EML or PML Does It Make a Difference

ERCFrankona EML or PML Does It Make A Difference? Practical Use And Calculation Of Loss Potential Estimates In Fire Insurance 1 4.3 7.3 6 6.2 7 7.1 5.4 7. Maximum Possible Loss Overview of Various Concepts Final Remarks Appendix – LIRMA Definition of a “Single Risk” References 3 4 5 3 6 4 4.6 7 10 12 14 8 9 15 16 17 18 .Contents Page Foreword 1 2 Historical Development Consequences of Incorrect Loss Estimates General Approach to Loss Estimates Estimated Maximum Loss Definition Assumptions and Assessment Criteria Fire Loss of Profits Probable Maximum Loss Definition Assumptions and Assessment Criteria Fire Loss of Profits Example of Loss Estimates Estimated Maximum Loss Probable Maximum Loss Other Commonly Used Concepts Normal Loss Expectancy Maximum Foreseeable Loss Catastrophe Loss Maximum Amount Subject Maximum Credible Loss Possible Maximum Loss.2 5.2 4.2 7.3 5 5.1 6.5 7.1 7. may mean either “probable” or “possible” maximum loss. This is particularly important for losses exceeding the previously calculated loss potential. earthquake. An overview of terms currently in use in various countries has also been included. i.). the liability assumed by insurers and reinsurers in any given risk is ultimately limited by the share accepted in the risk’s total sum insured. which illustrates the inherent danger in assuming that similar or identical abbreviations and terminology are identical. The meaning of abbreviations used may also vary widely. For example.Foreword I rrespective of the definition and method used to assess loss potential. i. and particularly of technical.g. windstorm. however. it is imperative for insurers and reinsurers to have a common understanding of the various definitions and criteria applied in determining EML/PML to allow them to assess accurately the financial consequences of loss occurrences. we may be permitted to emphasise how important it is that underwriters always make the appropriate analysis (e. Within this context. but such deviations have not been dealt with in this publication. Underwriters employ a variety of definitions of and methods of determining Estimated Maximum Losses (EMLs) and Probable Maximum Losses (PMLs). flood. are not considered in detail. The objective of this brochure is to establish a common understanding of the various approaches to Fire loss assessment. In broad terms. no common standard has yet been adopted by the insurance industry as a whole. the diverse definitions result from differences in the ways in which various levels of fire protection and fire-fighting features are taken into consideration. calculations of EML and PML. the purpose and practical use of loss potential estimates and the basis of practical. 3 .e.e. the most commonly confused abbreviation. Nevertheless. cumulative losses. Loss estimations at the portfolio level. This brochure provides a general introduction to loss potential estimates in Fire insurance. Misinterpretations may prove to be dangerous and costly. etc. There may be deviations peculiar to certain companies and insurance clients as a result of their specific calculation assumptions. It focuses exclusively on single-risk exposure. Despite the relevance of loss potential estimation for Property underwriting. “PML”. However. which is now expressed as “Amount Subject” (AS). The ROA has since been superseded by the London Institute Insurance and Reinsurance Management Association (LIRMA).1 Historical Development I nitially. and last but not least due to generally favourable loss experience. the use of fire walls and fireproof materials in accordance with strict building regulations. resulting in losses considerably exceeding the estimates on which the net retention had been based. subject to one fire at each location”. as industries grew and individual policies were extended to cover more plants. 4 . Also. even today. The various terms gave rise to the major problem. the letter P in MPL and PML caused a great deal of confusion because some companies used it to mean “possible”. Experience showed. PML. the introduction of automatic fire-extinguishing installations and fire alarms. underwriting policy was again placed on a more conservative footing. Since the LIRMA definition is the only common definition of maximum loss potential available.. Despite the obvious advantages of having a single. all Property underwriting and reinsurance was done on the basis of the total sum insured per policy. etc. the LIRMA definition has unfortunately never been generally accepted by the market as it deserved to be. that this was an extremely dangerous approach because too many fires spread to adjacent sections. Underwriting policy evolved concurrently with technical developments in the building sector. however. etc. when assessing risks and deciding the size of their net retentions. and somewhat later. we will initially focus on this definition. which is now expressed as “Maximum Unit at Risk” (MUR). Before examining this definition in detail. we would like to discuss briefly the general approach to loss estimation and the consequences of actual losses which exceed loss estimates. MFL. This is