By Ingrid Sapona   |    September 2018    |    24 minute read

As one insurance commentator adroitly pointed out, global supply chains have been around since traders plied their wares on the Silk Road. But, the rise of globalization and the desire to find ways of cutting costs and improving efficiency have dramatically changed manufacturing and trade. As a result, the complexity of supply chains and the types of disruptions that can befall them have changed since the time of trade along the Silk Road. As well, climate change and rising trade tariffs and threats have also helped bring supply chain risk management to the fore.

It’s not unusual to find references to “supply chain insurance” in articles and on-line. But, closer study shows that these generally aren’t stand-alone products. XL Catlin’s Jeff Abramson, Head of Special Risks, Political Risk, Credit & Bond, Americas, suggests semantics may be the reason there are lots of references to “supply chain insurance”. “I think people use that term ‘supply chain’ broadly because it has resonance with business. So, people use it to cover pieces of different things that may impact a supply chain,” he says.

In this paper we’ll look at some of the risks inherent in a supply chain and ways insurance can be used to help manage particular supply chain risks.

The Impact of Supply Chain Disruption

It’s difficult to find hard statistics about the global economic impact of supply chain disruption. One of the few sources that provides insights on the topic is Resilinc’s 2017 EventWatch Supply Chain Disruption Annual Report. Though they don’t provide absolute dollar figures, the report does include some interesting statistics, for example:

- supply chain disruptions globally nearly doubled in 2017;
- natural disasters and weather-related events were a significant source of disruption globally;
- all industries reported increased disruption, with the automotive industry experiencing the most; and
- 32% of S&P 500 companies were impacted by supply chain disruptions.

Economists studying the global impact of unexpected meteorological events have noted that, “since the beginning of the 21st century, the structural evolution of the global supply network has been such as to foster an increase of climate-related production losses.” In terms of quantifying the costs, some estimate them to be in the billions: “In the last two decades associated costs from supply chain disruption due to extreme weather events has grown staggeringly, averaging tens of billions of dollars per year.”

IBM’s supply chain consulting group also reports some statistics about the economic impact of various high-profile supply chain disruptions, such as the 2010 Iceland volcano and the 2011 Japanese tsunami. And, to make things interesting, the website provides the information via an innovative on-line “game”.

While Resilinc points out that natural disasters and weather-related events were considerable sources of disruption in 2016 and 2017, it also points out that supply chains are vulnerable to many less high-profile events. “…[i]t is clear that the more frequent, low-impact events that may go unnoticed by most are not only the majority of supply chain events, but should be as highly prioritized as the larger-scale and more severely disruptive events…”.

Who is vulnerable to supply chain disruption?

Any business that needs to get a physical item from one place to another can face supply chain disruption. Interestingly, despite the common belief that shorter, less complex supply chains are more efficient, shorter isn’t necessarily better. In fact, modelling has shown that longer supply chains are more resilient to extreme weather events.

A company’s size or sophistication doesn’t necessarily make it immune to supply chain disruption. A recent news story is proof that even big, well respected companies can end up squeezed by supply chain disruptions. In early August 2018, Apple’s iPhone chipmaker was forced to close several of its factories as a result of a virus that infected its fabrication tools. The virus was launched when the supplier was installing software. As a result, the Taiwanese chipmaker has warned Apple that shipments of the new iPhone could be delayed. Perhaps the most surprising thing about that news item was the fact that the supplier is Apple’s sole source of chips for the iPhone.

What regions contribute most to supply chain disruption?

When supply chain professionals are asked what region is most likely to experience supply chain disruption due to natural disasters, most point to Asia, given its vulnerability to typhoons and earthquakes. But, in 2017 North America was the most disrupted region due to naturally occurring events, including storms and extensive forest fires.

It’s also noteworthy that it’s not just supply chains that traverse wide swaths of the globe that are subject to supply chain disruption. Those that operate in a more restricted geographic area are also vulnerable. As 2017’s devastating US hurricanes showed, North American supply chains are at risk due to climate change, not just international supply chains.

