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By DAN REYNOLDS, senior editor of Risk & Insurance®.

In its brief history, supply chain insurance could be having its first moment.

In April, Japan-based automakers reported devastating effects from the March 11 Tohoku earthquake which struck off the northeast coast of Japan. Compared with April a year ago, Honda's production was down 81 percent for the month, Toyota's was down 78 percent and Nissan's was down 49 percent.

Suppliers also suffered as smaller parts makers were hobbled directly by the effects of the tsunami that swept ashore, or by the constriction of power capacity due to the shutdown of the Fukushima nuclear power plant.

Insurance carriers that offer supply chain coverage and buyers who think about supply chain risk are talking to one another now more frequently than they used to only months ago. "There is a realization that as good as our model is, it could get better," said Al Gier, the director of corporate risk management for General Motors.

"We obviously have a huge purchasing organization as well as a logistics organization, too. I would say we are looking at where best some of that information should come from and where the responsibilities should lie," he said.

Even though there is renewed interest and attention to supply chains in general, there will be a pattern to this interest and the willingness of some corporate risk managers to devote the resources to measuring and then mitigating supply chain risk, said Gary Lynch, the head of supply chain consulting for Marsh.

Given the well-publicized disruptions that the events in Japan caused for some industries, there will be a rush by executives to conduct inquiries into supply chain risk mitigation and insurance products. But getting clear information from second- and third-tier suppliers on how long they could be out of operation, or on the factors that might take them out of operation, can be difficult.

It would be a mistake to assume, for example, that every supplier in a supply chain is going to bend over backward to help corporate risk managers understand the vulnerability of individual pieces of a particular supply chain.

"The reality is that they are in probably the worst position to do that because they are already operating on thin margins," Lynch said.

"They typically don't have the experience at the same level the OEM (original equipment manufacturer) does and there is very little motivation to go to the next level. So my concern is that that is going to fall on deaf ears."

Despite an urgency to give supply chain coverage another look, the expense of hardening that supply chain is going to give some executives second thoughts.

"So we have to throttle that back and so I think we have a bit of that," Lynch said, describing what he is seeing as he watches customers first express an eager interest in assessing their supply chain risk and then modifying that eagerness when reality sets in.

Indeed, there exists a substantial gap between companies' perception of the importance of their supply chain and the efforts they are taking to mitigate supply chain risk, according to a catastrophic claims survey conducted by Risk & Insurance® magazine and Ernst & Young.

Allen Melton, the Dallas-based Americas practice leader for insurance claims services for Ernst & Young, said roughly 70 percent of survey respondents said their supply chain was "critical" to "very critical" to their operations.

Less than 25 percent of those surveyed, however, stated that risk management played a key role in identifying and mitigating supply chain risk.

Supply chain insurance differs from its cousin contingent business interruption insurance, in that supply chain coverage offers cover for nonphysical damage such as supplier insolvency, fuel supply loss or communications system failure. Trade disruption insurance, a cousin of supply chain insurance, in some cases covers nonphysical events, like the closure of a canal or port.

It's not that companies don't sincerely want to quantify their supply chain risk, said Jamie Miller, a managing director in New York with Swiss Re. It's that the nature of some businesses and the competitive nature of the markets they operate in require companies to move quickly in the areas of procurement and deal making.

That can make the art of analyzing and assessing the supply chain tricky. There is only so much the risk manager can do without winding up getting in the way of the buyers and deal-makers that can be crucial to a given business.

In the end, there is only so much a risk manager can control, "because it is hourly or daily or whatever, and they can't own that, there is an element of business fluidity that is a requirement there," Miller said.

In many cases it can take six months to a year before risk mitigation programs are even communicated through the organization and deployed through complex supply chains, Lynch said.

Part of that communication and deployment will hinge on how well the risk manager can interact and carry his or her weight with other divisions in an organization, such as corporate procurement for example, that may have disparate goals for how to handle a supply chain.

A West Coast-based manufacturer with a sophisticated and effective approach to supply chain risk management, for example, reported no direct impact from the events in Japan. Still, it is pushing forward with the engineering work to better protect its manufacturing facilities, and is studying which pieces of its supply chain it might want to buttress to be even better protected.

"Rather than paying money for the insurance policy that may or may not be needed and may or may not work, our philosophy is to invest in our infrastructure," said Vince Staub, who runs the enterprise risk group for Milpitas, Calif.-based KLA-Tencor, a manufacturer of inspection and process control tools for the semiconductor and microelectronics industry.

In other organizations that pay keen attention to cost cutting and subscribe to the mantra of just-in-time delivery, procurement managers may be tempted, for example, to sell the second of two warehouses that house products or parts in their supply chain, figuring that they can save money on inventory and real estate. But just how much risk is the company bringing into the equation with that one-warehouse approach, and does the size of that risk outweigh the savings the procurement officer is striving for with just-in-time delivery?