because. In the early seventies this led to a proposal by the Reinsurance Offices’ Association (ROA) in London that a standard definition of EML be used for reinsurance purposes. Insurers found that they could increase their net retention without endangering their company’s share capital by basing their underwriting and net retention first on the “highest sum insured per location”. however. Following the crisis in the fifties.e. Many insurers determined their net retentions on the basis of “maximum loss under normally unfavourable circumstances per location” or even “per fire section”. that each and every insurer could have used different philosophies and definitions of what they thought to be a proper loss estimate. i. and loss potential estimates were redefined. The definitions are all subjective and open to different interpretations. insurers found that they were being compelled to cede too much of their business in the form of reinsurance and/or coinsurance. commonly accepted definition of maximum loss estimation. however. The terms most frequently used to express the maximum loss which might be caused by a single fire (or other insured peril) were – and still are – the following: PML: Probable Maximum Loss PML: Possible Maximum Loss MPL: Maximum Probable Loss MPL: Maximum Possible Loss MCL: Maximum Credible Loss MFL: Maximum Foreseeable Loss EML: Estimated Maximum Loss. while others used it to mean “probable”. companies prefer to use their own definitions of EML. on the “maximum sum insured. Here a view of the tank farm in flames. but the consequences of EML failure might be damaging. their calculation is based on a human evaluation of the loss potential entailed in specific risks. but when they do occur. 1 Sedgwick Energy Ltd.5%. In other words. the purpose of EMLs is to allow insurers to optimise their net retentions and thus to keep as much premium as possible for their own account. This means that it will always be possible for estimates to vary. Despite the fact that the incident took place more than 20 years ago. however. The EML. E stimated Maximum Losses (EMLs) are produced for the use of the underwriter to assist him or her with deciding the size and extent of line to be written and the level of reinsurance required. They are useful in demonstrating the relationship between the level of premium being obtained and the likely extent of loss. In addition. Although a small difference in percentage. the frequency of inaccurate calculations in general should be low. or possibly pass on to its reinsurance programme. the balance amounted to USD 1 million. For example. The chemical plant was insured against material damage due to fire or explosion up to an amount of USD 43 million. underwriters and production companies have developed a number of methods to help quantify such catastrophic EMLs. the insurers and reinsurers had to pay nearly USD 27 million more than had been anticipated when they accepted shares of the risk. engineering-based models1 and empirical approaches based on loss history are now favoured in energy insurance. the insured was also protected by a Loss of Profits (LOP) policy with a limit of USD 9 million. The balance of 60% amounted to nearly USD 26 million. they are often of serious magnitude.. however. Leakage led to a devastating explosion which destroyed nearly 80% of the plant. However. If the “true“ maximum loss is incorrectly assessed and then actually occurs. A reinsurance programme based on EML is not problematic in itself. Insurance brokers. It is obvious that such errors could lead to solvency problems for the parties involved. it continues to be a good example because the damage was so extensive that most insurers and reinsurers still remember what happened on 1 June 1974. the purpose is to decide how large a monetary loss the company is prepared to bear for its own account. By writing a share on EML basis. set against its own financial strength. In addition to the Property damage. March 1994. 5 . had been estimated at only 20%. Irrespective of how EMLs are defined. the LOP loss was 66. One of the most spectacular errors involving an inaccurate EML calculation was the Flixborough disaster. All in all.2 Consequences of Incorrect Loss Estimates A devastating explosion in the 1970s at a chemical plant in Flixborough caused enormous damage. an insurer can write more of the risk. both the ceding company and its reinsurer may have to pay a considerably greater amount than was assumed when the treaty or facultative offer was accepted. for which the EML had been assessed at 60%. Vapour Cloud Explosion Methodology. Fortunately. Reports. e. flood.g. q Site interviews should be conducted with members of senior management.g. EML Assessments: London Market Practice. the peril representing a greater exposure should also be evaluated in more detail. Business Interruption assessments should take into account any interdependencies which may exist and the length of the indemnity period. windstorm or aircraft damage represents a greater exposure. q Calculations should be accompanied by a description of the assumptions made and the method used. In this context it is worth mentioning that in some countries the buildings will be insured at the new replacement value without a fixed maximum sum insured. General practice guidelines may be summarised as follows3: q Any loss estimation. 