eml or pml does it make a difference

8/8/2019 EML or PML Does It Make a Difference

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ERC Frankona

EMLorPMLDoes It MakeA Difference?Practical Use And CalculationOf Loss Potential EstimatesIn Fire Insurance


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Foreword

1 Historical Development

2 Consequences of IncorrectLoss Estimates

3 General Approach to LossEstimates

4 Estimated Maximum Loss4.1 Definition4.2 Assumptions and Assessment

Criteria4.3 Fire Loss of Profits

5 Probable Maximum Loss5.1 Definition5.2 Assumptions and Assessment

Criteria5.3 Fire Loss of Profits

6 Example of Loss Estimates6.1 Estimated Maximum Loss6.2 Probable Maximum Loss

7 Other Commonly Used Concepts7.1 Normal Loss Expectancy7.2 Maximum Foreseeable Loss7.3 Catastrophe Loss7.4 Maximum Amount Subject7.5 Maximum Credible Loss7.6 Possible Maximum Loss,

Maximum Possible Loss

8 Overview of Various Concepts

9 Final Remarks

Appendix LIRMA Definitionof a Single Risk

References

Contents

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Foreword

rrespective of the definition and method used to assess loss potential, the liabilityassumed by insurers and reinsurers in any given risk is ultimately limited by theshare accepted in the risks total sum insured. Nevertheless, it is imperative forinsurers and reinsurers to have a common understanding of the various definitions

and criteria applied in determining EML/PML to allow them to assess accurately thefinancial consequences of loss occurrences. This is particularly important for lossesexceeding the previously calculated loss potential.

Despite the relevance of loss potential estimation for Property underwriting,no common standard has yet been adopted by the insurance industry as a whole.Underwriters employ a variety of definitions of and methods of determining EstimatedMaximum Losses (EMLs) and Probable Maximum Losses (PMLs). In broad terms, the

diverse definitions result from differences in the ways in which various levels of fireprotection and fire-fighting features are taken into consideration. The meaningof abbreviations used may also vary widely, which illustrates the inherent danger inassuming that similar or identical abbreviations and terminology are identical.Misinterpretations may prove to be dangerous and costly. For example, the mostcommonly confused abbreviation, PML, may mean either probable or possiblemaximum loss.

This brochure provides a general introduction to loss potential estimates in Fireinsurance, i.e. the purpose and practical use of loss potential estimates and the basis ofpractical, and particularly of technical, calculations of EML and PML. It focuses exclu-sively on single-risk exposure. Loss estimations at the portfolio level, i.e. cumulativelosses, are not considered in detail. Within this context, however, we may be permittedto emphasise how important it is that underwriters a lways make the appropriateanalysis (e.g. earthquake, windstorm, flood, etc.).

An overview of terms currently in use in various countries has also been included.There may be deviations peculiar to certain companies and insurance clients as a resultof their specific calculation assumptions, but such deviations have not been dealt within this publication.

The objective of this brochure is to establish a common understanding of thevarious approaches to Fire loss assessment.

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The various terms gave rise to the major problem,however, that each and every insurer could have useddifferent philosophies and definitions of what theythought to be a proper loss estimate. The definitions areall subjective and open to different interpretations. Also,the letter P in MPL and PML caused a great deal ofconfusion because some companies used it to meanpossible, while others used it to mean probable.In the early seventies this led to a proposal by theReinsurance Offices Association (ROA) in London that astandard definition of EML be used for reinsurance

purposes. The ROA has since been superseded by theLondon Institute Insurance and Reinsurance Manage-ment Association (LIRMA).

Despite the obvious advantages of having a single,commonly accepted definition of maximum loss estima-tion, the LIRMA definition has unfortunately never beengenerally accepted by the market as it deserved to be.This is because, even today, companies prefer to usetheir own definitions of EML, PML, MFL, etc. whenassessing risks and deciding the size of their net reten-tions.

Since the LIRMA definition is the only common defini-tion of maximum loss potential available, we will initiallyfocus on this definition. Before examining this definitionin detail, however, we would like to discuss briefly thegeneral approach to loss estimation and the conse-quences of actual losses which exceed loss estimates.

Historical Development1

nitially, all Property underwriting and reinsurancewas done on the basis of the total sum insured perpolicy. However, as industries grew and individualpolicies were extended to cover more plants, insurers

found that they were being compelled to cede too muchof their business in the form of reinsurance and/orcoinsurance.

