Energy Industry

‘Among the Largest Catastrophe Losses in Canadian History’

Business interruption losses from the Alberta fire will be "massive" according to experts.
By: | May 12, 2016 • 4 min read

About 2,400 structures in and around Fort McMurray lie in ruins in the middle of 700 charred square miles of northern Alberta.

The oil sands boom town, once known as “Fort Make Money,” is now going to cost money — at least $4 billion (C$5 billion) by early estimates — to rebuild after a monster wildfire swept around and through parts of town the first week of May.

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The immediate insurance question is not the property loss in town; that is quite straightforward.

Rather, it is the length of the oil sands outage and two stages of business-interruption (BI) claims: immediate losses for the time out of operation, as well as possible contingent losses for refiners that rely on the oil sands for raw materials.

At the peak of the fire, 1 million barrels a day of oil sands production was taken out of service — about 40 percent of total output, and roughly one-quarter of all Canadian oil production.

Some operations have already airlifted in skeleton crews to begin safety checks in advance of resuming operations, but the bulk of production is expected to remain out of service for several weeks, if not a month or more.

The wildfires “will be a huge BI event,” said Paul Cutbush, senior vice president catastrophe management at Aon Benfield Analytics in Toronto.

“Even with no damage we will have to see when workers are allowed to come back — and then how many and how soon. A lot of these facilities have been used for evacuations, a goodwill gesture. A great deal will depend on manuscript wording for each policy.”

Waiting periods for BI claims will likely not be as large a factor as in past large losses, Cutbush noted. “It used to be that 90 days was standard. Today, that is shorter, 60 days, maybe even just 30.”

It may take longer than that to get claims sorted, because the size and scope of the fire has presented so many new unknowns.

“The biggest thing is getting people back to work,” said Cutbush, but they need places to live and shop.

“It is our understanding that a lot of the housing in the area was rental or temporary housing for oil sands and services workers.” That means not just property claims for the assets themselves, but lost value from their revenue.

Utilities and infrastructure also have to be inspected, repaired or replaced.

“There is also the issue of ash-contaminated water,” said Cutbush. “The Athabasca River is used for injection water, but ash can make the water caustic and not suitable for use without treatment.”Canadian Disaster Losses chart

The fires continue to rage uncontrolled, but are now in the deep boreal forest south and east of town. The evacuation order and state of emergency for the area remained in effect as of May 11.

During a press tour through the town, Alberta Premier Rachel Notley gave the first official estimate of initial recovery time: “First responders and repair crews have weeks of work ahead of them to make the city safe. I’m advised that we will be able to provide a schedule for return within two weeks.”

Official numbers said 88,000 people, were evacuated, but a local source puts the number closer to 100,000, counting transient workers.

Remarkably, there has been no loss of life, not even any major injuries. And the vast oil sands mining and processing operations that sprawl for more than 100 miles in every direction around Fort McMurray were undamaged.

On May 10, Notley met with industry officials and was told the operations were secure.

“The magnitude of the current destruction suggest that the new fires will generate among the largest catastrophe losses in Canadian history, affecting both personal and commercial property writers,” according to an initial evaluation by the ratings agency Moody’s.

“I suspect some of the [energy companies’ insurance] coverage may be on the lean side.” — Jason Mercer, assistant vice president and analyst, Moody’s

“Early estimates of the wildfires peg the cost of damages rising to C$5 billion or around 1.5 percent of Alberta’s GDP — an estimate that could increase,” Moody’s reported.

“The Fort McMurray fires destroyed four times as many buildings as the Slave Lake [Alberta] wildfire of May 2011, which cost Canadian property and casualty insurers more than C$700 million in pretax losses.”

“Home and auto insurance coverage in Canada is substantially similar to that in the U.S.,” said Jason Mercer, assistant vice president and analyst at Moody’s in Toronto, who co-wrote the report.

“The only notable difference is that some lines, such as workers’ compensation, are typically government issued.”

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BI is also similar in the two countries, Mercer noted. “There is named peril and all-risk. Both are available, but my sense is that all-risk is probably more difficult to get and more expensive, if only because of the higher number and cost of major losses in the province.

“More than half of the major losses in recent years in Canada have been in Alberta.”

Mercer also emphasized that the price of oil has been depressed for almost two years, leading some operators to tighten their belts – including insurance protection.

“I suspect some of the coverage may be on the lean side,” he said.

It will also depend whether companies have limited BI coverage — which would cover losses beginning with the evacuation and ending with the “all clear,” or extended coverage, which would “could run until there is a return to the profit level pre-event.”

