Supply Chain Risks - Mind the Gap!
Commercial Risk Europe
Supply chain risk and business interruption in particular is a hot topic in the European and international risk and insurance community currently as companies the world over try and work out how and why they were so badly hit by the Japanese earthquake and Thai floods. Insurance buyers are keen for the insurance industry to respond with broader coverage for the risks but the insurers say the risk managers need to manage their risks more effectively.
This topic will be one of the key emerging risks discussed at the Malta International Risk & Insurance Congress on May 24 and 25 organised by Commercial Risk Europe and will spark lively debate. CRE Editor Adrian Ladbury reviews the ongoing debate that is taking the market by storm.
A survey of US insurance buyers carried out by forensic accounting and claims firm Dempsey & Partners shows that only half of the risk and insurance managers surveyed who had experienced a supply chain disruption in the last five years had actually recovered claims.
Given the sharp focus on supply chain risk since the Japanese earthquake and Thai floods last year it is no surprise that risk and insurance managers worldwide are calling on their insurers to deliver broader and deeper business interruption coverage, particularly for catastrophe prone regions of the world.
Equally unsurprisingly the big reinsurers and insurers are not falling over each other in a rush to meet the sudden spike in demand with cheap and condition-free coverage.
The leading commercial insurers and reinsurers argue that they cannot offer to renew existing contracts without more information and transparency, let alone offer more innovative and broader-based products.
The relative lack of transparency is obviously a key sticking point in this discussion and was debated at length during Commercial Risk Europe’s series of national risk manager roundtable discussions as part of our annual Risk Frontiers survey.
But more generally, Dempsey argues that a lack of uniform business interruption value reporting requirements methods may well stifle development of potential new insurance products too.
This point was stressed earlier this month in South Africa too as CRE gathered a group of leading risk managers and brokers in partnership with the Institute of Risk Management South Africa (IRMSA) to discuss developing risks and insurance solutions as part of this year’s Global Programmes project.
The South African brokers in particular believe that the scarcity of robust and formalised reporting systems used by risk and insurance managers in the country make it more difficult for them to gain the ear of the main board and negotiate better and more innovative coverage terms with insurers (the full Global Programmes – Africa report, sponsored by Zurich Global Corporate and including roundtable discussion held in Johannesburg and Cape Town will be published with the May issue of CRE).
The insurers are of course more than aware of the demand from insurance buyers and the potential for new business, not least because it comes at a time when margins are under increased pressure and demand in Europe and the US remains sluggish on the back of low economic growth.
At the recent AMRAE conference in France, Philippe Jouvelot, Chief Operating Officer of AXA Corporate Solutions, said that it would certainly be looking to increase dialogue with its corporate customers to try and find solutions to avoid a capacity crunch.
And, earlier this month Allianz Global Corporate & Specialty (AGCS) said that it had decided to extend its supply chain coverage to include non damage business interruption (NDBI), albeit on a bespoke basis.
AGCS revealed that more than half of the claims it received from the Japanese earthquake and tsunami last year came as a result of supply chain disruptions that are not caused by physical damage.
It said that evidence suggests that customers are improving the way they identify, measure and manage the risk and has started to offer NDBI coverage to its customers to cover threat to production from the failure of suppliers to deliver for example.
But AGCS will only offer this coverage on a customised basis and customers will have to prove that they are on top of their risks or face refusal.
The need for such extensions of coverage was made clear by the findings of the Dempsey survey that included responses from 67 corporate risk managers or those in finance responsible for the risk management function.
The claims firm found that 61% of those surveyed had experienced a supply chain disruption in the last five years that led to a loss of earnings. But only 30% had actually recovered insurance claims related to those losses.
“There’s a great deal of inconsistency in the responses we received, which points to a lack of clear standards for quantifying business interruption and contingent BI exposures,” said John Dempsey, Managing Partner, Dempsey Partners.
“That could be one reason behind the lack of innovation the industry has shown in addressing supply chain risk,” he added.
The survey participants were divided over whether their property insurers clearly articulate and explain their requirements for reporting business interruption values. Some 54% stated that their insurers do clearly articulate the requirements, but 42% disagreed.
The balance tilted away from insurers when the risk managers were asked whether insurers clearly explain and articulate the information needed to insure supply chain risks. Only 43% of the survey participants said that this information is clear while 46% disagree.
Only one in four (26%) of survey participants expressed confidence that the risk modelling performed by their property insurers provides accurate business interruption exposure data and 51% lack confidence in this area. Dempsey suggested that this is perhaps as a result of experiences with losses in Thailand and Japan.
The New York-based forensic accounting firm said that the survey also found a dramatic variance in the methods used by insurance managers to report their business interruption values to their insurance companies.
The majority of survey participants (88%) report these values each year but their methods range from informed estimates (4%) to comprehensive annual studies (10%).
The most popular reporting approaches include customised worksheets tailored to their business (39%) and business interruption worksheets supplied by their insurers (32%).