Insurers found that they could increase their netretention without endangering their companys sharecapital by basing their underwriting and net retentionfirst on the highest sum insured per location, which is

now expressed as Maximum Unit at Risk (MUR), andsomewhat later, on the maximum sum insured, subjectto one fire at each location, which is now expressed asAmount Subject (AS).

Underwriting policy evolved concurrently with tech-nical developments in the building sector, i.e. the use offire walls and fireproof materials in accordance withstrict building regulations, the introduction of automaticfire-extinguishing installations and fire alarms, etc., andlast but not least due to generally favourable loss experi-ence. Many insurers determined their net retentions onthe basis of maximum loss under normally unfavourablecircumstances per location or even per fire section.Experience showed, however, that this was an extremelydangerous approach because too many fires spread toadjacent sections, resulting in losses considerably exceed-ing the estimates on which the net retention had beenbased.

Following the crisis in the fifties, underwriting policywas again placed on a more conservative footing, andloss potential estimates were redefined. The terms mostfrequently used to express the maximum loss whichmight be caused by a single fire (or other insured peril)were and still are the following:PML: Probable Maximum LossPML: Possible Maximum LossMPL: Maximum Probable LossMPL: Maximum Possible LossMCL: Maximum Credible LossMFL: Maximum Foreseeable LossEML: Estimated Maximum Loss.

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A reinsurance programme based on EML is not prob-lematic in itself. Irrespective of how EMLs are defined,however, their calculation is based on a human evalua-tion of the loss potential entailed in specific risks. Thismeans that it will always be possible for estimates to vary.Fortunately, the frequency of inaccurate calculations ingeneral should be low, but when they do occur, they areoften of serious magnitude. If the true maximum lossis incorrectly assessed and then actually occurs, both theceding company and its reinsurer may have to pay aconsiderably greater amount than was assumed when

the treaty or facultative offer was accepted.One of the most spectacular errors involving an

inaccurate EML calculation was the Flixboroughdisaster. Despite the fact that the incident took placemore than 20 years ago, it continues to be a goodexample because the damage was so extensive thatmost insurers and reinsurers still remember whathappened on 1 June 1974.

The chemical plant was insured against materialdamage due to fire or explosion up to an amount ofUSD 43 million. Leakage led to a devastating explosionwhich destroyed nearly 80% of the plant. The EML,however, had been estimated at only 20%. The balanceof 60% amounted to nearly USD 26 million. In additionto the Property damage, the insured was also protectedby a Loss of Profits (LOP) policy with a limit of USD 9 mil-lion, for which the EML had been assessed at 60%.However, the LOP loss was 66.5%. Although a smalldifference in percentage, the balance amountedto USD 1 million. All in all, the insurers and reinsurershad to pay nearly USD 27 million more than had beenanticipated when they accepted shares of the risk.

It is obvious that such errors could lead to solvencyproblems for the parties involved. Insurance brokers,underwriters and production companies have developeda number of methods to help quantify such catastrophicEMLs. For example, engineering-based models 1 andempirical approaches based on loss history are nowfavoured in energy insurance.

stimated Maximum Losses (EMLs) are producedfor the use of the underwriter to assist himor her with deciding the size and extent of lineto be written and the level of reinsurance re-

quired. They are useful in demonstrating the relationshipbetween the level of premium being obtained and thelikely extent of loss. In addition, the purpose of EMLs isto allow insurers to optimise their net retentions andthus to keep as much premium as possible for their ownaccount. In other words, the purpose is to decide howlarge a monetary loss the company is prepared to bearfor its own account, set against its own financialstrength, or possibly pass on to its reinsurance pro-gramme. By writing a share on EML basis, an insurercan write more of the risk, but the consequences ofEML failure might be damaging.

Consequences of IncorrectLoss Estimates

2

E

A devastating explosion in the 1970s at a chemical plant

in Flixborough caused enormous damage. Here a view of the

tank farm in flames.

1 Sedgwick Energy Ltd., Vapour Cloud Explosion Methodology, March 1994.


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enerally, the Estimated Maximum Loss (EML)or Probable Maximum Loss (PML) are estimatedby dividing the risk into complexes. A com-plex may consist of one or more buildings or

rooms or structures which themselves contain structuralboundaries or separations. They need not be completelyseparated from neighbouring buildings or structures.

Caution should be exercised in defining complexesbecause experience has shown that structural separationin the conventional sense is no longer entirely effectivein the event of a loss. For example, todays rapid techno-

logical advancement has greatly increased fire loads andthe danger of explosion.

