An Eye on the Chain
Supply chain risk had been steadily escalating for the last few decades, but it took natural disasters in Japan and Thailand in 2011 to bring the true extent of the risk to the surface.
In addition to the enormous financial and human losses suffered in those countries, businesses around the globe faced major disruption as key suppliers were wiped out and supply chains ground to a halt.
It was a harsh wake-up call.
“The events in Japan and Thailand really gave rise to a realization of how much greater the risk in people’s supply chains is today than 10 or 20 years ago,” said David Shillingford, senior vice president, supply chain solutions for Verisk Analytics.
“Supply chains have become more efficient — thinner, longer — but in many ways less resilient.”
Video: Supply chain risk management as discussed at the University of Bath.
In the automotive industry, for example, there are significant interdependencies regarding raw materials and parts. The Japanese tsunami wiped out essential component manufacturers and halted car production around the globe.
Meanwhile, added Shillingford: “Supply chain disruption in the pharmaceutical industry can be very costly because of the value of the ingredients, and in both pharmaceuticals and food there are evolving compliance risks to consider too.”
In fact, in today’s interconnected world, almost all industries are affected by supply chain risk. And as an increasing amount of production is farmed out to specialist manufacturers — often in emerging markets — risk is becoming more concentrated.
Sid Feagin, director, enterprise risk management, Aon Risk Solutions, noted that it is now common for firms across many industries to farm out 85 percent or more of their core product to a long chain of suppliers.
“In many cases the risks associated with this are uninsurable, which makes the management of supply chain risk paramount to the success of an organization,” he said.
A Lack of Visbility
However, gaining visibility into the risks of suppliers deep into a complex supply chain is extremely difficult, and many companies have turned to analytic software for help.
“A lot of businesses have a pretty good grip on their direct suppliers, but it’s the second, third, fourth tiers in their supply chains where there is a gap in knowledge and information and an accumulation of risk,” said Caroline Woolley, leader of Marsh’s global business interruption center of excellence.
Computer manufacturer Lenovo uses suppliers from all around the world. According to Mick Jones, the firm’s vice president of supply chain strategy worldwide, analytics have become an essential risk management tool in addition to improving business efficiency. So much so that the firm has created a role akin to a “chief analytics officer,” running analytics teams stationed around the world, he said.
“Analytics offers massive value to the business. We are at a start of the journey of using analytics to help us focus on risk. We are investing a lot of time in getting product visibility and order visibility along the entire supply chain, which is an area we can always improve on,” said Jones.
Jones explained that analytics have become essential given the volatile environment of the last five years characterized by natural disasters, socio-economic unrest and financial instability.
“The algorithms in the software are becoming more intuitive and intelligent, so you are able to do more with data and analytics,” he said.
“In four years, we’ve moved from a very ‘descriptive’ analytics approach — reporting, scorecards, dashboards — through to a more ‘prescriptive’ approach, using simulation and optimization tools to almost predict what is going to happen going forward.”
However, meaningful data on supply chain risk is patchy because a great deal of supply chain risk is not insured and companies typically don’t keep detailed records of their losses. Such risk historically fell between the cracks as far as insurers were concerned, but the last decade has seen a number of specialist products emerge to protect companies against these risks.
“These losses were treated almost as operational risk, which was something companies had to deal with on daily basis, so they weren’t recorded,” said Woolley.
“As we are seeing more of these incidents and getting more data on the impact of supply chain risk, we are seeing a lot more interest in alternative supply chain policies.”
Shillingford said that analytics being developed by Verisk could make it easier for both companies and insurers to identify and calculate the impact of supplier risks more accurately.
“We want to encourage ‘risk-adjusted supply chain optimization.’ Often, supply chain optimization focuses only on efficiency, but we rarely hear people talk about risk and resiliency. In order to do that you have to put a value against the risk,” he said.
“The events in Japan and Thailand really gave rise to a realization of how much greater the risk in people’s supply chains is today than 10 or 20 years ago.” — David Shillingford, senior vice president, supply chain solutions, Verisk Analytics.
“The chasm between the amount of risk not insured at the present time and the amount of capital available to be deployed to insure supply chain risk [results from a] lack of visibility into the risk. If we are able to provide that visibility it could be the biggest risk transfer opportunity of the next 10 years.”
