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Business interruption losses generate concerns over rising global supply chain exposures

Business interruption losses generate concerns over rising global supply chain exposures

A series of natural catastrophes that disrupted supply chains around the world in the past year have shown that business interruption is an ongoing risk for manufacturers.

“Supply chain management is one of our key priorities,” said Scott P. Borup, director of corporate risk management for Johnson & Johnson in New Brunswick, N.J.

Johnson & Johnson operates more than 250 companies in more than 50 countries with approximately 100 manufacturing plants, he said.

“The reliable delivery of the highest-quality medicines, medical devices, diagnostic products and consumer health care products to our patients and customers is absolutely one of (Johnson & Johnson's) highest priorities,” Mr. Borup said.

The multinational manufacturer has established an organization that is exclusively responsible for managing supply chain issues, with a subgroup focused solely on supply chain risk management, in which Mr. Borup's staff participates.

“We look at supply chain risk holistically at an enterprise level,” he said.

“But more from a business interruption insurance perspective, it's certainly an area of major focus of my group, the risk management group,” Mr. Borup said, using the key toolkit of risk management: identify, assess and mitigate the risks, then make informed decisions about a risk management strategy.

In its insurance market outlook for 2012, New York-based Marsh Inc. estimated that insured catastrophe-related losses in 2011 exceeded a “record-setting” $105 billion.

Commercial property insurance policies—which often include business interruption coverage with the ability to add endorsements and increase limit amounts—are trending upward in pricing, notably for catastrophe-exposed accounts, due to significant catastrophe modeling changes in the past year, industry experts say.

Rick Vassar, general manager of risk for Volkswagen Group of America Inc. in Herndon, Va., said the automaker's first challenge when working with business interruption exposures is to quantify the risk.

The “biggest challenge is trying to determine, if we did have a catastrophic loss that brought our manufacturing plant in Chattanooga offline...based on past losses throughout the Volkswagen global system, what the impact would be and try to insure for the maximum financial loss that may occur should there be a covered event,” Mr. Vassar said.

As manufacturers consider business interruption risks, “the challenge is visualizing how events can impact their business,” said Jeffrey Beauman, Factory Mutual Insurance Co.'s Johnston, R.I.-based vp and manager of all-risk underwriting. The insurer does business as FM Global.

“Measuring business interruption losses can often can lead to some surprises,” he said. These can include exposing the company to risks they weren't aware of and the difficulty in quantifying financial losses due to interruption of business operations.

It's not uncommon that an insurance company can change its loss reserves on a particular claim, Mr. Beauman said.

For example, an adjuster examining the loss at a client's manufacturing facility can see exactly what equipment was burned or flooded, get information on upcoming sales and what the product mix is for the quarter, Mr. Beauman said.

“Yet at the time of that event, when they're standing in the rubble, they still aren't able to estimate what the final business interruption may be by the time that plant has been rebuilt,” Mr. Beauman said. “If you can't predict that when you're standing amid the rubble, if you're a buyer of business interruption insurance, how can you predict that at the time that you're trying to negotiate your coverage?”

For Volkswagen, the company decided to have its own fire department as part of its sprawling 2 million square foot manufacturing plant in Chattanooga, Tenn., that opened last year, Mr. Vassar said.

When putting together the insurance program with an unnamed insurer, Volkswagen estimated that if the plant went offline for one day due to business interruption, it would cost the carmaker at least $5 million to $7 million per day in lost revenue, Mr. Vassar said.

The second business interruption challenge is trying to fit the risk within the framework of an insurance budget that is provided at a competitive price, Mr. Vassar said.

“Our particular insurance program is a global property program, of which business interruption is a component. We have that coverage and use the economies of scale to be able to leverage the coverage that we can receive for business interruption and also to reflect a lower premium,” he said.

However, a series of natural disasters in Japan, New Zealand, Thailand and the United States last year compounded manufacturers' contingent business interruption exposures and their accumulation of risk, or a single-loss event that could involve multiple perils and types of coverage.

“The deep dive isn't business interruption, but more pronouncedly in contingent business interruption. And that is the huge bugaboo,” said Jim Rubel, executive vp at Lockton Cos. L.L.C. in New York.


“Insurance companies are petrified of an earthquake and it hitting multiple clients at the same time—one event triggering business interruption coverage and property damage coverage on a plethora of policies all at once,” Mr. Rubel said.

Regarding earthquake and wind-exposed property, insurers' big fear is that they have contingent exposures with many more contingent receivers or suppliers of those goods, Mr. Rubel said.

If there were to be an earthquake, insurers “fear is that all these sublimits will trigger and it's an unknown commodity to the carriers, so they will further sublimit contingent business interruption—especially after the disasters in Japan where a lot of American manufacturers are obviously getting their goods,” he said.

Risk managers who see the need to clearly define and quantify their supply chain exposures for insurers to try to take advantage of better coverage pricing can find that a difficult task, experts say (see related story).

Lance Becker, area president for New York and global risk management co-director at Arthur J. Gallagher & Co. in New York, said the brokerage has devised questionnaires to be sent to a manufacturer's suppliers to assess various risks.


“The biggest challenge manufacturing companies are having is getting information on the second-tier and third-tier (suppliers) and making sure they understand the risks that are ahead,” he said.

Once data of a manufacturer's supply chain has been collected, manufacturers need a system to work closely with second- and third-tier suppliers to spread the supply risk geographically, Mr. Becker said.

Some risk managers have taken alternative approaches in efforts to avoid the high cost of contingent business interruption coverage.

For example, some clients are candidates for stock through-put insurance, which is “a cargo-type policy that insures stock from where it's manufactured,” Lockton's Mr. Rubel said, noting that the coverage is not a solution for everyone, as it covers a single loss and not a continuous exposure.

Manufacturers can insure a specific type or amount of inventory, especially if that inventory is in a cat-exposed area, with a low earthquake deductible at a cheaper rate than it can through conventional property insurance, Mr. Rubel said.