Covering the links broken in Japan’s supply chain

Estimates of the insured loss from the Japanese earthquake and tsunami continue to roll in. They range from $12 billion (Eqecat’s low estimate) to $60 billion (London insurance analyst Barrie Cornes). Mainichi (Japan) Daily News gives a roundup.

But one of the big unknowns for insurers is what the total loss will be from various types of business interruption coverage. As I.I.I. explains, “Business interruption insurance compensates you for lost income if your company has to vacate the premises due to disaster-related damage that is covered under your property insurance policy, such as a fire.”

That sounds simple, but it can be an enormous portion of claims after a disaster. Business interruption constituted about a third of all losses from the 9/11 terrorist attacks. Eqecat, a catastrophe modeling firm, estimated that business interruption losses would be about 20% of its Japan estimate, as the coverage is less common in Japan than in the United States.

Another type of coverage, contingent business interruption, presents a trickier wrinkle. Contingent business interruption reimburses lost profits and extra expenses when the premises of a customer or supplier suffers an interruption of business.

So a business with contingent business interruption coverage might have a claim if it depends on a Japanese supplier whose operation is shut down. And if the business has to turn to a new, more expensive supplier, the extra cost might be covered under extra expenses coverage.

A web page produced by the International Risk Management Institute (IRMI) explains details, such as:

  • Insureds can get protection against a set list of suppliers or purchase blanket coverage protecting any supplier’s shutdown.
  • The claim must be of a type that would be covered under the insured’s own policy.
  • Usually there is a time deductible (48 or 72 hours, for example). That period must expire before an insured can receive reimbursement.

The coverage is designed to protect against a prolonged interruption of the supply chain. For example, last week the Wall Street Journal reported that ON Semiconductor, out of Phoenix, Ariz, is working with insurers regarding coverage under business interruption and “supply chain disruption.”

It’s quite difficult to know how much the contingent business interruption claims will total, since a contingent business interruption claim could be filed by a company anywhere in the world. For that reason, catastrophe modelers like Eqecat don’t include contingent business interruption claims in their estimates.

Some in the industry indicate that the losses won’t be a big part of the losses from the Japan disasters. One insurance coverage attorney told the Journal that a business that itself lacks earthquake insurance might not be able to claim on its contingent business interruption. Remember, a company can only claim for a loss that would have been covered had its own property sustained it. An expert with the brokerage Aon Benfield said the claims aren’t something that “moves the needle in the insurance industry.”

And the New York Times notes that Japan’s importance in some industries, like semiconductor manufacturing, has waned in recent years as countries like South Korea, Taiwan, and China have gained market share.

I.I.I. continues to update its web page covering the Japan disasters.

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