Pulp and paper insurance is a risky business, so it's no wonder that there are only a few companies around that are brave enough to try it

Are you taking enough precautions?

From the point of view of the insurance companies, there are significant risks involved in the pulp and paper business. But fortunately for the producers, a number of insurance companies have taken the plunge in this high risk market and set themselves up as specialists in pulp and paper risk management. Increasingly, these companies are offering policies that are tailor-made for the pulp and paper business and some groups are even branching out into global coverage as the industry itself expands worldwide.

Unsurprisingly perhaps, Scandinavian insurers have been particularly keen to jump on the pulp and paper bandwagon. Groups elsewhere are also offering insurance opportunities that pulp and papermakers are keen to take up, but on a more limited basis.

Safe and sound

Apart from the high asset values to be insured, there are many other considerations to be taken into account when designing a specific policy for the pulp and paper sector. The usual procedure is to take a more general insurance policy and then add on special pulp and paper clauses, usually by means of negotiation between the two parties.

Marianne Granberg, risk manager at MoDo in Sweden, follows this path when mapping out policies for her company. "We start with the insurers laying out the general insurance cover as a base, but then we always need to tailor the policy to the specific circumstances in our industry environment," she says. "An example would be felts, which are normally treated as an interchangeable tool with no cover provided for them. However, within my company, we have negotiated with the insurers that felts are covered by the property insurance. Even though they have a reduced value with age, they are still covered at least."

Two of the main Scandinavian insurers that are active in the pulp and paper field are the Sampo Group of Finland and Skandia, based in Sweden. Carl-Henrik Borin, senior marine underwriter at Skandia, outlines the coverage that his company offers. "In a pulp and paper package, we offer a special service that is tailor-made in many cases for the forest industry. This would include, among other things, block valuation, SSA (Skandia Safety Analysis), camera survey and transport risk analysis," he explains. The SSA tool is used to assess the protection and safety levels in a plant, with the focus on major risks like fire and machinery breakdown, Borin adds.

According to senior property underwriter, Lena Dixon at Sampo Industrial Insurance in the UK, the company offers a number of services as part of its tailor-made policy, including risk analysis, consulting, benchmarking tools, non-destructive testing services and quality assurance.

Both Skandia and Sampo also offer Jaakko Pöyry's block valuation method when assessing a mill's value. The insurance value for each mill is based on the replacement cost for the facilities, taking into account key technical parameters and the capacity of each mill department. According to Skandia, this method has the advantage of offering clients higher cost efficiency compared to conventional valuation methods. The main reason for the efficiency gain is that claim handling takes less time as the insurance values are considered 'correct' with the block valuations.

Risky business

For many of the insurers, the main challenge is to ensure that such large risks can be covered. That, at least, is the view of Kurt Vistbacka, department manager for international business at the Finnish insurance company, Tapiola. "The biggest challenge in pulp and paper is the large sums to be insured. You have to see if the insurer can carry the risk or not. Pulp and paper companies are normally much more expensive to reinsure than other industry sectors," Vistbacka explains.

This is the main reason why there are only a handful of insurance specialists prepared to deal with the sector, according to Yngve Nygårdas, vice president of forest industry at Sampo. "Only a few insurance companies specialize in the risk management and insurance of the pulp and paper industry due to the high risk exposure and the need for specialized engineering skills," he claims.

The biggest outlay in terms of insurance costs for pulp and paper companies is the property damage and business interruption (PDBI) cover. Among other things, this would include the mill's machinery, buildings, machine breakdowns and fire damage. Within this category, the losses incurred from business interruption are usually much higher than for property damage itself, according to Nygårdas (Figures 1 and 2).

Figure 1 - Main Fire and Breakdown Risk Exposures for an Integrated Pulp and Paper Mill
Source: Sampo

Figure 2 - Major Fire and Breakdown Loss Exposures for a Typical European Paper Mill
Source: Sampo

Much less costly, but far more noticeable to the customers, is the transport insurance. As Sören Kullberg, marine risk manager at Stora Enso in Sweden, explains, "The major insurance premiums are for PDBI, but this is more of an internal matter. Cargo loss prevention (CLP) is more of an outside issue. It is more important in customer terms and is integrated with the quality side. The latter can be divided into two types of losses - very big and very small, there is not much in the middle."

