Last fall, an early-morning fire broke out at 30 Rockefeller Center, in New York City. NBC's "Today" show was forced to do an impromptu remote broadcast from the sidewalk outside the building. Network producers held curbside meetings and writers wrote news copy longhand as firefighters battled the blaze that sent smoke throughout the 70-story building. More than 2,000 employees arriving for work that morning were told to turn around and go home. Telephone service and many computer systems were inoperable. Fortunately, no serious injuries were reported, but the total losses exceeded $20 million.
Those losses, however, were covered by equipment breakdown insurance, which was included in General Electric's (NBC's parent company) global property policy. And according to Andrea Pearson, manager for insurance programs at GE, the coverage kicked in without a hitch. "Everything worked perfectly," she says. "It was a very fair settlement and resolved quickly, even though it involved numerous parties, each with a special interest."
Like GE, more and more businesses are critically dependent on machines--and the electrical power that runs them--for survival, but it often takes an accident like the one at Rockefeller Center to make companies painfully aware of that fact. In Business Perspectives magazine, published by Liberty Mutual, Eugene Eral, regional underwriting manager of ALM Services, an affiliate of Liberty Mutual; and Richard Kinner, senior vice president for the commercial division at Hartford Steam Boiler Inspection and Insurance Co., write:
"Today, the world has more than 10 billion microprocessors. They are the brains behind fax machines, PBX phone systems, elevators, environmental control systems, and production equipment. Businesses depend on this sophisticated equipment, as well as on systems for heating, air conditioning, and electricity.
"While modern equipment is smart and fast, it is also fragile and sensitive to vibration, dirt, moisture, and heat. Breakdown of equipment or systems can shut down a business, yet many companies don't have the insurance coverage they need. To be properly protected today, a business needs equipment breakdown coverage as part of its insurance package."
That kind of insurance has changed enormously from the days when it was christened "boiler and machinery coverage," primarily in response to the proliferation of sophisticated machines of every ilk into all kinds of businesses, Eral said in an interview. Now the coverage can encompass everything from electrical machinery to high-tech equipment, he says.
Yet many companies mistakenly believe that they don't need such coverage, says Eral. "Because of the old terminology of boiler-machinery, a lot of customers don't realize that many property policies have electrical and mechanical breakdown exclusions in them." The result, adds Kinner, is that of the 10 million commercial establishments in the United States, only 600,000 have adequate equipment breakdown coverage.
The Electrical Connection
This type of coverage has traditionally been geared to companies that have exposures critical to their businesses. For example, if a machine breaks down and its workload can be transferred to another machine, coverage isn't as important to that business as it would be to an enterprise in which a breakdown could shut down an assembly line and stop the production of an entire facility.
More and more businesses, however, are facing equipment breakdown exposure. The main culprit is companies' increased dependence on electricity and the simultaneous lack of maintenance of electrical connections. "Buildings created 20 years ago weren't built at a time when there were multifunction phones and computers on every desk," explains Hartford Steam Boiler's Kinner. "The use of electrical power is much more pervasive today." Still, he adds, new buildings are often in no better shape, because tenants and landlords frequently ignore essential electrical maintenance.
A recent study by the insurer, in fact, found that 75 percent of all electrical-system failures result from a lack of maintenance. Part of the problem, says Matthew Glennon, Hartford Steam Boiler's director of electrical loss control, is that people believe there are no moving parts in electrical systems. But that's a misconception, he continues. There are connections in the system subject to thermal expansion and contraction. That expansion and contraction loosens those connections over time. In addition, if electrical equipment isn't cleaned periodically, moisture and dirt can cause electrical failure.
He cites a case in New York City in which an office building was closed for four weeks due to an electrical problem. The snag was traced to the installation of an electrical panel 25 years before. The panel wasn't riveted in place properly, so each time a surge passed through it, the panel wobbled. That led to a fire. "We're seeing a lot of failures in equipment that's only 20 years old, even though the equipment is rated to last 50 or 60 years," Glennon says. "That's because in many cases, electrical cabinets in those buildings haven't been opened since they were installed."
Electrical problems shouldn't be taken lightly, says Kinner, especially since they're the second most prevalent reason for fires in commercial buildings. The NBC fire, for example, started in an electrical closet on the fifth floor. "We're seeing a dramatic increase in the frequency of losses," he observes. "And we think that frequency is commonly caused by the ever-increasing stress loads on every building."
The numbers bear him out. From 1980 through 1983, Hartford Steam Boiler logged 813 cases to electrical-system loss. From 1990 through 1993, cases attributed to electrical-system loss more than quadrupled, to 3,464. And in the past five years, the company has paid out $100 million in electrical-equipment losses.
Antiquated and inadequately maintained electrical systems aren't the only contributors to equipment breakdowns. The quality of the power in those systems can also be a culprit.