It is necessary to identify the complex with thegreatest exposure. Additionally, it should be consideredthat a fire can also spread to other complexes. The pos-sibility that a fire may spread beyond the complex in whichit starts is suggested by the following risk characteristicsor events 2:q Risk of explosionq Risk of consequential damage resulting from corrosive

gases or vapoursq Risks created by the neighbourhoodq Cases of simultaneous arson in several separate

complexesq Disaster-like effects of external factors connected

neither directly nor indirectly with the risk insured,e.g. plane crash.

General practice guidelines may be summarised asfollows 3:q Any loss estimation, and particularly EML/PML

calculations, should be accompanied by definitions ofthe terms used.

q Calculations should be accompanied by a descriptionof the assumptions made and the method used.

q Assessments should consider a range of factors.Business Interruption assessments should take intoaccount any interdependencies which may exist andthe length of the indemnity period.

q Maximum loss assessments should be based onfire/explosion potential unless another peril such asearthquake, flood, windstorm or aircraft damagerepresents a greater exposure. In that case, the perilrepresenting a greater exposure should also beevaluated in more detail.

q Site interviews should be conducted with membersof senior management.

q Loss estimates should be updated regularly.When assessing the EML or PML, the actual policy word-ing has to be considered too, e.g. coverage for residualvalues, compliance with new building regulations, re-moval of debris. In this context it is worth mentioning thatin some countries the buildings will be insured at thenew replacement value without a fixed maximum suminsured.

EMLs or PMLs are expressed as a percentage of thetotal sum insured or in an absolute amount.

In order to clarify this issue, the following definitionsand assumptions may be taken as a possible guideline inassessing the risk term of EMLs and PMLs.

General Approach toLoss Estimates

3

G

As with this major fire which caused damage

amounting to more than USD 5 million, it is often difficult

to prove whether arson is involved.

2 Recommendations by the former German Association of Property

Insurers, Cologne, on the Determination of the Probable Maximum Losswith Fire and FLOP Insurance. Published in the Manual for IndustrialFire and Fire Loss of Profits Insurance, Reports.

3 Insurance Institute of London, EML Assessments: London MarketPractice, September 1995.


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he only definition generally recognisedtoday is the one originally proposed by theROA (which has now been superseded byLIRMA)4:

DefinitionEstimated Maximum Loss (Fire and explosion,material damage only)An estimate of the monetary loss which could be sus-tained by insurers on a single risk as a result of a single

fire or explosion considered to be within the realms ofprobability. The estimate ignores such remote coincidencesand catastrophes as may be possibilities but which stillremain unlikely.

As is evident, this definition contains a number ofsubjective words which make it possible to take into con-sideration local experience and factors which may varyfrom country to country or even from place to place.

However, the LIRMA definition goes on to state whatis meant by a single risk 5 and to list the parameterswhich should or should not be taken into account whenestimating the monetary loss, i.e. the definition attemptsto specify what should be regarded as being within therealms of probability and what should be considered tobe remote and unlikely coincidences or catastrophes.

Most of the insurance industry uses the LIRMAdefinition as a basis for defining both a single risk andan EML.

Estimated Maximum Loss4

4.1T Assumptions and Assessment CriteriaEstimated Maximum Losses (EMLs) are based on anumber of assumptions: firstly, that automatic fire-alarm

and extinguishing systems (e.g. sprinklers, carbondioxide and foam systems, etc.) are not in service, orthey are non-existent. Secondly, it is also assumed thatcompetent private and public assistance is delayed, andthat the fire doors between at least two adjacent fireareas are open. Fire doors that are held open magnetic-ally do not close. Thirdly, it should be assumed that full,

sealed firewalls will hold, unless an exceptionally highfire load or evident risk of explosion makes it seem justi-fied to assume otherwise. The separation walls, firedoors included, are constructed to withstand fire for atleast two hours.

It is also assumed that the risks are exposed to nor-mal circumstances. Abnormal circumstances, which arenot taken into account:q Plane crashes or objects falling from the skyq Explosion in a vessel due to vapourq Arson and sabotage.