Causes of Supply Chain Disruption

The cause of supply chain disruption are often categorized as falling into one of three types: natural disasters, man-made, and economic. Below are examples (by category) of noteworthy events that caused supply chain disruption. Though it’s natural disasters that tend to make their way into the headlines, especially if they are attributable to climate change, for many businesses, supply chain disruption attributable to man-made and economic causes can be more devastating.

Natural disasters

Hurricanes and typhoons that cause major flooding – A 2011 monsoon that caused massive flooding in Thailand disrupted the electronics industry (approximately 25% of all hard drives are made there) and the automotive industry (production was stopped for Honda, Nissan, Toyota, Ford and Mitsubishi).
Volcanic eruption – The 2010 Iceland eruption of the Eyjafallajokull volcano forced cancellation of a number of flights over a number of days. The eruption was a logistics nightmare that necessitated cancellation of over 100 Fedex flights.
Earthquake and tsunami – the 2011 Japanese earthquake and tsunami shut down various factories, including one that produced 60% of global car engine airflow sensors. As well, in the months afterward, rolling brownouts delayed production in many other areas, causing further disruption.
Wildfires – In 2016 the California wildfires cut off key rail and trucking routes.
Power outages– In 2017, Hurricane Maria, which hit Puerto Rico, knocked out power to the island, disrupting production and distribution of pharmaceuticals. According to the US Food and Drug Administration (FDA), about 10% of pharmaceuticals used by Americans are made in Puerto Rico, so the disruption had down-stream impact on the entire US healthcare system.

Man-made

Cargo containers lost at sea – From 2014-2016 an average of 1,390 shipping containers are lost at sea each year.
Fire – In 2016 a fire in a Gap warehouse in New York State that accounted for more than 30% of the company’s distribution space slowed the company’s holiday distribution. Factory fires, such as the Rana Plaza fire of 2013, have taken workers’ lives and livelihoods and disrupted supply chains.
Terrorist attacks – The September 11, 2001 terrorist attack, for example, closed the Canada/US border for a number of days.
Cyber attacks and problems – As noted, in August 2018 Apple faced delays because the company that produces the main processor for its phones was hit with a virus that infected its fabrication tools.
Production halts for Repair/Maintenance – The June 2018 closure of CO2 producing plants in Europe for scheduled maintenance and repair led to shortage of CO2 in the UK, hampering production of beer and other food products, leaving certain items in short supply at grocery stores and bars.
Labour disruptions – Strikes at ports, railways, and other cargo carriers can halt shipment of goods.
Brexit – The verdict is not in yet on whether – or to what extent – Brexit may have an impact on supply chains, but some disruption seems inevitable.

Economic

Failure of a supplier – The 2016-2017 bankruptcy of Hanjin Shipping, the world’s seventh largest container carrier is a classic example of economic forces that had a tremendous impact on many supply chains. Hanjin’s financial collapse left goods stranded on ships that were no longer allowed to come into various ports to unload. According to one report, the collapse of Hanjin left US$14 billion worth of goods adrift.
Trade Disputes – The current trade dispute between the U.S. and China has manufacturers looking at shifting production from international to domestic locations.

So far, 2018 has been a banner year for events that can impact supply chains, with everything from earthquakes, to wildfires, massive floods, volcanic eruptions, bridge collapses, and the initiation of what some are calling trade wars.

Disruption from Tariffs and other Protectionist Actions

Imposition of tariffs can have an economic impact and may cause businesses to modify their supply chains. Supply chains could be disrupted if governments apply protectionist measures that limit, or prohibit, the import or export of goods, or that target particular companies for specific restrictions, or if they confiscate foreign companies’ property.