"There is no way a risk manager can be 100-percent comfortable that they have all the contingent business relationships identified," Miller said.

One piece of business, the consulting end in which a carrier can help an insured understand the potential value of supply chain losses, is now in demand, said Linda Conrad, head of strategic business risk management for Zurich Global Corporate North America.

"We start by helping companies understand and quantify which are their crucial suppliers," Conrad said.

Originated about three years ago through the efforts of Lexington Insurance Co., then Zurich and Berkshire Hathaway, the supply chain insurance product is relatively new to the United States. Though not yet a hot seller, it's certainly getting a good look since the March earthquake and tsunami in Japan.

Zurich's supply chain insurance offering typically has a starting point of $50 million in limits but can go up to $100 million on a "case by case" basis, Conrad said.

"We have recently seen that there is a greater demand for Zurich's risk assessment, as companies seek to fully understand the balance between cost and risk in their supply chain," Conrad said. "We view the risk assessment as a normal piece of consultancy work or loss control work which a company should undertake on any top-ten enterprise exposure."

Jill Dalton, a partner in New York with Dempsey Partners, a firm authorized by Zurich to conduct analysis of potential supply chain breaks for customers, also said she has seen more interest. "Clients are coming to us and saying,'I know we talked about this before, I know you do this, let's open that up again and tell me what the process would be,' " she said.

Rather than focus on weather models or global demand for certain commodities, Dalton said Dempsey pays strict attention to a company's financials in determining what the exact cost of a supply chain break or an interruption could mean.

"Once we quantify that they then take that information and it is useful to them for lots or reasons: making decisions about their insurance program possibly, or making decisions about investments in alternate suppliers," she said.

In the analysis of a supply chain's weaknesses, it's not just the defensive minds that are looking at this. It's also those business players who like to bet on outcomes that could spell trouble for others.

Hedge funds in particular like to poke around for detailed information about multiple industry supply chains and single points of failure, or concentration points within a global supply chain, Lynch said.

As risk managers ponder the role of supply chain insurance within their organizations, Zurich's Conrad offers sobering statistics.

A Zurich study, done in conjunction with the Business Continuity Institute, found that 70 percent of the companies it surveyed had undergone some kind of business disruption in 2010. The institute's historical data indicates that 40 percent of companies that experience a supply chain disruption of more than a year don't recover.

"What happens to a customer's thinking on day one versus day five of not having that product?" Marsh's Lynch said.

"If you are in a captive market where you own the market and there are not a lot of competitors it might not mean very much. But if one of your detergents aren't available people are just going to go to the next one," Marsh's Lynch said.

Conrad said that one-eighth of the companies in Zurich's data base have suffered disruptions lasting more than a year. The financial impact has been more than $500 million due to the disruptions, "so we are talking some big numbers here."

The losses are there, the interest is there, but so far the supply chain insurance products have yet to capture the imagination of buyers. That could change over time and some would go so far as to say it is likely that it will change over time, particularly in the wake of the Tohoku earthquake.

Ben Tucker, a senior vice president with Marsh, points to his company's launch, two and a half years ago with Lexington of coverage called Global Supply Chain Secure. At pretty much the same time, in Europe, Zurich was launching its supply chain insurance.

"And since then nothing else has been launched," Tucker said.

"There is a lot of interest in these products and selling them but I wouldn't say there has been new innovation as a result of Japan or the 2010 events," Tucker said.

Buyers are still trying to get a grip on this risk and carriers are trying to adddress it without amassing too much concentrated risk. The economy is global, and the risks so potentially massive that a more syndicated approach by carriers might be in order here.

Is there a day when many carriers might be able to band together to provide the syndication that global supply chains demand in risk mitigation? "I see it coming, I really do," said Dick Bennett, who works in the insurance practice of the Philadelphia-based Cozen O'Connor law firm.

"It's not that you would see a lot of insureds purchasing it but you would see a lot of risk managers looking into it," Bennett said. "And I know the carriers will take advantage of that."

Especially after the earthquake in Japan, which is a highly valued supplier, regardless of how large its importing presence is in terms of percentage of total imports.

"The buying community clearly has a feeling that this is a very strong and high quality supply chain and the alternatives are risky for them," Swiss Re's Miller said.

"In conversations that I am having with my clients and our agents, what I am hearing is that it has brought a renewed attention to the whole issue," said Mike Thoma, a vice president and chief underwriting officer with The Travelers Companies.

Marsh's Lynch said, "Of course most recently, everybody and their brother wants to know about this type of coverage."

As Ernst & Young's Melton said in interpreting the catastrophic claims survey results, "Just looking at the responses, it looks like many companies are spending a significant amount of time on their supply chain," he said.

Buyers are thinking about how they can afford to insure against supply chain loss, but for Melton the issue is that buyers have to take it seriously. "To me, it's an issue that although it might take time is such a critical component to the livelihood of the business that they really can't afford not to do this," Melton said.

August 1, 2011

Copyright 2011© LRP Publications