AIR and Lloyd’s produce new quantitative model to help manage supply chain risk

AIR Worldwide and Lloyd’s have produced a new quantitative modelling framework to help risk managers and insurers better get to grips with supply chain risk.

The new Hidden Vulnerabilities in Supply Chain Risk: A Quantitative Risk Modelling Framework report, produced by the two companies and supported by UK risk management association Airmic, explains that a scarcity of historical claims data and evolution of unforeseen threats, means there are few systematic methods for corporate risk managers and insurers to quantify supply chain risk.

The new framework uses probabilistic modelling and predictive methods to bridge some of the existing data and knowledge gaps. It is designed to provide corporate risk managers and insurers with a rich set of quantitative metrics on supply chain risk that more accurately reflect the actual threat faced by business.

The model can be used by all industries to model business interruption and contingent business interruption, by analysing millions of disruption scenarios against supply chain networks to obtain losses for each event.

The model produces indexed risk scores that are easy to understand, enabling risk managers and insurers to identify nodes in their value chain needing the most attention, explains Airmic in its Complex Supply Chains in a Complex World report, launched at its ERM Forum on the same day as the framework from AIR and Lloyds.

The Hidden Vulnerabilities report notes that both corporates and the insurance industry traditionally employ qualitative methods to assess supply chain risk by building “Risk Scorecards” and “Decision Tree” frameworks. Although this method is an effective tool to track and measure supplier performance – and can be used to understand basic facts about supply chain risk – it does not deliver a detailed and nuanced view of risk, the authors say.

According to AIR and Lloyd’s, the proposed quantitative method solves these issues and allows risk managers and insurers to transition from reactively to proactively managing supply chain risk, by identifying interdependencies before events happen.

The five-step supply chain modelling framework relies on four critical components – trade data, supply chain industry exposure, product flow networks and stochastic event catalogues.

It is hoped that the new model will help insurers address problems that see many of them set relatively low limits, high deductibles and policy exclusions to constrain losses emerging from supply chain risk and business interruption.

Julia Graham, Airmic’s deputy CEO and technical director, welcomed the report and modelling framework.

“Supply chain disruption is a consistently front of mind risk for Airmic members, so we very much welcome this study. Quantifying risk in a modern supply chain is exceptionally complex and a huge challenge for businesses and underwriters. Any development that enhances the market’s understanding of this critical exposure will be of great benefit to our members – both for improved insurance coverage as well as an enhanced understanding of this key risk,” she said.

Lloyd’s head of innovation, Trevor Maynard, said the framework will help people to understand supply chain risk and exposure more scientifically. “We hope that this will help risk managers build resilience into their businesses, and we are urging insurers, brokers and risk managers to work together to develop solutions,” he added.

The report was published alongside Airmic’s new Complex Supply Chains in a Complex World guide this week at Airmic’s fourth ERM Forum in London.

Commercial Risk is holding a one-day Supply Chain Risk Management conference in London on 25 November 2019. Find out more about the programme or book your space here.