Cat­a­strophic Con­se­quences

The im­pact of the Ja­panese tsunami and Thai floods con­tinue to be felt across the world as or­gan­i­sa­tions re­alise that the global sup­ply chain can be threat­ened by the un­ex­pected. Liz Booth re­ports.

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In th­ese tight eco­nomic times, no busi­ness wants to carry more stock than they need, nor do they want the com­po­nent parts lan­guish­ing in ware­houses around the world. With the devel­op­ment of tech­nol­ogy, this has meant an in­creas­ing trend of ‘just in time’ de­liv­er­ies, with goods ar­riv­ing in ware­houses just min­utes be­fore be­ing shipped on to the end con­sumer. Think of trips to your lo­cal su­per­mar­ket where stocks are man­aged to within mil­lime­tres on the shelves and the buy­ers are aim­ing to buy pre­cisely the right amount of goods to keep shop­pers happy but never too much that they need to sell off goods cheaply at the end of the day. How­ever, this at­ti­tude car­ries an enor­mous risk. It makes buy­ers end­lessly at the mercy of a smooth run­ning sup­ply chain – one kink in that chain and the whole sys­tem is en­dan­gered. Last year the Ja­panese tsunami was a hu­man tragedy on an epic scale but there was also a less ob­vi­ous fall­out.

Dev­as­tat­ing floods

Ja­pan is home to thou­sands of man­u­fac­tur­ers sup­ply­ing goods and parts glob­ally. Many of those busi­nesses had no choice but to re­lo­cate in the wake of the tsunami and many of those chose Thai­land. Why not? Thai­land is not earth­quake prone, still rel­a­tively lo­cal and had the ca­pac­ity to cope with new busi­ness. Sadly, within months, the coun­try was hit by dev­as­tat­ing floods and many of those busi­nesses were closed for a sec­ond time. While in­sur­ers and rein­sur­ers con­tinue to ar­gue about the floods – were they one event or two – the re­sult for busi­nesses glob­ally were that the sup­ply chain was se­verely threat­ened. It has proved a real wake-up call. Busi­ness has seen that light­ning really can strike twice – while many had planned for one catas­tro­phe, no­body was really pre­pared for two. Risk man­agers across the world have been called in to see the board to dis­cuss the im­pact and have been work­ing hard to eval­u­ate the true global sup­ply chain risk. While many busi­nesses, par­tic­u­larly the huge con­glom­er­ates, have been quick to re­act not ev­ery­one has been as ef­fi­cient and there is a clear mes­sage that bro­kers and in­sur­ers are pass­ing on to the in­sured – take a look at your busi­ness and as­sess the risk.

Assess­ing the risk

This spring has seen a spate of new ini­tia­tives and warn­ings. Dr Ak­shay Gupta, di­rec­tor of AIR World­wide’s catas­tro­phe risk en­gi­neer­ing prac­tice, ex­plains: “While the catas­tro­phe risk to sup­ply chain net­works is quite com­plex, it can be ef­fec­tively quan­ti­fied. Once com­pleted, the work in­volved to quan­tify this risk can also help ex­pand risk as­sess­ment to other non-catas­tro­phe per­ils.” He con­tin­ues to ex­plain that a sup­ply chain is a col­lec­tion of op­er­a­tional points, or nodes (a lo­ca­tion with a sin­gle func­tion such as a pro­duc­tion fa­cil­ity, sup­plier, or distri­bu­tion cen­tre), that are linked based on func­tional and rev­enue stream re­la­tion­ships. When all nodes in the net­work are iden­ti­fied and ap­pro­pri­ately char­ac­terised, quan­ti­fy­ing the phys­i­cal dam­age po­ten­tially as­so­ci­ated with each in­di­vid­ual node is a rel­a­tively straight­for­ward ex­er­cise. How­ever, the tra­di­tional ap­proach to ac­count for the re­sult­ing im­pact on a sup­ply chain – and prop­a­gat­ing the ef­fect through­out the net­work – has con­sid­er­able lim­i­ta­tions. “The ex­ist­ing method of assess­ing sup­ply chain catas­tro­phe risk is based on worst case sce­nar­ios, es­tab­lish­ing ei­ther 0% or 100% dis­rup­tion one node at a time and prop­a­gat­ing the im­pact through the en­tire sup­ply chain,” says Dr Gupta. “It does not in­clude the like­li­hood or fre­quency of shut­down, nor does it con­sider the par­tial shut­down of a sin­gle node or the si­mul­ta­ne­ous dis­rup­tion of mul­ti­ple nodes. This tra­di­tional ap­proach can now be im­proved to pro­vide a real­is­tic and com­pre­hen­sive as­sess­ment of the sup­ply chain’s catas­tro­phe risk ex­po­sure.” Un­der­stand­ing both the up­stream and down­stream com­po­nents of the sup­ply chain net­work en­ables com­pa­nies to clearly iden­tify net­work vul­ner­a­bil­i­ties, as well as the po­ten­tial im­pact of catas­tro­phes to their sup­ply chain and, ul­ti­mately, to their busi­ness. Equipped with this in­sight, cor­po­ra­tions can con­sider var­i­ous phys­i­cal, fi­nan­cial, or op­er­a­tional mit­i­ga­tion mea­sures to un­der­take to im­prove sup­ply chain re­siliency; they can also in­cor­po­rate such mea­sures into the net­work anal­y­sis to quan­tify dis­tinct ben­e­fits. How­ever, it is not all about nat­u­ral catas­tro­phes. The TT Club, which pro­vides in­surance and re­lated risk man­age­ment ser­vices for the in­ter­na­tional trans­port

