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Maintaining supply chain integrity is a high-wire act with a small net, buffeted by myriad exposures from basic quality assurance and control to conflicts, coups and catastrophes in far-off lands.
Add in macroeconomic factors, such as inflation and labor shortages, and the process of aligning all the variables productively and profitably becomes exponentially more difficult, experts say.
The construction sector, due to its size and scope, is more exposed to supply chain woes that can cause concern for insurers than industries that do not consume similar volumes of raw materials or require as much skilled labor.
Building construction insurance programs that include contingencies for supply chain disruptions and related risks can help protect contractors and others, they say.
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Kevin Bates, group head of risk and insurance for Australian construction company Lendlease Corp. in Sydney, said a robust supply chain should include secondary and tertiary supply options and opportunities, which create a “strong competitive tension” that translates to improvements in quality, speed to market and safety.
“There’s a need for everybody to raise their game. It’s competitive. People want to win the work and they know that things like safety, quality and reliability are points of differentiation,” said Mr. Bates, who is also a board member of the Risk & Insurance Management Society Inc.
Redundancy and contingency planning should be a part of a well-designed supply chain, said Dallas-based Cheri Hanes, who heads the subcontractor default insurance risk engineering team at Axa XL, a unit of Axa SA.
To weather challenges, “you must really understand your supply chain, because it’s much more complex than you think. If it’s simple, that means it’s not redundant,” and potentially more exposed to disruption, she said.
“Where possible, redundancy is always a good idea, or at least having contingency plans in place,” said Cincinnati-based Pat Stoik, chief risk officer for Overhaul Inc., which specializes in in-transit supply chain risk management. “Route planning, proper security protocols for transit and storage, visibility of the goods while in the supply chain, and contingency plans all contribute to successful navigation of the supply chain challenges.”
“The risk manager and the supply chain team should work very closely to make sure that the risk handling matches the supply chain activities being followed,” Mr. Stoik said.
Larger companies should have risk management capability within the supply chain management function, said David Shillingford, an adviser to Troisdorf, Germany-based Everstream Analytics.
“There is an opportunity for insurers to work more closely with companies that are mapping their end-to-end supply chain to develop or extend supply chain risk transfer mechanisms,” he said.
Common causes of supply chain disruptions include price hikes for a broad range of input materials. In a recent risk survey conducted by the Association of General Contractors of America and management consulting company FMI Corp., price increases of materials and equipment overtook a lack of skilled and craft workers to become the top risks among contractors.
“With materials costs fluctuating so much month to month, contractors remain wary about committing to projects with unpredictable costs and lead times. While inflation in the broader economy is settling back to earth, construction costs keep hitting updrafts,” Ken Simonson, chief economist at the AGC in Arlington, Virginia, said in a recent statement on construction input costs.
Cost volatility is among the chief challenges facing the construction sector, said Danette Beck, head of industry verticals and national construction practice leader for USI Insurance Services Inc. in Valhalla, New York.
Early and frequent communication coupled with contract clarity, such as cost escalation clauses in builder’s risk policies, which cover building during the construction process, can help avoid flashpoints later. “You have to be able to get ahead of some of these challenges,” Ms. Beck said.
A material escalation clause allows for adjustments in contract pricing to account for changes in material costs or availability,
said Kansas City, Missouri-based Michael Campo, national construction practice director for IMA Financial Group Inc. He also suggested project owners could include a delay damages clause that specifies the damages that a contractor will be liable for in the event of a delay in the project schedule.
Careful inventory control can help mitigate cost exposures but must be managed to avoid creating additional exposures, Ms. Beck said. Warehousing materials may appear to make sense to control acquisition costs and delivery times but may have property exposure implications. Sublimits for off-site storage in builders risk policies can average between $5 million and $10 million, so policyholders should be careful not to exceed coverage limits with inventory, Ms. Beck said.
“Contractors have been pre-ordering materials and storing them for future usage in response to the risk of suppliers not delivering materials or equipment on time. This results in an inventory risk both in holding too much, resulting in storage costs, but also the risk of damage while in storage,” Mr. Campo said.
Many of the products and components used in construction are manufactured on a just-in-time basis, an inventory management method where goods are received from suppliers only as they are needed. The main objective of this method is to reduce inventory holding costs and increase inventory turnover, said Blanca Berruguete, global industry solutions director for construction in Madrid for Allianz Global Corporate & Specialty, a unit of Allianz SE.
Andrea Blair, Nashville-based director of business resilience and continuity management services for Zurich Resilience Solutions, part of Zurich North America, recommends general contractors incorporate pricing thresholds into their procurement contract language to help mitigate any potential upside pricing exposure due to market volatility.
Tracking lead times for materials can help avoid delays in procurement, Ms. Blair said. In addition, rigorous quality assurance and controls as materials reach a work site can help avoid further delays and complications.
The recent sudden surge in demand within the construction sector could also put supply chains and resources under additional pressure at a time when costs are being closely monitored, which can affect quality and increase susceptibility to error, Ms. Berruguete said.
Credit risk is another potential source of supply chain disruption and the exposure has increased with rising borrowing costs, said Doug Collins, head of trade credit in New York for Ascot Group Ltd.
For example, a metal fabricator or parts supplier could easily be caught and squeezed between a spike in a commodity price, such as aluminum or copper (see related stories here and here) and working within the limits of a fixed price contract with a customer. If that supplier is shipping net payment terms of 30, 60 or 90 days, it can further exacerbate the problem and hurt a business’s financial position and creditworthiness, or even threaten its survival.
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The AGC/FMI survey showed that almost 40% of respondents reported an increase in subcontractor defaults compared with a year ago. Mr. Collins said there is evidence of increased corporate bankruptcies and restructurings this year and that new submissions for trade credit insurance, which covers payment risk, are up substantially, perhaps twice the volume of this time last year.
Jon Handen, Hunt Valley, Maryland-based vice president, special products, for Atradius Trade Credit Insurance Inc., said small and medium sized enterprises are particularly sensitive to supply chain finance risk. He said such operations could benefit from the support of large corporate buyers, financial markets, governments and underwriters.
Mr. Bates, the risk manager, said he has heard of larger contractors extending support to key suppliers to avoid failures that could potentially cascade into larger events with greater potential exposures and losses.
Supply chain integrity and performance can be hurt by events that may at first seem unrelated but can have profound consequences for end users.