Gregory DL Morris is an independent business journalist based in New York with 25 years’ experience in industry, energy, finance and transportation. He can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Risk Report: Hospitality

Bridging the Protection Gap

When travelers stay home, hospitality companies recoup lost income through customized, data-defined policies.
By: | October 12, 2017 • 9 min read

In the wake of a hurricane, earthquake, pandemic, terror attack, or any event that causes carnage on a grand scale, affected areas usually are subject to a large “protection gap” – the difference between insured loss and total economic loss. Depending on the type of damage, the gap can be enormous, leaving companies and communities scrambling to obtain the funds needed for a quick recovery.

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RMS estimates that Hurricane Harvey’s rampage through Texas could cause as much as $90 billion in total economic damage. The modeling firm also stated that “[National Flood Insurance Program] penetration rates are as low as 20 percent in the Houston area, and thus most of the losses will be uninsured.”

In addition to uninsured losses from physical damage, many businesses in unaffected surrounding areas will suffer non-physical contingent business interruption losses. The hospitality industry is particularly susceptible to this exposure, and its losses often fall into the protection gap.

Natural catastrophes and other major events that compromise travelers’ safety have prolonged impacts on tourism and hospitality. Even if they suffer no physical damage, any hotel or resort will lose business as travelers avoid the area.

“The hospitality industry is reliant on people moving freely. If people don’t feel safe, they won’t travel. And that cuts off the lifeblood of the industry,” said Christian Ryan, U.S. Hospitality and Gaming Practice Leader, Marsh.

Christian Ryan
U.S. Hospitality and Gaming Practice Leader, Marsh

“People are going away from the devastation, not toward it,” said Evan Glassman, president and CEO, New Paradigm Underwriters.

Drops in revenue resulting from decreased occupancy and average daily room rate can sometimes be difficult to trace back to a major event when a hotel suffered no physical harm. Traditional business interruption policies require physical damage as a coverage condition. Even contingent business interruption coverages might only kick in if a hotel’s direct suppliers were taken offline by physical damage.

If everyone remains untouched and intact, though, it’s near impossible to demonstrate how much of a business downturn was caused by the hurricane three states away.

“Hospitality companies are concerned that their traditional insurance policies only cover business interruption resulting from physical damage,” said Bob Nusslein, head of Innovative Risk Solutions for the Americas, Swiss Re Corporate Solutions.

“These companies have large uninsured exposure from events which do not cause physical damage to their assets, yet result in reduced income.”

Power of Parametrics

Parametric insurance is designed specifically to bridge the protection gap and address historically uninsured or underinsured risks.

Parametric coverage is defined and triggered by the characteristics of an event, rather than characteristics of the loss. Triggers are custom-built based on an insured’s unique location and exposures, as well as their budget and risk tolerance.

“Triggers typically include a combination of the occurrence of a given event and a reduction in occupancy rates or RevPar for the specific hotel assets,” Nusslein said. Though sometimes the parameters of an event — like measures of storm intensity — are enough to trigger a payout on their own.

For hurricane coverage, for example, one policy trigger might be the designation of a Category 3-5 storm within a 100-mile radius of the location. Another trigger might be a 20 percent drop in RevPAR, or revenue per available room. If both parameters are met, a pre-determined payout amount would be administered. No investigations or claims adjustment necessary.

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The same type of coverage could apply in less severe situations where traditional insurance just doesn’t respond. Event or entertainment companies, for example, often operate at the whim of Mother Nature. While they may not be forced to cancel a production due to inclement weather, they will nevertheless take a hit to the bottom line if fewer patrons show up.

Christian Phillips, focus group leader for Beazley’s Weatherguard parametric products, said that as little as a quarter- to a half-inch of rain over a four- to five-hour period is enough to prevent people from coming to an event, or to leave early.

“That’s a persistent rainfall that will wear down people’s patience,” he said.

“A rule of thumb for parametric weather coverage, if you’re looking to protect loss of revenue when your event has not actually been cancelled, you will probably lose up to 20 to 30 percent of your revenue in bad weather. That depends on the client and the type of event, but that’s the standard we’ve realized from historical claims data.”

The industry is now drawing on data to establish these rules of thumb for more serious losses sustained by hospitality companies after major events.

“Until recently the insurance industry has not created products to address these non-physical damage business interruption exposures. The industry is now collaborating with big data companies to access data, which in turn, allows us to structure new products,” Nusslein said.

Data-Driven Triggers

Insurers source data from weather organizations that track temperature, rainfall, wind speeds and snowfall, among other perils, by the hour and sometimes by the minute. Parametric triggers are determined based on historical storm data, which indicates how likely a given location is to be hit.

“We try to get a minimum of 30 years of hourly data for those perils for a given location,” Phillips said.

“Global weather is changing, though, so we focus particularly on the last five to 10 years. From that we can build a policy that fits the exposure that we see in the data, and we use the data to price it correctly.”