and lo­gis­tics in­dus­try, has re­vealed hu­man er­ror to be the main cause of sup­ply chain claims.

Ris­ing claims

Re­search based on anal­y­sis of TT Club’s claims to­tal more than US $120m dur­ing the past six years has shown that nearly 80% of in­ci­dents re­sult­ing in claims were avoid­able. The vast ma­jor­ity in­volved some form of hu­man er­ror.

The over­all break­down of claims showed:

63% re­sulted from op­er­a­tional causes,

33% from main­te­nance is­sues and just

4% were weather re­lated. Lau­rence Jones, TT Club’s di­rec­tor of global risk as­sess­ment, says sup­ply chain claims are ris­ing and that glob­al­i­sa­tion is un­doubt­edly in­ten­si­fy­ing the com­plex­ity and po­ten­tial dis­rup­tions for trans­port and lo­gis­tics op­er­a­tors: “The Ja­panese earth­quake and sub­se­quent tsunami were a timely ex­am­ple of the wide­spread im­pact such an event can have on global sup­ply chains away from the ter­ri­tory that suf­fered that catas­tro­phe and this was a warn­ing most com­pa­nies heeded.” “How­ever, some op­er­a­tors are still not chang­ing how they man­age sup­ply chain risk, in­stead con­cen­trat­ing on im­prov­ing op­er­at­ing ef­fi­ciency and re­duc­ing costs, when they need to pre­pare their sup­ply chains to with­stand fu­ture events and the im­pact of re­sul­tant dis­rup­tions across the globe.” This warn­ing is echoed in Sup­ply Chain Re­siliency: How Pre­pared Is Your Or­gan­i­sa­tion? The au­thor, Gary Lynch, global leader of Marsh Risk Con­sult­ing’s sup­ply chain risk and re­siliency so­lu­tions prac­tice, warns: “Even af­ter re­peated warn­ings about the fragility of sup­ply chains, too many or­gan­i­sa­tions con­tinue to fo­cus on ef­fi­ciency at the ex­pense of re­siliency in the end-to-end de­sign of their sup­ply chains.” “Many or­gan­i­sa­tions also con­tinue to suf­fer from a lack of col­lab­o­ra­tion be­tween busi­ness lead­ers and risk man­agers, adding un­nec­es­sary com­plex­ity and so­phis­ti­ca­tion to sup­ply chains.” To build more re­silient sup­ply chains, Marsh rec­om­mends an ap­proach that in­cludes an or­gan­i­sa­tion’s to­tal ex­po­sure, in­clud­ing non­phys­i­cal per­ils, aligned to the value it de­rives from key prod­ucts or other sources of rev­enue. This ap­proach, which re­lies heav­ily on the use of an­a­lyt­ics, can help an or­gan­i­sa­tion iden­tify sin­gle points of fail­ure in its sup­ply chain along with risk mit­i­ga­tion and fi­nanc­ing op­tions.

