Filed Under:Agent Broker, Commercial Business

Coverage Trends in Manufacturing’s “Big 3” Risks: Workers’ Comp, Product Recall and Supply Chains

Louis Lubrano, the New York-based senior vice president of global crisis management for Liberty International Underwriters
Louis Lubrano, the New York-based senior vice president of global crisis management for Liberty International Underwriters

Those who manage and underwrite risks for manufacturers are facing familiar risks—but with some challenging new twists.

With Workers’ Compensation, the big shift is the medical component of costs exceeding indemnity costs—this after an extended period when companies could materially cut their Workers Comp’ expenses by focusing primarily on returning injured employees to work.

With Supply Chain risk, it’s the realization that supply and upstream customer chains can be far more fragile than anticipated in a catastrophe.

Insurers have realized this, too. After an earthquake and tsunami devastated Japan last year, Contingent Business Interruption coverage of supply-chain interruptions is now tougher to procure.

Compounding the supply-chain problems is the additional political risk that some companies are facing as they move some increasingly expensive manufacturing operations out of China to cheaper producers located in less politically stable countries.

And for food processors, the emerging challenge is a food-safety law that has given federal authorities sweeping new power to issue recalls.

In many of these cases, insurers have responded with either new or expanded coverages—coverages that many buyers either are unaware of or are examining and have not decided whether to procure.

Manufacturers & Food Safety

Any company involved in food production saw its Product Recall risk greatly magnified last year with the enactment of the U.S. Food Safety Modernization Act (FSMA), says Louis Lubrano, the New York-based senior vice president of global crisis management for Liberty International Underwriters.

Under FSMA, the federal government for the first time is empowered to order recalls of food products even when authorities only suspect a problem with a product but have no hard evidence, Lubrano says.

“That’s a game changer,” he observes. “The issue is still evolving on what could trigger a recall,” but Lubrano says that for now, “it’s what the government believes” rather than what it knows is a risk.

The law stems from a series of recalls of various products since the mid-2000s. Some of the recalls involved eggs, peanuts, milk and dog food. The 2009 peanut recall alone affected 2,000 companies that used salmonella-contaminated peanuts from a single processing plant in Georgia.

Before FSMA was enacted, the vast majority of food processors did not purchase Product Recall coverage, Lubrano notes. For many companies with tight insurance budgets, the coverage was too pricey.

In addition, the coverage responded only when the contaminated-food product either already had made a consumer ill or evidence showed that its consumption likely would cause illness, Lubrano says. Under FSMA, the U.S. Food and Drug Administration does not have to wait for those developments to order a recall.

Insurers have responded by offering an endorsement, for additional premium, that will cover the cost of FSMA recalls, he says.

As a result, Lubrano says, the number of submissions for Product Recall coverage at LIU “has been spiking ever since [this law] was passed.”

LIU can offer up to $15 million of limits on a primary or excess basis, and Lubrano says he has seen buyers build programs with up to $70 million of limits.

Exclusions vary by industry and client, but every policy contains an absolute lead exclusion, he says.

Despite buyers’ growing interest in the coverage, “there are still a lot of companies that don’t buy this but need to and should,” Lubrano says. He notes that while the largest brokers produce most of LIU’s Product Recall business, between 70 and 80 smaller producers each have brought LIU one or two policyholders.

Manufacturing & Workers’ Comp: Four Tips for Controlling Medical Costs

The National Council on Compensation Insurance Inc. (NCCI) reports that medical services now represent 60 percent of Workers’ Comp claim costs. In the past, indemnity costs made up the biggest part of the Workers’ Comp claim.

From provider networks to prescription plans to medical audits, there are a number of measures available to help companies contain medical costs.

But the economy will drive many employers to turn to additional measures, brokers and insurers said. Here are four strategies that work.

1) Workplace Safety:

An elementary but critical step in any plan to keep medical costs down is workplace safety.

With large employers retaining big chunks of their Workers’ Comp obligations under large deductible plans, they have to redouble their efforts on preventing losses in the first place, observes Mike Stankard, a Detroit-based managing director and the industrial materials practice leader at Aon Risk Solutions.

2) Bogus Claims:

And while establishing a culture of safety is essential to prevent workplace injuries, employers also should be guarding against bogus claims, Stankard says.  

