provide the same service as if they were licensed by the primary insurance carrier.
7. Then, and only then, sign the insurance contract. These due-diligence steps are time-consuming, and corporate CFOs and treasurers may be tempted to economize. However, taking shortcuts in shopping for global insurance might jeopardize your resilience.
Many insurers can’t satisfy all the requirements for robust global coverage—which involve extensive engineering expertise, analytical capabilities, commitment, time, money, and acceptance of risk. Moreover, some insurers simply value loss prevention more than others.
Full-service global loss prevention goes beyond buying capacity in the local market, engineering a risk, or paying a claim. It’s putting clients in a position where they actually understand their risk. It’s helping them to be confident that their risk is managed on a global scale. This confidence is a lot different from merely buying insurance coverage for an undetermined event.
Multinational insurance is complex, but corporate insurance buyers can take steps to make the process work in their favor. Corporate treasury and finance executives need to beware of the pitfalls of global property insurance, understand what they are buying, and take their due diligence very seriously. Then they can be confident that when they do suffer a loss, their insurance will perform as expected.