PROPERTY LOSS CONTROL: 'JUST-IN-TIME' APPROACH EXACERBATES RISK OF CONTINGENT BUSINESS INTERRUPTION

Greater efficiencies and economic advantages are the obvious upsides of the "just-in-time" inventory practices that are all the rage with manufacturers.

Countering that upside, though, is a potentially dramatic downside in the greatly expanded range of contingent business interruption exposures the just-in-time practices bring.

For the risk manager of an operation relying on a just-in-time approach, that means the job of identifying, mitigating and transferring those business interruption risks doesn't end at the plant gate. It can reach far down the line of suppliers and suppliers' suppliers, and potentially far up the line of customers and even those customers' customers, as well.

Events such as the recent disruption of shipping service at United Parcel Services of America Inc. stemming from the International Brotherhood of Teamsters' strike, or periodic reports of job actions by workers at plants manufacturing automobile components-which days later cause the shutdown of automobile manufacturing facilities-highlight the need for closely managing just-in-time exposures.

"It definitely makes the possibility of a contingent BI loss far more immediate than ever before," said Julian Stroud, vp-international property at Reliance National Insurance Co. in New York. "And it puts more pressure on good risk management practices all the way down the line."

"When it's a just-in-time type process, you're looking at a more immediate possibility of a loss. There's no back-up stock or anything. Things stop fairly immediately," Mr. Stroud said.

"There have to be good contingency plans. Losses happen a lot more quickly when it's just-in-time."

"What they had better do is find out who all their vendors are, what components they get from them and what product lines are impacted by those components," said Robert B. Edgar, vp at Chubb & Son Inc. in Warren N.J. "Get a listing of everything they get from outsiders."

By itself, "insurance isn't going to do the job," Mr. Edgar said. "I've got to have a plan to stay in the marketplace, and business is just waking up to that."

A business-impact analysis is often the first step in developing that continuity plan.

"The business-impact analysis is one of the early activities of a business continuity plan," said Craig Holmes, head of business continuity and planning for J&H Marsh & McLennan Inc. in Charlotte, N.C. "You have to reach an organizational consensus about the issues that face you."

During that process, the risk manager needs to ask questions throughout the organization about events that could harm the company, seeing where there is agreement and disagreement. Once a consensus is reached on those exposures, the risk manager should produce a report, then distribute it to the people who have been interviewed, asking them to refute, verify or expand on the information it contains.

"I think the challenge for the risk manager is to put themselves in the position to make a decision and get the buy-in from the organization so that they have enough information to know what is going on," he said. "I've been in situations where the risk manager didn't know how much 'just-in-time' their company had, and when they found out they were shocked."

Another important part of risk management in a just-in-time environment is to identify alternative suppliers for components or materials.

Those suppliers can be tough to find, because in today's manufacturing environment, components are often highly specialized for the needs of the particular customer, and a backup supplier might not be able to start providing them on short notice.

Manufacturers working on government contracts, particularly those involving security clearances, might find the task even more complicated.

While noting that his company doesn't engage in just-in-time practices to the extent that an automaker might, Michael Newman, manager of property loss prevention for Johnson & Johnson Inc. in New Brunswick, N.J., said his company has taken steps to minimize inventories of raw materials as well as finished products.

Beyond that, product lines are being concentrated in plants, he said. "So what you're seeing is less and less spare capacity. Years ago, there was always more spare capacity. If something happened you could always go to another plant."

Although the magnitude of the situation varies with different product lines, "if something was to happen at one of our contact lens manufacturing operations, there's no place left to go," Mr. Newman said. "That causes worries all along the line as far as business interruption is concerned."

The response is identify exposures, he said, and take steps to reduce them. With numerous facilities in hurricane-prone areas of Florida and Puerto Rico, for example, "if you have a plant harden up, you can at least come back to a plant that's functional."

In the case of the UPS strike, J&J's efforts to put contingency plans in place well before the job action have minimized its impact on the pharmaceutical company, Mr. Newman said.

That sort of risk management also was sparing Austin, Texas-based Dell Computer Corp. any major fallout from the strike, a company spokesman said. There, a just-in-time approach has Dell bringing all of the components of its personal computer systems-joining the monitor with the computer and keyboard, for example-"on the dock or in transit."

