A matter of debate

The topic of the second session of the roundtable held by Swiss reinsurance intermediary Reunion AG was industrial construction and, specifically, the clauses that determine maximum coverage limits.

The debate was introduced by Igor Prandetsky, a member of the board from Reunion based in Zug, Switzerland, who described the subject as a relatively new, but important, one to the Russian insurance market. He then handed over to Vitaly Valyuk, the head of the industrial insurance department at Russian insurer Sogaz, who outlined the key issues.

Valyuk first sought to draw attention to the increasing use of LEG 3 clauses in the market. This is an exclusion clause originally drafted by the London Engineering Group (LEG), which determines the extent of the maximum coverage of a policy and, often, for how long it is valid.

He said that the use of these clauses entered the Russian market only relatively recently and was driven by international brokers. “Because this market is so new and so young, clients in Russia are relying on brokers to tell them what they need and, under LEG 3, they are succeeding in securing wide coverage limits and policies that are valid for a long period afterwards,” he said.

The policies include items such as defect coverage, regardless of whether the client really needs it or, more importantly, the insurer has correctly accounted for these things in the pricing of the policy.

“These clauses were brought to the Russian market by international brokers. As a result of strong competition between them [brokers], clients often received the maximum coverage immediately in the new market,” said Valyuk.

“A very wide coverage is advantageous for clients and they grasped that, but unfortunately, they seldom understood why they needed it. Then the brokers started to compete on the validity period of the clause. As a result, they got a very wide coverage and long warranty periods. Also, clients wanted defect coverage, whether or not they needed it.”

Valyuk’s concern, he emphasised, was that few Russian insurance companies understand how to underwrite risks such as defect coverage. As projects in Russia become larger, thanks to huge electrical construction projects and modernisation schemes for oil and gas, so the risks get bigger. He also noted from discussions he has had with insurers elsewhere in Europe that many refuse to underwrite these risks with such a wide coverage.

In addition, he highlighted some of the challenges faced by Russian insurers when their clients demand terms such as assessing the reliability of suppliers and manufacturers, which could be based anywhere in the world, and the issue of whether reinsurers will take this risk. He asked the global companies in the room to explain how such risks are dealt with elsewhere.

Stanislav Moiseev, head of engineering at Moscow-based Ace JSC , said that just seven years ago, international insurers operating in Russia refused to use the LEG 3 clause or to offer guarantee maintenance coverage. This was because they were still wary of Russia as a market. As more global companies have moved in, however, and the equipment used has often been supplied by quality international companies with good reputations, they have been more willing to consider the use of the LEG 3 clause.

“LEG 3 endorsements are quite new so they are difficult to assess; it is hard to quantify the risk simply because of a lack of claims."

He added, however, that they will not cover it for free. “Some charge 10 percent over the rate, but it all depends on the particular industry. As for the guarantee maintenance, this is something still quite new to the market and few companies would give it freely. It is a very critical exposure and it needs a fine estimate. We do cover extensions such as guarantee maintenance but we are always clear about subrogation, who the manufacturer is and what the guarantee is. These factors have to be taken into account.”

Some of the reinsurers present expressed concern over the use of such clauses. Sebastian Awater, a senior engineering underwriter at Hannover Re, said that the effect of the inclusion of LEG 3 is very difficult to quantify. “If we are not happy with an extension then we communicate that. We will always be transparent and consistent. Clients have a right to know what our opinion is and why we would prefer to keep the coverage tighter,” he said.

Eric Bentz, a senior underwriter of engineering at SCOR , also expressed reservations. “Construction engineering is a long-tail business. If we start to widen what [risks] you are taking in the portfolio, the problem will come afterwards. If we are too open and that’s an issue with the long-term business, we lose.”

Christian Engeln, head of property/casualty business for Russia and CIS for PartnerRe Zurich, also expressed discomfort. “LEG 3 endorsements are quite new so they are difficult to assess; it is hard to quantify the risk simply because of a lack of claims. We have tried to keep the doors closed in the treaties for LEG 3 for the simple reason that it is very hard to understand the context in which these risks are written and how the risk management works here.”

Stephen Coward, president of Navigators Technical Risk, part of the Lloyd’s syndicate, brought an interesting perspective to the debate. As a founder member of the LEG some 30 years ago, he admitted helping to draft the LEG 3. He said that the application of these clauses “means different things in every single circumstance”.

He advised underwriters to look at several factors when asked to provide LEG 3 cover: why do they need it, why should they take the risk and what exactly are they being asked to insure.

“For any machine we are asked to insure, we ask whether we have grounds for confidence in this machine’s ability. It is also absolutely key to know who you are insuring, to what extent you are insuring them and to what extent they are covered by the policy.” He explained that many big manufacturers themselves offer warranties and also have a stake in the final project.

Oscar Treceno, head of engineering at Nationale Suisse, made a practical suggestion at this point: were statistics available showing the difference between losses on policies that include LEG 3 and those that do not? “It would be interesting to see proper statistics on the share of the claims that has been produced by those extensions,” he said. “The problem is pricing it correctly. But in order to do that, we need to know how big the claims are and how many claims we have due to this.”

Coward explained that accurate statistics were almost impossible to come by because each claim of this nature is unique. But he added that his sense was that the difference in claim size for LEG 3 versus LEG 2 was “enormous”. He added: “I don’t know any statistics but I know of half a dozen claims where the difference would be almost the whole of my new premiums in the portfolio for the year. There are significant sums involved.”

Utz Groetschel, IMIA secretary, agreed that getting statistics on this issue is difficult and added that this type of coverage also leads to additional complications such as who becomes responsible for the cost of repair: the manufacturer, the contractor or a subcontractor.

Bentz also commented on this issue. “It is not easy to extract statistics, but the difference between LEG 3 and LEG 2 in terms of loss could be millions—perhaps up to €50 million. That is why I would prefer to go more on selection than pricing in terms of the global balance of the portfolio. When you are speaking about long-term business, you need to be cautious for the future.”

A Reunion roundtable

Reunion AG, a Swiss reinsurance intermediary with a focus on non-life business in central and eastern Europe, including Russia and CIS countries, hosted a roundtable meeting in Munich, on the subject of engineering insurance in Russia. Insurers from across the region attended as did a number of global reinsurers including Munich Re, Swiss Re and PartnerRe.

Reunion AG organised the event because it felt that a forum of all those involved in this sector would be beneficial, and because any country’s development is underpinned by the strength of its construction and engineering sector—and this, in turn, is sustained by the insurance contracts that support those deals.