PROBABLE MAXIMUM LOSS IN INSURANCE

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PROBABLE MAXIMUM LOSS
BY
• N. VAIDYANATHAN
• BE(MECH)., D.O.M., M.I.E., F.I.V., F.I.I.I.S.LA.,
M.I.S.NDT, M.I.R.M(UK)
• CHARTERED ENGINEER
• RISK MANAGEMENT CONSULTANT

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PML AGENDA
• NEED FOR PML
• TERMINOLOGY USED
• ADVANTAGES
• DISADVANTAGES
• CALCULATION METHODS
• TAC DEFINITION
• DOCUMENT REQUIREMENTS

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“An estimate of the monetary loss
which can be sustained by insurers on
a Single Risk as a result of a single fire
or explosion considered by the
underwriters to be within the realms of
probability. The estimate ignores such
remote coincidence and catastrophe as
may be possible but which still remain
unlikely”.
“ defined by International Underwriters’
Association (IUA) formerly known as
London Insurance and Reinsurance
Market Association (LIRMA ) “
Probable MaximumLoss

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Probable Maximum Loss (PML) is
the maximum loss that an insurer
would be expected to incur on a
policy. Probable maximum loss
(PML) is most often associated with
insurance policies on property, such
as fire insurance. The probable
maximum loss represents the worst-
case scenario for an insurer.
Probable MaximumLoss

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Insurance companies use a wide variety of data
sets, including Probable Maximum Loss (PML),
when determining the risk associated with
underwriting a new insurance policy, a process
which also helps set the premium. Insurers
review past loss experience for similar perils,
demographic and geographic risk profiles, and
industry-wide information to set the premium.
An insurer assumes that a portion of the policies
that it underwrites will incur losses, but that the
bulk of policies will not.
Probable MaximumLoss

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Insurance companies differ on what probable
maximum loss means. At least three different
approaches to PML exist:
PML is the maximum percentage of risk that
could be subject to a loss at a given point in
time.
PML is the maximum amount of loss that an
insurer could handle in a particular area before
being insolvent.
PML is the total loss that an insurer would
expect to incur on a particular policy.
Probable MaximumLoss

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PROBABLE MAXIMUM LOSS
• MANY INSURERS FOLLOWED THE
CONCEPT BASED ON SUM INSURED
• STARTED MAINLY WITH FIRE
INSURANCE
• RETENTION BASED ON SUM
INSURED

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PROBABLE MAXIMUM LOSS
• TERMINOLOGY USED:
• PML - PROBABLE MAXIMUM LOSS
- POSSIBLE MAXIMUM LOSS
- POTENTIAL MAXIMUM LOSS
• MPL - MAXIMUM PROBABLE LOSS
• EML - ESTIMATED MAXIMUM LOSS
• NML - NORMAL LOSS EXPECTANCY

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PROBABLE MAXIMUM LOSS
• TERMINOLOGY USED:… CONTD…
• MEL - MAXIMUM ESTIMATED LOSS
• CML - CREDIBLE MAXIMUM LOSS
• MCL - MAXIMUM CREDIBLE LOSS
• FML - FORSEEABLE MAXIMUM LOSS
• MFL - MAXIMUM FORSEEABLE LOSS

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Definitions
 Numerous definitions in the
market
 Insurers have their own
definitions
 Most common definitions:
 Probable Maximum Loss (PML)
 Estimated Maximum Loss
(EML)
 Maximum Amount Subject
(MAS)
There No single
clear acronym and
for every acronym
there is a definition
and description,
which can further
be interpreted in
different ways …..
Probable MaximumLoss

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Construction
Occupancy
Protection
Exposures
S-COPE
Probable MaximumLoss

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Construction
First consideration
Relates to ability to withstand
damage by fire and other perils
and wind
Various Classes based on the
strength and material property
used for construction
Probable MaximumLoss

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Other Considerations
Age
Building Height
Fire Divisions
Building Openings
Building Codes

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Occupancy
Ignition Sources
Combustibility
Damageability
Probable MaximumLoss

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Occupancy
Habitational – apartments, hotels, motels,
nursing homes
Office – low hazard
Institutional – schools, churches, hospitals,
government property
Mercantile – department, hardware and
specialty stores
Service – dry cleaners, laundries, auto service
stations
Manufacturing – nature of product
Probable MaximumLoss

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Hazards
Common hazards
Housekeeping
Heating equipment
Electrical equipment
Smoking materials
Probable MaximumLoss

