October 7, 2011 by Claudio Totino
The earthquake and tsunami that devastated Japan earlier this year caused the country the kind of damage that will take decades to fully recover from, on both a human and an economic scale. But the financial impact of those terrible events stretched far beyond the shores of Japan and was felt around the world, more so today due to our increasingly interconnected societies than it would have been at any time in the past.
The Japan disaster and other recent natural catastrophes in Australia, New Zealand and South America have meant that supply chain failure and closely connected contingent business interruption issues have gained visibility in practically all insurance markets around the world. These events demonstrated that major business interruptions and contingent business interruption losses may now be triggered not only by occurrences in the immediate vicinity but also by those a long distance away.
The risk landscape is changing continuously and with increasing speed. New scientific findings are changing production methods and distribution channels in a global economy in which many production processes are now closely linked across continents and not simply between cities. Whereas in the past businesses had to worry about property damage at their own facility – and the effect it would have on production and their business – the increasing trend of outsourcing for price reasons means they are now reliant on more and more suppliers who are often scattered around the globe. But with the financial rewards this approach can potentially bring, there is also increased risk. Now more than ever, brokers and risk managers need to work together to ensure companies have the necessary safeguards in place. There needs to be a regular dialogue between broker and client and that information should be shared with the insurer on a regular basis and not just when there is a market-changing event.
Closing down a business for a protracted period can quickly threaten the claimant’s survival if no precautionary measures have been taken. However, if the company has good risk management with clear planning, then part of this planning should include adequate economic loss cover for such an event. This is where a broker has a particularly important role to play with the advice they give a risk manager. Recommending a detailed audit of a client’s business interruption coverage, exclusions and business interruption values, as well as available extension of coverages, can help risk managers to better understand the exposures their company has. Brokers can help to collect valuable data that their clients can utilize to model the impact of various potential supply chain failures.
A further way a broker can assist a client is by advising them to ensure they are fully aware of a list of alternative suppliers in a variety of different locations should their main supplier be incapacitated. Being able to react quickly to events that are out of a client’s control is vital.
Suppliers and Customers
Canada is not immune from supply chain disruptions. The economy is largely fueled by primary industries such as oil, mining and forestry. The country is a net exporter of raw materials like ore, crude and logs or intermediate/finished product such as gold, plywood and copper. Although Canada was not significantly impacted by the Japanese disasters, the country did not escape unscathed. Car manufacturing plants in Ontario, for example, saw their supply chain disrupted with production halting for a number of weeks.
The Japanese earthquake and tsunami showed what can happen if goods cannot be supplied because of material damage at the premises of a supplier. Production can slow or even stop and turnover decreases, profits begin to diminish and can eventually turn to losses. What if the fire was at the premises of an important customer? What does a corporation do then?
Canadian brokers and risk manages must be wary of not only where present threats lie but also where potential future exposures might come from. At present Canada’s major trading partner is the United States. Potential events such as a North Atlantic hurricane, or California earthquake could severely impact the ability of US customers to receive the above noted Canadian goods thus eroding Canadian firms’ revenue and potentially exposing CBI coverages contained in policies.
Going forward, the Pacific Rim buyer base will become increasingly important to Canada’s West Coast economy to the extent that future events in Japan or in emerging economies such as China and India may prove as impactful as the potential loss of US based customers.
Although it is still much too early to tell how precisely contingent business interruption extensions will eventually be impacted by the Japanese earthquake loss, it would come as a surprise to us if the relatively small number of contingent business interruption (CBI) losses would not have a significant impact – i.e. in excess of 5% – of the total insured PD/Business Interruption losses triggered by the event.
The ever growing internal and external interdependence of businesses and industries together with soft-market tendencies of extending covers beyond the boundaries of transparency has seen the accumulation potential of these former “fringe-covers” become much more significant. Last but not least, the increasing vulnerability of industrial supply chains is intensifying the demand for yet higher limits and lower self-retention.
CBI coverages to “protect” revenue stream generated by selling goods to third parties are used widely but often without much science or rigour built into the analysis. Insureds typically purchase as much as possible based on the level of sophistication of their in-house risk management team and that of the broker they use.
What makes evaluating CBI risk so challenging is the ebb and flow of numerous contracts. Put simply, the playing field is always changing and evolving and it’s almost impossible for a risk manager to know the exact risk on his or her books at any given time.
There is, however, a growing field of business continuity firms that specialize in this area and offer the skills to measure a client’s business continuity needs through detailed processes like forensic accounting. When a client asks their broker about the newest ways to protect themselves it is vital that brokers are cognizant of methods like this.
These specialists are able to review a firm’s books and operations and provide a report on potential exposure. In the past, clients regularly conducted post-claim analysis to determine their exposure but now with the help of specialists they can conduct pre-claim analysis to better understand where they stand.
The value of this can be seen from the fact that companies are often surprised by the findings, allowing them to purchase CBI coverage in a more educated way, securing the type of limits that better suit their needs and exposure.
Should insurance solutions for particular supply chain problems prove to be unavailable or too expensive, brokers should be aware of the benefits of parametric trigger covers and indexed deals, helping their clients find the solution that best fits their needs.
In summary, this issue is not much different from other risk and insurance scenarios. Best results can only be achieved through open dialogue between insureds and insurers and the sharing of information so as to identify needs, evaluate exposures, where possible mitigate through diversification and ultimately develop coverage strategies to satisfy all stakeholders.
Risk managers should meet with their brokers to closely examine the business interruption coverages they have in place. A key takeaway should be that properly calibrated BI coverage can be one of the most important assets for ensuring there is the working capital needed to survive a catastrophic event.
Claudio Totino is head of property, Canada, for Swiss Re Corporate Solutions.
Copyright 2011 Rogers Publishing Ltd. This article first appeared in the July/August 2011 edition of Canadian Insurance Top Broker magazine.
This story was originally published by Canadian Insurance Top Broker.