“We found some striking contradictions in the responses we received to a number of the survey questions. That underlines the fact that there’s plenty of room for improvement in how businesses and their insurance companies approach business interruption, contingent BI and their overall supply chain exposures,” said Mr Dempsey.
“Furthermore, with related insurance coverages becoming more restrictive, businesses clearly need to examine supply chain and business interruption risk with greater precision and understand the extent and limits of the protection afforded by their insurance programmes,” he added.
Some 81% of the participants said that they feel that their reported business interruption values are a good estimate of their business interruption exposures.
But some 61% of those surveyed said they also believe that more accurate business interruption value and exposure data would help them structure a broader, more cost-effective property insurance programme.
Also some 85% of those in the survey indicated that their organisations have identified their key supply chain risks. But only 69% feel their organisation has adequately described these risks to their insurers.
The insurers that shouldered the heavy losses from Japan and Thailand last year and saw their year-end results hit as a result are more than aware of the problem.
Andreas Shell, Global Head of Property Claims at AGCS, said earlier this month: “More than half of our insurance losses from the Japan disaster were the result of business and supply chain interruptions—that’s a new dimension.”
AGCS pointed out that many companies’ supply chains have become more global in recent years while, at the same time, inventories have been scaled back because of the cost-driven focus on just-in-time deliveries.
Companies have also outsourced larger shares of their operations and reduced the number of individual component suppliers in an increasing drive for competitiveness, said the insurer.
“The disasters in Japan and, even more so, the extensive flooding in Thailand late in 2011 showed companies and insurers just how vulnerable global supply chains are,” stated AGCS this week.
“The electronics and automotive industries, in particular, were faced with bottlenecks or even production outages around the world through so-called ‘contingent business interruptions’ where suppliers were unable to deliver as planned, impacting production in these industries directly,” it added.
AGCS recently carried out a survey that showed that many companies now understandably view disruptions in the supply chain and business interruptions as a major business risk, a conclusion shared by Commercial Risk Europe’s annual Risk Frontiers survey of Europe’s leading risk managers published last October.
The good news for AGCS and its rival international corporate insurers is that many companies are undertaking what it described as ‘systematic’ efforts to make their supply chain risks more transparent and limit their risks.
“For cost reasons, many companies will still be forced to source their components from just a few suppliers or even a single one in the future. But risk awareness is growing,” said AGCS Risk Consultant Ralf Dumke.
The insurer said that companies are taking an increasingly professional approach to address specific risks. This includes the listing of key suppliers and their production locations, running through catastrophe scenarios, the application of geo-coding and the development of business contingency plans.
But the insurer stressed that companies should not merely ‘professionalise’ their own risk management, but also engage their suppliers in the process. “Even the suppliers’ suppliers must be involved,” Mr Dumke said.
Beyond the development of better proprietary risk management systems to manage the risk at source many companies are also preparing for business interruptions by taking the necessary insurance cover. But for it to work the insurers need more information, said AGCS.
“While we had to deal with a high claims burden as a result of the large number of natural disasters last year, we continue to provide sufficient cover for business and supply chain interruptions. But we expect companies to allow us an insight into their risk management approach and also into their supplier structures, particularly when loss exposures are high,” explained Volker Muench, Head of Corporate Underwriting Property at AGCS.
Risk and insurance managers who work for complex modern companies should, however, not expect off-the-shelf products to meet their rising demands. AGCS explained that conventional business interruption policies are only triggered by physical damage, for example, when either a company or its suppliers are unable to produce because of accidents such as a fire or an earthquake.
The insurer pointed out, however, that many companies nowadays also seek cover for business interruptions that are caused by events that are not necessarily sparked by physical damage, such as strikes or power blackouts.
AGCS said this week that it will offer risk managers this type of policy in the future but stressed that it will not be an ‘off-the-shelf’ product.
“We don’t have enough historical data for risk modelling. In addition, we are looking at potentially high cumulative totals because entire sectors or regions could be affected,” Mr Muench explained, adding that in a first step, AGCS would therefore cooperate with select clients and offer them a customised product.
The simple fact is of course that neither the risk managers nor their brokers and insurers should have allowed themselves to get into this pickle in the first place. Why were un-modelled BI risks in far flung territories being created by the companies in the first place and why were the insurers and reinsurers happy to carry them without adequate risk assessment?
The answer to that is equally simple: That was a different age in which money grew on trees and everyone was doing everything in their power to grab their share, regardless it seems of the real underlying risk. The good news is that it has not taken that long for the market to start earnestly looking for solutions that should last after the problem was so horribly exposed in Japan and Thailand. Keep up the pressure!
The insurability of supply chain risks will be one of the key topics debated by industry leaders at the Malta International Risk & Insurance Congress, organised by CRE, and held at the Hilton Malta on May 24 and 25. The congress is free for risk managers and offered at a competitive rate for the insurance market.
To secure your seat please visit our website at www.commercialriskeurope.com for booking details.
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