Do you know your interdependencies?

A company can be dependent on parties outside the company, in the form of external dependencies such as suppliers and public utilities, as well as on parties within the Group.

Specialising can affect the risk and the insurance programme

In the effort always to improve and become even more competitive, one of the steps is to specialise: to do more of what you are really good at. In a company, this could have the effect that some steps in the process are done by one part of the Group while other production sites in the Group execute other parts of the production process before the end product reaches the final customer.

This way of becoming even more competitive will affect the risk and also the cover in an insurance programme.

Definition of interdependency

First of all, let’s start with what we at – If P&C mean by interdependencies. Looking at dependencies, a company can be dependent on parties outside the company, in the form of external dependencies such as suppliers and public utilities, as well as on parties within the Group.

We define the internal dependencies, called interdependencies, as the business interruption impact that a claim will have at another site within the Group, or the impact that will arise at another legal unit within the same Group, either at the same site where the claim occurred or elsewhere. To spot the interdependencies, we therefore have to look at both the process before the end product reaches the end customer and the business model applied within the Group.

The impact on the process within the Group can be seen as the impact that a site will have both up-stream and down-stream within the Group, as the process flows towards the end customer. The business model often means that the ownership of a product changes within the Group, from one legal unit to another, so that different prices are set, creating margins in the process. The most common change might be the addition of some margin from a producing company within the Group, when the ownership is transferred to a selling company within the Group.

A Chain reaction started

The topic of interdependencies became really “hot” after the major international natural catastrophes starting with the Japanese earthquakes and the flooding in Thailand in 2011, when many insurers and companies were surprised by the huge and complicated chain reactions that came as a consequence of single factories getting hit. When an insurer tries to see what kinds of risks a company is asking to transfer to the insurer, a very important step is to estimate what the maximum impact of a claim could be at the sites belonging to the insured. This estimate is called EML at If, and similar names at other insurers.

The effects of interdependency after the above-mentioned disasters were much higher than anticipated, which is why the insurance industry has focused on this issue ever since. Of course, triggers other than natural catastrophes such as fires could trigger this chain reaction of interdependencies within your Group.

If you do not know your inter-dependencies, you cannot start your risk mitigation work.

If you do not know your interdependencies, you cannot start your risk mitigation work. We therefore recommend that you include this as a very important part of conducting Business Continuity Management (BCM) work.

If has a competence centre working on business interruption, which has developed a quick guide on how to conduct BCM. Keep in mind, too, that your interdependencies will change continuously, which is why the map has to be rewritten on a regular basis.

Once you know what you face in terms of risks from interdependency losses, you can start to mitigate those risks. This can be done, for example, by getting alternative suppliers within the Group whenever that is suitable, having plans for external alternatives, improving the risk standard in critical processes, and so on.

When that is done, there will most likely still be interdependency risks left, but you will have a grip on them and will know the approximate monetary effects that you would like to transfer to the insurer.

Business interruption

If is able to include interdependency effects in a business interruption solution for your company. The more we know about the interdependencies, the higher the limits are that we can provide. Having cover that is adapted to the actual risk will also affect the premium in a positive way.

If you and If do not know what kinds of risks we mutually face, we will have to put a limit on this unknown parameter to cap it. We will be forced to suppose that the limit is always at stake if a very large claim occurs, which is why this unknown interdependency will have a negative impact both on the cover and on the premium.

To conclude, the more we know together about the interdependencies within your Group, and the more we can mitigate the risks, the better cover we can provide, and at an even more competitive premium.

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Article by
Staffan Ljung

Staffan Ljung

Chief Underwriter
Business Interruption, Property, Industrial, If
staffan.ljung@if.se