Covering supply chain vulnerability

Freight crates An increasing demand for goods, together with 'just in time' production has made supply chains more important than ever.

Catastrophes in today’s globalised world can often be felt far beyond the region where the disaster has occurred

The Japanese earthquake, Christchurch earthquake, floods in Australia and severe weather in southern and south-eastern US have devastated communities in the first few months of 2011. The impact on business has also been widespread, with disruption to many industries intrinsic to the global supply of goods.

Such disruption can ripple through supply chains and across Continents in today’s globalised world. With organisations adopting “just-in-time” techniques and pressures to limit working capital there is a growing dependency on the perfect functioning of supply chains.

Insurers are responding to these increasingly small margins for error by developing products which transfer some of the risk of supply chain disruption.

Catastrophes and unrest

Earthquakes, tsunamis, floods, twisters and even political upheaval have put many business continuity plans to the test so far in 2011. But even those with superior risk management processes can be caught out.

Companies often place too much confidence in the continuity of external infrastructure, warn Australasian risk management experts Grant Purdy and Roger Estall.

Some homes and businesses in Christchurch were without electricity, water and sewage for up to a month following the February earthquake, they point out. In addition, many parts of the central business district were cordoned off and this meant business owners were unable to enter offices, shops or access stock for weeks after the event.

Purdy, an associate director of Broadleaf Capital International, and Estall, director of Risk Solutions Consultancy, think the increasing risk arising from disruption as a result of greater criticality of supply chains, has not always been fully appreciated. “Diversity of supply has been exchanged for price advantage of single source supply. Stockpiles and contingent stores have been reduced or designed out.”

In Queensland, flooding damaged infrastructure in and around the Bowen Basin, home to Australia’s largest coal reserve and a big exporter of fuel for the steel industry.

While many mines were able to get back up and running in a short space of time, damaged railway lines and roads meant they were unable to transport their product to the ports. This led to an increase in the global price of coal and steel, while the price of other global commodities, such as wheat and sugar, also rose.

Unrest in the Middle East has also highlighted vulnerabilities, with rising energy prices affecting every stage of the supply chain from the acquisition of raw materials, through to manufacturing and final distribution.

Stock markets around the world fell following the Japan earthquake in March amid fears the catastrophe would severely disrupt global manufacturers’ supply chains, in particular those in the car and electronics industries.

Chinks in the chain

Supply chain vulnerability was one of the topics discussed in last year’s Lloyd’s 360 Risk report on Globalisation and Risks for Business: Implications in an Increasingly Connected World.

“Globalisation has allowed businesses to expand across many countries and provided more choice of suppliers,” said the report, produced by Lloyd’s and The James Martin 21st Century School, University of Oxford. “However, as supply chains become more complex, additional layers of risk are added.”

Businesses may have less direct control over these tight and complex chains, noted the report, while small disruptions in one location can quickly cascade to production failure in another part of the chain.

It highlighted the potential for “cascade failure” in long and lean supply chains where a system-wide shutdown is caused by the failure of one or more critical elements. “Their causes are manifold and include operational and technological risks, social risks, natural hazards, economic variations and legal and political disruptions.”

Insuring the risk

Insurers have an important role to play in helping to mitigate supply chain risk, in addition to the preventative role of risk engineering, effective contingency planning and other risk management responses.

“Following the Japanese earthquake and problems in Libya and the Middle East you’re seeing a lot of coverage on supply chain disruption,” says Paul Culham, active underwriter at Kiln Syndicate 510. “That is a product which we very much specialist in.”

Should a clothing company be unable to export their goods for sale overseas as a result of a natural or human catastrophe for instance, they might be forced to sell their product to secondary sources at reduced pricing. This is where a supply chain policy, usually termed “trade disruption cover”, would kick in.

“In this scenario the actual goods themselves are not damaged,” explains Culham. “Most business interruption insurance that you can conventionally get from the insurance market is triggered by physical damage to goods or named premises. What this policy is doing is it triggers when the goods are undamaged but you still physically can’t move the goods.”

 

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