Tim Press and Rupert Sawyer, supply chain risk specialists at independent insurance broker Miller, look at the way that international trade is changing, the emerging risks to which businesses and their financiers are exposed, and possible solutions.
The World Economic Forum launched its global risk network report before their Davos 2008 annual conference. The Daily Telegraph commented “the world also faces less widely anticipated problems…possibly explosive problems with companies’ supply chains.”
As we write, Russia is in conflict with Georgia which could impact the key Baku-Tbilisi-Ceyhan oil pipeline even though it is far from conflict zone. This raised fears that the conflict would tighten Moscow’s stranglehold on Europe’s energy supplies. Only last year the Russians temporarily turned off the pipelines into the Baltic States.
Today’s manufacturing processes are extremely complex, moving towards single sourcing and outsourcing to other organisations. Combining that with the fact that these organisations are often in emerging markets and hold limited stock piles the potential for an interruption in the chain is seriously increased. ‘Just-in-time’ and similar interconnected business processes have also put increased pressure on the supply chain if a disruption occurs. It has all become a balancing act. On one side there is the pressure for a quick, efficient, flexible and lowest cost delivery of a product and, on the other, there is the risk of something going wrong, creating negative financial and reputational consequences. Physical perils are the most obvious issues that can cause disruption, but less tangible risks such as those caused by political intervention, political violence, insolvency of key suppliers or damage to an organisation’s intellectual property have become critical.
Sources of disruption
Traditional physical risk loss was illustrated by the loss of the container vessel, the MSC Napoli, off the UK south coast in 2007. However the real financial consequences of this barely made the media. Critically, much of the cargo was not physically lost, so cargo policies did not respond other than covering the contribution to the salvage expenses. However, the delay in delivering the undamaged cargo snapped the supply chain for factories in South Africa which had to go on to short time working. The effects of this are still being felt. In addition, a highly significant amount of the world’s annual supply of nickel was also on board, resulting in a major price increase on the world’s markets.
Earlier this year, Kenya, formerly a byword for political stability, erupted into violence following a contested general election. The fact that virtually all imports and exports for a range of Central and East African countries are taken through the Rift Valley to the port of Mombasa (both of which were either closed or disrupted) created a substantial problem for businesses – irrespective of whether they had any ownership of the physical assets in the region.
For banks, traders and specialised funds which finance much of the investment and trade in emerging markets, the situation in Kenya had serious knock-on financial consequences due to the non delivery of the goods.
Importantly, political risks are not restricted to events in unstable countries. The 2005 Bra Wars debacle between the EU and China meant the detention of 75mn items of imported Chinese garments in EU ports that year. Quota agreements are a business restriction, but arbitrary reductions in quotas are an embargo which is an insurable risk.
The impact of such situations adds further weight to the toughened approach being taken by credit committees. Increasingly bankers and financiers are now looking to explore the option for credit risk transfer that Basel II allows for correctly structured insurance products.
Managing the risks
Companies need to examine every detail of their supply chains, know who supplies each stage and understand all the cross-supplier relationships. Supply chain risks should be subject to the same continuity risk evaluation as physical damage exposures. A business should analyse its exposures, perform regular reviews and constantly monitor processes, including keeping track of the political environment overseas. Tried and tested business continuity plans are a key indication of good risk management and these plans should be put in place ready to help organisations back to business after disruptions that are beyond their control occur.
Insuring the financial risks
Transit and storage risks for physical damage are generally the standard coverage offered by supply chain insurance policies. There are, however, other innovative risk financing solutions that manage the consequences of financial loss and can help financially support business continuity plans connected to supply chain failure. Underwriters such as Kiln have been at the forefront of developing such insurance solutions. As Paul Culham, marine and special risks underwriter at Kiln comments: “The fact that long and complex supply chains are being created means that there are more opportunities for underwriters to develop bespoke insurance products that can meet the international trading community’s risk transfer requirements. The objective is to provide a safety net for when the supply chain snaps – Trade Disruption Insurance (TDI) is the leading example of these products.”
TDI pioneered by Miller and Kiln, covers the financial consequences of disruption to the supply chain, whether by way of lost revenue, financing contingency plans or funding the increased cost and expense of mitigation. Critically, TDI does not require physical loss or damage to the policyholder’s assets to give rise to a claim. Disruption may be caused by natural perils (windstorm, earthquake and the like), political events (including embargo and confiscation), political violence (including war and terrorism), and insolvency of a key supplier or customer or physical events (such as closure of a navigable waterway).
The legal and regulatory requirements for directors and officers to protect company profitability, reputation, and ultimately company survival are ever increasing – bringing risk management and transfer firmly into the boardroom. Whilst the global economy offers increasing opportunities for business, it can also open the doors of instability. Insurance to recover lost revenue or simply pay for the unexpected cost of implementing contingency plans is a vital tool to assist finance directors.