Tracking Insolvency Risk
While data on weather or catastrophe-related supply chain losses is increasingly abundant, it is far more difficult to track the risk of insolvency within a supply chain in real time. The financial data of companies is released sporadically and can be incomplete. Given the precarious nature of the economy since 2008, the risk of suppliers going bust is very real.
“Insolvency is a significant risk but it may be near impossible to fully understand,” said Feagin. “The key to understanding whether a supplier is solvent or not comes down to access of information.
“I see companies relying on various sources of information which may be too old or inaccurate to draw relevant conclusions from.”
According to Shillingford, while there are a variety of companies that offer services to assess financial strength, “each has a different methodology, usually expressed as a score, and all face similar challenges obtaining financial data for suppliers to their client’s suppliers.”
Indeed, the software industry has yet to develop an approach that can map solvency risk in real time.
Jones said that analytics play virtually no role in mitigating insolvency risk in Lenovo’s supply chain. “We deal with global suppliers who are based in many parts of the world and the data is difficult to get, but we do have a very sound supplier management approach that allows us to identify issues earlier and more collaboratively.”
Feagin said it’s crucial for companies to focus on their relationships with their suppliers, rather than just crunching numbers.
“In order to get these numbers you need to build up a relationship and trust with the suppliers. Without a strong relationship, you don’t have much power to gain information.
“There is not a piece of software out there that can tell you whether or not to do business with a particular vendor — it comes down to taking a strategic and focused approach to managing supply chain risk.”
He also noted that companies add uncertainty to their supply chains by failing to pay their suppliers promptly.
“The greatest insurance [against insolvency risk in the supply chain] is being a prompt payer and having a good relationship with suppliers,” he said.
Connected to Custom Coverage
Seismic changes are afoot in the insurance world with new technological developments stemming from the rush to the Internet of Things (IoT).
According to a report from McKinsey Global Institute, IoT has the potential to unleash as much as $6.2 trillion in new global economic value annually by 2025.
But what value will it bring to the insurance industry and, more specifically, to their customers? Let’s take a look at a few common areas of insurance — automotive, health benefits and commercial real estate — and see what the future holds.
Do you have the same driving patterns as your friends, family and colleagues? It’s highly unlikely, but until now, you’ve had no choice but to pay the same rates and premiums, based on the average risk level. If you are a safer than average driver, you end up paying to cover those at greater risk. Is it fair and is this the best system we can have?
One in five new cars already collect driver and driving data for car manufacturers, but the future of the connected car will allow consumers to manage their individual automotive policies from the comfort of their driver seats.
Automotive dealers will be able to team up with insurance companies to provide data on driving habits and behaviors such as acceleration and taking corners too harshly via embedded sensors, and assign highly personalized risk scores.
But take this another step into the future and picture your car connecting to your Facebook. According to Ovum, insurers should focus on creative initiatives that analyze data from a number of sources, including social media and machine-to-machine communications.
If your car could sort through your contacts and match your driving profile (developed by the embedded sensors) to other people with similar driving profiles then you could band together to buy insurance as a group. For this example’s sake, imagine that you’re the picture-perfect driver with zero black marks on your record and your car has grouped you with other spotless drivers.
Your group of safe drivers can now buy insurance for a much lower premium and will qualify for a massive safe driver discount. Will connected cars be the ticket to replacing individual or company policies?
Driving Like a Girl
You may read this and think I’m being sexist, but the insurance industry has notoriously charged teenage male drivers much higher premiums than their female counterparts. In 2012, however, the European Court of Justice passed the “EU Gender Directive” that stated men and women must be offered the same quote if their circumstances are otherwise identical.
In response, Drive Like a Girl, a UK-based, telematics car insurer, has used little black boxes to record driving behaviors and discern whether a driver is driving with the profile of a 17-year-old girl regardless of age, gender, occupation, etc.
Video: Wireless Car describes the wide-ranging benefits of telematics to both drivers, manufacturers and businesses.
Telematics allows an insurer to provide lower rates accordingly. So, you don’t actually have to be a 17-year-old girl to catch a break on your insurance; you just have to drive like one!
The EU ruling is only one factor fueling the massive growth of global insurance telematics subscriptions, expected to grow 81 percent from 5.5 million at the end of 2013, to 107 million in 2018. More consumers want to take insurance underwriting into their own hands.
The United States doesn’t have a similar ruling on the books yet, but some companies, such as Progressive, are relying on the technology.
