Vendors May be Weak Link
Vendor risk management is often too overlooked by Fortune 1000 companies.
Three-quarters of supply chain executives said operational risk management is important for dealing with unpredictable events such as disasters, geopolitical risk, and demand volatility, according to “Don’t Play it Safe When it Comes to Supply Chain Risk Management,” a survey of more than 1,000 companies conducted by Accenture.
At the same time, 65 percent of executives at Fortune 1000 companies do not believe vendors are doing enough to minimize risk, according to another recently-released survey from the Consero Group, which focused on shared services.
The findings are indicative of one of the most volatile business environments seen in the last 15 to 20 years, as reflected by indices such as the Chicago Stock Exchange index, according to Mark Pearson, managing director of Accenture’s operations strategy consulting practice, and an author of the study.
“But this phenomenon is not just about the downside, because it has an upside as well, in that there is an opportunity to take market share if a company has the right tools in place to manage that risk,” he explained.
Business trends in recent decades have increased the importance of supply chain risk, Pearson said.
“We’ve spend the last 25 years globalizing supply chains, and applying concepts like just-in-time manufacturing, making our supply chains pretty lean, but also fragile,” he said.
To address the vulnerability, companies have developed strategies to respond to interruptions in the supply chain, with planning, analytics, and better visibility, Pearson said. Such strategies have included the creation of supply chain control towers.
According to Capgemini Consulting, a supply chain control tower is a central hub that captures and uses supply chain data to enhance visibility for short and long term decision-making that aligns with strategic objectives.
“These control towers,” Pearson said, “are fairly physical, and the concept is becoming very popular, due in part to some very good and well developed examples, coming out of the high-tech industry, such as Dell, for example.”
However, such control towers normally involve significant investments that run into the millions of dollars spent on technology and personnel, he said.
Executives also recognize the importance of vendor risk in shared services centers, which have increased in importance to organizations: 72 percent of leaders have increased their budgets over last the year, while 66 percent increased staff size, according to the Consero 2014 Shared Services & Outsourcing Data Survey.
Shared services executives rely on a host of vendors, ranging from law and accounting firms to software and other products.
“If vendors are unable to deliver the products or tools required, it creates difficulties,” said Paul Mandell, founder and CEO of Consero Group, based in Bethesda, Md.
“In addition, all kinds of legal risk exists when you have vendors handling data, if they’re not attuned to appropriate data security protocols. Another area of legal risk is rule violations by vendors, if they are making bribes across international lines,” Mandell said.
“Some commercial carriers offer insurance to cover supply chain risk, and compliance risk, but that will often only go so far when it comes to intentional violations of law. There may be financial compensation of some kind, but the damage to your relationship is hard to quantify,” Mandell said.
“Insurance companies are starting to build supply chain insurance products,” agreed Pearson, “but they don’t have a lot of experience. Whether it’s a soft or hard market, it’s a new market,” he said.
Quantifying Supply Chain Risks
Would it surprise you to learn that of 130 countries worldwide, the most favorable location for supply-chain exposures is Norway?
The Scandinavian country might not be a risk specialist’s first guess about supply chain conditions throughout the world, but that is indeed the case, said Steve Zenofsky, FM Global assistant vice president and spokesperson.
Coming in behind Norway in terms of affording favorable supply-chain factors were Switzerland and Canada. Most challenging areas for risk managers? Kyrgyzstan, Venezuela and the Dominican Republic.
The rankings are according to FM Global’s new, free online Global Resilience Index, which assesses conditions in 130 nations, and analyzes such factors as corruption, political risk, local infrastructure, risk of natural hazards, availability and price of oil, and quality of local suppliers.
George Haitsch, executive vice president and practice leader of Willis Global Solutions, said the Index is unique in offering free access to a tool that addresses factors specifically related to supply chain risk hazards.
For its part, he said, Willis offers clients an online tool called Atlas, which allows them to track natural catastrophes worldwide in real time.
“That’s the technology we have been working on,” said Haitsch, noting that natural-disaster risk and supply-chain risk have become increasingly intertwined.
Torolf Hamm, executive director in Willis’ catastrophe risk management practice, said in a blog post earlier this year that businesses are “increasingly keen to identify which key parts of the supply chain could be affected by the same natural hazard event and what risk mitigation options are available to reduce this exposure.”
Eric Jones, assistant vice president for Business Risk Consulting at FM Global, said the “real power with this tool is getting our clients to start thinking about the risks in their supply chain from a physical risk standpoint.”
“Using the index, risk specialists can get the attention of the C-suite and increase their organizational commitment from a time and resource standpoint,” he said.
The Index is designed to permit users to search for “core resilience drivers” impacting supply-chain risks, to learn which countries have the highest and lowest scores.
In drilling down for political risk climate, Switzerland, Finland, and New Zealand, for example, ranked highest.
For natural-hazard risk management, Ireland, Portugal and Singapore ranked highest, while Costa Rica, Israel, and the United States ranked highest for fire risk management.