In recent years as the economy soured, employers have faced spikes in Workers’ Comp claims—not all legitimate—when some workers who feared layoffs or knew they were pending filed claims to secure income after their jobs were lost.

Establishing ongoing testing of various job-related physical functions, such as hearing, gives employers a baseline measure they can track and respond to quickly at the first sign of a problem—rather than after a worker has filed a claim, according to Stankard.

3) The Right Hires:

Some manufacturers are seeing improvements in orders and are rehiring, which brings up a third important element in controlling Workers’ Comp costs: avoiding hiring workers who pose high claim risks.

 “Data analysis tells a story of hot spots around an organization,” Stankard says. In many cases, the analysis takes employers back to the point of hire and their ability, or lack thereof, to match hires to a job. One step that can help: making sure the job description adequately characterizes the demands of the job.

Filling jobs with the workers who are best suited psychologically for those positions also will help prevent injuries; it will also help prevent myriad indirect costs associated with a Workers’ Comp claim, according to Scott Higgins, president of commercial accounts at Travelers Cos. Inc. of Hartford Conn.

Travelers offers its Workers’ Comp policyholders psychological profile testing of job candidates as a tool in selecting those who will be safe and reliable workers.

Data compiled by Travelers show that new hires who are poorly matched psychologically to their jobs are five times more likely to be injured, even when they have received appropriate job training, says David Nelson, industry manager for the metals and high hazards product program at Travelers.

4) The Age & Weight Impact

In their efforts to prevent claims, employers also should consider the impact of an aging and increasingly overweight workforce, says Calvin Beyer, the Edina, Minn.-based head of the manufacturing group at Zurich North America’s commercial division.

In helping workers control their weight, an employer can expect to see fewer Workers’ Comp claims attributable to sprains and strains, Beyer says.

Winning Plan for Workers’ Comp: The Kennametal Case Study

At Kennametal Inc., the need to focus on the medical component of Workers’ Comp claims is an obvious one for the Latrobe, Pa.-based Fortune 1,000 company, which manufactures metal-product solutions for various industries.

The company, recognized by National Underwriter last year for improving workplace safety and curbing its Workers’ Comp costs, slashed its overall Workers’ Comp costs by 70 percent over a three-year period ending in 2012.

And the company has cut the indemnity component of its Workers’ Comp cost to 10 percent of its total—meaning medical costs account for 90 percent, according to Michael Murphy, manager of global property & casualty insurance.

Looking at its 90/10 Workers’ Comp cost split between medical and indemnity expenses, “it really becomes apparent where our efforts should be,” Murphy says.

To bring down medical costs, the company’s risk-management team is focusing on the company’s provider network and its communication process with providers.

For example, the company brings providers to worksites to understand the work demands their patients face upon returning to their jobs. That understanding among providers is an important guide in their treatment regimens and decisions to release patients for work, Murphy explains.

“You can eliminate extremely expensive case management if you communicate your expectations to providers,” Murphy says.

Another important element of the communication process involves engraining in workers the importance of reporting even minor incidents immediately, which helps keep costs in check, Murphy notes.

Helping workers realize that they are not babying themselves by reporting what they initially consider a minor back or knee tweak on a Friday afternoon can save the company significant costs if it can steer the worker to a network provider and keep them out of a hospital emergency room over the weekend if the worker determines the tweak actually is a more serious problem, Murphy explains.

Supply Chain Risks: Responding to the Wake-Up Call

2011 was a wake-up call for manufacturers on the fragility of their supply chains. Catastrophes last year—including massive floods in Thailand that disrupted electronic- and auto-parts manufacturers—caused record totals of $105 billion of insured losses and $380 billion of total economic damages worldwide, according to Munich Reinsurance America.

Jim Rubel, a New York-based executive vice president for Lockton Inc., characterized supply-chain management as a major priority for manufacturers since the earthquake and tsunami wrecked Japan nearly a year ago.

In addition to contractual indemnity provisions with suppliers, manufacturers can turn to their property insurers for Contingent Business Interruption insurance—which covers losses arising from a supply-chain interruption even when the policyholder did not suffer a property loss.

It was coverage that, until a year ago, property insurers “didn’t think too much about” before adding the coverage to a buyer’s policy, Rubel notes. In the wake of what happened in 2011, it is now top of mind for many.

