Managing Through Disruption: The Importance of Risk Management for Supply Chains

This post is part of a series sponsored by The Hanover Insurance Group.

Over the last decade, we have witnessed many types of unpredictable disasters, including terrorist attacks, wars, earthquakes, economic crises, devaluation of currencies, SARS, tsunamis, cyber-attacks, and more recently the COVID-19 pandemic. Today’s global economy has made the world more interconnected than ever, and with the increasing trend to source globally, the COVID-19 virus has demonstrated the extensive impact that supply chain disruptions can have on a business. This has led to an increased need for global insurance coverage as one of the means to protect against supply chain disruptions – specifically, business interruption (BI) and contingent business interruption (CBI) coverage.

Addressing supply chain disruptions can be challenging. Insurers are increasingly finding that there is a ripple effect, in which one event can affect multiple customers and lead to high losses. Insurance can provide protection for many of the losses faced by business disruption, although dependence on insurance alone is an incomplete strategy. Multinational companies therefore must be sure their risk management strategies are strong enough to manage stakeholder interests after a business interruption. Robust business continuity plans will vastly improve supply chain resilience in the event of a breakdown in these cases and help protect a business from losing its customer base and reputation.

Disruptions are also more global than regional. In today’s world of sourcing globally, complex supply chains are designed to minimize production costs. However, there is a growing interdependency of many industries and processes, which means that multinationals are exposed to an increasing number of disruptive scenarios that could affect their business or operating models. A disruption in one part of the world is rarely contained to that area. Rather, there is a chain reaction that can devastate business operations. The impact of a disturbance at the manufacturing end of the chain is almost immediate, but the subsequent impact follows rapidly down the supply chain to other companies and it can take years for affected companies to recover fully. Losses can only partially be protected by insurance.

After the March 2011 earthquake and tsunami in Fukushima, Japan, many multinational companies learned painful lessons about the hidden weaknesses in their supply chains. Weaknesses that resulted in loss of revenue, and in some cases, loss of market capitalization. Throughout Japan, many plants closed, at least for several days, with uncertainty on restart dates. In addition, there were ramifications worldwide. For example, a disruption in the supply of small component parts that may cost only a few cents can have much more costly effects of shutting down a factory in another part of the world due to the failure to supply.

Supply lines are longer and far more complex than in the past. Although multinationals could quickly assess the impacts that Fukushima had on their direct suppliers, they were blindsided by the impacts on their second- and third-tier suppliers operating in the affected region. Knowledge of primary suppliers are regularly tracked but it’s the secondary layer of suppliers where the greater risk is due to lack of knowledge or attention paid to them. Supply-chain managers know the risks of single sourcing and may regret their reliance on a single company for items they directly purchase. Often, they have limited options to choose from, and increasingly those options are only in China or Asia.

Corporate risk managers may believe that the right supply chain or CBI insurance coverage is unavailable, inadequate, or cost prohibitive. In recent times, BI has become a necessary coverage rather than “nice to have.” Business interruption insurance covers lost profits after a multinational’s own facility is damaged by a covered peril, while CBI insurance covers lost profits if an insured peril shuts down a critical supplier or a major customer. However, CBI insurance would be triggered if the insured is still forced to slow or halt production – and therefore lose profits – because the supplier with damaged operations cannot deliver critical raw materials or parts. BI and CBI coverage generally only cover supply chain disruptions resulting from physical loss or damage to insured property. These coverages do not cover events without physical losses such as power outages or labor disruptions and will not provide protection for loss of market share for example once their customers have moved their business to a competitor. BI and CBI losses can account for 50% to 70% of catastrophe losses and because of this, insurers are beginning to put more focus on the underwriting of supply chain risks.

Policy language varies across the world. Policy language internationally has different terms, conditions and coverages than you typically would find in U.S. issued policy language. This can lead to potential misunderstandings of policy coverage and/or create unrecognized gaps in coverage. This is especially true as it relates to BI and/or CBI coverages when it was thought that a loss scenario was covered but it transpires otherwise. This can have a detrimental effect on a business.

The structuring of an efficient, cost-effective global program requires a close understanding of the evolving regulatory environment. Multinational companies traditionally have focused on whether a local jurisdiction has compulsory coverages, but many multinational companies may be unaware of more global compliance requirements, as well as unanticipated tax, reputational and other financial repercussions. Intensifying regulatory pressures make it progressively more difficult to insure global risks in a consistent and cost-effective manner. By upgrading their due diligence, multinational organizations will be able to assure compliance with two basic principles of insurance regulation, one governing the transactional elements, which generally regulate insurer conduct, and the other governing the location of the risk, which generally regulate the conduct of the local subsidiary and local broker. Not appreciating both principles can result in consequences that are unexpected and costly.

A controlled master program (CMP) can be an effective way to insure global exposures. Implementing a CMP brings a consistency across multiple countries by combining local policies with a global master policy harmonizing coverages, terms and conditions, and financial limits across a worldwide program. Local policies are compliant with local laws and regulations, written in the local language, provide access to networks of highly respected local insurers around the globe and designed to effectively address customers’ local exposures. Without a locally admitted policy, a subsidiary company may be left without coverage for certain losses. The master policy, which is purchased at the corporate level, supplements local admitted policies with difference in conditions (DIC)/difference in limits (DIL) coverage. A CMP maximizes global insurance capacity, minimizes costs while maintaining centralized control over risk management and risk transfer practices. These programs eliminate the stitching together of international coverages that often leaves clients and agents open to coverage gaps, compliance issues or coverage that does not fit the needs.

With all the evolving complexities facing U.S. companies and supply chain disruptions, agents who partner with carriers that offer customizable and robust controlled master programs, can help simplify the administration and process for themselves, while providing a more comprehensive, compliant and cohesive experience for their clients with a total global solution.

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