A standard method for calculating EMLs shouldconsider the following specific risk factors 6:q The dimensions and shape of the area potentially

exposed to a single fire or explosionq The construction of roof, walls and floorsq The presence of combustible linings on walls, roofs,

ceilings and partitionsq The nature, distribution and combustibility of contents

(fire load)q The use of hazardous processes and substances and

the degree to which they are separatedq The susceptibility of the contents to damage by smoke,

heat and waterq The risk of explosion (where liquefied petroleum gas,

flammable goods and dust are stored/used)q Any hazards arising from gases or corrosive materialsq Any concentrations of value within a small areaq The standards of management and housekeepingq The clearance between buildings, with consideration

given to design and materialsq The distance to any stocks such as timber, goods,

cistern park or liquefied petroleum gas tankq Any special geographical or meteorological features

such as wind conditions.

4.2

4 Reinsurance Offices Association, Definition of Estimated Maximum Loss,London, 1974.

5 LIRMA Definition of a Single Risk, see Appendix.6 LIRMA Definition of Estimated Maximum Loss.


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1. Identify the potential risk areas among the singlerisks at the plant. When defining fire areas, alsoconsider any production bottlenecks or specialisedmachinery. Business Interruption losses often exceedProperty damage (PD) losses.

2. Identify the loss scenario entailing the maximummonetary loss in the selected areas (PD and FLOP),taking into consideration the continuity of combust-ibles, hazards, building construction, unimpairedprotection and business interruption. Estimate theextent of fire spread and damage which would resultfrom a major fire, given the fire area and factorsassumed.

3. Calculate the PD and FLOP losses for the selectedareas, based on the identified loss scenarios.

All calculations should be prepared in accordance withthe selected definition of EML (i.e. if the LIRMA defini-tion is used), giving due thought to the list of applicablefactors and, of course, the actual sums insured andcoverage provided.

Fire Loss of ProfitsThe obvious weakness of the LIRMA definition is that itsays nothing about Fire Loss of Profits (FLOP), which isnow often the most important factor in estimating losspotential. However, since the maximum Business Inter-ruption loss is usually triggered by physical loss ordamage, the LIRMA definition can easily be amended insuch a way that it could also be applied to combinedEMLs for Property damage and FLOP. Combined lossestimates should be prepared in all cases where bothProperty damage and Business Interruption are beingunderwritten.

In addition to the principles applied to Fire EMLs,underwriters assessing Fire Loss of Profits EMLs or

Factors which should not be included when assessingan EML7:q Any horizontal separations within a buildingq Fire-resisting doorsq The absence of normal sources of ignitionq The presence or planned installation of fire-detection,

prevention or extinguishing systems, including sprink-lers, and the adequacy of fire-brigade services.

The existence of such protective installations may merit ahigher net retention than that calculated for a similar,unprotected type of risk, but it should be clearly under-stood that such protective systems may be rendered in-operative and should therefore be disregarded when cal-culating an EML.

In certain territories, however, it is customary tomake allowance for the presence of overall sprinklerprotection, horizontal separations and fire-resistingdoors in calculating non-LIRMA EMLs. In such cases, theamount by which the EML has been amended should beclearly stated, as should also the fact that such protec-tive facilities have been taken into account.

Regardless of how EMLs are defined, the practicalcalculation of the maximum Property loss, the maximumBusiness Interruption loss or the maximum combinedloss can be divided into three steps:

Fire or faults in control rooms can also disrupt operations

in other sections of a plant.

4.3

7 LIRMA Definition of Estimated Maximum Loss.


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combined EMLs should also take into consideration thefollowing general aspects:q Bottlenecks, e.g. key machineryq Rebuilding or reinstatement periodq Computer dependency, e.g. process computerq Contingency plans, which should be fully documented,

continually updated and, where feasible, validatedthrough testing

q Market situation, recovery of market shareq Dependencies upon suppliers and/or utility companies,

e.g. dependence on public utilitiesq Interdependencies, e.g. between locations or premises

of an insured who owns several operating companiesand many sites

q Just-in-time deliveries, e.g. of raw materials, compon-ents, parts or finished products

q Off-site exposures from adjacent sites owned byother insureds.

In addition to these general aspects, it is obviouslynecessary to consider a number of specific questionswhich vary, depending on the type of company involved,for example whether it is a company that operateson a seasonal basis, whether rental facilities are availableand whether it makes extensive use of automationand/or robotics, central warehousing or centralcomputing facilities.

Since it is not unusual for an insured to own severaloperating companies and a number of sites, BusinessInterruption losses are not always premises-specific.Also, in cases where a single event may affect more thanone insured, underwriting should be aware of the com-plexity involved in the accumulation of risk.