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Protection
Key may be location of water supply
and fire hydrants
Water hoses/ Fire detectors/ Fire
extinguishers
Smoke detectors
5 -17
Probable MaximumLoss

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PROBABLE MAXIMUM LOSS
• IT IS GENERALLY BASED ON:
• 1. FREQUENCY
• 2. SEVERITY OF THE LOSS

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PROBABLE MAXIMUM LOSS
• CALCULATION OF PML:
• NO FORMULA AVAILABLE
• NO HARD AND FAST RULES LAID
OUT
• IT IS ONLY A GUESTIMATE
• A COMPLEX EXERCISE
• ANALYSIS OF TECHNICAL DATA

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PROBABLE MAXIMUM LOSS
• ADVANTAGES:
• LARGER SHARES OF RISKS CAN BE
HANDLED
• EASY FOR PLACING LARGE RISKS
• ACHIEVING A BALANCED
PORTFOLIO

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PROBABLE MAXIMUM LOSS
• DISADVANTAGES:
• IT IS ONLY A GUESTIMATE AND
SUBJECTIVE
• LARGER LOSS THAN PML WOULD
BE DISASTEROUS
• NO STANDARD DEFINITION OR
FORMULA
• CONTINOUS REVIEW NOT
POSSIBLE

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While in practice PML underwriting is a powerful tool in the hands
of underwriters, it has to be used with great care and diligence.
The disadvantages of the practice include
PML is a subjective assessment of maximum severity of loss,
and too much reliance on it can prove costly. If actual loss
exceeds PML, the reinsurer will suffer.
Judgment plays an important role in the determination of PML,
and may go wrong if made by inexperienced person.
The lower the PML, the higher the underwriting capacity. Hence
there is a tendency to fix the PML on the lower side to generate
higher capacity. At the same time, the lower the PML, the
greater the possibility of the actual loss amount being higher
than anticipated.
Disadvantages ofPML

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PROBABLE MAXIMUM LOSS
• DEFINITION:
• ‘ THE PROBABLE MAXIMUM LOSS IS AN
ESTIMATE OF THE MONETORY LOSS
WHICH CAN BE SUSTAINED BY THE
INSURER ON A SINGLE RISK AS A
RESULT OF A SINGLE FIRE OR
EXPLOSION, AS CONSIDERED BY THE
INSURER TO BE WITHIN THE REALMS
OF PROBABILITY. THE ESTIMATE
INGNORES SUCH REMOTE
CATASTROPHES AS MAY BE POSSIBILE
BUT WOULD REMAIN UNLIKELY’

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ELEMENTSOF RISK

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PROBABLE MAXIMUM LOSS
• MANDATORY RISK INSPECTION:
• IT IS MANDATORY TO CARRY OUT
RISK INSPECTION FOR ARRIVING
AT PML ASSESSMENT OR ANY
REVISION THEREAFTER. RISK
INSPECTION MUST BE CARRIED
OUT ATLEAST ONCE IN 2 YEARS

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PROBABLE MAXIMUM LOSS
• RISK INSPECTION REPORT:
• PRODUCTION/PROCESS DATA – FLOW
DIAGRAM
• BLOCK WISE PROCESS/OPERATION DATA –
SHOWING PRESSURE/TEMP
• LAY OUT OF THE FACTORY
• EQUIPMENT LAYOUT PLAN
• DETAILS OF CONSTRUCTION
• QUANTITY AND NATURE OF STORAGE
• DETAILS OF HAZARDOUS/ NON HAXARDOUS
GOODS

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PROBABLE MAXIMUM LOSS
• RISK INSPECTION REPORT:.. CONT.
• UTILITIES/POWER DISTRIBUTION
• REPAIR FACILITIES
• DETAILS OF SPARES
• RELATIVE IMPORTANCE OF MACHINES
• HOUSE KEEPING/MAINTENANCE
• DISASTER MANAGEMENT PREPAREDNESS
• HAZOP/ HAZAN REPORTS
• DETAILS OF FIRE PROTECTION SYSTEMS

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PROBABLE MAXIMUM LOSS
• RISK INSPECTION REPORT:.. CONT.
• POLICY SCHEDULE GIVING BLOCK
WISE SUM INSURED
• GROSS PROFIT AS PER PL ACCOUNT
• SUM INSURED VS GROSS
PROFIT/INDEMNITY PERIOD/TIME
EXCESS
• CLAIM HISTORY
• HISTORY OF CATASTROPHE EVENTS