Supply-Chain Limits

The amount of coverage an insurer will offer typically depends on the size of the buyer’s operations.

For mid-sized companies, Rubel estimates that sub-limits range from $5 million to $10 million.

Larger manufacturers—and those mid-sized ones—can command higher limits but not without providing much more information about their supply chain than they have had to in the past.

“The higher the limit, the more information you have to supply the underwriter about what your supply chain looks like,” Aon’s Stankard says.           

(Smaller companies that may find a $10 million limit woefully inadequate for their needs can get higher limits with the right information—with one caveat: “Smaller accounts are generally written by a single carrier, so larger limits can be constrained by the Facultative Reinsurance marketplace that may have to be accessed by the single carrier underwriter as opposed to multiple carrier programs where the limits are shared, Rubel notes.)

Buyers typically have been able to provide insurers solid projections on how their profits would be affected by a business interruption resulting from a physical loss on their own premises—but not how profits would suffer if a major supplier went down, Rubel notes. Insurers now want that kind of information, he says.

Specifically, insurers want the names and locations of suppliers and engineering data that indicates how well protected they are against typical perils in the regions where they are located, according to Rubel.

Essentially, insurers, which are trying to get a firm grasp on their true exposure to this risk, want to know as much about suppliers than as if they were a policyholder’s wholly owned operations, he says. “Information is king” in obtaining the coverage, he says.

Rubel says that with enough information, insurers will write higher limits than they previously have, but insurers also are charging more because of the increased demand for the coverage.

Policy Fine Points of Supply Chain Coverage

Experts note that supply-chain coverage has some limitations that policyholders often do not consider.

For example, Contingent Business Interruption insurance responds only when a supplier is crippled by a peril for which the U.S. manufacturer is covered. If an Ohio-based manufacturer has an important supplier in China that an earthquake knocks offline, the Ohio company has to have earthquake coverage for the supply-chain insurer to respond.

“A lot of people don’t think of those things,” Rubel says.

Aon’s Stankard also notes that “some underwriters will cover only first-tier suppliers.” As a result, a policyholder would not be protected if its supplier is shuttered because its flow of parts or materials from its own supplier was interrupted.

Manufacturing E&O Coverage and Political Risk

Meanwhile, manufacturers face increased demands from upstream customers for contractual protection, which has driven up interest in Manufacturing Errors & Omissions coverage, says Beyer of Zurich.

The coverage, which a few insurers offer, is geared toward mid-sized manufacturers of large finished products or major component parts, Beyer says. Insurers typically offer $1 million of limits, although manufacturers involved in producing wind turbines can obtain $5 million of limits and sometimes more, Beyer says.

Insurers have written the coverage for a few years, but the market for it is far from saturated, according to Beyer. 

Another supply chain issue—the cost of outsourcing—has meant expanded political risk for many manufacturers, says Evan Freely, the New York-based global political risk and trade credit practice leader at Marsh Inc.

Because of the growing cost of doing business in China, triggered by labor reforms and inflation, many U.S. manufacturers that had outsourced work to suppliers there have switched to suppliers in other countries to trim production costs.

But the stability of the political climate in those countries—Vietnam, Malaysia, Indonesia, Sri Lanka and some African nations—is more uncertain, Freely says. In those countries, there is an increased risk of civil uprisings, terrorism and nationalization, Feely says. 

U.S. companies are addressing the issue by performing more due diligence of the country to which they are shifting operations, Feely says. Typically, U.S. companies consider Political Risk coverage only when they have a capital investment in an operation overseas, he says.

Speaking of China—the 800-pound gorilla in overseas manufacturing—a catastrophe here could produce the “mother lode” of claims, given the number of U.S. companies that have outsourced operations to suppliers there, Rubel notes.

Kennametal & Catastrophes

Kennametal was not materially affected by the catastrophe in Japan, nor would a catastrophe elsewhere around the globe likely impair its operations extensively, Murphy says.

“We’ve grown diverse enough to be able to handle a specific incident in a region” of the world says Murphy, noting the company has warehouses in Singapore and Germany as well as the United States.

He says Kennametal addressed its interdependencies with suppliers several years ago when it began engaging in enterprise risk management.

 

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