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To Share, or Not to Share?
January 06, 2014
Mammoth Prototypes of Single-Supplier Risk
In quick succession, first the volcanic ash from Iceland in 2010, and then the 2011 tsunami in Japan followed by the Thai Flood event at the end of 2011 delivered painful lessons on the fragility of global supply chains. Since the ash fallout failed to convince manufacturers to act swiftly and decisively to protect the supply chain, the tsunami and flood events drove the lesson home.
Sweeping incapacitation in Japan and the region revealed that a tiny group of agents there was supplying swathes of global manufacturers with raw materials and components for everything from computers to automobiles. Global inventories were depleted, production was suspended, and consumer prices rose by as much as 20%.
This lesson still resonates with insurers worldwide in the form of lower policy limits, and manufacturers feel the sting.
How can manufacturers secure optimal coverage for contingent business interruption (CBI), when insurers have become more aware of and therefore more wary of the niggling, obscure risks potentially threatening the supply chain? The answer: Increased data disclosure.
It’s all over the news. This is not an age in which anybody can afford to put big money behind intuition alone, or hide behind number shuffling. Nothing has driven this point home more than the spectacular failures of a few global financial experts.
Transparency is essential, the sooner the better, and companies that take intelligent steps to better inform insurers will have the advantage.
Most recently, we were able to offer four times the original limit to a fine chemical manufacturing company seeking contingent supplier exposure.
The reason: the company and its supplier agreed to an exceptional level of data disclosure. This offered us the unusual opportunity of examining and calculating supply-side disruption risk, enabling us to incorporate coverage for it into the final policy.
Risks, Risks Everywhere
This company relies on a single supplier for one raw material, not uncommon in the industry. The company not only uses the material directly, but also distributes it to its subsidiaries.
This single-supplier risk is exacerbated by the fact that the supplier plant stands directly next to the company’s manufacturing plant, adding “single-location risk”.
Clearly, chemical plants are highly flammable, so if the supply plant explodes, the chances are it will set fire to the manufacturing plant. It would destroy property and halt production locally, as well as preventing the downstream supply of raw material, suspending several business operations.
These interdependencies multiply the supply risk by magnitudes. But before a collaborative investigation on the part of the manufacturing company, supplier and insurers, the risks were practically impossible to quantify.
Scrutiny is Your Friend
The company had identified the extreme risk exposure and petitioned for a robust insurance solution to match. They understood that they would have to offer superior information.
First, they provided an intricate product-flow scheme, a powerful tool for preliminary supply-chain evaluation.
Next, both the company and supplier agreed to an exhaustive team survey of their sites.
The company, supplier and insurance consortium leader visited the neighboring sites, analyzing every property element, including fire and explosion risks, protection measures, and occupancy. Most importantly, they were able to scrutinize the interaction between the manufacturing and supply premises.
The depth of scrutiny, especially of this interaction, and the detailed product flow scheme enhanced calculations of incident probability and the various potential consequences to business.
We Can Handle the Truth
Transparency can also bring to light greater risk-mitigation potential.
Clearly companies understand the risks facing them better than anyone else. But often, on close examination of sites and supply chain elements, insurers have the opportunity to suggest risk-reduction strategies, based on expertise and experience across sectors, which the companies had not considered.
In this case, the manufacturer demonstrated exemplary risk management. Not only had property protection measures been implemented wherever possible, but most importantly, an alternative supplier had been secured for downstream subsidiaries. So the company had already calculated real replacement costs, and the risk of supply-side failure was drastically reduced, making a claim less likely.
Hands Off Our Books! You Don’t Need to Know That!
Maybe, maybe not.
When risk burdens remain internal, potential losses can be distributed across different segments.
As soon as a company wants, or needs, to externalize the risk burden for CBI, their best course is to offer even more detailed data disclosure than they might initially think necessary, including very clear numbers. This is the only way companies, not to mention insurers, can truly gauge the loss potential. Everybody wins, when the less obvious risk points along the supply chain are illuminated and appraised.
Policy prices are painstakingly calculated to be fair to everyone, and to guarantee critical capacity in a catastrophe. It seems like a good deal when the weather is fair. But when the storms come, if an insurer has charged too little for high coverage, based on underestimated risk, the well runs dry when it is needed most. Disaster, everybody loses.
You Say, You Don’t Like to Share?
If a company is content with a low policy limit, or if the interaction between supplier and manufacturer is minimal, a company may be able to avoid diving into meticulous detail, provided material facts are disclosed.
But if the manufacturer relies on a single supplier, the concentrated interdependencies need to be unambiguous and managed with extreme care; a single incident could deliver a bitter financial blow. Above all, the margins should be absolutely clear to the manufacturer.
It’s natural to wish to maintain confidentiality wherever possible, but overprotecting facilities and balance sheets from prying eyes strips companies of the real protection available to them. When data is withheld or hazy, you can expect responsible insurers today to err on the side of caution, and either deny or severely limit coverage.
Want to Place the Safety Net Higher?
What happens to the bottom line, when companies allow insurers to dive into the deep end of the data pool?
In this case, the rigorous site analysis, evidence of the manufacturer’s aggressive risk mitigation, and transparent supply-chain values enabled us to quadruple our CBI capacity from USD 50 million to 200 million, contributing to the consortium coverage of USD 1.4 billion.
It’s up to each company to determine how far they are willing to go to secure real protection. Currently, only about 5%-10% of companies are transparent enough to get the coverage they really want, and actually need, at a fair price. Heightened trust and collaboration between manufacturers, suppliers, brokers, and insurers creates a synergistic solution for the optimal fiscal safeguard.
Wouter Haak is Underwriting Manager for International Property in the Benelux region. A chemical engineer, he is an expert in risk analysis and underwriting for oil, gas, and chemical factories.