New Paradigm Underwriters collects their own wind speed data via a network of anemometers that stretch from Corpus Christi, Texas, all the way to Massachusetts, and works with modeling firms like RMS to gather additional underwriting information.

The hospitality industry is reliant on people moving freely. If people don’t feel safe, they won’t travel. And that cuts off the lifeblood of the industry.– Christian Ryan, U.S. Hospitality and Gaming Practice Leader, Marsh

While severe weather is the most common event of concern, parametric cover can also apply to terrorism and pandemic risks.

“We offer a terror attack quote on every one of our event policies because everyone asks for it,” said Beazley’s Phillips.

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“We didn’t do it 10 years ago, but that’s the world we live in today.”

An attack could lead to civil unrest, fire or any number of things outside an insured’s control. It would likely disrupt travel over a wide geographic region.

“A terrorist event could cause wide area devastation and loss of attraction, which results in lost income for hospitality companies,” Nusslein said.

Disease outbreaks also dampen travel and tourism. Zika, which was most common in South America and the Caribbean, still prevented people from traveling to south Florida.

“Occupancy went down significantly in that region,” Marsh’s Ryan said.

“If there is a pandemic across the U.S., a parametric coverage would make sense. All travel within and inbound to the U.S. would go down, and parametric policies could protect hotel revenues in non-impacted areas. Official statements from the CDC such as evacuation orders or warnings could qualify as a trigger.”

Less data exists around terror attacks and pandemics than for weather, though hotels are taking steps to collect information around their exposure.

“It’s hard to quantify how an infectious disease outbreak will impact business, but we and clients are using big data to track travel patterns,” Ryan said.

Hospitality Metrics

Any data collected has to be verified, or “cleaned.”

“We only deal with entities that will clean the data so we know the historical data we’re getting is accurate,” Phillips said.

“There are mountains of data out there, but it’s unusable if it’s not clean.”

Parametric underwriters also tap into the insured’s historical data around occupancy and room rates to estimate the losses it may suffer from decreased revenue.

Bob Nusslein, head of Innovative Risk Solutions for the Americas, Swiss Re Corporate Solutions.

“The hospitality industry uses two key metrics to measure loss of business income. These include occupancy rate and revenue per available room, or RevPAR. These are the traditional measurements of business health,” Swiss Re’s Nusslein said.  RevPAR is calculated by multiplying a hotel’s average daily room rate (ADR) by its occupancy rate.

“The hotel industry has been contributing its data on occupancy, RevPAR, room supply and demand, and historical data on geographical and seasonal trends to independent data aggregators for many years. It has done an exceptional job of aggregating business data to measure performance downturns from routine economic fluctuations and from major ‘Black Swan’ events, like the 9/11 terrorist attacks, the 2008 financial crisis or the 2009 SARS epidemic.”

Claims history can also provide an understanding of how much revenue a hotel or an event company has lost in the past due to any type of business interruption. Business performance metrics combined with claims data determine an appropriate payout amount.

Like coverage triggers, payouts from parametric policies are specifically defined and pre-determined based on data and statistical evidence.

This is the key benefit of parametric coverage: triggers are hit, payment is made. With minimal or no adjustment process, claims are paid quickly, enabling insureds to begin recovery immediately.

Applying Parametric Payments

For hotels with no physical damage, but significant drops in occupancy and revenue, funds from a parametric policy can help bridge the income gap until business picks up again, covering expenses related to regular maintenance, utilities and marketing.

Because payment is not tied to a specific type or level of loss, it can be applied wherever insureds need it, so long as it doesn’t advance them to a better financial position than they enjoyed prior to the loss.

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Parametric policies can be designed to fill in where an insured has not yet met their deductible on a separate traditional policy. Or it could function as excess coverage. Or it could cover exposures excluded by other policies, or for which there is no insurance option at all. Completely bespoke, parametric coverages are a function of each client’s individual exposures, risk tolerance and budget.

“Parametric insurance enables underwriting of risks that are outside tolerance levels from a traditional standpoint,” NPU’s Glassman said.

The non-physical business interruption risks faced by the hospitality industry match that description pretty closely.

“Hotels are a good fit for parametric insurance because they have a guaranteed loss from a business income standpoint when there is a major storm coming,” Glassman said.

While only a handful of carriers currently offer a form of parametric coverage, the abundance of available data and advancement in data collection and analytical tools will likely fuel its popularity.

Companies can maximize the benefits of parametric coverages by building them as supplements to traditional business interruption or event cancellation policies. Both New Paradigm Underwriters and Beazley either work with other property insurers or create hybrid products in-house to combine the best of both worlds and assemble a comprehensive risk transfer solution. &

Katie Siegel is an associate editor at Risk & Insurance®. She can be reached at [email protected]