Other factors which should be taken into considera-tion include the presence of special risk parameters,e.g. polychlorinated biphenyls (PCBs) and/or asbestosroofing, which may be noted on the PD survey, meaning

that access to the site may be restricted followingdamage and thus result in a longer interruption ofbusiness. The effects of delays in receiving planning per-mission are important: for example, authorities couldclose a site, impose restrictions on operation or require aredesign in order to bring the plant technically up to date.

Furthermore, failure to keep off-site copies of specifi-cations and/or drawings for tooling and computersystems records should be considered. Attention shouldalso be paid to workforce availability and construction/fabrication market conditions. Factors delaying recoverymay include requirements for a unique asset, a uniquelocation, critical off-site dependencies or key types ofemployees.

Assuming a uniform period of liability of 12 monthsfor each fire area insured, the EML can be calculated onthe basis of the maximum estimated loss of capacityduring this period and the corresponding values involved.If shorter indemnity periods have been fixed for salaries,wages and commissions, the EML may be reduced.It should be noted that the possibilities of reducing aloss are not as great in cases where indemnity periodsare shorter.

In some cases loss limits are introduced in originalpolicies, as for example with large FLOP risks in theGerman market. The maximum indemnity payable in theevent of a loss is determined by the loss limit whichcorresponds to the EML.

Carelessness during welding work caused highly flammable plastics to ignite

and led to the terrible disaster at Dusseldorf Airport in April 1996.


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Assumptions and Assessment CriteriaThe underlying assumption is that all fire-protectionsystems and measures, for example automatic sprinklersystems and fire alarms, are ineffective.

The assumptions made for estimating the PML canbe summarised as follows:q Water spray is ineffective against radiant heatq Water spray is effective in preventing steel from

failureq The sprinkler systems are properly designed but will

fail to control fires in areas containing high concen-trations of plastics

5.2

fter the term EML, the second most commonlyused term is Probable Maximum Loss (PML).The basic concept is nearly the same as in EMLassessment. The following section describes

the definition of PML and the assumptions made incalculating it.

The concept of PML attempts to quantify the conse-quences of a major fire or explosion regardless of howthe fire or explosion started when the risks primaryfire-protection system is impaired. The key to under-standing the concept of PML is the word probable.

Recognising that even the best fire-protection system issubject to the ravages of Murphys Law

If something can go wrong,it will, and always at

the most inopportune time.,

a probable or likely hypothetical impairment of therisks primary fire-protection system is assumed. A lossscenario is then prepared based on the construction,occupancy, protection and exposure of the risk.

DefinitionThe PML is defined as the largest estimated loss arisingfrom a single event which was assessed with due care,taking into account all the elements of the risk 8.

In order to estimate the PML for a risk, it is necessaryto define a scenario in which a major fire occurs underreasonably adverse conditions. The term reasonablyadverse conditions is assumed to mean that the fireoccurs in the worst possible place at the worst possibletime. An example would be a fire occurring in the middleof a warehouse in the early hours of the morning at atime when the sprinkler system has been shut off forrepairs.

Probable Maximum Loss5

A

5.1

The cause of the fire, which completely destroyed this plant

producing the raw materials for paint, is still unknown. The resultant

property damage came to more than USD 60 million.

8 K. Gerathewohl, Reinsurance Principles and Practice, 1980.


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PMLs for non-sprinklered buildings of combustibleconstruction (frame, joisted masonry) will usuallyapproach 100% in amount subject fire divisions. Excep-tions would include long or widespread buildings insituations where good fire-department response isexpected and plentiful water supplies are available.Damage estimates for non-combustible construction willbe a function of the building size, combustion load andfire-department response.

Fire Loss of ProfitsTo develop a Business Interruption PML, it is necessary toprepare an analysis using the full annual risk values. ThePML will be limited only by the policy limit or the BI sub-limit where such a limit exists in the clients policy.

A number of factors should be considered in deter-mining the BI resulting from a PML-type fire. In additionto Fire factors, underwriters should take into account thefollowing Fire Loss of Profits (FLOP) factors:q Operations and/or production facilities which can

cause total BIq Operations and/or production facilities which can

cause partial BIq Department(s) whose failure has the most critical

effect(s) on profits.When assessing a FLOP PML, analysts should not reducethe PML because buffer stocks or redundant capacityexist, nor should they include any unusual changes in thecompanys financial situation or entrepreneurial risk.