“The topic being discussed a lot in industry forums is really the potential for trade disruption and trade war and the protectionism that’s rising,” says Daniel Riordan, President Political Risk, Credit & Bond Insurance, XL Catlin. “The shift from a global interconnected economy to one where there’s regional blocks forming is an area that get attention of underwriters of these products, like us,” he says.

“As underwriters for political risk and credit, we’re always looking at different global economic, social, and political issues. For us, good things happen when countries are getting along and trading. There’s concern that if the tariff situation and some of the brinksmanship were to continue going forward, that could have an impact on global GDP and on certain companies not being as effective and not being able to access important inputs for their production, or at a price that’s sustainable,” says Riordan.

There are a few positives coming out of this fear of protectionism, such as sharpened focus on supply risk management. Riordan says they’ve noticed a bit of an uptick in submission activity generally for political risk and trade credit coverage. “Because there’s some uncertainty that’s causing some worry, it’s highlighting the need to look at arrangements and relationships business have with their suppliers. They’re looking at how well structured these relationships are with a view to developing a sense of resilience in the event there’s potential disruption. It’s not all bad. It’s causing companies to look at their risk management and whether it’s sound and that they are doing scenario planning in the event they lose access to a supplier. They’re looking at things like building in redundancy, making sure contracts are strong, and so on, so that the first sense of trouble doesn’t cause a catastrophe for them,” he says

Managing Supply Chain Risk

Things like just-in-time inventory, climate change/extreme weather events, and globalization have amplified supply chain risk. And yet, a survey of 150+ firms released in 2015 reported that 90% didn’t formally quantify supply chain risks when outsourcing production, nor did any of the survey participants use outside experts to help assess supply chain risk.

Similarly, though supply chain failure was ranked as one of the top 10 risks in the food processing and beverage industry, only 58% of companies in that sector reported having plans in place for supply chain disruption. By comparison, a survey by Aon survey showed that 82% of those same companies have plans in place for product recall.

Due to the complexity of supply chains and the significant risks they expose businesses to, a number of brokers and risk management consultants provide supply chain risk assessment and management services. Zurich, for example, provides such risk assessment services. Their services often help companies identify bottlenecks within their supply chains and identify solutions, according to Markus Franc, Director, Corporate Underwriting, Zurich Insurance Company Ltd. “We have specialized risk engineers who help the business quantify the financial risk and help them decide, for example, if they need to find a second supplier. Often the risk assessment formalizes things the business probably knew, but they really appreciate an outsider analyzing it,” he says. The fee for a risk assessment varies, but it is typically charged at an hourly rate that is not a big deal for big companies says Franc.

Though different firms have different, often proprietary, methods, the following tasks, or steps, are fairly standard:

Conducting a supply chain audit – this involves reviewing/understanding all the individual links in the supply chain and the logistics of how goods travel through the supply chain.
Assessing the risks applicable to each link (each supplier) in the chain – this involves understanding where suppliers are located and assessing things like political risk, climate/disaster risk, cyber risk, determining how much the supplier contributes to revenue. It also requires an assessment of the disaster and disruption plans suppliers have in place and of the logistics of how items flow between suppliers and sub-suppliers, as well as an assessment of the scope and impact of contract provisions (such as force majeure clauses).
Providing specific risk management suggestions – recommendations regarding risk mitigation, such as identifying alternative or multiple sources, keeping more inventory on hand, investing in emerging technology like 3D printing to reduce dependence on suppliers, creation of contingency plans, ways of transferring the risk, and design of a comprehensive insurance program.
Continual (real-time) monitoring of supply chain risks – Real-time monitoring of risks lets the company shift production schedules, adjust shipping routes, and coordinate activities of suppliers along the chain to help minimize potential disruptions. For example, there are services that provide maps that provide insights into how heat and rain will impact specific crops; as well, there is software that helps companies track shipments up to 10 days before tender, providing detailed alerts about storms and other things that might disrupt the shipment.

