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By DAVID A. JONES, vice president at Lockton Companies. He served as a risk and finance manager for various Fortune 500 companies before joining Lockton

Supply chain risk management is receiving heightened attention in part due to the critical state of the economy. Recessionary pressures coupled with the volatility and complexities of our current global trade market are forcing companies to run leaner operations with expected zero-inventory and "sense and respond" movement of goods.

One effective strategy in managing this uncertainty that is often overlooked and underutilized is the application of stock throughput insurance. Stock throughput insurance is not intended to replace supply chain insurance. However, using stock throughput insurance in conjunction with a business interruption policy can be a comprehensive, holistic and progressive way of addressing transit risk in today's complex global supply chain.

Stock throughput coverage is not new but it has gained validity in recent years. Stock throughput insurance combines transit (ocean and inland cargo) with "static location" coverage, insuring owned goods in both storage and transit by sea, air, or land most anywhere in the world.

Any company shipping goods to customers and receiving goods for production or service should take as much control of their transit risks as possible. A company's ability to survive from a loss may hinge on it.

There are several misconceptions about insuring transit risk--notions which leave a company's operations susceptible to sizable exposures and potentially uncovered losses.

-- Misconception: Goods in transit are covered under a company's property policy.

A common misconception is that all-risk property policies cover raw materials and finished goods in transit. When a company believes its property policy is best in class, it often assumes that the transit risk of all raw materials and finished goods are equally covered.

This, compounded with the perception that transit insurance is an unnecessary expense and administrative headache best left to third parties, leads to higher premiums and unpaid or partially paid claims.

It is true that a property policy can be endorsed for transit exposure. However, attaching a transit endorsement to a property policy may needlessly increase premium. Property policies are designed for infrequent, larger claims rather than the more frequent and smaller values of losses in routine transit claims.

Carving out the inventory risk from a property policy enables underwriters to rate and price that exposure according to its true insurance expense.

Furthermore, a standard property policy does not contain the same specific terminology as a stock throughput policy. A stock throughput policy includes ocean and inland cargo (transit) language that has been tried and tested in the open seas and over land for the past 350 years.

-- Misconception: A stand-alone transit policy provides sufficient coverage.

A stand-alone transit policy in general provides broader coverage than a property policy with a transit endorsement. However, a more comprehensive solution is to apply a stock throughput policy, which combines transit, warehouse and production exposures under one manageable policy form.

The single form provides seamless protection of a company's supply chain assets from the raw materials stage to the final destination of finished goods. This reduces potential gaps in insurance or coverage conflicts that may arise from multiple carriers and policies responding to a single claim. Eliminating policy language conflicts ensures faster claims settlements.

Furthermore, since the limits for a stock throughput policy are significantly less than a company's general property policy, carriers can price the coverage more efficiently.

Lastly, business interruption exposure should be maintained on the property form to ensure best risk transfer of lost income and extra expenses from a loss.

-- Misconception: The carrier, freight forwarder and warehouse owner provide full indemnity for any lost, damaged, or shorted goods while in their possession and control.

Relying on a third party policy such as one provided through the freight forwarder or supplier may be the most convenient approach. However, this approach limits the product owner to partial indemnity and is the most expensive option. In the case of a carrier or freight forwarder policy, coverage is written to protect the interests of the third party, not the company or owner.

Secondly, law and tariff restrictions severely reduce the liability of most carriers and freight forwarders, restricting claimants from fully recovering a loss.

Finally, these policies include the loss experience of numerous companies, a collective risk that often increases the premium beyond the rate of a single company-owned policy. Freight forwarders may be experts in logistics but they're probably not experts in insurance.

-- Misconception: The supplier is in charge of insurance coverage.

Alternatively, companies may opt for the supplier to arrange insurance coverage and include the cost in the overall invoice under cost, insurance, and freight (CIF) terms of sale. The price for this convenience can be high, particularly for the company that discovers its million-dollar claim has been denied due to an exclusion in the supplier's policy. Without controlling the policy's terms and conditions, a company cannot ensure appropriate policy limits of its goods, full indemnification for potential losses, or proper claims handling.

Furthermore, the supplier may be surcharging the insurance expense buried in a bill of lading, waybill, or invoice. Quite often, the supplier insures the goods at cost, charges the customer a formulated rate based on the sale price of the goods, and collects the difference as profit.

Under a stock throughput policy, the company can govern the premium expense and take better control of the claims process in the event of a loss.

Companies can manage their insurance premium expense by controlling the volume of shipments and loss experience. In addition to using a higher deductible to lower the premium, controlling more of the supply chain increases purchasing volume, resulting in a better rate on the premium. Finally, since premium is based on prior loss experience, a high-risk shipping route could be removed from the policy and selectively transferred to the freight forwarder or supplier.

A well-informed insurance expert can help companies design the best-in-class insurance program for goods in transit and storage. In addition, the expert can navigate the marketplace by evaluating carrier solvency or the ability for the carrier to pay a claim, which could damage precious relationships and credit between a supplier and customer. Finally, factors such as deducible, limits, inventory valuation methods and coinsurance are important when selecting the best program.

Details about transit risk, title transfer and contract terms should be reviewed by the careful eye of a CFO. Contracts written to control transit risk may unexpectedly delay revenue recognition until goods are delivered at the customer's site. In some cases, this could delay revenue recognition 30 days or more depending on the destination and mode of transport.

The transfer of materials and goods through supply chains has never been more fragile. Global outsourcing, economic impairments, governmental imposition and bills-of-materials with countless suppliers compound the volatility of supply chains. Thus, companies should make every effort to command control of the goods in transit to and from their operations.

Purchasing a separate stock throughput policy rather than a basic transit policy can provide seamless coverage of goods and more control of inventory risks throughout the entire supply chain--from the supplier or point of origin through to the customer's location or final destination.

May 1, 2010

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