"Most equipment today uses some kind of electronic component that is fragile and susceptible to damage from problems associated with electrical characteristics," Glennon explains. "You've got this kind of equipment in hospitals, on factory floors, in robotics and computer-controlled machinery, and in office buildings with automated systems that control lighting, heat, and air conditioning. And, increasingly, we're seeing some power- quality problem, such as a surge, destroying that component and knocking the equipment out of commission."
Glennon cites a case in which a hospital left a number of its high-tech medical devices unprotected. Electricians pulling cable through a conduit touched two wires not meant to be touched, and $400,000 of diagnostic equipment was lost. A simple precaution that can foil this problem is the use of surge suppressors between devices and their power source. These suppressors can cost as little as $20 per unit, but, Kinner observes, "you would be shocked at how often they're not used."
"The two strongest recommendations we can make as a company," Kinner adds, "is to conduct routine maintenance and to use surge suppression. Neither of these two recommendations is very expensive to implement. However, they do require a level of continuity and a level of awareness. You don't wash your car once and never wash it again."
The other recommendation Hartford Steam Boiler makes, of course, is to purchase equipment breakdown insurance. Observes vice president Don Hartford: "Simply stated, the world has changed, and the underinsured or unserved market for equipment breakdown insurance coverage is astonishing. While the cost to include equipment breakdown protection is just a fraction of property insurance, the cost of an uncovered loss in the $15,000 to $40,000 range can break a business, cost you a customer, and generate an omission claim."
Still, despite the increased vulnerability of businesses to equipment breakdown, the message about the coverage doesn't appear to be taking hold in many management suites. There doesn't appear to be a tidal wave of interest in breakdown coverage, according to Rick Betterley, president of Betterley Risk Consultants, in Sterling, Massachusetts. "I don't see any land rush for buying breakdown insurance that wasn't there before," Betterley says.
One excuse risk managers can't use is price. "The pricing competition caused by the soft markets lets us tweak the coverage a bit more," says Michael Kaminski, manager of risk management at Wisconsin Energy in Milwaukee, who has seen his company's property and equipment breakdown insurance premiums drop 15 to 25 percent over the past two years. "In general," he continues, "I would say the trend, over the last five years, is that the pricing for similar covers has been going down." And that's likely to remain the case in the near term, he contends. "As long as the stock market stays good, the insurance markets will stay soft."
Indeed, while the cost of breakdown insurance is subject to many variables--such as the value of the equipment, the industry the equipment is used in, the loss experience of an individual company--it is relatively inexpensive. According to Hartford Steam Boiler, which, among the handful of carriers writing the coverage leads the pack with more than a third of the market, a small business with policy limits from $100,000 to $500,000 can purchase a premium for as little as $200, although most premiums run from $900 to $1,400; midsized companies with limits from $5 million to $25 million can expect to pay premiums ranging from $2,500 to $25,000; and large companies with limits exceeding $50 million will face premiums exceeding $35,000. Policies are usually written for one year, but multiyear coverage is also available.
From a coverage standpoint, it's difficult to discern significant differences in equipment breakdown coverages, according to consultant Betterley. Loss-prevention services are the main distinction, he says, adding that "good loss-prevention services can be worth more than the premium that you're paying for the insurance itself."
The two leading underwriters of equipment breakdown coverage-- Hartford Steam Boiler and Factory Mutual--are both known throughout the insurance industry as having outstanding loss- prevention programs, Betterley adds. These programs offer a variety of engineering services to help companies stem losses. For example, when a brewer found its hops supply threatened by repeated fires in its hops storage areas, Hartford Steam Boiler cooked up some suggestions to improve the company's sprinkler system and correct the problem. And Lisa Dickson, vice president of risk and loss control at Brinker International Inc., a restaurant holding company based in Dallas, points out that the same insurer "performs inspections of most of our restaurants" on an annual basis. "It is a critical part of our loss-prevention efforts," she says.
However, according to Kaminski of Wisconsin Energy, the soft insurance market has made it easier for businesses to obtain equipment breakdown insurance from carriers that offer it, without making concessions to carriers over loss prevention programs. "Right now, you can buy insurance without as much stress on loss control," he says. "Eventually that's going to catch up with people, but you can do it now because of the competition among carriers."
That lower-premium carrot can prove irresistible to some companies. Duane Wendt, CFO of Broadway Services Inc., a building management firm in Baltimore, says that he switched his company's boiler and machinery carrier after many years with Hartford Steam Boiler. "We got a better rate with [London- based] Royal Insurance, and the coverage is packaged with our other property policies, so we don't have to worry about a separate policy," he explains.