3 Insurance Institute of London. It is necessary to identify the complex with the greatest exposure. and particularly EML/PML calculations. 6 . Published in the Manual for Industrial Fire and Fire Loss of Profits Insurance. September 1995. compliance with new building regulations. As with this major fire which caused damage amounting to more than USD 5 million. q Loss estimates should be updated regularly. the Estimated Maximum Loss (EML) or Probable Maximum Loss (PML) are estimated by dividing the risk into complexes. When assessing the EML or PML. on the Determination of the Probable Maximum Loss with Fire and FLOP Insurance. Caution should be exercised in defining complexes because experience has shown that structural separation in the conventional sense is no longer entirely effective in the event of a loss. Additionally. today’s rapid technological advancement has greatly increased fire loads and the danger of explosion. removal of debris. EMLs or PMLs are expressed as a percentage of the total sum insured or in an absolute amount. the actual policy wording has to be considered too. should be accompanied by definitions of the terms used. They need not be completely separated from neighbouring buildings or structures. 2 Recommendations by the former German Association of Property Insurers. q Maximum loss assessments should be based on fire/explosion potential unless another peril such as earthquake. Cologne. q Assessments should consider a range of factors. e. plane crash. coverage for residual values. it should be considered that a fire can also spread to other complexes. For example. The possibility that a fire may spread beyond the complex in which it starts is suggested by the following risk characteristics or events2: q Risk of explosion q Risk of consequential damage resulting from corrosive gases or vapours q Risks created by the neighbourhood q Cases of simultaneous arson in several separate complexes q Disaster-like effects of external factors connected neither directly nor indirectly with the risk insured. A complex may consist of one or more buildings or rooms or structures which themselves contain structural boundaries or separations.3 General Approach to Loss Estimates G enerally. it is often difficult to prove whether arson is involved. In order to clarify this issue. In that case. the following definitions and assumptions may be taken as a possible guideline in assessing the risk term of EMLs and PMLs. The separation walls. roofs. carbon dioxide and foam systems. . it should be assumed that full. this definition contains a number of subjective words which make it possible to take into consideration local experience and factors which may vary from country to country or even from place to place. 6 LIRMA Definition of Estimated Maximum Loss. material damage only) An estimate of the monetary loss which could be sustained by insurers on a single risk as a result of a single fire or explosion considered to be within the realms of probability. the definition attempts to specify what should be regarded as being “within the realms of probability“ and what should be considered to be “remote and unlikely coincidences or catastrophes“. distribution and combustibility of contents (fire load) q The use of hazardous processes and substances and the degree to which they are separated q The susceptibility of the contents to damage by smoke. sealed firewalls will hold. fire doors included. Most of the insurance industry uses the LIRMA definition as a basis for defining both a single risk and an EML. g. sprinklers. cistern park or liquefied petroleum gas tank q Any special geographical or meteorological features such as wind conditions. walls and floors q The presence of combustible linings on walls. Definition of Estimated Maximum Loss. Fire doors that are held open magnetically do not close.4 Estimated Maximum Loss T 4. unless an exceptionally high fire load or evident risk of explosion makes it seem justified to assume otherwise. goods. London. Thirdly. or they are non-existent. It is also assumed that the risks are exposed to normal circumstances.1 he only definition generally recognised today is the one originally proposed by the ROA (which has now been superseded by LIRMA)4: 4.) are not in service. Secondly. A standard method for calculating EMLs should consider the following specific risk factors6: q The dimensions and shape of the area potentially exposed to a single fire or explosion q The construction of roof. with consideration given to design and materials q The distance to any stocks such as timber. 