With growing concern over bird flu, Andrew Tunnicliffe considers how alternative risk transfer could provide a solution to this pandemic risk

Lurid headlines about avian flu, with predictions of a influenza pandemic to rival the 1918-1919 pandemic may be a little wide of the mark, but undoubtedly there is great concern over the possibility, however remote, of avian flu mutating so that it can pass from human to human. Avian flu affects those involved with birds, whereas a flu pandemic arising from avian flu would potentially affect everyone. Indeed, a flu pandemic would be a personal and social catastrophe, but for businesses the risk would likely be more of an interruption risk than a catastrophe risk.

Traditional response

In the event of a pandemic, many organisations will be looking to their insurance policies to respond, but they are likely to be disappointed. Generally speaking, for property insurances to be triggered, there should be physical damage to the asset being insured, which is an unlikely result of a pandemic. In some cases it has been possible to obtain cover for infectious diseases as a policy extension but these tend to refer to cover being limited to an incident or outbreak on the insured's premises.

The problem is that business interruption policies are designed for situations where the insured's asset is damaged in some way or there is denial of access. But such policies are not designed to cover a situation where the business is interrupted because of a lack of workforce. Specific cancellation and abandonment insurances for events are also likely to be limited in cover. With something like a pandemic risk, if it is topical and in the public domain, you can probably assume it will be excluded.

The practical reality is that conventional insurance is unlikely to provide solutions to this issue. Organisations should therefore be focusing on managing the risk as far as possible and perhaps considering what the alternative risk market can offer to hedge against any financial uncertainty. For liability cover there is a similar feel. These policies will respond only to situations where legal liability on the part of the insured can be established.

Continuity planning

The importance of business continuity planning cannot be stressed enough. The reality is that the majority of organisations without a plan do not survive a major disaster. An Aon survey undertaken to discover how seriously businesses are taking the pandemic issue, found that more than eight out of ten (85.5%) respondents view a possible influenza pandemic as a threat to their business, but fewer than six out of ten (57%) have put measures in place to protect themselves against such a risk.

In addition, existing business continuity arrangements are typically focused around the recovery of infrastructure or process and not on situations where a proportion of the workforce is lost or a major disruption to the national and/or global environment occurs.

The problem is that a flu pandemic does not conform to normal business continuity issues. For example, most traditional contingency plans assume the loss of a facility or systems and the need to relocate staff. However, during a pandemic there may be a systemic failure of transport/logistics infrastructure with the workforce unable to get to work.

As a result, the impact of a pandemic may be felt in a variety of ways, notably the unavailability of key personnel and offices for lengthy periods; disruption to transport systems; and restrictions on travel and the movement of people. In addition, suppliers may close, the customer base could decline, and litigation may result from subsequent claims. Business continuity plans should, of course, be tailor-made to the particular organisation but for effective business continuity planning, it is important to:

- Implement effective knowledge management;

- Make communications issues a priority;

- Plan for and develop flexible work practices;

- Provide secure transport;

- Review your supply chain;

- Review your customer base and other revenue generation opportunities;

- Review security and plan for reduced law and order;

- Review legal, regulatory and insurance position; and

- Exercise plans and develop a business continuity culture.

Managing the human risk

As far as a flu pandemic is concerned, there are a number of human aspects to consider. The UK Health Department's Influenza Pandemic Contingency Plan states that: "Absence from work will depend on the age-specific attack rate, although even if working age people are relatively spared, additional absenteeism may result from staff needing to take time off to care for family members, or difficulties with transport ... It is suggested that business continuity plans are based on a cumulative total of 25% of workers taking some time off - possibly five to eight working days - over a period of three to four months." In response to this, organisations should:

- Identify critical business processes, partners and staff groups;

- Determine minimum levels of resourcing;

- Identify vulnerabilities;

- Consider segregation of teams;

- Develop back up/ancillary teams;

- Identify temporary accommodation needs;

- Develop remote working and communication processes;

- Recommend business travel restrictions;

- Establish hygiene and meeting protocols;

- Implement employee consultation and communication; and

- Ensure access to healthcare and funding for staff.

Financing the risk

In the life sector there have been some abnormal mortality bonds issued where a loss payment is triggered by an index based on public mortality data, weighted by age and gender to reflect the underlying life exposure. The bonds have been structured to allow for payment if any two consecutive years in a five-year period produce mortality rates exceeding 110% of the expected index level. The bonds cover all mortality without exclusion for war, terrorism etc. The main exposure is seen as pandemics.

For individual firms and businesses in certain sectors and geographies there is no doubt that these risks could be fatal if not managed efficiently. Most businesses, however, can manage risk better and improve the risk profile of the organisation.

One can speculate that the type of indexation or parametric trigger applied (albeit in a limited way) in the life sector could be applied to a number of non-life risks if the exposure was diverse enough and the solution makes economic sense. In reality, most corporate buyers will not have such diversity and actually the risk concentration will be quite high. As is often the case, risk securitisation is an alternative to reinsurance for insurers, but less applicable to corporate buyers. Nevertheless for some of the larger multinationals these solutions could be investigated.

In reality, well thought out practices and procedures should really be the focus in order to deliver a platform for corporate buyers to design meaningful risk financing programmes - not only for an imminent flu pandemic but also for all aspects of new and emerging risks and future pandemic threats. As is often the case captives can provide a useful financial interface between the corporate centre and business units. In the case of a flu pandemic, it is not a case of optimising risk retention - the fact is, as we have seen, the risk has to be retained. Captives may, however, provide a structured vehicle for corporate buyers to offer its wider business units meaningful business interruption cover across international borders.

In this context, the captive would genuinely assist the business continuity process. Indeed, it would be an integral part of that process by supplying genuine and meaningful cash flow support where all other measures that have been put into place fail. All of which can enable the business unit to deal with an increased cost of operating until the threat/impact has moved on.

It is important to stress that it is only worth pursuing this type of strategy if it is supported by comprehensive risk management and business continuity planning processes, thus allowing a progressive attitude towards captive underwriting for such exposures. As stated at the beginning of this article, the risk would be an interruption risk rather than a catastrophe risk. As such, the captive would in essence be writing risk as a primary market and not as a catastrophe underwriter. This statement may seem a little odd at first glance. However, risks successfully applied to captive programmes should not be fatalistic business risks (catastrophic in nature), rather they should be well managed and profiled.

Conventional insurers tend to respond well to risks that have a historic performance and that can be measured. With a pandemic this is not the case. Captives however, can respond to the latter.

It is also important to think about complementary strategies including the often talked about contingent capital structures. Other structured risk financing arrangements may also make sense. However, the key to this is the provider's ability to recognise a businesses ability to survive a crisis and deal with the interruption to business - ie the ongoing credit worthiness of the business. And this positive message can only be supported by implementation of appropriate business continuity plans and strategies designed to manage the human risk.

- Andrew Tunnicliffe is business development director at Aon Captive Services Group/IRMG Risk Consulting.