Supply Chains Stressed in 2011

Companies face complex risks and costlier insurance.

John Dempsey of Dempsey Partners John Dempsey of Dempsey Partners

As supply chains stretch out longer and longer, they seem to be snapping more often. And while companies generally insure against such risks, the standard insurance product, contingent business interruption coverage, has some shortcomings.

A survey of more than 550 companies worldwide found 85% had experienced at least one supply chain interruption in the last year, up from 72% in 2010 and 74% in 2009. The survey, which was conducted by the Business Continuity Institute and sponsored by Zurich and DHL, also showed that 29% of the companies reported more than one supply chain disruption, up from 20% in 2010.

“That shows it’s really a systemic problem,” says Linda Conrad, director of strategic business risk at Zurich.

Companies cited weather as the main cause for 51% of the disruptions in the last year. Al Tobin, national property practice leader at Aon Risk Solutions, points to the floods in Thailand and Japan’s earthquake and tsunami as weather events that caused significant disruptions this year for the automotive and electronics industries. “A lot of manufacturing is done in those regions for component parts for U.S. products,” Tobin says.

The survey also shows problems can occur at various points in a company’s chain of suppliers. While 61% of the disruptions started with companies’ direct suppliers, 30% originated with tier two suppliers—the companies that supply their suppliers—and 9% with tier three or lower suppliers.

Companies should take a thorough look at their supply chain, Tobin says. “People need to peel back the onion and look at the second or third level of suppliers,” he says, and adds that such scrutiny needs to occur regularly. “There are suppliers you have today, you could have different suppliers next year. It’s not a project you do once.”

Conrad says the procurement department can often list all of a company’s suppliers by the amount of money spent with each of them, but that amount isn’t necessarily a good measure of the company’s supply chain risk. “If you were a hospital, you might spend the most on drugs or major equipment like an MRI,” she says. “But if you don’t have rubber gloves, you’re not allowed to open your doors. Supply chain risk assessment requires a broad analysis to understand which multiple suppliers would cause an impact on your end value chain.”

Collecting the information companies need about their suppliers is a challenge, says John Dempsey, managing partner at Dempsey Partners, a forensic accounting firm that works with large companies to quantify and recover property and business interruption insurance claims. “It’s hard enough to identify among the hundreds of vendors that any large corporation will do business with which are the key suppliers and which are the suppliers that are nonessential or could be easily replaced,” Dempsey says. “We’re looking for that supplier who is the sole source of the most valuable part that goes into your widget. If you can find that supplier, you can take steps to mitigate your risk.

“If it’s hard to pick out suppliers who are key to are operation and profit, how do we go to the next level and find the suppliers who are key to our suppliers’ getting the goods and services to us in a timely way?” he adds.

Most companies try to offset risks to their supply chain by buying contingent business interruption insurance, which extends the coverage for interruptions to the company’s own business to those of its suppliers and customers. But given this year’s string of catastrophes, companies may find such insurance costlier or harder to obtain.

“There are pricing increases for this coverage,” Aon’s Tobin says. “The market’s been hit and they want more money. They want more money for earthquake, they want more money for flood, and they want more money for contingent business interruption.”

“What we’re starting to see is the insurers are not willing to offer as much coverage for contingent business interruption and are starting to put in restrictions,” Dempsey says, adding that insurers may have more questions about companies’ supply chains. “I think the carriers are starting to believe that they don’t have enough information to maintain the same capacity, the same pricing, the same terms and conditions for contingent business interruption,” he says.

Dempsey notes that there are some problems with contingent business interruption coverage, starting with the fact that it’s traditionally triggered by physical damage to property. So when the volcanic eruption in Iceland halted air traffic in the fall of 2010, for example, airlines lost a lot of money, but the fact that there was no physical damage to their insured property meant contingent business interruption coverage didn’t come into play.

Conrad says the fact that contingent business interruption usually covers the perils the company has selected for its own business interruption coverage can also raise issues. “If you’re in an area that doesn’t have earthquakes, you wouldn’t purchase earthquake peril,” she says. “But many suppliers are in an earthquake zone. If you’re relying on the same perils to be extended to your suppliers, you may miss something.”

Zurich rolled out a new policy, supply chain insurance, a few years ago, that covers all risks and does not require physical damage to property to trigger coverage.

But experts say a thorough investigation of a company’s supply chain may also point to risk management measures that can make a difference.

“If I were doing business in Thailand now, I would be focusing on who I’m doing business with, doing a thoughtful analysis of what could happen within reason and is there anything I could do about it,” Dempsey says. “If insurance risk transfer is my best solution, I’m going to be sure I have adequate limits. On the other hand, it may be that I can encourage my largest supplier to build a four-meter flood wall around his factory, and that might make an equally important reduction in the risk.”

 

 

For an earlier look at innovations in supply chain finance, see Best Friends Forever.

 

 

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