According to Kullberg, it is often difficult for companies to foresee the major losses that could potentially arise from a warehouse fire or an accident at sea. On the other hand, he believes that pulp and paper companies can take action to reduce the minor losses, which occur more frequently - for example, through improved packaging and security.

In turn, measures taken to improve on the smaller losses will reflect well on the company's customer service. Per Larsson is the group risk manager at SCA and as he points out, "Delivery terms are not just an insurance issue. They are also caught up in the marketing and customer service field."

Kullberg believes that in a mature industry such as pulp and paper where it is increasingly difficult to find a competitive edge, customer service is one of the areas where a company can boost its rating over rival firms. As part of Stora Enso's delivery terms for example, the group is offering more and more deals on a DDP (delivery duty paid) basis where the responsibility lies with the paper company rather than the buyer.

Whose fault?

Deciding whether the responsibility lies with the buyer or seller is one of the stickiest issues in cargo insurance and this is where the importance of clear-cut delivery terms comes into the insurance sphere. Although many companies have a central policy on delivery terms, this is often open to interpretation on a local level. "People invent new terms. They think they know what CIF or FOB means, but there are different interpretations," Kullberg says. One way to get round this problem is to use the INCO terms (issued by the International Chamber of Commerce in London) which regulate the risk transfer in delivery terms, he believes.

On the insurers' side, cargo insurance is becoming an increasingly difficult area to cover. According to Harri Ek, vice president and head of marine insurance at Sampo, "The ongoing consolidation process of the industry has markedly reduced the need to insure all transit risks. The increased share of JIT (just-in-time) deliveries has reduced the typical size of the shipments so that today many manufacturers choose to leave domestic and land-borne transit risks uninsured. The need to insure goods is concentrating on ocean shipments and on accumulated storage risks in port warehouses and terminals."

Ek also claims that as insurance companies are faced with dwindling client numbers they are being forced to refocus their activities on consulting services that target risk assessment and loss prevention.

Along with specialized pulp and paper policies and attempts to branch out into consultancy, marketing departments at insurance companies have come up with the concept of global policies. For a number of years, globalization has been the industry buzzword in pulp and paper and insurance companies now offer policies in line with this trend. Sampo, for example, recently launched a global package for pulp and paper whereby the company provides a team to service mills worldwide, backed up by support from branch offices and local partners.

But it is not always that easy to implement a global insurance strategy, as Henrik Diesen, vice president of risk management at UPM-Kymmene, points out. "Before the merger of UPM-Kymmene it was not possible to have one global policy due to the structure of the organization. But with the reorganization after the merger, this became possible. With more merger and acquisition activity, more companies should be able to carry out global policies," Diesen says.

Although the company has streamlined its cargo insurance policy so that it is virtually standardized across the group, UPM-Kymmene does not operate a global policy across its insurance issues as a whole. "We use local insurers [outside Finland], but they normally cooperate with our main risk carriers. So it is tied to a global program, but we do not have a genuine master plan," Diesen explains.

Kullberg also views the global insurance policies with a certain amount of skepticism. "The policies are not totally global. There is one umbrella policy then underneath there are national policies. Even though we have a free EU insurance market, there is always local legislation. There is a development in the global policy direction, but it is going slowly - there is a lot of harmonization still to be done," he believes.

Captive audience

Offering tailor-made policies and global programs may not be enough for the insurers to stave off the competition from within the pulp and paper companies themselves though. One of the major trends this decade, particularly in Scandinavian countries, has been the creation of captive insurance companies (CICs).

