Supply Chain Risks: Responding to the Wake-Up Call

Last year served as a wake-up call for manufacturers on the fragility of their supply chains. Catastrophes in 2011—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 2011 earthquake and tsunami in Japan.

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 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 midsize companies, Rubel estimates that sublimits range from $5 million to $10 million.

Larger manufacturers—and those midsize ones that may find a $10 million limit inadequate for their needs—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,” says Mike Stankard, a Detroit-based managing director and the industrial-materials practice leader at Aon Risk Solutions. 

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 in which they are located.

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

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

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, according to coverage experts.

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

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 sub-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 Calvin Beyer, head of the manufacturing group at Zurich North America’s commercial division.

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

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 increasing 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, he adds, there is an increased risk of civil uprisings, terrorism and nationalization.

U.S. companies are addressing the issue by performing more due diligence on the country to which they are shifting operations, says Freely. 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 there could produce the “mother lode” of claims, Rubel notes, given the number of U.S. companies that have outsourced operations to suppliers there.

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