4 Reinsurance Offices’ Association. the LIRMA definition goes on to state what is meant by a “single risk“5 and to list the parameters which should or should not be taken into account when estimating the monetary loss. Abnormal circumstances. heat and water q The risk of explosion (where liquefied petroleum gas. 7 . which are not taken into account: q Plane crashes or objects falling from the sky q Explosion in a vessel due to vapour q Arson and sabotage. flammable goods and dust are stored/used) q Any hazards arising from gases or corrosive materials q Any concentrations of value within a small area q The standards of management and housekeeping q The clearance between buildings. it is also assumed that competent private and public assistance is delayed. The estimate ignores such remote coincidences and catastrophes as may be possibilities but which still remain unlikely. etc. Assumptions and Assessment Criteria Estimated Maximum Losses (EMLs) are based on a number of assumptions: firstly. i.2 Definition Estimated Maximum Loss (Fire and explosion. that automatic fire-alarm and extinguishing systems (e. ceilings and partitions q The nature. 5 LIRMA Definition of a “Single Risk” see Appendix. However.e. are constructed to withstand fire for at least two hours. and that the fire doors between at least two adjacent fire areas are open. 1974. As is evident. In certain territories. Business Interruption losses often exceed Property damage (PD) losses. as should also the fact that such protective facilities have been taken into account. Identify the loss scenario entailing the maximum monetary loss in the selected areas (PD and FLOP). the actual sums insured and coverage provided. since the maximum Business Interruption loss is usually triggered by physical loss or damage. 2. also consider any production bottlenecks or specialised machinery. it is customary to make allowance for the presence of overall sprinkler protection. However. based on the identified loss scenarios. the LIRMA definition can easily be amended in such a way that it could also be applied to combined EMLs for Property damage and FLOP. hazards. including sprinklers. unprotected type of risk. if the LIRMA definition is used). which is now often the most important factor in estimating loss potential. All calculations should be prepared in accordance with the selected definition of EML (i. the practical calculation of the maximum Property loss. 4. however. Factors which should not be included when assessing an EML7: q Any horizontal separations within a building q Fire-resisting doors q The absence of normal sources of ignition q The presence or planned installation of fire-detection. taking into consideration the continuity of combustibles. prevention or extinguishing systems. building construction.Fire or faults in control rooms can also disrupt operations in other sections of a plant. horizontal separations and fire-resisting doors in calculating non-LIRMA EMLs. the amount by which the EML has been amended should be clearly stated.3 Fire Loss of Profits The obvious weakness of the LIRMA definition is that it says nothing about Fire Loss of Profits (FLOP). Calculate the PD and FLOP losses for the selected areas. 3. Estimate the extent of fire spread and damage which would result from a major fire. and the adequacy of fire-brigade services. Combined loss estimates should be prepared in all cases where both Property damage and Business Interruption are being underwritten. given the fire area and factors assumed.e. Identify the potential risk areas among the single risks at the plant. When defining fire areas. giving due thought to the list of applicable factors and. 8 . the maximum Business Interruption loss or the maximum combined loss can be divided into three steps: 1. of course. unimpaired protection and business interruption. but it should be clearly understood that such protective systems may be rendered inoperative and should therefore be disregarded when calculating an EML. In such cases. Regardless of how EMLs are defined. underwriters assessing Fire Loss of Profits EMLs or 7 LIRMA Definition of Estimated Maximum Loss. In addition to the principles applied to Fire EMLs. The existence of such protective installations may merit a higher net retention than that calculated for a similar. g. e.g. parts or finished products q Off-site exposures from adjacent sites owned by other insureds. failure to keep off-site copies of specifications and/or drawings for tooling and computer systems records should be considered. recovery of market share q Dependencies upon suppliers and/or utility companies. The maximum indemnity payable in the event of a loss is determined by the loss limit which corresponds to the EML. which should be fully documented. meaning that access to the site may be restricted following damage and thus result in a longer interruption of business. a unique location.g. between locations or premises of an insured who owns several operating companies and many sites q Just-in-time deliveries.Carelessness during welding work caused highly flammable plastics to ignite and led to the terrible disaster at Dusseldorf Airport in April 1996. process computer q Contingency plans. dependence on public utilities q Interdependencies. e. as for example with large FLOP risks in the German market. components.g. wages and commissions. 