Spoilt for Choice - Finding the Right Risk Financing for Supply Network Interruptions

Oct 1, 2014    Markus Groth


riskmethods welcomes a guest post from Markus Groth, Head of Marsh Risk Consulting and Council Member of Marsh’s Business Interruption Center of Excellence.

As the world economy changes with increasing velocity, global supply networks grow correspondingly more complex and vulnerable. While rapid advancements in automation, single sourcing, cloud computing, and off-shoring in emerging economies have provided competitive efficiencies for organisations, these advantages are threatened by a growing array of risks – from cyber-warfare campaigns, opportune terrorism, and global pandemics to traditional risks arising from natural disasters and economic disruptions. In this volatile business environment, a deep understanding of supply network ecosystems and the organisational resiliency to respond quickly to threats and their impact is critical to business success.

Many organisations are under enormous pressure to reduce costs in their supply network and improve efficiency, whilst also finding ways to improve customer service and responsiveness. Reducing costs can often result in the unintentional increased exposure to risks of disruption, and companies must understand and manage the complex web of risks that arise.

From a risk strategy standpoint the various risk financing options that are available and that may cover financial losses and extra costs resulting from supply network interruptions should always be taken into account – at least at the risk treatment selection stage which is about finding the right return on risk investments and implementing actions accordingly.

Risk managers have historically looked to contingent business interruption (CBI) and contingent extra expenses (CEE) insurance as a way to mitigate financial risks associated with loss events that affect their suppliers and customers. CBI reimburses insureds for loss of net profits and necessary continuing expenses resulting from an interruption of business due to insured physical loss or damage at a supplier or customer location(s). CEE reimburses insureds for the additional expenses over and above normal operating costs to avoid or diminish an interruption of business following insured physical loss or damage at a supplier or customer location(s). The cause of the interruption – a fire or an earthquake, for example – must be from a covered peril and must result in physical damage that inhibits the third-party supplier or customer from being able to supply or receive the insured’s goods.

CBI and CEE, however, do not cover the increasingly frequent disruptions that many organisations face that are not related to physical damage. For example, the eruptions of Iceland’s Eyjafjallajokull volcano caused little physical damage to insured property, yet air traffic was interrupted, leading to significant disruptions and delays in the transport of goods and services into and out of Europe. Following the events of 2011 in Japan, many buyers of CBI and CEE came to realise it often is restricted to first-tier suppliers, meaning that CBI or CEE resulting from damage to “indirect” second- or third tier suppliers will not be covered.

Emerging risk financing solutions for covering supply network interruptions are considerably broader than CBI and can offer additional protection. In addition to indemnifying for business interruption and extra expenses resulting from physical damage to a supplier or customer (i.e. typically excess of “all risk” programme CBI and CEE limits), supply chain insurance products also offer insureds protection against non-physical interruptions to their supply networks, such as strikes, riots, ingress / egress, service interruption, pandemics and more. Such coverage can be tailored to an insured’s unique supply network exposures.

Insureds should review all of their risk financing options carefully with their insurance advisors. Whichever product(s) or tailor-made alternative risk transfer solutions an insured decides to purchase, it is imperative to provide underwriters with complete, accurate and thorough data in order to differentiate its risk profile from other companies. The most successful organisations will be those that make insurance decisions as part of a broader approach to supply network risk management that optimizes risk investments against the value of the business, product, or service to the organisation.

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