Catastrophic Chemical Industry Losses—Structuring Coverage and
Maximizing Recovery
January 2012
Chemical industry risk managers
know their business and clearly understand the importance of strong
loss prevention and risk management tools. Yet, even with this knowledge,
maximizing insurance recoveries can be a tricky and contentious
process.
by
Christopher M. Brophy,
CPA
FTI Consulting
Christopher Loeber, Esq.
Morgan Lewis & Bockius LLP
The risk of a catastrophic loss in the chemical industry is real.
Chemical plants work hard to identify loss prevention procedures
and to maintain impeccable safety records. That said, losses do
occur and often leave management scrambling to determine the cause
of a given loss, implement a disaster recovery plan, identify workarounds
to mitigate the loss, and tender/pursue insurance claims.
Most chemical companies have highly integrated production networks.
Raw material feedstock is received, typically by pipeline, barge,
or rail, and processed into intermediary chemicals. A portion of
that product may be sold externally; the remainder may be further
processed. Specialty chemical companies often start with a petroleum-based
product, perform a series of chemical processes, and produce thousands
of products for both commercial and consumer use.
A significant loss can disrupt the production process and require
workarounds to mitigate the loss. Chemical plant managers are adept
at modifying the production process, often by shifting production
to other plants. This can help, albeit with higher production and
freight costs.
Many chemical companies operate 24 hours per day, 7 days per
week, and work to sell everything that they produce. They cannot
shut down without incurring significant restart costs. Moreover,
because they are already producing to their effective capacity,
they have no way to "make more." As a result, after a catastrophic
event, many chemical plants simply cannot recover their lost production.
That's where insurance comes in.
Given the unique nature of the chemical industry, having the
appropriate insurance coverage is essential. As many companies have
learned the hard way, the failure to fully review and understand
insurance policies at the purchase and renewal stage can lead to
dire consequences when a claim is eventually tendered. The following
is a brief summary of several key insurance policy provisions that
can have a dramatic impact on chemical industry claims.
Insured Values
Many insurers require chemical industry policyholders to provide
insurance values for property and business interruption on a location-by-location
basis. For a sophisticated company with integrated operations and
multiple locations, it can be very difficult after a loss to determine—and
reach an agreement with the insurers regarding—the proper values.
Thus, beginning the insurance procurement process with a comprehensive
analysis of the insured's "maximum probable loss" (showing the risk
at each location, the values at each location, and the ability of
each location to mitigate damages) is a proactive way to hedge against
a postloss "values" dispute.
Deductibles and Waiting Periods
Most chemical industry policies include significant deductibles
and waiting periods. The deductible for business interruption is
often stated in terms of a number of days of "average daily value."
The policy may also include a waiting period before a claim can
be triggered. Generally, after that waiting period is reached, the
policy is triggered, and the insured loss is measured from the date
of the loss (not after the waiting period) less the applicable deductible.
In the event of a catastrophic integrated loss, deductible calculations
can make or break a chemical company's insurance claim. Thus, although
the temptation may exist to accept a higher deductible in exchange
for a lower premium, chemical industry policyholders are well advised
to weigh carefully the risks and benefits. What saves a few dollars
at policy inception could cost millions down the road.
Period of Indemnity and Extended Period of Indemnity
While the period of indemnity is typically the time to complete
repairs "with due diligence and dispatch," this definition may not
be sufficient in the chemical industry. Losses will often persist
at "downstream" plants well after repairs are completed at the damaged
plants. If the period of indemnity is defined simply as the date
of the loss through the time to complete repairs, the insurer may
contend that there is no coverage for downstream losses incurred
after the damaged facility has been repaired. Though such a result
would be illogical from the standpoint of the insured, it is a coverage
defense that an insurer could use to eliminate a significant component
of a given claim.
Extended period of indemnity coverage can be helpful when losses
persist after repairs are complete. Large supply contracts can be
particularly vulnerable to long-term losses. Yet, because "period
of indemnity" is a term that can be overlooked during the policy
negotiation phase, it is possible for this key element of a chemical
company's business to effectively go uninsured. In short, a policyholder's
failure to remain vigilant on this point could end up costing millions
in uninsured losses.