9 . central warehousing or central computing facilities. critical off-site dependencies or key types of employees. the EML may be reduced. e. of raw materials. validated through testing q Market situation. the EML can be calculated on the basis of the maximum estimated loss of capacity during this period and the corresponding values involved. polychlorinated biphenyl’s (PCBs) and/or asbestos roofing. key machinery q Rebuilding or reinstatement period q Computer dependency. If shorter indemnity periods have been fixed for salaries. authorities could close a site. The effects of delays in receiving planning permission are important: for example. it is obviously necessary to consider a number of specific questions which vary. In some cases loss limits are introduced in original policies. e. Attention should also be paid to workforce availability and construction/ fabrication market conditions. It should be noted that the possibilities of reducing a loss are not as great in cases where indemnity periods are shorter. continually updated and.g. Also. Furthermore. Other factors which should be taken into consideration include the presence of special risk parameters.g. Factors delaying recovery may include requirements for a unique asset. which may be noted on the PD survey. Business Interruption losses are not always premises-specific. impose restrictions on operation or require a redesign in order to bring the plant technically up to date. e. underwriting should be aware of the complexity involved in the accumulation of risk. Assuming a uniform period of liability of 12 months for each fire area insured. depending on the type of company involved. Since it is not unusual for an insured to own several operating companies and a number of sites. whether rental facilities are available and whether it makes extensive use of automation and/or robotics. combined EMLs should also take into consideration the following general aspects: q Bottlenecks. in cases where a single event may affect more than one insured. for example whether it is a company that operates on a seasonal basis. where feasible. e. In addition to these general aspects. The cause of the fire. The resultant property damage came to more than USD 60 million. occupancy. In order to estimate the PML for a risk.”. a probable or likely hypothetical impairment of the risk’s primary fire-protection system is assumed.2 Assumptions and Assessment Criteria The underlying assumption is that all fire-protection systems and measures. 5. The basic concept is nearly the same as in EML assessment. for example automatic sprinkler systems and fire alarms. it is necessary to define a scenario in which a major fire occurs under reasonably adverse conditions. 5. it will. which completely destroyed this plant producing the raw materials for paint. Reinsurance Principles and Practice. The key to understanding the concept of PML is the word “probable”. taking into account all the elements of the risk8. 1980. protection and exposure of the risk. A loss scenario is then prepared based on the construction. The following section describes the definition of PML and the assumptions made in calculating it. The assumptions made for estimating the PML can be summarised as follows: q Water spray is ineffective against radiant heat q Water spray is effective in preventing steel from failure q The sprinkler systems are properly designed but will fail to control fires in areas containing high concentrations of plastics 8 K. 10 . Recognising that even the best fire-protection system is subject to the ravages of Murphy’s Law “If something can go wrong. An example would be a fire occurring in the middle of a warehouse in the early hours of the morning at a time when the sprinkler system has been shut off for repairs. and always at the most inopportune time.1 Definition The PML is defined as the largest estimated loss arising from a single event which was assessed with due care. The concept of PML attempts to quantify the consequences of a major fire or explosion – regardless of how the fire or explosion started – when the risk’s primary fire-protection system is impaired. are ineffective. Gerathewohl. the second most commonly used term is Probable Maximum Loss (PML). is still unknown.5 Probable Maximum Loss A fter the term EML. The term “reasonably adverse conditions” is assumed to mean that the fire occurs in the worst possible place at the worst possible time. 5. 11 . When assessing a FLOP PML. In addition to Fire factors. q Tied walls will remain standing q The fire brigade is unable to control or extinguish a fire q The fire brigade is effective in controlling damage from salvage and clean-up procedures q Highly sensitive facilities and stocks will sustain ex- tensive damage from water and/or smoke q Offices are considered as an ordinary hazard q Combustion safeguards on ovens. The factors that are not taken into consideration are basically the same as those described in the EML section.3 Fire Loss of Profits To develop a Business Interruption PML. Exceptions would include long or widespread buildings in situations where good fire-department response is expected and plentiful water supplies are available. joisted masonry) will usually approach 100% in amount subject fire divisions.PMLs for non-sprinklered buildings of combustible construction (frame. analysts should not reduce the PML because buffer stocks or redundant capacity exist. furnaces and other fired vessels are inoperable. underwriters should take into account the following Fire Loss of Profits (FLOP) factors: q Operations and/or production facilities which can cause total BI q Operations and/or production facilities which can cause partial BI q Department(s) whose failure has the most critical effect(s) on profits. A number of factors should be considered in determining the BI resulting from a PML-type fire. Damage estimates for non-combustible construction will be a function of the building size. nor should they include any unusual changes in the company’s financial situation or entrepreneurial risk. it is necessary to prepare an analysis using the full annual risk values. The PML will be limited only by the policy limit or the BI sublimit where such a limit exists in the client’s policy. combustion load and fire-department response. Production I and Production II (silo explosion).000. Plant values Total sum insured (TSI) Amount in USD 20.000 5. The facility’s exposure does not seem to be increased by neighbouring plants.000 5.000.000 3. e.000 5.000 2. in particular to the areas Storage I. The building and plant-framing construction consists primarily of fireproof components. standard wire-mesh fence.g. saboteurs or arsonists. to enter the premises over the unsecured.6 Example of Loss Estimates T he facility in question is a food processing plant with extensive processing installations whose fire/explosion hazard is very high in relation to the fire load.000 The values break down as follows: Production I Production II Storage I Storage II Other Facilities Storage I (Silos) Raw Materials 50 metres Administration Gatehouse 25 metres Production I Foodstuff Production II Special Products 25 metres Storage II Products Plant site plan 12 50 metres .000.000. In view of the structure type and explosion hazard. It is possible for unauthorised persons. loss events are sure to spread to other areas of the plant and buildings.000.000. and completely destroy the whole production area. the Production I and Production II buildings are not adequately separated by a firewall.000. The EML for Fire Property – as a percentage of the total sum insured – is calculated as follows: USD 13. The PML for Fire Property – as a percentage of the total sum insured – is calculated as follows: USD 18.000. However. On the one hand. However. The underlying assumptions here are that all possible and/or required fire-safety measures are ineffective.000 USD 20.1 Estimated Maximum Loss This denotes the largest loss that can result from a single incident in the plant. The fire spreads to Storage II and destroys it completely. and that no effective fire-fighting occurs. such as spacing and fire proofing. On the other hand. The distance of 25 metres between Storage I and Production I is assumed to be inadequate in the event of a silo explosion. Storage II can be rescued even assuming the private/public fire fighting is delayed.2 Probable Maximum Loss This denotes the largest estimated loss resulting from a single event in the plant under reasonably adverse conditions. The fire will spread to Production I and II. and only the passive protection facilities.000 x 100 = 90% 13 . It assumes that the initial incident is so extensive that the active protection systems are rendered inoperative. particularly in Production area I. are effective.000.000 USD 20. the administration building is adequately separated (each 50 metres).000. A scenario with a silo explosion and fire in Storage area I has been presumed. the underwriter should take into account the heavy fire load.000 x 100 = 65% 6. Damage is limited only by adequate separation. The difference is that the fire-fighting is completely ineffective. The given scenario is nearly the same as in the EML calculation.6. assuming that all available protective systems and measures function properly. doing just that. Maximum Possible Loss The Possible Maximum Loss (PML) or Maximum Possible Loss (MPL) are defined as the monetary loss which may occur in extraordinary coincidences of the most disadvantageous circumstances with the effect of preventing or impeding fire-fighting measures. 7. Common concepts for calculating Property damage or Business Interruption losses include: q Tank or vessel failures resulting in the combustion Normal Loss Expectancy The Normal Loss Expectancy (NLE) is an estimate of the largest loss – excluding a catastrophe loss – which is to be expected at a given site. natural disasters such as hurricanes or earthquakes.7 Other Commonly Used Concepts F 7. including attendant heat. commonly known as vapour cloud explosions 7. including boiling liquid expanding vapour cloud explosions (BLEVEs) q Pressure ruptures of process equipment resulting in shrapnel damage q The escape of a large quantity of toxic gas which. plus the cost of debris removal if such is included in the treaty. i.” Expressed in other terms.5 Maximum Credible Loss The Maximum Credible Loss (MCL) is defined as the largest monetary loss that can credibly result from a single major occurrence of an insured peril at a specific risk. Possible Maximum Loss. The only factor which has a limiting effect on PD amount subject is adequate separation. 