Sup­ply chain in­surance

Risk man­agers are also en­cour­aged to be­come more fa­mil­iar with emerg­ing sup­ply chain in­surance prod­ucts, which are con­sid­er­ably broader than tra­di­tional con­tin­gent busi­ness in­ter­rup­tion (CBI) and con­tin­gent ex­tra ex­pense (CEE) prod­ucts on which risk man­agers have pre­vi­ously re­lied. In ad­di­tion to in­dem­ni­fy­ing for busi­ness in­ter­rup­tion and ex­tra ex­penses re­sult­ing from phys­i­cal dam­age to sup­pli­ers, sup­ply chain in­surance prod­ucts also of­fer in­sureds pro­tec­tion against non-phys­i­cal in­ter­rup­tions to their sup­ply chains. Th­ese can

in­clude strikes, ri­ots, ingress/egress, ser­vice in­ter­rup­tion and pan­demics. Volker Munch, head of strat­egy and devel­op­ment, chief un­der­writ­ing of­fice prop­erty, Al­lianz Global Cor­po­rate & Spe­cialty, ex­plains that most CBI and BI is based around phys­i­cal prop­erty dam­age and is read­ily avail­able from the in­surance mar­ket. How­ever, Al­lianz will ask for more de­tails about the sup­plier’s and cus­tomer’s lo­ca­tion if higher lim­its are re­quested. He stresses, how­ever, that this is not just about sup­pli­ers but also about cus­tomers. “For ex­am­ple, if you sup­ply seats to a car man­u­fac­turer and they have a prob­lem at their man­u­fac­tur­ing base, they will not need your seats, dis­rupt­ing your busi­ness,” he says. “I would say both bro­kers and in­sur­ers have a job to do in ed­u­cat­ing in­sureds, not just about the risks, but also what trig­gers the cov­er­age they have.” Mr Munch stresses the need for a phys­i­cal event to trig­ger most poli­cies. “We aim our prod­ucts at the larger busi­nesses where there is an aware­ness of the is­sues and an un­der­stand­ing of how th­ese poli­cies work. But there is a great dif­fer­ence be­tween th­ese and the medium or smaller busi­nesses where there is lit­tle grasp of their sup­ply chain and there is also a greater risk of a sin­gle sup­ply de­fi­ciency caus­ing ma­jor dam­age to their busi­ness.” He has no­ticed an in­creased aware­ness among com­pany board mem­bers, which is driv­ing de­mand for in­surance so­lu­tions and is also help­ing as com­pa­nies start to do their own risk as­sess­ments. “In­surance pro­vides money in the case of a loss – but that is not good if the loss has caused the busi­ness to fail in the mean­time. It can be very hard to win back mar­ket share af­ter a ma­jor event.” With a ‘just in time men­tal­ity’, many cus­tomers feel they can sim­ply pick up the phone and find an­other sup­plier. Of­ten this is the case, but such a move will usu­ally come at a cost, with the sec­ond sup­plier de­mand­ing higher prices. So while the end con­sumer sees no dis­rup­tion in ser­vice or sup­ply of goods, the pro­ducer will see the profit mar­gin squeezed. Again this is an in­sur­able event – as long as the orig­i­nal dis­rup­tion in­cluded phys­i­cal prop­erty dam­age.

Non-phys­i­cal dam­age

The next ques­tion comes around non-phys­i­cal dam­age, for ex­am­ple a cy­ber at­tack that stops pro­duc­tion at a plant. This is not in­cluded on stan­dard CBI or BI poli­cies, although it may be cov­ered un­der some spe­cial elec­tronic or prop­erty poli­cies. The mar­ket, Mr Munch says, is look­ing for non-phys­i­cal dam­age cov­er­age trig­gers such as in­ter­rup­tion of the sup­ply chain caused by ash cloud, power out­age, im­port or ex­port re­stric­tion to name a few. Al­lianz, Zurich, Char­tis and JLT are among the few who have non-phys­i­cal dam­age poli­cies avail­able. Mr Munch ex­plains the dif­fi­culty is that few peo­ple are buy­ing the poli­cies as yet, mak­ing it hugely volatile and pro­duc­ing cap­i­tal re­straints, which in turn re­sult in a higher price for the in­sureds. Rein­sur­ers too are watch­ing de­vel­op­ments closely, highly aware of the po­ten­tial of an ac­cu­mu­la­tion of claims. Mr Munch feels the mar­ket will come but for now it is lim­ited. He be­lieves that, for most, the ex­ist­ing dam­age-only poli­cies help in mit­i­gat­ing the risks and are a good start­ing point as busi­ness wakes up to the in­creas­ing chal­lenges of a global sup­ply chain. i The ar­ti­cle is re­pro­duced with the per­mis­sion of the Char­tered In­surance In­sti­tute and it first ap­peared in the June/July 2012 edi­tion of The Jour­nal.

In­surance pro­vides money in the case of a loss – but that is not good if the loss has caused the busi­ness to fail in the mean­time. It can be very hard to win back mar­ket share af­ter a ma­jor event.

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