Preservation of Property
This clause provides coverage when a policyholder takes steps
to prevent a loss before it occurs or to minimize the impact once
it does. Suppose a chemical plant operating 24/7 is threatened by
a significant impending hurricane. The plant manager may decide
that a controlled shutdown is necessary, both for the safety of
the employees and to minimize the impact should damage be severe.
And that shutdown will have a significant effect on the insured's
operations.
Insurers favor property preservation because when losses
are minimized, so are insurance payouts. But policy terms can vary
as to the scope of scale of appropriate actions. The time to review
and understand these terms is at policy negotiation—not during a
loss or after it has occurred.
Service Interruption
Many chemical plants use a significant amount of power in their
production process. It is common for insurance policies to cover
losses attributable to service interruption, often subject to a
waiting period for a number of days. The loss of power coverage
may have specific requirements, such as being attributable to damage
within a certain number of feet from the insured's premises. Here
again, it is essential that a policyholder address these issues
in the policy negotiation phase. If the risks are not comprehensively
analyzed, they cannot be properly insured.
Mitigation
When faced with a crisis, chemical companies work diligently
to mitigate their damages. For example, if a loss occurs, management
may reschedule future maintenance, or "turnaround," so that it takes
place during the same time that the plant is closed for repairs.
Such forward thinking by a policyholder can be a tremendous benefit
to an insurer, as it can greatly reduce the ultimate insurance payout.
Contingent Business Interruption
This endorsement to a standard policy is especially important
within the chemical industry. It allows the policyholder to recover
when a supplier or customer suffers a loss "of the type insured"
under the policyholder's own policy. For example, if a supplier
is unable to provide your plant with a raw material because of earthquake
damage, you would be able to recover if your policy includes coverage
for earthquakes.
"Contingent business interruption" coverage can be extremely
valuable, but only if properly structured. In some cases, contingent
business interruption coverage only insures losses when direct suppliers
or customers suffer a loss. It may not provide coverage when the
loss is indirect—that is, when the loss is sustained by a supplier
to the policyholder's supplier or by a customer to the policyholder's
customer.
A simple illustration is a third party's declaration of
force majeure. Contingent business
interruption coverage could be triggered if the insurance policy
at issue is broad enough to cover the specific third party. Bottom
line: In the policy negotiation phase, it is essential that the
chemical industry policyholder review and assess supply chain risks
and secure appropriate coverage against them.
Conclusion
Maximizing insurance coverage after a catastrophic loss is difficult
for any company but can be especially complex for policyholders
in the chemical industry. Most chemical plants are integrated production
networks that convert feedstock into thousands of intermediary and
final products. The final production at one plant may be partially
sold externally and partially used as feedstock at another plant.
And, any break in the supply chain—whether it is experienced internally
by the insured or externally by outside suppliers or customers—can
lead to a costly workaround, irreplaceable production, lost sales,
and extensive additional expense.
Once a loss occurs, it is too late to revise an insurance policy.
Consequently, the chemical industry policyholder must be extremely
diligent during policy purchase and renewal. Understanding specific
insurance requirements, carefully calculating the property and business
interruption values, outlining contingency plans, and anticipating
the potential losses at each location are all key steps in maximizing
future insurance recoveries. In sum, paying close attention to the
potential impact of a loss at the insurance procurement stage will
help to minimize issues and maximize recovery when a loss does occur.
Christopher M. Brophy
is a managing director with FTI Consulting in the business insurance
claims practice of FTI's Forensic and Litigation Consulting business
segment. He writes the catastrophe risk management column for
www.IRMI.com. For background and contact
information for Mr. Brophy, see his full
biography.
Christopher C. Loeber
is a partner in Morgan Lewis' litigation practice, with a focus
on insurance recovery. Mr. Loeber's diversified practice covers
a wide variety of complex commercial disputes. His work includes
counseling and representing chemical industry clients in insurance
coverage disputes, contract and business tort actions, internal
corporate investigations, and all manner of general commercial litigation
and arbitration.
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