Insurance for Managing Supply Chain Disruption Risks

Of course, one risk management tool businesses often look for is insurance. In this section we survey some of the insurance products available to help mitigate some risks associated with supply chains.

“Supply Chain Insurance”

Brian Kelly, Managing Partner, Risk Management at BFL Canada, points out that until recently, Zurich offered broad supply chain insurance. “It covered many risks not covered by traditional insurance including supplier or transporter insolvency, port blockage, strikes, denial of access, political risk – those are just some that come to mind. It was very broad but the underwriting process was heavy and the pricing was expensive in comparison to other types of insurance,” he said. Zurich Insurance’s Franc confirmed that for the last seven years Zurich offered supply chain assessments and insurance. “There is a big interest in the marketplace from the broker’s side and from customers. We have great tools available to assess the risk and to quantify exposures. In many cases the assessment helped the customer to handle their supply chain situation and didn’t trigger a risk transfer solution. With our risk transfer product we provide a very broad cover and, therefore, the current assessment process is complex. While we continue to provide risk assessments Zurich is currently revisiting its offerings on the risk transfer side with the intent to provide more options.

Zurich views the product as an extension of contingent business interruption (CBI) embedded in a Property & Business Interruption policy and would generally only bind a Supply Chain policy with such a property BI policy in place with Zurich.

Zurich initially developed its product after the Thai flooding of 2011 and the earthquake in Japan, which hit around the same time. “Those events demonstrated how many industries depend on suppliers in very ‘CAT’ exposed areas of the world. You can have a very local occurrence where a very small areas is effected but it’s felt throughout the whole world,” notes Franc.

BFL’s Kelly noted that, “My impression is that most customers interested in supply chain initially wanted to pursue coverage for a broad range of supply chain exposures but this created a need for significant information flow for underwriting purposes and the product became expensive, when compared to other traditional lines of insurance coverage. A more pragmatic approach, and less costly, is to focus on specific risks that can have a severe financial impact. For example, in working with a large retailer we narrowed down the material risks to 1) port blockage at two major ports in Asia and the port of Vancouver; 2) a strike by CN or CP employees; and 3) the risk of insolvency of a top five global marine transport company. The insurance would cover the extra expense and loss of revenue for a pre-determined period sufficient to allow alternative logistic sources to be implemented. The information required of the customer was focused on the number of containers that would be impacted during the period of indemnity, the additional re-routing expenses and, where applicable, the loss of revenue. It was straightforward for the insured to compile the information and I believe this approach would have led to a greater uptake on the purchase of this insurance.”

For customers that are pre-occupied by supply chain disruption from traditional property perils such as fire, explosion, and natural catastrophe events, Kelly has found Affiliate FM’s proVision® policy to be a good solution. Coverage is triggered by the perils insured under an all risk property policy to insured property and covers the insured’s extra expense and/or loss of revenue from such disruption. The policy contains a built-in sublimit in the $500K range that could be increased based on the underwriting appetite for the specific exposure, says Kelly. Different from Contingent Business Interruption coverage, supply chain also includes coverage at indirect suppliers, customers and contract service provider locations.

There are also a number of London insurers that will entertain supply chain coverage but in large part they are covering physical damage caused by natural catastrophes which is a general pre-occupation for many companies, says Kelly.

Contingent Business Interruption (CBI) Coverage

CBI coverage has been around for some time now and most property policies include some form of coverage. But, Kelly says insurers vary on their appetite for covering unnamed suppliers/customers in terms of the sub-limit they are willing to provide while some restrict coverage to named suppliers/customers. Unnamed CBI exposures typically will be subjected to a “throw in” low sub-limit while Named CBI exposures allow the Insurers to quantify the risk and provide limits that meet the specific risk exposure assessment.

Having done insurance due diligence work in support of M&A transactions, Kelly frequently encounters situations where the CBI risk has not been reviewed and quantified. Often this leads to a standard “frill” sub-limit that is very low and most likely significantly insufficient, he says. This is more prevalent in the small- to medium-size enterprise space as typically risk managers review CBI exposures on an on-going basis.

