6 Overlooked Real Estate Risks
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Part II in a Series: Lessons for Flood Risk Management
(Read Part I here)
A life insurer is considering policies for two men, both 35 years old and similarly overweight based on standard height and weight charts. Upon initial assessment, they present similar risk, meriting similar premiums. But as clinical data comes in, it becomes clear that while they weigh about the same, one man is an athlete with significant muscle mass and low cholesterol; the other carries more weight around his mid-section and has high cholesterol, making him a much greater risk. The two policies now carry significantly different premiums.
Now consider two inland flood underwriters assessing two similar looking multi-story structures. Common practice will typically examine (1) where each building sits on a FEMA flood map (which categorizes wide swaths of land based on flood hazard) and (2) what, if any, past flood losses the building has seen. In this case both buildings are categorized as being in Zone “X” by FEMA, and both have little in the way of past losses.
If the property underwriter stops there, the risks appear very much the same. But much of the story will remain untold. As with the life insurance underwriting scenario, more relevant data specific to the buildings can create pivotal differentiation between risks and reduce surprises when the flood event occurs.
Flood Zone ≠ Flood Risk
Two buildings may fall into the same large flood zone, but could react quite differently in a flood, resulting in markedly different losses and recovery times.
Photo credit: Julie Dermansky
Traditional flood models measure the potential flood depth (for each return period) at a building’s location relative to its ground elevation. However, the elevation level of a building’s finished first floor can vary significantly from the underlying ground level. This distinction is important in determining how much flooding could be expected in a particular building and can make two structures in the same large flood zone markedly different flood risks.
Additionally, what’s inside the building – and where – matters too. One building may have a basement, while another may not. One may house critical mechanical, electrical, and plumbing (MEP) systems in the basement. The other may house these systems on higher floors. All else being similar between the two buildings, the one with MEP systems on higher floors will likely fare much better in a flooding event.
Hurricane Sandy underscored the massive damage, particularly time element losses, that can result when floodwaters, and more so saltwater, swamp MEP systems. Major city skyscrapers were taken out of commission for months in some cases due to basement and ground floor flooding that would have been relatively inconsequential – had it not been for the MEP systems housed there.
More recently, when Hurricane Harvey dropped more than 40 inches of rainfall in Houston, many commercial assets suffered significant loss, primarily business interruption, due to flooding of underground parking lots and basements. One particular asset was spared major structural damage, but floodwaters flowed into its underground parking lot and the basement — which housed mechanical and electrical equipment. Despite dodging major structural damage, the facility is not expected to resume normal operations until nearly a year after the event – a costly interruption that would have been greatly minimized if critical systems were above grade.
While elevating the habitable space for an entire structure can minimize potential damages, such a move is costly for many existing commercial buildings. It is, however, observed at industrial facilities where critical assets, such as MCCs, can be entirely elevated. Moving critical systems and higher value items from a lower level floor to a higher one is a more economical way to mitigate potential flood damage and help ensure business continuity for conventional commercial buildings.
Awareness = Avoidance
At BHSI, we believe that when customers are informed on the issues that can impact inland (or hurricane induced) flood exposure, they are better positioned to manage the risk and avoid unanticipated large losses. When we work closely with our customers to assess flood risks, they can be confident that they are receiving the best possible pricing and limits for their particular exposure.
Our flood insurance pricing algorithm is built to differentiate flood risk based on how high a building’s finished floor is relative to the adjacent ground (i.e., bare ground level versus finished floor level.) We always inquire whether a location has a basement; the answer can result in a significantly different premium for a customer. We also differentiate flood risks by examining each building’s floor-by-floor TIV distribution. This allows us to give credit (or premium discounts) to buildings that have critical systems located on higher floors.
It’s all part of our commitment to help customers mitigate their flood losses and ensure that they secure the right flood coverage for their risk, at the right price, year after year.
To learn more, visit https://bhspecialty.com/.
This article was produced by Berkshire Hathaway Specialty Insurance and not the Risk & Insurance® editorial team.
Lingering hopes that large-scale cyber attack might be a once-in-a-lifetime event were dashed last year. The four-day WannaCry ransomware strike in May across 150 countries targeted more than 300,000 computers running Microsoft Windows. A month later, NotPetya hit multinationals ranging from Danish shipping firm Maersk to pharmaceutical giant Merck.
Maersk’s chairman, Jim Hagemann Snabe, revealed at this year’s Davos summit that NotPetya shut down most of the group’s network. While it was replacing 45,000 PCs and 4,000 servers, freight transactions had to be completed manually. The combined cost of business interruption and rebuilding the system was up to $300 million.
Merck’s CFO Robert Davis told investors that its NotPetya bill included $135 million in lost sales plus $175 million in additional costs. Fellow victims FedEx and French construction group Saint Gobain reported similar financial hits from lost business and clean-up costs.
The fast-expanding world of cryptocurrencies is also increasingly targeted. Echoes of the 2014 hack that triggered the collapse of Bitcoin exchange Mt. Gox emerged this January when Japanese cryptocurrency exchange Coincheck pledged to repay customers $500 million stolen by hackers in a cyber heist.
The size and scope of last summer’s attacks accelerated discussions on both sides of the Atlantic, between risk managers and brokers seeking more comprehensive cyber business interruption insurance products.
It also recently persuaded Pool Re, the UK’s terrorism reinsurance pool set up 25 years ago after bomb attacks in London’s financial quarter, to announce that from April its cover will extend to include material damage and direct BI resulting from acts of terrorism using a cyber trigger.
“The threat from a cyber attack is evident, and businesses have become increasingly concerned about the extensive repercussions these types of attacks could have on them,” said Pool Re’s chief, Julian Enoizi. “This was a clear gap in our coverage which left businesses potentially exposed.”