5.3

q Tied walls will remain standingq The fire brigade is unable to control or extinguish

a fireq The fire brigade is effective in controlling damage

from salvage and clean-up proceduresq Highly sensitive facilities and stocks will sustain ex-

tensive damage from water and/or smokeq Offices are considered as an ordinary hazardq Combustion safeguards on ovens, furnaces and other

fired vessels are inoperable.The factors that are not taken into consideration arebasically the same as those described in the EML section.


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Example of Loss Estimates6

Plant values Amount in USD

Total sum insured (TSI) 20,000,000

The values break down as follows:

Production I 5,000,000

Production II 5,000,000

Storage I 3,000,000

Storage II 5,000,000

Other Facilities 2,000,000

he facility in question is a food processing plantwith extensive processing installations whosefire/explosion hazard is very high in relation tothe fire load. In view of the structure type and

explosion hazard, loss events are sure to spread to otherareas of the plant and buildings, in particular to theareas Storage I, Production I and Production II (silo ex-plosion). The building and plant-framing constructionconsists primarily of fireproof components. The facilitysexposure does not seem to be increased by neighbour-ing plants. It is possible for unauthorised persons, e.g.

saboteurs or arsonists, to enter the premises over theunsecured, standard wire-mesh fence.

T

Gate-house

Storage I (Silos) Raw Materials

Production I Foodstuff

Production II Special ProductsStorage II Products

Administration

5 0 m e

t r e s 2

5 m e

t r e s

50 metres

25 metres

Plant site plan


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Estimated Maximum LossThis denotes the largest loss that can result from a singleincident in the plant. It assumes that the initial incidentis so extensive that the active protection systems arerendered inoperative, and only the passive protectionfacilities, such as spacing and fire proofing, are effective.

A scenario with a silo explosion and fire in Storagearea I has been presumed. The distance of 25 metresbetween Storage I and Production I is assumed to beinadequate in the event of a silo explosion. However,

the administration building is adequately separated(each 50 metres). The fire will spread to Production I and II,and completely destroy the whole production area.However, Storage II can be rescued even assuming theprivate/public fire fighting is delayed.

The EML for Fire Property as a percentage of thetotal sum insured is calculated as follows:

USD 13,000,000 x 100 = 65%USD 20,000,000

6.1 6.2 Probable Maximum LossThis denotes the largest estimated loss resulting from asingle event in the plant under reasonably adverse condi-tions. The underlying assumptions here are that all pos-sible and/or required fire-safety measures are ineffective,and that no effective fire-fighting occurs. Damage islimited only by adequate separation.

On the one hand, the underwriter should take intoaccount the heavy fire load, particularly in Productionarea I. On the other hand, the Production I and Produc-

tion II buildings are not adequately separated by a fire-wall. The given scenario is nearly the same as in the EMLcalculation. The difference is that the fire-fighting iscompletely ineffective. The fire spreads to Storage II anddestroys it completely.

The PML for Fire Property as a percentage of thetotal sum insured is calculated as follows:

USD 18,000,000 x 100 = 90%USD 20,000,000


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inally, it should be mentioned that most companiesnow use two or even three different concepts ofloss estimation. Common concepts for calcu-lating Property damage or Business Interruption

losses include:

Normal Loss ExpectancyThe Normal Loss Expectancy (NLE) is an estimate of thelargest loss excluding a catastrophe loss which is tobe expected at a given site, assuming that all available

protective systems and measures function properly. TheNLE for a risk will typically be the loss resulting from asignificant fire or explosion which was extinguished orcontrolled and will take into consideration the adequacyof the risks fire protection systems. 9

Maximum Foreseeable LossThe Maximum Foreseeable Loss (MFL) is an estimate ofthe largest loss excluding a catastrophe loss which isto be expected at a given site, assuming that the primaryprotection systems are either impaired or activated onlyafter a delay. 9

The MFL for a risk is expressed in the same manneras the PML. The MFL concept quantifies the under-writers greatest fear of everything that can go wrong,doing just that. Expressed in other terms, the MFL for arisk represents the values for the amount subject firedivisions. It is assumed that fire damage will be limitedonly by the structural features of the buildings involved,i.e. blank, free-standing fire walls or adequate distancesbetween buildings.

Catastrophe Loss 9

The Catastrophe Loss (CL) is an estimate of the losswhich will occur at a site as a result of the followingtypes of events:q Explosions resulting from massive releases of

flammable vapours or gases, commonly known asvapour cloud explosions

q Tank or vessel failures resulting in the combustionof flammable liquids over large areas of the plant,including boiling liquid expanding vapour cloudexplosions (BLEVEs)

q Pressure ruptures of process equipment resulting inshrapnel damage

q The escape of a large quantity of toxic gas which,while not necessarily causing significant propertydamage, may result in significant business interrup-tion due to a shutdown pending investigation.