"To suggest that the UPS strike has had no impact would be foolish," he said. "We did have alternative plans. Not necessarily anticipating a walkout but anticipating some sort of interruption of shipments."

Dell uses "a multitude of carriers" of which UPS is "not the largest," the spokesman said, and "the alternate plan we went to was simply to take that (UPS) volume to other carriers."

While Dell has experienced some reports of delays of final shipments to customers, it has experienced "no serious interruption," he said.

When looking to reduce contingent business interruption exposures that just-in-time practices create, the risk manager should make a decision from a cost-benefit perspective, said Harry Taback, manager of loss control at J&H Marsh & McLennan in New York, weighing such options as eliminating the risk, buying insurance or changing suppliers.

"The last alternative is to buy insurance, and that (decision) is sort of the risk manager's role," Mr. Taback said. "The risk management decision is not just to buy or not buy insurance."

For example, if a manufacturing process involves ethylene and the supplier shuts down and there is no alternate, "you have a catastrophe."

"You ultimately could lose market share," he said. "You can't buy insurance to replace market share."

"Insurance is probably your last option. There are business operational concerns," agreed Mr. Holmes. "Insurance is going to give you your money back, but it's not going to give you your business back."

Mr. Newman said that while "market share-driven" Johnson & Johnson buys business interruption coverage, "our ultimate goal is to have the customer not feel any effect" of an event that could disrupt production.

Contingent business interruption insurance is an important consideration in addressing the risks posed by a just-in-time system.

All too frequently, however, it's a consideration that's overlooked, said Tony Trivella, vp-commercial with Hartford Steam Boiler Inspection & Insurance Co. in San Francisco. "The key mistake that some of our insureds make is often they don't consider contingent BI coverage when thinking about their commercial property insurance program or, if they do, they only purchase insurance on suppliers rather than customers," he said.

It's not enough to just look back in the process to suppliers, Mr. Trivella said. "Looking ahead also represents a contingent BI exposure."

"Even when (risk managers) do consider suppliers, often there's a need to look even farther back the chain and consider suppliers of suppliers," he said.

Another problem is many of those carrying contingent business interruption coverage fail to see the extent of their just-in-time exposures and fail to carry adequate limits, he said.

"I think most insurers are receptive to providing substantial amounts of coverage if they get the right information," he said. "It's just that many times that information is not provided or is not available. I think there are situations where risk managers might even be fooled into thinking their exposure is less than it really is."

Another form of contingent business interruption coverage-utility service interruption-also can be key and frequently is overlooked, he said.

Although many see just-in-time as a recent trend in manufacturing, "this whole service interruption issue has been a form of just-in-time that's been around forever," Mr. Trivella said.

Many policyholders have limited service interruption coverage, however, covering only interruptions resulting from damage to their facility or within 1,000 feet of their business.

"Many of them don't buy service interruption coverage all the way back to the utility, and they should," Mr.Trivella said. "It's such an important exposure, but I would say the majority of commercial insureds are only partly insured for service interruption, and that is one of the things I think is most critical to protect, because that is one of the things that you have no control over."

Extra expense coverage also is important in transferring risk associated with just-in-time practices.

Chubb's Mr. Edgar noted that many times when a company can find an alternative supplier in a pinch, that supplier-being well aware of the customer's plight-might only deliver the component or material at a premium price. Contingent extra expense coverage responds in those situations.

William Krouslis, assistant vp in the business continuity services division of AIG Consultants, a unit of American International Group Inc., emphasized it's important that the company calculate its business interruption and extra expense limits properly.

The risk manager should work closely with the company's broker to determine appropriate limits. Normally the business interruption limit should be the loss of net profits plus continuing business expenses, he said.

He said just-in-time practices force a risk manager to be aware of potential exposures lurking in the company's information systems. "From the risk manager's perspective, a just-in-time inventory system would be an information- and computer-dependent system," he said. "So they should be looking at the reliability and dependability of their information systems."

The risk manager must ensure the company's disaster recovery and business continuity plans address its information technology with an eye toward making sure a system is in place to back up the system on which the just-in-time processes rely.