14 .4 7. while not necessarily causing significant property damage. Maximum Amount Subject The Maximum Amount Subject (MAS) is defined as the largest percentage of the total sum insured values (PD and BI) at the location which is subject to fire. 7. August 1992. For BI. may result in significant business interruption due to a shutdown pending investigation.1 inally.6 9 Chemical Industries Association. or efforts to extinguish it. smoke or water damage resulting from the fire. or falling aircraft. the MFL for a risk represents the values for the amount subject fire divisions. The MFL concept quantifies the underwriter’s greatest fear of “everything that can go wrong. it should be mentioned that most companies now use two or even three different concepts of loss estimation. free-standing fire walls or adequate distances between buildings. blank. Guidelines on Business Interruption Risk Assessment in the Chemical Industry. It is assumed that none of the safeguards are effective.e. It is assumed that fire damage will be limited only by the structural features of the buildings involved.9 of flammable liquids over large areas of the plant. unless the surveying engineer feels that larger values are likely. These events do not include sabotage.3 Catastrophe Loss9 The Catastrophe Loss (CL) is an estimate of the loss which will occur at a site as a result of the following types of events: q Explosions resulting from massive releases of flammable vapours or gases. 7. the MAS is 100% for 12 months. assuming that the primary protection systems are either impaired or activated only after a delay.2 Maximum Foreseeable Loss The Maximum Foreseeable Loss (MFL) is an estimate of the largest loss – excluding a catastrophe loss – which is to be expected at a given site. The NLE for a risk will typically be the loss resulting from a significant fire or explosion which was extinguished or controlled and will take into consideration the adequacy of the risk’s fire protection systems. in which case an explanation should be provided. so that the fire continues to burn until it has exhausted the supply of combustible material or is stopped by impassable obstacles.9 The MFL for a risk is expressed in the same manner as the PML. 8 Overview of Various Concepts The table below provides a summary of commonly used terms and the main assumptions which are made. are not effective q Private/public fire-fighting is delayed q Damage is limited by adequate separation of structures Probable Maximum Loss Maximum Credible Loss Maximum Amount Subject PML MCL MAS Worst-case fire/explosion q No fire protection systems are effective q No effective fire-fighting q Damage is limited only by adequate separation of structures Possible Maximum Loss / Maximum Possible Loss Catastrophe Loss PML MPL CL Worst-case fire/explosion q No fire protection systems are effective q No effective fire-fighting q Damage is not limited by separation q Vapour cloud explosion q BLEVEs q Natural hazards Overview of Commonly Used Terms and Main Assumptions 15 . Term Abbreviation NLE Scenario Main Assumptions Normal Loss Expectancy Normal fire/explosion q All fire protection systems. including sprinkler systems. including automatic fire alarm and sprinkler systems. are effective q Private/public fire-fighting is effective Maximum Foreseeable Loss MFL Worst-case fire/explosion q Primary protection systems are either impaired or activated only after a delay q Private/public fire-fighting is delayed q Damage is limited by adequate separation of structures Estimated Maximum Loss EML Worst-case fire/explosion q Fire protection systems. We can only support this approach. ERC Frankona prefers the LIRMA definition of EML. MFL and PML. It should be emphasised that. There should be two basic concepts. windstorm and flood. MFL or PML. Even though a variety of terms are used in the insurance market. The first should deal with normal losses in which at least some of the available protection systems are operational and effective. A wider set of definitions is found in facultative business. it is advisable to use a conservative method and to have estimates prepared only by highly experienced people possessing the requisite technical knowledge.e.9 Final Remarks I t is clear that the insurance industry needs to develop standardised methods of estimating loss potentials. Quite often. loss estimates remain subjective estimates which still depend on the experience and skill of the person making the assessment. Both concepts should be broad enough to deal with PD. In view of the possibly serious consequences of too optimistic loss estimates. The second concept should be a worstcase estimate. Due to the nature of the insurance marketplace. EML is the term generally used between insurers and reinsurers. while emphasising at the same time how important it is to document any loss estimation advised with a clear definition. however. This concept might also take into account the availability of a rigorous engineering and loss-prevention programme. This compels us to make loss estimates which may be either too conservative or not conservative enough for the specific risk. despite the availability of any definitions. we find the concepts MAS. LOP and other perils such as earthquake. 