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By Jared Shelly

On the surface, supply-chain risks seem simple enough to identify. If a car manufacturer loses its lock supplier, the car maker doesn't have locks for its cars.

"I don't think there are quantitative risk models [for supply chain]," said Akshay Gupta, vice president and director of AIR Worldwide's catastrophe risk engineering practice.

Modeling supply-chain risk is tricky because there are so many variables. An automobile manufacturer is certain to have a supply chain that's very different from a pharmaceutical company -- they use different machinery and make their products in different areas of the world.

Complicating matters further is that original equipment manufacturers may not want to disclose their supply chains to their insurance companies or to a supplier because they are concerned that that information will be shared with the competition. In other cases, they simply don't know how to map their supply chains past tier-one suppliers.

Experts seem to agree that supply-chain risk can only be modeled after doing serious consulting work where detailed data about a company's supply chain is revealed. "This is the only problem that I have ever come across where the complex solution is easier to do than the easy solution," said Gupta.

Playing Keep-Away

As supply-chain modeling emerges from infancy, companies are doing their best to map their supply chains, and identify suppliers of their suppliers. But a new development seems to be taking hold: businesses don't seem to trust insurance companies when it comes to their supply-chain secrets. Original equipment manufacturers think that if they have an ace supplier, an insurance company might turn around and tell their competitors.

John Frank, risk engineer at XL Capital, said that clients and their tier-1 suppliers can be quite tight-lipped when asked to identify their supply chains. Sometimes they open up when nudged, other times they won't budge. That leads the XL team to dig elsewhere. For publicly traded companies, a little digging can yield big results. What kinds of suppliers do competitors use? What do you know about the elements in the existing product? For an electronics company perhaps, is there a type of metal that's commonly used? Where is it typically mined? Are there geopolitical risks in that region of the world?

"With some digging and curiosity it can be found out, or sometimes you can't know and an underwriting decision has to be made," said Frank. "It can be subjective based on an array of factors based on overall insurability."

On the modeling side, EQECAT is hoping to differentiate itself by hoping that businesses will trust them with supply-chain data over an insurer.

"Some of these things are very strategic as far as operations for a company and they may not want to share this with their insurance company because these insurers are working with their competitors," said Tom Larsen senior vice president. "EQECAT can work as a more discreet partner on this."

Linda Conrad, director of strategic business risk management at Zurich, said that the insurer "absolutely" finds that companies are hesitant to share their supply-chain maps because it is "the life blood of a company."

But Zurich counters with a nondisclosure agreement to insure that any competitive secrets are kept safe. That, Conrad said, is usually enough to have them share their supply-chains.

"The risk assessment is for their benefit to improve," said Conrad. "We take it confidentially and don't share it."

A Tough Nut

In the global natural catastrophe disasters that struck in 2011, as many as 85 percent of companies had a supply-chain issue, and 40 percent of those were from suppliers below tier-1, according to the Business Continuity Institute. Despite the growing risk, just 8 percent ask suppliers about their continuity plans, according to Zurich.

To help with the problem, AIR-Worldwide developed a consulting service around supply-chain risk. First, AIR studies a company to determine which nodes on that chain are susceptible to being interrupted by natural catastrophe risks. The modeler can also determine the impact that a partially shut down node would have on the overall operation, said Gupta.

It also helps examine how much product inventory a company has in reserve. If a car company's lock supplier is disabled for 20 days, does the manufacturer have more than 20 days of supplies in reserve? Gupta said that it's a whole lot easier to have reserve suppliers for an easily reproducible commodity. If it's a high-value product that can only be produced by specific suppliers, then it'll be a lot tougher.

That issue gets even more complicated with just-in-time producing where companies try to only produce what they need for a product, which can save money but make them more susceptible to supply-chain disasters.

"I like to call it just-in-case," said Conrad, from Zurich. "What if a just-in-time provider doesn't deliver? What is your continuity plan? What are you going to do if a supplier can't get goods? How much extra will it cost you?"

Those questions aren't easily answered.

AIR-Worldwide also asks questions about redundancy. Are there alternative suppliers that can be used? How about an alternative way to ship products? If the port of Long Beach in Southern California is shut down, for example, is it possible to ship further north to Oakland, then drive the product south by truck?

EQECAT is asked about supply-chain risk a lot these days as well, said Larsen who admits that "it's a tough nut to crack."

The modeling company is also taking a consulting approach for the small number of clients it helps with the problem. What they offer is the percentage probability that a company can maintain its corporate goals, found after studying the supply chain as well as other resources.

"We can't eliminate uncertainty but we can help you put it in context of other business risks," said Larsen.

Zurich's supply-chain risk model first attempts to determine the critical suppliers -- which is harder than it might seem. A food company may point to all its food distributors as critical but perhaps the most critical element of their production line is salt, since it can be in almost every product the company makes, said Conrad.

Then it asks the company a series of questions to help them map their supply chain, then Zurich rates the riskiness on 23 factors and fills in other data based on what they know about similar companies. In the end, Zurich comes up with a quantifiable number determining supply-chain risk.

"We often find that companies underestimate that exposure," said Conrad. "One company [we dealt with underestimated its risk] by 10 fold."

Companies are looking to Zurich for help because they realize that the problem is simply becoming too important to ignore.

"It is no longer OK to say 'This won't happen to us,' " said Conrad.

While a general model is not possible today -- the consultative model is the only way -- some say one could exist. AIR-Worldwide is working on developing a more general model that would group companies by industry to seek out likely risks. For example, auto manufacturers are likely to have plants in similar areas so AIR-Worldwide can model the risk of flooding and storms for that region and give a quantitative result.

"You can get a reasonable understanding of where pinch points are," said Gupta. "You can abstract an industry and say which regions of the world typically constitute supply chain [risk] for this industry" then map their natural catastrophe risks.

EQECAT's Larsen agrees that the future could hold more general models.

"Will we have all data necessary to run it? That will be the challenge," he said. "There will be models, they will be data-input intensive and they will reduce but not eliminate uncertainty."

JARED SHELLY is senior editor/web editor of Risk & Insurance®. He can be reached at riskletters@lrp.com.

September 15, 2012

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