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PROBABLE MAXIMUM LOSS
• RISK INSPECTION REPORT:.. CONT.
• WARNING:
• PML IS ASSESSED ON BASIS OF FIRE AND
EXPLOSION PERILS IN MIND. IN THE
EVENT THE CATASTROPHE (FLOOD,
CYCLONE, EARTHQUAKE ETC) PERILS
ARE DOMINANT, THE RISK INSPECTION
SHOULD QUALIFY THE SAME SUITABLY

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PROBABLE MAXIMUM LOSS
• THE GUIDELINES GIVEN ARE FOR
DETERMINATION OF PML FOR
RISKS WHICH ARE EXPOSED TO
FIRE, SMOKE, WATER DAMAGES
ONLY

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Fire Area Separation
Structural Fire Area Separation

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PROBABLE MAXIMUM LOSS
• METHODOLOGY:
• FIND OUT DISTANCES BETWEEN
BLOCKS. CONSIDER THE BLOCKS
AS A SINGLE RISK UNLESS THE
FOLLOWING DISTANCES ARE
MAINTAINED FOR THE
OCCUPANCIES MENTIONED
AGAINST THEM

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PROBABLE MAXIMUM LOSS
Occupancy Superior Class I Class II
Light hazard 5 M 7 M 10 M
Ordinary Hazard 10 M 15 M 20 M
High Hazard 15 M 30 M 50 M
High Piled
storage/ Storage
of Flammable
Liquids/ Gases
50 M 50 M 50 M
CLASS OF CONSTRUCTION

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PROBABLE MAXIMUM LOSS
• ESTIMATE THE DAMAGE RANGE (IN TERMS OF
SUM INSURED) ON THE FOLLOWING BASIS:
• PERCENTAGES FOR LIGHT HAZARD
RISKS ARE SHOWN IN THE NEXT SLIDE.
THE DAMAGE PERCENTAGES SHOULD
BE SUITABLY ARRIVED AND LOADED IN
CASE OF ORDINARY HAZARD RISKS AND
HIGH HAZARD RISKS.

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PROBABLE MAXIMUM LOSS
Description Superior Class I Class II
Buildings 5-25% 20-50% 30-80%
M/c.
Equipment
10-40% 15-50% 40-90%
Heavy
Precision
25-80% 25-100% 70-100%
Stocks 40-100% 40-100% 70-100%
PERCENTAGES FOR LIGHT HAZARD RISKS

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PROBABLE MAXIMUM LOSS
• IN THE EVENT THE LOWER
HAZARD RISK OCCUPANCY IS
WITHIN THE STIPULATED
DISTANCES FROM THE HIGHER
HAZARD RISK, THE PERCENTAGE
DAMAGE IS TO BE TAKEN FROM
THE TABLE ON THE BASIS OF
HIGER HAZARD RISK OCCUPANCY

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PML - EXAMPLE
• CALCULATE PML FOR THE RISK HAVING THE
FOLLOWING DATA:
• RISK – TEXTILE MILLS
• TOTAL SI – 100 CRORES
• BLOW ROOM, CARDING, SPINNING ROOMS ARE
SEPARATED FROM EACH OTHER
• WEAVING, WINDING, WARPING, CLOTH
PROCESSING, PACKING ARE COMMUNICATING
WITH EACH OTHER
• FINISHED GOODS GODOWN IS WITHIN 10 M OF
PACKING DEPT
• BUILDINGS NOT COVERED UNDER POLICY

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PML - EXAMPLE
• DATA ON SUM INSURED: FINISHED GOODS – 64 CRORES
BLOCK MACHINERY SUM
INSURED
STOCKS
BLOW ROOM GEN.MACHINE 1 CRORE 1 CRORE
HEAVY 2 CRORES
CARDING/SPINNING GEN. MACHINE 3 CRORES 2 CRORES
PRECISION 10 CRORES
WEAVING/WINDING
AND OTHERS
GEN.MACHINE 2 CRORES 5 CRORES
HEAVY 10 CRORES

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PML -EXAMPLE
• RISK – TEXTILE MILLS
• SINGLE RISK
• CATEGORY – ORDINARY HAZARD (IN CRORES)
BLOCK
SUM INSU
BLOW
ROOM
CARDING/
SPINNING
WEAVING
WINDING
FINISHED
STOCKS
GEN.MAC
01 03 02
HEAVY/
PRECISIO
02 10 10
STOCKS
01 02 05
FINISHED
STOCKS
64

