Eliminating underinsurance in sawmills

Over the past decade, the growth of Nordic softwood sawmills has been slow and steady in terms of production volumes in both Sweden and Finland. The global recession hit the business sector heavily more than ten years ago, and it has taken a decade to return to the same production volumes as the sawmills had before.

According to the Finnish associations Metsäteollisuus ry (Finnish Forest Industries) and Sahateollisuus ry (Finnish Sawmills Association), the total production of softwood sawn timber in Sweden and in Finland in 2017 was approximately 30 million m3 per annum.

The Swedish sawmills accounted for approximately 2/3 of the total Nordic volume. Nordic sawmills produced roughly 30 percent of the sawn timber production in Europe and, from a global perspective, European sawmills produced almost one third of the total amount of global softwood sawn timber.

Correct insurance cover

Sawmills have typically been very sensitive to fluctuations in the global economic market. Being an export-driven business means that currency fluctuations, the worldwide general economic situation, and the prices of local raw materials have a strong impact on the sawmill business. The construction industry is one of the main end-users of sawn timber, and therefore any change occurring in the rate of construction is a major demand driver for the sawmill business.

Market-related risks are not the only types of risks that can stagnate a sawmill's business. Property damage or business interruption losses are types of risks that sawmills can protect themselves against by implementing proper loss prevention measures or by transferring the risks. Insurance is an essential part of any business, as it transfers the risks and thus provides financial security for the insured. The essential element of ensuring adequate insurance cover is to select the appropriate cover and to evaluate the sums insured correctly.

In property insurance, the sums insured are typically based on either the replacement value, the first loss value, or the daily value of the property. The replacement value means a financial value that is equivalent to the cost of replacing the property with the same kind of new property. In other words, it is not same as the book value, and therefore it should be increased annually.

This increase is often taken into account by the use of building and machinery cost indexes. If the property is insured on a first loss value basis, then the amount of the indemnification payable in a loss situation is the same as the agreed sums insured. If the insurance is based on the daily value, then the property is evaluated on the date of the loss, and the amount of indemnification payable is based on the actual value on the loss date.

Determining what the sums insured should be

Determining what the sums insured for property insurance should be is not the only important issue to consider when selecting and formulating property insurance cover. Having the correct cover does not only refer to the insurance wording, but it also means that the cover limits adequately reflect the insured's needs. In Business Interruption insurance, the key elements to consider are whether the amount of gross profit and the required length of the indemnity period have been calculated correctly, and whether the need to insure the variable wages has been recognized.

Fire is still the most severe type of loss in the sawmill industry in terms of paid losses. According to If P&C Insurance's own claims statistics, 79% of the paid losses over the past decade in sawmills were caused by fires. There are also other significant fire risks such as the further processing of sawn timber and its by-products, namely the planing of the timber, as well as the production of pellets.

With regard to property insurance, the insured is always the party responsible for providing the insurer with the sums insured, either by themselves or with the assistance of an insurance broker or valuator. If the sums insured are too low or if the cover is not sufficient, then in the event of a loss, a situation arises in which underinsurance exists.

Property insurance policies typically take underinsurance into account by providing the insurance company with the option to calculate the amount of indemnification to be paid based on the ratio of the sums insured to the correct values of the new property. The claim settlement will only be the same percentage value as the sums insured represent to the correct value of the property.

Property losses are typically partial losses

Property losses are typically partial losses, meaning that only a part of the insured's property is damaged. In a partial loss, only part of the machine or machinery line needs to be replaced. In these types of losses, it is equally important to a case of a total loss that the machinery is insured on the basis of the up-to-date replacement value of a new machine or machinery line.

This is because the amount of indemnification to be paid will be based on the sums insured. In other words, if the insured has evaluated the insured property to be 70% of the correct replacement value, and therefore pays only 70% of the premium, the amount of indemnification will only be 70% of the claim's total value.

If the insured, after suffering a property loss, receives only part of the costs of the lost property, it will have an impact on the time needed to replace the lost property, as the insured needs to source funds to be able to pay the costs of replacing that part of the loss for which the insurance does not provide indemnification. This makes the recovery time longer than in an optimal situation.

Property losses are typically partial losses.

Block valuation tool

To ensure that property insurance delivers the desired risk transfer to insured sawmills, in 2018 If P&C Insurance developed, together with Pöyry Management Consulting, a new calculation tool that determines the sums insured based on the replacement values of the buildings and machinery. If P&C Insurance is a significant forest industry insurer in the Nordic countries and, since the 1980s, has successfully used a similar tool for pulp and paper mills.

Through the application of this new tool, the insured will achieve several benefits. As the sums insured are valued using the tool, If P&C Insurance will not apply the underinsurance clauses. These clauses could have reduced the amount of indemnification paid to the insured, if the sums insured had not be set at the correct level.

The client does not need to worry about whether the values are incorrect or do not reflect the current situation regarding the real value of the buildings and machinery. The use of the model reduces the workload in the insured's organisation, as the collection of the correct insurance values is easier.

The valuation procedure consists of three parts:

  1. The preliminary collection of data, in which the insured fills in the capacity data concerning the sawmill's different departments for continuous production
  2. An interview with a site tour
  3. The reporting and use of the modelled values in the insurance cover

Based on the daily production capacities, meaning the maximum volume of production during a continuous period of 24 hours for each department or production line, the programme calculates the block values as investment costs for a modern, new plant or production department.

Once the valuation has been done for the first time, it is simple and straightforward to bring the valuation up-to-date prior to insurance renewal.

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Sirja Pajari photo

Sirja Pajari

Underwriter, Property, If