CBI coverage offers protection against economic losses and increased costs of operations an insured might suffer as a result of physical damage to property at the premises of a supplier and/or, customer. Note that it’s not necessary that the supplier or customer be completely shut down in order to make a claim under CBI. All that’s necessary is that an insured loss occur at a location covered under the policy and that the insured’s business is interrupted as a result.

Kelly pointed out that it’s particularly important to compare the insurance coverage for natural catastrophe perils against the financial impact anticipated from CBI exposures situated in high risk natural catastrophe zones. “The financial impact can be devastating if not properly insured, especially when there are multiple CBI exposures in the same zone that are vulnerable to the same natural catastrophe peril. Most Insurers will require CBI location addresses for exposures situated in elevated natural catastrophe zones before increasing the limit as they also need to monitor their aggregate exposure to a common event, says Kelly.

Just as supply chain risks have become more complicated for businesses to manage, so too has the provision of CBI become complicated for insurers because of the ripple effects that can occur in the case of a loss. “In the past, CBI cover would typically be triggered by isolated perils … today the major threats come from natural catastrophes to which insurance companies are already exposed under other policies.”

Political Risk Coverage

Aon’s annual political risk map rates countries’ political risk based on a number of criteria. Supply Chain Disruption is one of them. Political risk coverage is for companies doing business in an unpredictable geopolitical environment. “It’s not exclusively limited to emerging markets. We have something called multi-country policies where you have companies with investments around the world, those often include investments in developed countries,” says Riordan.

For more information about Political Risk Insurance, see the May 2015 Trends Paper on the topic.

Political Risk insurance aims to cover perils that other, conventional policies don’t cover. Though the perils covered by it vary and can be tailored to specific situations, it often covers supply chain disruption due to political risks including export embargos, and license cancellations. If the insured has contracts with a foreign government and the government takes actions that frustrate the contract, political risk coverage could cover such actions. As well, if the company’s property located in a covered foreign jurisdiction is expropriated, political risk insurance may respond.

If protectionism gives way to governments expropriating a company’s assets or nationalizing certain industries, XL Catlin’s Riordan says it’s possible companies may have a political risk loss. “Say a non-US or non-North American company has a distributorship or manufacturing operations and – as a result of protectionist action like nationalization or some abrogation of their ability to operate in some way – if it’s capricious or targeted at a class or company partly because of their nationality, that could rise to political risk losses,” says Riordan. But, mere imposition of tariffs would not amount to a covered political risk. “Political risk insurance does not protect against the normal ability of a country to promulgate laws and regulations. For an action to be covered, it has to rise to the level of being discriminatory or expropriatory. It has to deny them the ability to operate or utilize their investment,” he says.

Political Violence Coverage

Certain types of politically-motivated violence – such as insurrections, strikes, and riots – have the potential to disrupt supply chains and are often covered perils under Political Risk insurance.

“If you have inflamed situations, protectionism, trade wars, or what have you, that lead to violence – whether it’s war, insurrection, or civil strife – you could have damage to facilities that interrupt supply chain capabilities, says Riordan. “Sometimes we also get requests for business interruption loss tied to that political violence coverage. If there’s damage and that interrupts the supply chain for a period, we may provide coverage for six to 12 months of the inputs or costs associated with the facility being down due to political violence, assuming the facilities are re-built,” he adds.

Trade Credit Coverage

Trade credit insurance is designed to cover risks related to non-payment by a buyer. Supply chain disruptions resulting from imposition of tariffs and other protectionist measures could pose financial hardships on some buyers, causing them to default on contracts or debt obligations.