Development of cyber BI insurance to date reveals something of a transatlantic divide, said Hans Allnutt, head of cyber and data risk at international law firm DAC Beachcroft. The first U.S. mainstream cyber insurance products were a response to California’s data security and breach notification legislation in 2003.
Of more recent vintage, Europe’s first cyber policies’ wordings initially reflected U.S. wordings, with the focus on data breaches. “So underwriters had to innovate and push hard on other areas of cyber cover, particularly BI and cyber crimes such as ransomware demands and distributed denial of service attacks,” said Allnut.
“Europe now has regulation coming up this May in the form of the General Data Protection Regulation across the EU, so the focus has essentially come full circle.”
Cyber insurance policies also provide a degree of cover for BI resulting from one of three main triggers, said Jimaan Sané, technology underwriter for specialist insurer Beazley. “First is the malicious-type trigger, where the system goes down or an outage results directly from a hack.
“Second is any incident involving negligence — the so-called ‘fat finger’ — where human or operational error causes a loss or there has been failure to upgrade or maintain the system. Third is any broader unplanned outage that hits either the company or anyone on which it relies, such as a service provider.”
The importance of cyber BI covering negligent acts in addition to phishing and social engineering attacks was underlined by last May’s IT meltdown suffered by airline BA.
This was triggered by a technician who switched off and then reconnected the power supply to BA’s data center, physically damaging servers and distribution panels.
Compensating delayed passengers cost the company around $80 million, although the bill fell short of the $461 million operational error loss suffered by Knight Capital in 2012, which pushed it close to bankruptcy and decimated its share price.
Awareness of potentially huge BI losses resulting from cyber attack was heightened by well-publicized hacks suffered by retailers such as Target and Home Depot in late 2013 and 2014, said Matt Kletzli, SVP and head of management liability at Victor O. Schinnerer & Company.
However, the incidents didn’t initially alarm smaller, less high-profile businesses, which assumed they wouldn’t be similarly targeted.
“But perpetrators employing bots and ransomware set out to expose any firms with weaknesses in their system,” he added.
“Suddenly, smaller firms found that even when they weren’t themselves targeted, many of those around them had fallen victim to attacks. Awareness started to lift, as the focus moved from large, headline-grabbing attacks to more everyday incidents.”
Publications such as the Director’s Handbook of Cyber-Risk Oversight, issued by the National Association of Corporate Directors and the Internet Security Alliance fixed the issue firmly on boardroom agendas.
“What’s possibly of greater concern is the sheer number of different businesses that can be affected by a single cyber attack and the cost of getting them up and running again quickly.” — Jimaan Sané, technology underwriter, Beazley
Reformed ex-hackers were recruited to offer board members their insights into the most vulnerable points across the company’s systems — in much the same way as forger-turned-security-expert Frank Abagnale Jr., subject of the Spielberg biopic “Catch Me If You Can.”
There also has been an increasing focus on systemic risk related to cyber attacks. Allnutt cites “Business Blackout,” a July 2015 study by Lloyd’s of London and the Cambridge University’s Centre for Risk Studies.
This detailed analysis of what could result from a major cyber attack on America’s power grid predicted a cost to the U.S. economy of hundreds of billions and claims to the insurance industry totalling upwards of $21.4 billion.
Lloyd’s described the scenario as both “technologically possible” and “improbable.” Three years on, however, it appears less fanciful.
In January, the head of the UK’s National Cyber Security Centre, Ciaran Martin, said the UK had been fortunate in so far averting a ‘category one’ attack. A C1 would shut down the financial services sector on which the country relies heavily and other vital infrastructure. It was a case of “when, not if” such an assault would be launched, he warned.
Despite daunting potential financial losses, pioneers of cyber BI insurance such as Beazley, Zurich, AIG and Chubb now see new competitors in the market. Capacity is growing steadily, said Allnutt.
“Not only is cyber insurance a new product, it also offers a new source of premium revenue so there is considerable appetite for taking it on,” he added. “However, whilst most insurers are comfortable with the liability aspects of cyber risk; not all insurers are covering loss of income.”
Kletzli added that available products include several well-written, broad cyber coverages that take into account all types of potential cyber attack and don’t attempt to limit cover by applying a narrow definition of BI loss.
“It’s a rapidly-evolving coverage — and needs to be — in order to keep up with changing circumstances,” he said.
The good news, according to a Fitch report, is that the cyber loss ratio has been reduced to 45 percent as more companies buy cover and the market continues to expand, bringing down the size of the average loss.
“The bad news is that at cyber events, talk is regularly turning to ‘what will be the Hurricane Katrina-type event’ for the cyber market?” said Kletzli.
“What’s worse is that with hurricane losses, underwriters know which regions are most at risk, whereas cyber is a global risk and insurers potentially face huge aggregation.”
Nor is the advent of robotics and artificial intelligence (AI) necessarily cause for optimism. As Allnutt noted, while AI can potentially be used to decode malware, by the same token sophisticated criminals can employ it to develop new malware and escalate the ‘computer versus computer’ battle.
“The trend towards greater automation of business means that we can expect more incidents involving loss of income,” said Sané. “What’s possibly of greater concern is the sheer number of different businesses that can be affected by a single cyber attack and the cost of getting them up and running again quickly.
“We’re likely to see a growing number of attacks where the aim is to cause disruption, rather than demand a ransom.
“The paradox of cyber BI is that the more sophisticated your organization and the more it embraces automation, the bigger the potential impact when an outage does occur. Those old-fashioned businesses still reliant on traditional processes generally aren’t affected as much and incur smaller losses.” &