MoDo, SCA, UPM-Kymmene and Stora Enso are among the many pulp and paper companies who are the proud owners of their own in-house insurance company. Setting up an insurance company as a subsidiary allows companies to gain access to the lucrative reinsurance market, which is normally only open to insurance firms.

Sampo knows this trend all too well. According to Ek, "Today, traditional all-risk policies with zero deductibles are increasingly being replaced by insurance cover with large deductibles and with a direct or indirect involvement of the insured group's captive company. Major pulp and paper companies are buying the service needed from the local service producers and are taking routine claims entirely in their own hands."

SCA is one of the many companies that is increasingly using its CIC to provide cover for all of the company's units, Larsson says. According to Larsson, "The advantage is that we gain better control over what is being done in the different entities. We issue the policies ourselves so we know what is going on. We also get bulk purchasing conditions when we buy reinsurance and there is a price advantage there."

At UPM-Kymmene, the captive insurance company has also allowed the company to tie the local units together into a more universal program, according to Diesen. He was also quick to point out that although the CICs provide many advantages, tax gains are not among the benefits as the company is taxed on any profits generated.

While Granberg at MoDo agrees with the benefits that a CIC can offer, she also sounded a cautionary note over using the companies. "The main disadvantage could be that if you are funding a lot in your captive, it can be quite costly to bring the money back to your company again," she warns.

How low can you go?

Insurance companies have also had a tough time stopping the rot in premiums over the last few years. Ek estimates that the average level of insurance premiums today is less than half that of five years ago. There appear to be two trends that have contributed to the falling premiums in the pulp and paper sector. First, many companies have carried out improvements in logistics, security and other risk prone areas which have led to lower premiums. And secondly, the general insurance market has been very soft in recent years.

A number of industry observers believe that the luxury of falling premiums in the pulp and paper industry may soon be over though. On the insurers' side, Dixon says, "It is difficult to imagine that premium rates could get much lower than they are at the moment. Although it is hard to predict future trends, we would expect to see some premium increases in the not too distant future."

Even the paper producers are getting slightly edgy over the possibility of rising premiums. As Granberg at MoDo says, "Premiums have decreased a lot in the last five years and I think there is more or less a bottom line now. It would surprise me if insurers can still continue to be risk carriers if the premiums get much lower."

But there are measures that pulp and paper companies can take to ensure that their premiums do not shoot up too quickly, including further minimization of potential risks. Skandia believes that 75% of cargo losses can be avoided by taking preventative measures to control transport risks. "We start with a transport risk analysis and from there we recommend and suggest what to do. It is easy to become 'home blind'," Borin explains. In essence, Borin is suggesting that there is ample room for slashing risk levels if companies are prepared to look at their operation with a fresh perspective. This is perhaps borne out best in Skandia's company motto - an accident does not occur, it is caused and can therefore be prevented.

As Dixon at Sampo points out, "A well run, protected and clean mill will have a lower premium than a mill without fire protection and with inferior housekeeping. Attitudes toward risk management and the level of self-retention (deductible) also influence the premium."

One of the major pieces of advice that Sampo gives to its clients is to invest in a sprinkler system. "The most efficient protection measure is the installation of automatic sprinkler systems. Installed at the vital areas, our experience tells us that it can cut the loss expectancy of the entire mill by 70-80%," according to Nygårdas.

In other cases, more general preventative measures are advised. Sampo offers one example where the guides for the roller shutters at one mill were being damaged by forklift trucks. Instead of taking the traditional route and repairing the damage, the alternative was to take corrective and preventive action. In this case, Sampo's solution was to start a shutter inspection program to alert the forklift drivers to the importance of caring for the doors.

Measures such as these not only benefit pulp and paper companies in terms of risk management, but they also help impress customers - a crucial concept in an industry that is waking up to the importance of customer service. Not only that, but pulp and paper companies will also benefit from fewer compensation costs and lower insurance premiums, which can ultimately lead to increased company profits.

Clearly, no paper company will want to take the risk of missing out on a chance to boost profits. So perhaps now is the time to go back and check how your premiums could be improved through better risk management.

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