“The most relevant trade credit product vis-à-vis supply chain is mostly focused on the end of the supply chain – the sale that people are looking to protect. The big mono-line carriers and excess loss carriers like ourselves are typically supporting corporate entities and covering non-payment of their receivables once they make a sale. Where that product gets applied to supply chain is really in terms of the financing of corporate entities’ supply chain,” says XL Catlin’s Abramson.

“For example, there may be a company that’s feeling pressured by their customers to provide longer credit terms and this is then putting pressure on them to not pay their own suppliers for longer periods of time. Their suppliers may not be happy with that circumstance. So, one tool that’s utilized is that a bank or other financier may set up with that corporate entity a supply chain finance program whereby that company’s suppliers will make sales to them and sell those receivables to the financier. This allows the supplier to be paid out very quickly, rather than waiting for the company to be able to pay them,” explains Abramson. “Where insurance comes in is sitting behind those supply chain financiers. If the buyer fails to repay its supplier, then the trade credit policy would protect the bank or non-bank financial institution against non-payment. That’s the basic way trade credit insurance is used in a supply chain context,” he says.

Cyber Coverage

Cyber risk occurs with supply chains too, particularly as companies give suppliers access to their networks. According to Aon, “Some of the biggest data breaches to date have been a hacker infiltrating a third-party supplier to get at their clients.” Retailer Target experienced a major hack in 2013 when a third-party vendor’s credentials were used to access Target’s system. Indeed, in its 2017 Risk Report, Allianz noted that it expects that cyber issues will cause more supply chain disruption than physical damage.

Though some cyber loss may be covered under Property, General Liability and D&O policies, there is no substitute for a dedicated cyber insurance policy, says Kelly. “Normally a cyber breach will trigger several coverage modules, such as damage to digital assets, privacy liability, business interruption, PCI fines, and so on, where a well-coordinated crisis response is key to mitigating the extent of damages and in preserving the company’s reputation. A cyber policy covers crisis response expenses and insurers have vetted the capabilities of the crisis response team, which is a critical benefit,” says Kelly. From a supply chain standpoint, coverage is triggered by interruption, degradation, or failure of the insured’s network, but it is possible to extend coverage to include breaches at cloud/data hosting companies. There is no automatic blanket coverage for damages from breaches occurring at a customer or supplier’s premises but it would be possible to explore coverage providing the relevant underwriting information can be provided, says Kelly.

Conclusion

Despite the obvious risks inherent in supply chain disruption, a recent survey on supply chain resilience found that 51% of businesses said their supply-chain related losses were uninsured. A number of reasons are usually cited for such a high number of businesses failing to purchase coverage, including supply chain complexity and the fact that, while most companies have a good handle on their direct suppliers, it’s difficult for them to identify all the secondary suppliers in the chain. Also contributing is a general lack of knowledge about the types of cover that’s available, and the fact that there is no standard product available.

BFL’s Kelly offers an additional possible reason for the shortcoming. “Most companies in Canada do not have a risk manager or risk management department. The insurance/risk management role is added to a long list of responsibilities of the controller, credit manager, VP Finance, or CFO in some cases. Insurance comprises a small fraction of their time while understanding the financial impact of supply chain events and mapping CBI exposures is time consuming and the risk profile changes constantly. It also requires cooperation from several people, such as the logistic manager, supplier/vendor quality control auditor, purchase manager, etc. It takes a level commitment for an organization to round up the proper resources to assess supply chain properly but I do believe this will change in the future and the demand for insurance will grow,” he says.

The uniqueness of each supply chain means the cover must be customized, which limits the available loss data, which insurers need. This, in turn, has made it difficult for the industry to develop standard coverage. But, given that insurers have quite a lot of supply chain risk assessment expertise and that there’s a lot of interest in the marketplace for coverage, it could be just a matter of time before a cost-effective insurance product is available. Indeed, in the future, technology may also play a role in development of a product. Some have mused about the potential benefits of running supply chains on a blockchain platform. This would generate transparency and allow for better supply chain risk management and may allow for creation of more tailored cover at competitive prices.