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.
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.
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.
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.
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.