Supply Chain Disruption
Supply Chain disruptions have become more mainstream in recent years. During the pandemic, the world shut down – millions began working full time from home offices, and manufacturing sites were closed, only to re-open after employing major safety enhancements.
At the same time, production of many everyday products came to a virtual stand-still. Everyone now working from home had increased demand for many items causing inventory depletion as never seen before. Who could’ve predicted that toilet paper would be the most sought-after product at the grocery store and online? The shift from commercial grade toilet paper to residential was so swift and so great, production lines simply could not keep up with demand. Adding to that, the continued shortage of warehouse workers, production/assembly line workers and trucker drivers exacerbated the already troubled supply chain process.
The supply chain disruption hit some industries much harder than others, and a trickle-down effect still continues today. Industries hardest hit included manufacturing, construction, and retail trades. The biggest impacts in these industries were shortages of building materials (e.g., steel and lumber) and semiconductor chips for vehicles. These supply issues directly impacted housing and vehicle sales, as well as secondary impacts of increased home improvement projects and car repairs. This supply chain crisis is expected to persist through 2022 in various capacities.
In the construction industry, supply chain issues continue with only minimal relief. Contract risk management, supply chain management, and sourcing labor are the three major areas at top of mind for construction insurers and sureties. Due to supply chain delays, labor shortages, and volatility in material costs, project durations are extending beyond what carriers can offer. This situation creates challenges in both carrier availability and capacity for certain types of projects.
As we have become a more global society, the impact of supply chains has increasingly played a part in insurance programs; specifically, Business Interruption (BI) and Contingent Business Interruption (CBI) coverage. Addressing supply chain disruptions can be challenging. Insurers are increasingly learning of the ripple effect, in which one event can affect multiple customers and lead to high losses.
Insurance can provide protection for many losses faced by business disruption, but insurance alone is not the answer. Robust Business Continuity plans will immensely improve supply chain resilience in the event of a breakdown and help protect a business from losing its customer base and even more importantly, its reputation.
Supply lines are longer and far more complex than in the past driving the impacts on second tier and third tier suppliers. Typically, knowledge of primary suppliers is regularly tracked but often the secondary layer of suppliers poses greater risk due to lack of knowledge or attention paid to them. Supply-chain managers now more than ever know the risks of single sourcing and have come to regret reliance on a single company for items they directly purchase.
Fifteen years ago, companies turned to offshoring due to labor and operational cost savings. In more recent years, companies have begun to re-shore and integrate sourcing of raw materials and production from Latin America and Canada. Smart firms started diversifying and increasing their sources for materials and inventory long before the pandemic took shape.
In recent times, Business Interruption (BI) has become a necessary coverage rather than “nice to have.” BI covers lost profits after a company’s own facility is damaged by a covered peril, while Contingent Business Income (CBI) covers lost profits if an insured peril shuts down a critical supplier or a major customer. CBI insurance would be triggered if the insured is still forced to slow or halt production – and therefore lose profits – because the supplier with damaged operations cannot deliver critical raw materials or parts.
BI and CBI coverage generally cover supply chain disruptions resulting from physical loss or damage to insured property. These coverages do not cover events without physical losses such as power outages or labor disruptions and will not provide protection for loss of market share (e.g., once their customers have permanently moved their business to a competitor). BI and CBI losses can account for 50% to 70% of catastrophe losses and due to this, insurers are now emphasizing the underwriting of supply chain risks.
The Importance of Risk Management
Supply chain is also impacting risk management via cyberattacks. Targeting Supply Chains is currently one of the five main ransomware threats. Compromising software supply chains allow cybercriminals to gain access to multiple victim organizations in one breach. As a result, supply chain questions and contractual requirements around provider agreements are more and more standard in underwriting.
Potential effects of supply chain disruptions could include:
- Reduced market share
- Loss of customers
- Damage to image, reputation or brand
- Higher cost of capital
- Potential breach of contract
- Failure to meet legal or regulatory requirements
- Decrease in sales & increase in costs, from which many companies never recover
The Importance of Risk Management
Now is the time to engage in tightening your risk management practices.
- Choose suppliers carefully, and conduct regular audits and inspections to ensure that their commitment to business interruption prevention matches yours:
- Check the Moody’s or S&P rating of potential suppliers.
- Verify suppliers’ insurance coverage. Remember, a certificate of insurance is evidence of insurance only when the certificate is written, and not at any time after issuance.
- Clearly define contract scopes and draft contracts with the assistance of specialized legal counsel. Contracts should include indemnification, hold harmless and defense agreements.
- Work with Sentinel Risk Advisors to understand the extent of your exposure and create a business interruption worksheet to quantify as accurately as possible the effect these exposures could have on revenue and profit.
- Re-evaluate the worksheet on a regular basis to account for changes in the market or your business model. Focus not only on the inherent risk of a broken link in the supply chain, but the interdependencies between links throughout the chain:
- When there is a global event, examine your supply chain to see if any part of it might be affected.
- Be aware of developing risks, e.g., cyber warfare, climate change, nanotechnology and synthetic biology.
- After identifying risks, put a plan into place. While it is easy to prioritize speed over follow-through, identifying risks is of little use if steps are not taken to mitigate these risks. Plans might include these components or others:
- Business continuation plan
- Geographical diversification of servers
- Plan to relocate business to an alternate location
- Sourcing of goods from alternate suppliers
- Transfer your risk by purchasing appropriate coverage, which could include the following, depending on your exposure mix and risk tolerance:
- Business Income Disruption
- Marine and Cargo coverage for long voyages taken by commodities, components and finished products
- Liability coverage, including Commercial General Liability, and Directors and Officers Liability
- Other special endorsements specific to your exposures
- Carefully read your policy and ensure that it includes coverage of loss of supplier, stoppage of supply and interruption of service.
Safeguarding Your Success
Your team of risk specialists at Sentinel stands ready to assist you assess your possible supply chain disruptions and possible risk transfer options. Contact us today to learn more.