These events do not include sabotage, natural disasters

such as hurricanes or earthquakes, or falling aircraft.

Maximum Amount SubjectThe Maximum Amount Subject (MAS) is defined asthe largest percentage of the total sum insured values(PD and BI) at the location which is subject to fire,including attendant heat, smoke or water damage result-ing from the fire, or efforts to extinguish it, plus the costof debris removal if such is included in the treaty. Theonly factor which has a limiting effect on PD amountsubject is adequate separation. For BI, the MAS is 100%for 12 months, unless the surveying engineer feels thatlarger values are likely, in which case an explanationshould be provided.

Maximum Credible LossThe Maximum Credible Loss (MCL) is defined as thelargest monetary loss that can credibly result from asingle major occurrence of an insured peril at a specificrisk. It is assumed that none of the safeguards areeffective.

Possible Maximum Loss,Maximum Possible Loss

The Possible Maximum Loss (PML) or Maximum PossibleLoss (MPL) are defined as the monetary loss which mayoccur in extraordinary coincidences of the most disad-vantageous circumstances with the effect of preventingor impeding fire-fighting measures, so that the fire con-tinues to burn until it has exhausted the supply of com-bustible material or is stopped by impassable obstacles.

Other Commonly UsedConcepts

7

F

7.3

7.4

7.1

7.2

9 Chemical Industries Association, Guidelines on Business InterruptionRisk Assessment in the Chemical Industry, August 1992.

7.6

7.5


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Term

Normal Loss Expectancy

Maximum Foreseeable Loss

Estimated Maximum Loss

Probable Maximum LossMaximum Credible LossMaximum Amount Subject

Possible Maximum Loss /Maximum Possible Loss

Catastrophe Loss

Main Assumptions

q All fire protection systems, includingsprinkler systems, are effective

q Private/public fire-fighting is effective

q Primary protection systems are eitherimpaired or activated only after a delay

q Private/public fire-fighting is delayedq Damage is limited by adequate

separation of structures

q Fire protection systems, includingautomatic fire alarm and sprinklersystems, are not effective

q Private/public fire-fighting is delayedq Damage is limited by adequate


q No fire protection systems are effectiveq No effective fire-fightingq Damage is limited only by adequate


q No fire protection systems are effectiveq No effective fire-fightingq Damage is not limited by separation

Abbre-viation

NLE

MFL

EML

PMLMCLMAS

PMLMPL

CL

Scenario

Normal fire/explosion

Worst-case fire/explosion




q Vapour cloud explosionq BLEVEsq Natural hazards

Overview of Commonly Used Terms and Main Assumptions

Overview of VariousConcepts

The table below provides a summary of commonly usedterms and the main assumptions which are made.

8


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t is clear that the insurance industry needs to de-velop standardised methods of estimating loss poten-tials. There should be two basic concepts. The firstshould deal with normal losses in which at least

some of the available protection systems are operationaland effective. This concept might also take into accountthe availability of a rigorous engineering and loss-preven-tion programme. The second concept should be a worst-case estimate. Both concepts should be broad enough todeal with PD, LOP and other perils such as earthquake,windstorm and flood. We can only support this

approach, while emphasising at the same time howimportant it is to document any loss estimation advisedwith a clear definition.

It should be emphasised that, despite the availabilityof any definitions, loss estimates remain subjective esti-mates which still depend on the experience and skill ofthe person making the assessment. In view of the pos-sibly serious consequences of too optimistic loss esti-mates, it is advisable to use a conservative method andto have estimates prepared only by highly experiencedpeople possessing the requisite technical knowledge.

Final Remarks9

IEven though a variety of terms are used in the insur-

ance market, EML is the term generally used betweeninsurers and reinsurers. A wider set of definitions isfound in facultative business, i.e. MFL and PML.ERC Frankona prefers the LIRMA definition of EML. Dueto the nature of the insurance marketplace, however, weare compelled to adapt our definition to match that ofour clients. Quite often, we find the concepts MAS, MFLor PML. This compels us to make loss estimates whichmay be either too conservative or not conservativeenough for the specific risk.