More than one million drivers have chosen to install that company’s device under the wheel, which allows Progressive to analyze individual driving habits and track projected savings, allowing a totally personalized rate for the driver.
The emergence of mobile apps and enhanced customer experiences through the use of technology in order to improve customer retention are additional reasons for this growth.
Impact on Health
Wearable devices such as smart watches or wristbands allow employees and consumers to say, and prove, that their lifestyles are low-risk. Fitness junkies and professional athletes are already commonly using this technology to monitor heart rate, stress levels, sleep schedules and calories burned.
But the next logical step is to use these devices to qualify for better employee health insurance or personal health insurance discounts.
Video: Some employees at Atlantic Corp. talk about the health changes they have experienced since wearing Fitbit.
According to research from the Henry J. Kaiser Family Foundation and the American Hospital Association’s Health Research and Educational Trust, the cost of employee health insurance is still increasing faster than wages and overall inflation.
Currently, the average price for a single worker is $6,025 and the average annual premium for a family plan rose to $16,834. But with the Affordable Care Act’s higher costs for employers, we will begin to see more companies turning to wearable devices to help them monitor their employee’s health in the near future.
In order to combat costs, wearables will be given to employees, and incentive programs will be created to encourage their use.
For example, British Petroleum handed out Fitbit Zip devices to about 14,000 employees in 2013. If employees took one million steps, they received points that qualified them for lower insurance premiums.
In fact, Fitbit reports that sales to companies are one of the fastest growing segments of its customer base. We may need to establish a new technology acronym to replace BYOD — perhaps BYOW will take off in 2015?
The technology can also usher in crowdsourcing for personal health insurance as well — there is undeniably more buying power with 1,000 individuals than just one person.
Perhaps this will even open the door to pet insurance as well given new wearables designed specifically for man’s best friend continue to roll out. And what does the insurance industry love more than the ability to break into niche markets? Insurance companies can use this technology to target low-risk opportunities to drive a better return and greater volumes.
The advent of smart commercial buildings will eliminate the need for building managers to total a stated insurable value by listing everything on its premises.
With a smart building monitoring itself and updating its central system in real time, the building can tell an insurer that its risk profile this afternoon is at at a lower risk than it was just yesterday.
Instead, property premiums can be automatically tallied by connecting the insurance company to the building’s central smart hub, which houses all of the data such as air quality and temperature.
Access to security systems, sprinklers, and disaster recovery plans in one location provides a much crisper insurance profile than just relying on raw building and cost data.
With a smart building monitoring itself and updating its central system in real time, the building can tell an insurer that its risk profile this afternoon is at at a lower risk than it was just yesterday.
Rather than replacing an annual policy or going through the hassle of a three year deal, policies can be adjusted daily.
As such, building owners could qualify for better insurance premiums by providing a historical view of building trends. There are also benefits aside from cost savings.
For example, say you own a building in Miami. You can match and profile your hurricane risk by the minute and remediate high-risk issues very quickly. Additionally, the need to hire field evaluators to do this process manually is eliminated.
Thanks to the advancements taking place within the IoT, shopping for insurance of any sort will be akin to shopping for new clothes.
It won’t be a cumbersome process where you are purchasing retrofitted policies that don’t seem to match. It will be a sleek and automated experience where policies will be developed to fit individual needs.
We’re entering an insurance era where consumers and companies are empowered and we all should be ready for it.
A Renaissance In U.S. Energy
America’s energy resurgence is one of the biggest economic game-changers in modern global history. Current technologies are extracting more oil and gas from shale, oil sands and beneath the ocean floor.
Domestic manufacturers once clamoring for more affordable fuels now have them. Breaking from its past role as a hungry energy importer, the U.S. is moving toward potentially becoming a major energy exporter.
“As the surge in domestic energy production becomes a game-changer, it’s time to change the game when it comes to both midstream and downstream energy risk management and risk transfer,” said Rob Rokicki, a New York-based senior vice president with Liberty International Underwriters (LIU) with 25 years of experience underwriting energy property risks around the globe.
Given the domino effect, whereby critical issues impact each other, today’s businesses and insurers can no longer look at challenges in isolation one issue at a time. A holistic, collaborative and integrated approach to minimizing risk and improving outcomes is called for instead.