16 . we are compelled to adapt our definition to match that of our clients. i. the minimum open space between units or groups of tanks for the purpose shall be 25 metres. Variation of this rule is allowed only in cases where the maximum value of stocks in the “single risk” is clearly limited by the capacity of the building or buildings. chemical factories and the like) or of tank storage. strong winds or extreme cold. stone or concrete (reinforced or otherwise) of at least 21 centimetres thickness. Wherever there is sloping ground coupled with a risk which. which could have a material effect on fire spread must also be taken into account in defining “single risk”. entirely without opening and extending at least 37 centimetres above the roof of both sides. timber or any other combustible element) of 15 metres where there are no opposing openings and where the other buildings have external walls of bricks. would not be considered as forming communication. notwithstanding the existence of separations as defined above. e. In the case of plants in the open (refineries. tiles. concrete (reinforced or otherwise) or metal sheeting b from other buildings by an open space (with no combustible element) of 25 metres where there are opposing openings or where the other buildings are of a construction inferior to that defined in a) above c from adjacent property by a perfect party wall of brick. Prevailing climatic conditions. could produce burning liquid. where highly explosive materials are used. storage tanks must be adequately bonded by container walls sufficient to hold at least 110% of the maximum capacity of the tanks. the total sum insured on stocks. Used by kind permission of LIRMA 17 . a perfect party wall (see c) above) cannot necessarily be considered adequate separation. in the event of fire. not used for any trade process or for storage. Where one roof is of concrete. regard should be taken of the fact when assessing “a single risk”.g. the party wall need not extend above it. in which case the amount to be taken into account shall not be less than that related to the maximum capacity. These separations are considered to be adequate to prevent the spread of fire. means any building or range of buildings not separated either: a from other buildings by an open space (with no tall grass. In addition. Where stocks are insured on a “floating” or “declaration” basis. In buildings separated in accordance with a) or b). where there is no loss limit. an open-sided covered way.Appendix LIRMA Definition of a “Single Risk” “A single risk”. the amount to be taken into account is the loss limit on stocks in the “single risk” under consideration or. for this purpose. even greater distances are required to provide adequate separation. stone or concrete (reinforced or otherwise) and are roofed with slates. However. where an inherent explosion hazard exists. Moreover. Insurance Institute of London. London. Reports. on the Determination of the Probable Maximum Loss with Fire and FLOP Insurance. September 1995. 1980. March 1994. Abbreviations AS BI BLEVEs CL EML FLOP LIRMA LOP MAS MCL MFL MPL MPL MUR NLE PD PML PML ROA Amount Subject Business Interruption Boiling Liquid Expanding Vapour Cloud Explosions Catastrophe Loss Estimated Maximum Loss Fire Loss of Profits London Institute Insurance and Reinsurance Management Association Loss of Profits Maximum Amount Subject Maximum Credible Loss Maximum Foreseeable Loss Maximum Possible Loss Maximum Probable Loss Maximum Unit at Risk Normal Loss Expectancy Property Damage Possible Maximum Loss Probable Maximum Loss Reinsurance Offices’ Association 18 . Reinsurance Principles and Practice. Definition of Estimated Maximum Loss. Published in the Manual for Industrial Fire and Fire Loss of Profits Insurance. K. Recommendations by the former German Association of Property Insurers. Guidelines on Business Interruption Risk Assessment in the Chemical Industry. August 1992. Vapour Cloud Explosion Methodology.References Sedgwick Energy Ltd. Chemical Industries Association. 1974. Cologne. Reinsurance Offices’ Association (now LIRMA). Gerathewohl.. EML Assessments: London Market Practice. 6. P. Text reprinting allowed provided source quoted and complimentary copy supplied. +49 (0)89 9228-716 19 . Germany Telephone: +49 (0)89 92 28-0 Telefax: +49 (0)89 92 28-395 Production EGE-Verlagsservice Munich Design Stahl Grafikbüro Munich Printed by Universal Druck GmbH Munich Illustration Erik Liebermann Photos The Image Bank (Title.Publisher ERC Frankona Rückversicherungs-AG Munich Editor-in-Chief Frank Reichelt Property Manager ERC Frankona Rückversicherungs-AG Munich Authors Kurt Bjørlig Dr Erika Penzenstadler Final Editing Dr Erika Penzenstadler Editorial Address ERC Frankona Rückversicherungs-AG Maria-Theresia-Strasse 35 D-81675 Munich. 5. 3 & 8) dpa (P. 9 & 10) Copyright 1997 by ERC Frankona. Our experts will be happy to answer any queries! Tel.