The tool also displays a color-coded map showing which parts of the world are most and least risky in terms of supply chain factors from 2011 through 2014.
Global Program Premium Allocation: Why It Matters More Than You Think
Ten years after starting her medium-sized Greek yogurt manufacturing and distribution business in Chicago, Nancy is looking to open new facilities in Frankfurt, Germany and Seoul, South Korea. She has determined the company needs to have separate insurance policies for each location. Enter “premium allocation,” the process through which insurance premiums, fees and other charges are properly allocated among participants and geographies.
Experts say that the ideal premium allocation strategy is about balance. On one hand, it needs to appropriately reflect the risk being insured. On the other, it must satisfy the client’s objectives, as well as those of regulators, local subsidiaries, insurers and brokers., Ensuring that premium allocation is done appropriately and on a timely basis can make a multinational program run much smoother for everyone.
At first blush, premium allocation for a global insurance program is hardly buzzworthy. But as with our expanding hypothetical company, accurate, equitable premium allocation is a critical starting point. All parties have a vested interest in seeing that the allocation is done correctly and efficiently.
“This rather prosaic topic affects everyone … brokers, clients and carriers. Many risk managers with global experience understand how critical it is to get the premium allocation right. But for those new to foreign markets, they may not understand the intricacies of why it matters.”
– Marty Scherzer, President of Global Risk Solutions, AIG
Basic goals of key players include:
- Buyer – corporate office: Wants to ensure that the organization is adequately covered while engineering an optimal financial structure. The optimized structure is dependent on balancing local regulatory, tax and market conditions while providing for the appropriate premium to cover the risk.
- Buyer – local offices: Needs to have justification that the internal allocations of the premium expense fairly represent the local office’s risk exposure.
- Broker: The resources that are assigned to manage the program in a local country need to be appropriately compensated. Their compensation is often determined by the premium allocated to their country. A premium allocation that does not effectively correlate to the needs of the local office has the potential to under- or over-compensate these resources.
- Insurer: Needs to satisfy regulators that oversee the insurer’s local insurance operations that the premiums are fair, reasonable and commensurate with the risks being covered.
According to Marty Scherzer, President of Global Risk Solutions at AIG, as globalization continues to drive U.S. companies of varying sizes to expand their markets beyond domestic borders, premium allocation “needs to be done appropriately and timely; delay or get it wrong and it could prove costly.”
“This rather prosaic topic affects everyone … brokers, clients and carriers,” Scherzer says. “Many risk managers with global experience understand how critical it is to get the premium allocation right. But for those new to foreign markets, they may not understand the intricacies of why it matters.”
There are four critical challenges that need to be balanced if an allocation is to satisfy all parties, he says:
Across the globe, tax rates for insurance premiums vary widely. While a company will want to structure allocations to attain its financial objectives, the methodology employed needs to be reasonable and appropriate in the eyes of the carrier, broker, insured and regulator. Similarly, and in conjunction with tax and transfer pricing considerations, companies need to make sure that their premiums properly reflect the risk in each country. Even companies with the best intentions to allocate premiums appropriately are facing greater scrutiny. To properly address this issue, Scherzer recommends that companies maintain a well documented and justifiable rationale for their premium allocation in the event of a regulatory inquiry.
Insurance regulators worldwide seek to ensure that the carriers in their countries have both the capital and the ability to pay losses. Accordingly, they don’t want a premium being allocated to their country to be too low relative to the corresponding level of risk.
Without accurate data, premium allocation can be difficult, at best. Choosing to allocate premium based on sales in a given country or in a given time period, for example, can work. But if you don’t have that data for every subsidiary in a given country, the allocation will not be accurate. The key to appropriately allocating premium is to gather the required data well in advance of the program’s inception and scrub it for accuracy.
When creating an optimal multinational insurance program, premium allocation needs to be done quickly, but accurately. Without careful attention and planning, the process can easily become derailed.
Scherzer compares it to getting a little bit off course at the beginning of a long journey. A small deviation at the outset will have a magnified effect later on, landing you even farther away from your intended destination.
Figuring it all out
AIG has created the award-winning Multinational Program Design Tool to help companies decide whether (and where) to place local policies. The tool uses information that covers more than 200 countries, and provides results after answers to a few basic questions.
This interactive tool — iPad and PC-ready — requires just 10-15 minutes to complete in one of four languages (English, Spanish, Chinese and Japanese). The tool evaluates user feedback on exposures, geographies, risk sensitivities, preferences and needs against AIG’s knowledge of local regulatory, business and market factors and trends to produce a detailed report that can be used in the next level of discussion with brokers and AIG on a global insurance strategy, including premium allocation.
“The hope is that decision-makers partner with their broker and carrier to get premium allocation done early, accurately and right the first time,” Scherzer says.
For more information about AIG and its award-winning application, visit aig.com/multinational.