Aging Infrastructure, Aging Personnel
The irony of the domestic energy surge is that just as the industry is poised to capitalize on the bonanza, its infrastructure is in serious need of improvement. Ten years ago, the domestic refining industry was declining, with much of the industry moving overseas. That decline was exacerbated by the Great Recession, meaning even less investment went into the domestic energy infrastructure, which is now facing a sudden upsurge in the volume of gas and oil it’s being called on to handle and process.
“We are in a renaissance for energy’s midstream and downstream business leading us to a critical point that no one predicted,” Rokicki said. “Plants that were once stranded assets have become diamonds based on their location. Plus, there was not a lot of new talent coming into the industry during that fallow period.”
In fact, according to a 2014 Manpower Inc. study, an aging workforce along with a lack of new talent and skills coming in is one of the largest threats facing the energy sector today. Other estimates show that during the next decade, approximately 50 percent of those working in the energy industry will be retiring. “So risk managers can now add concerns about an aging workforce to concerns about the aging infrastructure,” he said.
Increasing Frequency of Severity
Current financial factors have also contributed to a marked increase in frequency of severity losses in both the midstream and downstream energy sector. The costs associated with upgrades, debottlenecking and replacement of equipment, have increased significantly,” Rokicki said. For example, a small loss 10 years ago in the $1 million to $5 million ranges, is now increasing rapidly and could readily develop into a $20 million to $30 million loss.
Man-made disasters, such as fires and explosions that are linked to aging infrastructure and the decrease in experienced staff due to the aging workforce, play a big part. The location of energy midstream and downstream facilities has added to the underwriting risk.
“When you look at energy plants, they tend to be located around rivers, near ports, or near a harbor. These assets are susceptible to flood and storm surge exposure from a natural catastrophe standpoint. We are seeing greater concentrations of assets located in areas that are highly exposed to natural catastrophe perils,” Rokicki explained.
“A hurricane thirty years ago would affect fewer installations then a storm does today. This increases aggregation and the magnitude for potential loss.”
On its own, the domestic energy bonanza presents complex risk management challenges.
However, gradual changes to insurance coverage for both midstream and downstream energy have complicated the situation further. Broadening coverage over the decades by downstream energy carriers has led to greater uncertainty in adjusting claims.
A combination of the downturn in domestic energy production, the recession and soft insurance market cycles meant greatly increased competition from carriers and resulted in the writing of untested policy language.
In effect, the industry went from an environment of tested policy language and structure to vague and ambiguous policy language.
Keep in mind that no one carrier has the capacity to underwrite a $3 billion oil refinery. Each insurance program has many carriers that subscribe and share the risk, with each carrier potentially participating on differential terms.
“Achieving clarity in the policy language is getting very complicated and potentially detrimental,” Rokicki said.
Back to Basics
Has the time come for a reset?
Rokicki proposes getting back to basics with both midstream and downstream energy risk management and risk transfer.
He recommends that the insured, the broker, and the carrier’s underwriter, engineer and claims executive sit down and make sure they are all on the same page about coverage terms and conditions.
It’s something the industry used to do and got away from, but needs to get back to.
“Having a claims person involved with policy wording before a loss is of the utmost importance,” Rokicki said, “because that claims executive can best explain to the insured what they can expect from policy coverage prior to any loss, eliminating the frustration of interpreting today’s policy wording.”
As well, having an engineer and underwriter working on the team with dual accountability and responsibility can be invaluable, often leading to innovative coverage solutions for clients as a result of close collaboration.
According to Rokicki, the best time to have this collaborative discussion is at the mid-point in a policy year. For a property policy that runs from July 1 through June 30, for example, the meeting should happen in December or January. If underwriters try to discuss policy-wording concerns during the renewal period on their own, the process tends to get overshadowed by the negotiations centered around premiums.
After a loss occurs is not the best time to find out everyone was thinking differently about the coverage,” he said.
Changes in both the energy and insurance markets require a new approach to minimizing risk. A more holistic, less siloed approach is called for in today’s climate. Carriers need to conduct more complex analysis across multiple measures and have in-depth conversations with brokers and insureds to create a better understanding and collectively develop the best solutions. LIU’s integrated business approach utilizing underwriters, engineers and claims executives provides a solid platform for realizing success in this new and ever-changing energy environment.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Liberty International Underwriters. The editorial staff of Risk & Insurance had no role in its preparation.