Wendt's decision raises another issue: Is it better to purchase the coverage separately or fold it into a property policy? Jerry Liebers, senior vice president for boiler machinery at CNA Commercial Insurance, in Monmouth Junction, New Jersey, believes packaging boiler and machinery insurance dilutes its effectiveness. "The boiler line is a specialty line and needs to be treated as a specialty line," he says. "These policies require a different amount of expertise than an ordinary property policy," he adds. "You have high- valued equipment. You have very high business interruption exposures, exposures much higher than the property loss potential. These policies require engineering. They require risk analysis. In addition, they require close contact with the client to evaluate things like maintenance. I don't think a lot of property carriers have the time to devote to all that."
Ironically, however, Hartford Steam Boiler has been promoting inclusion of equipment breakdown coverage into package policies. A company publication, Whistlestop, notes: "Today, many companies are choosing to integrate equipment breakdown coverage into their packages instead of offering it as an option. This trend, which began as a trickle a few years ago, is quickly building momentum as insurers ante up to ensure their packages are as broad as their competitors'."
Adds Jeff Watt, director of the company's commercial division: "This streamlined approach eliminates much of the paperwork and processing costs that agents and package insurers bear to handle endorsements or stand- alone policies."
"The challenge for any risk manager is to figure out [which insurance company] is just writing good brochures and [which] is actually providing the necessary loss prevention services," Betterley says. That may be easier said than done. "Most risk managers go by reputation and prior experience when choosing a company," he explains. "If an insurance company is known in the business as delivering on what it promised, then you're more inclined to buy from it. Even then you're challenged to make sure it delivers the right services to your account. That means you have to be involved in managing the services a carrier provides your company."
Still, whether it is separate or part of a property package, any equipment breakdown policy can provide only so much coverage, says Scott Lange, risk manager at Microsoft Corp., in Redmond, Washington. "If you've got $25 million in equipment breakdown insurance and that equipment generates $100 million in revenue a week, your problem is going to be to get the thing up and running, not collecting on a $25 million insurance policy," he argues. "You may feel great that you've got the Mona Lisa insured, but when the artwork's gone, you can stack all those dollars on the wall, but they are never going to look as nice as the Mona Lisa did."
The Nonmanufacturer's Warranty
Traditional equipment breakdown insurance typically covers factory machinery, but businesses are becoming increasingly dependent on equipment that plugs into a wall socket-- especially computers and phone-switching equipment. Many of these devices are covered by service contracts from their manufacturers. But dealing with a rat's nest of service warranties can induce any manager to pull out his hair by the handful. That's why many managers have shown growing interest in equipment maintenance insurance, according to Francis Murphy, vice president for the warranty products group of American International Group Inc. (AIG), in Chicago.
Equipment maintenance insurance is similar to the extended service contract a consumer would purchase for a major appliance such as a refrigerator, washer, or dryer. The coverage-- exclusively for commercial users--is aimed at protecting a business against the uncertainties associated with the corrective maintenance of equipment for offices, banks, hospitals, and myriad other equipment for which there exists a mature repair industry. "It covers about 85 percent of the equipment you would find in an office," Murphy says.
There are more than just administrative advantages to the coverage. "It allows you to flatten out that annual budget for the maintenance of all your equipment," Murphy explains.
The insurance offered by AIG, the largest underwriter of the coverage, comes in several variations. In its most basic form, a company repairs a piece of equipment that is misbehaving, sends the bill to AIG, and is reimbursed. In addition to corrective maintenance, the coverage can also provide preventive maintenance. A company can say to AIG, for example, handle our maintenance for us, and the carrier--for a price--will schedule all the required maintenance calls for the equipment.
The broadest equipment maintenance coverage is called AIG AssetGuard. This coverage includes repair-vendor dispatching. Every piece of equipment covered under the policy is tagged with a sticker that contains an 800 number. If that equipment breaks, a user dials the 800 number and speaks to a technician, who will try to work out the problem over the phone. If that fails, AIG will dispatch a repairperson to fix the device.
A typical AssetGuard policy stipulates that broken equipment will be back on line by the end of the next business day, according to Murphy. If it isn't, the insurance pays for the rental of replacement equipment or the cost of subcontracting work until the old equipment is up and running.
Murphy says the coverage has several advantages over standard service contracts. It includes breakage due to operator error and damage due to off-premise power surges. And all of a business's equipment can be covered under a single contract. "In most circumstances, you have a service contract for every photocopier you have, another one for your phone system, and one for each brand of PC you have," he observes. "We eliminate all that. There's only one contract to negotiate."
The policies are expensive, however. Initially, the premium is based on the replacement value of the equipment covered. But as the carrier gains more experience with the account, the premium is adjusted to that experience, or to reflect specific losses as opposed to general losses. Murphy says that the coverage makes more sense for midsized and large firms than it does for small firms with $100,000 or less of equipment.