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LIRMA Definition of a Single RiskA single risk, for this purpose, means any building orrange of buildings not separated either:a from other buildings by an open space (with no tall

grass, timber or any other combustible element) of15 metres where there are no opposing openingsand where the other buildings have external walls ofbricks, stone or concrete (reinforced or otherwise)and are roofed with slates, tiles, concrete (reinforcedor otherwise) or metal sheeting

b from other buildings by an open space (with no com-

bustible element) of 25 metres where there areopposing openings or where the other buildings areof a construction inferior to that defined in a) above

c from adjacent property by a perfect party wall ofbrick, stone or concrete (reinforced or otherwise) ofat least 21 centimetres thickness, entirely withoutopening and extending at least 37 centimetres abovethe roof of both sides. Where one roof is of concrete,the party wall need not extend above it.

In buildings separated in accordance with a) or b), anopen-sided covered way, not used for any trade processor for storage, would not be considered as forming com-munication.

In the case of plants in the open (refineries, chemicalfactories and the like) or of tank s torage, the minimumopen space between units or groups of tanks for thepurpose shall be 25 metres. In addition, storage tanksmust be adequately bonded by container walls sufficientto hold at least 110% of the maximum capacity of thetanks.

Wherever there is sloping ground coupled with a riskwhich, in the event of fire, could produce burning liquid,regard should be taken of the fact when assessing asingle risk, notwithstanding the existence of separationsas defined above.

Appendix

These separations are considered to be adequate toprevent the spread of fire. However, where an inherentexplosion hazard exists, a perfect party wall (see c)above) cannot necessarily be considered adequateseparation. Moreover, where highly explosive materialsare used, even greater distances are required to provideadequate separation.

Where stocks are insured on a floating or declara-tion basis, the amount to be taken into account is theloss limit on stocks in the single risk under considera-tion or, where there is no loss limit, the total sum insured

on stocks. Variation of this rule is a llowed only in caseswhere the maximum value of stocks in the single risk isclearly limited by the capacity of the building or buildings,in which case the amount to be taken into account shallnot be less than that related to the maximum capacity.

Prevailing climatic conditions, e.g. strong winds orextreme cold, which could have a material effect on firespread must also be taken into account in definingsingle risk.

Used by kind permission of LIRMA


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Sedgwick Energy Ltd., Vapour Cloud ExplosionMethodology, March 1994.

Recommendations by the former German Associationof Property Insurers, Cologne, on the Determination of the Probable Maximum Loss with Fire and FLOP Insurance.Published in the Manual for Industrial Fire and Fire Lossof Profits Insurance, Reports.

Insurance Institute of London, EML Assessments:London Market Practice, September 1995.

Reinsurance Offices Association (now LIRMA),Definition of Estimated Maximum Loss, London, 1974.

K. Gerathewohl, Reinsurance Principles and Practice, 1980.

Chemical Industries Association, Guidelines on BusinessInterruption Risk Assessment in the Chemical Industry,

August 1992.

Abbreviations

AS Amount Subject BI Business InterruptionBLEVEs Boiling Liquid Expanding Vapour Cloud ExplosionsCL Catastrophe LossEML Estimated Maximum LossFLOP Fire Loss of ProfitsLIRMA London Institute Insurance and Reinsurance

Management AssociationLOP Loss of ProfitsMAS Maximum Amount Subject MCL Maximum Credible LossMFL Maximum Foreseeable LossMPL Maximum Possible LossMPL Maximum Probable LossMUR Maximum Unit at Risk NLE Normal Loss Expectancy PD Property DamagePML Possible Maximum LossPML Probable Maximum LossROA Reinsurance Offices Association

References


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PublisherERC FrankonaRckversicherungs-AGMunich

Editor-in-ChiefFrank ReicheltProperty ManagerERC FrankonaRckversicherungs-AGMunich

AuthorsKurt BjrligDr Erika Penzenstadler

Final EditingDr Erika Penzenstadler

Editorial AddressERC FrankonaRckversicherungs-AGMaria-Theresia-Strasse 35D-81675 Munich, GermanyTelephone: +49 (0)89 92 28-0Telefax: +49 (0)89 92 28-395

ProductionEGE-VerlagsserviceMunich

DesignStahl GrafikbroMunich

Printed byUniversal Druck GmbHMunich

IllustrationErik Liebermann

PhotosThe Image Bank (Title, P. 3 & 8)dpa (P. 5, 6, 9 & 10)

Copyright 1997 by ERC Frankona.Text reprinting allowed providedsource quoted and complimentarycopy supplied.

Our experts will be happyto answer any queries!Tel. +49 (0)89 9228-716

eml or pml does it make a difference

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