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PML -EXAMPLE
SR.NO ASSETS TOTAL
S.I
% OF
PML
PML
1 GEN.MACH
IN
06 CR 25% 1.5 CR
2 HEAVY/
PRECISION
22 CR 80% 17.6 CR
3 STOCKS 08 CR 100% 8.0 CR
4 FINISHED
STOCKS
64 CR 80% 51.2 CR

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PML -EXAMPLE
SUMMARY:
TOTAL SUM INSURED: 100.00 CRORES
PMLARRIVED AT: 78.30 CRORES

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PML RATINGS
SR.NO PML RATING RANGE IN %
1 MINIMUM PML UPTO 10
2 LOW PML 11 TO 30
3 MODERATE PML 31 TO 60
4 HIGH PML 61 TO 90
5 VERY HIGH PML 91 UPWARDS

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PML –EXAMPLE --- 2 method
BY GROUPING BLOCK WISE WITH MERITS
CARDING/
SPINNING
S.INSURED % ge PML PML-SI
GEN.MACH 3.0 CR 50% 1,50,00,000
HEAVY 10.0 CR 70% 7,00,00,000
STOCKS 2.0 CR 85% 1,70,00,000
TOTAL 10,20,00,000

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PML –EXAMPLE --- 2 method
BY GROUPING BLOCK WISE WITH MERITS
WEAVING/
WINDING
S.INSURED % ge PML PML-SI
GEN.MACH 2.0 CR 25% 50,00,000
HEAVY 10.0 CR 65% 6,50,00,000
STOCKS 5.0 CR 70% 3,50,00,000
TOTAL 10,50,00,000

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PML –EXAMPLE --- 2 method
BY GROUPING BLOCK WISE WITH MERITS
BLOW
ROOM
S.INSURED % ge PML PML-SI
GEN.MACH 1.0 CR 40% 40,00,000
HEAVY 2.0 CR 75% 1,50,00,000
STOCKS 1.0 CR 100% 1,00,00,000
TOTAL 2,90,00,000

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PML – EXAMPLE – 2 METHOD
• SUMMARY:
• BLOW ROOM ETC 2,90,00,000
• CARDING/SPINNING 10,20,00,000
• WEAVING/WINDING 10,50,00,000
• FINISHED STOCKS 51,20,00,000
(FINISHED STOCK 64 CR AT 80%)
TOTAL PML 74,80,00,000

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A1 A2
A3
A4
A5
A6
Probable MaximumLoss

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FIRE AREA
SUM
INSURED
MPL
A1
Finished Product
Storage
15 M
15%
- Building
5 M
- Plant & Machinery -
- Stock 10 M
A3
Raw Paper Stores I &
II
10 M
10%
- Building
4 M
- Plant & Machinery -
- Stock 6 M
A4
Admin Block 5 M
5%
- Building 5 M
- Plant & Machinery -
- Stocks
-
FIRE AREA
SUM
INSURED
MPL
A5
Boiler House 10 M
10%
- Building 3 M
- Plant & Machinery 7 M
- Stock -
A6
Fuel Storage Area 10 M
10%
- Building -
- Plant & Machinery
4 M
- Stock 6 M
Total Sum Insured
(TSI)
100 M
Production area 50M
Building 20M
Plant and machi 25M
Stocks 5M

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PROBABLE MAXIMUM LOSS
• GUIDELINES FOR DETERMINATION OF
PML FOR RISKS UNDER MBD POLICIES:
• 1. IDENTIFY THE MACHINERY WITH
HIGHEST SUM INSURED VALUE
• 2. IF DAMAGE TO ONE WILL LEAD
DAMAGES TO OTHER(S), TAKE ALL
MACHINES FOR CALCULATION
• 3. HIGER OF THE TWO PML, TO BE
CONSIDERED

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It is hereby noted and agreed that with effect from
March 2019, following amendments will be made to
the contract written under Fire department:
MINIMUM PML TO BE REVISED AS UNDER: IN INR
100%SUM INSURED
(MD+BI)
MINIMUM PML (MD+BI)
UPTO 500 CRORES 100% SUM INSURED BASIS
500 CRORES TO 1500
CRORES
60% MD + 100% BI – TOP LOCATION
1500 CRORES TO 2500
CRORES
40% MD + 100% BI – TOP LOCATION
ABOVE 2500 CRORES 30% MD + 100% BI – TOP LOCATION
All risks with Sum Insured INR 20,000 crores and
above to be referred to GIC Re for approval
before any cession is made.

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3-51
Knowledge of Risk Manager
INSURANCE
SAFETY
Your
INDUSTRY

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ANY QUESTIONS ???

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