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The Effect of Deductibles & Policy Wording – Is It What You Think?

With a typical Energy claim standing at approximately USD 4.5 million, it’s no surprise that Business Interruption (BI) is once again the #1 business risk for the fourth year in a row[i].

To help insurers mitigate their exposure when an interruption occurs, power generation and petrochemical companies frequently retain a portion of the loss themselves in the event of a fire, explosion, machinery breakdown, power interruption or other disaster.

Because of this, the type of deductible is a critical factor when determining the recoverable versus the gross BI loss. Additional factors related to the deductible can also impact how the loss is calculated. Some of these include the policy wording and how it relates to the deductible, the circumstances surrounding the outage period and whether or not Increased Cost of Working (ICW) was incurred.

For example, a deductible involving a fixed monetary amount is easier to apply and gives certainty to both the insurer and insured. However, when daily values run in excess of USD 500,000 per day, a 60-day waiting period (i.e. first number of days) deductible is easier to sell than the monetary deductible of USD 30 million or more, even though they may amount to the same thing.

Likewise, average daily value (ADV) deductibles can create their own quantification issues, especially in partial loss situations, when a plant is running at an increased cost for an extended period or in a deferred repair shutdown scenario, which can create a “dilution” of the ADV calculation.

ADV deductibles can be more equitable than a waiting period in certain circumstances. One such example would be a power generation claim that occurs toward the end of the summer. Because capacity payments are more heavily weighted to the summer period, the insured’s retention could otherwise have been much higher than the insurer’s liability under the policy.

It’s also not uncommon for policy wordings to be amended or updated with ambiguous terms and phrases as a means of anticipating potential loss scenarios. However, these changes often lead to further questions such as:

  • Does the policy’s use of the word “affected” mean “financially affected” or “physically damaged”?
  • Does the policy consider contractual forced outage allowances which the insured can use to negate financial loss during its self-retained waiting period while leaving nothing for the insurers?
  • If the policy states “60 days” as the deductible, does it refer to a waiting period or an ADV?
  • What happens if the interruption is shortened as a result of ICW being incurred? Should the ADV deductible increase?
  • How do you deal with ICW incurred during a waiting period?

Because the financial difference between various interpretations can vary greatly, it’s important for underwriters and claims handlers to work with professionals who can alert them to potential issues and pitfalls.

By Daniel Thorpe. Published in the Onshore Energy Conference Magazine in May 2016.

  1. Allianz Global Corporate & Specialty Global Claims Review 2015 (http://www.agcs.allianz.com/assets/PDFs/Reports/AGCS-Global-Claims-Review-2015.pdf)

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