Supply chain: a critical risk undergoing rapid evolution

Kenneth Travers, technical hazards team and global business impact specialist at AIG, took part in the panel discussion on risk identification and modelling at Commercial Risk Europe’s supply chain risk conference in London at the end of last year. As we prepare for this year’s event that will be held in London on 10 and 11 December, we asked Mr Travers how he believes supply chain risk should be most effectively managed and insured.

AL: Why has supply chain risk become such an important area for companies?

KT: As the world becomes more connected, supply chains are becoming more complex, spread over more countries and creating even more risk. The risks are continually evolving as new business trends emerge.

For example, the significance of third party suppliers has grown tremendously as businesses that outsource components increasingly rely on just-in-time systems for their inventory management. Organisations depend on external suppliers to provide them with raw materials, parts, services and technologies. It’s not uncommon to have at least seven layers, or tiers, within a supply chain.

As a result, the financial condition of suppliers is also critical. Deteriorating supplier performance is often related to financial issues, resulting in late deliveries that can cause a delay in production. Should a supplier go bankrupt, the impact on a buyer’s business can be significant where ready alternatives have not been identified or arranged.

Supplies are also coming from further afield. For example, low-cost manufacturing is beginning to shift away from China’s coastal areas to inland provinces. This means the risks to export goods are greatly increased as thousands of miles are added to their routes.

In addition, the onset of climate change may accelerate the frequency and severity of natural disasters, impacting supply chains worldwide.

AL: How should this risk be managed to ensure business continuity is secured?

KT: Unfortunately, there is no silver bullet to guarantee business continuity. However, companies should work with their insurers, brokers and other professional advisers to understand the threats to their supply chain, and identify the best approaches to use to mitigate against them. This is a serious matter that needs to be on the c-suite agenda.

There are three steps they can take straight away. First, identify high-risk suppliers within their supply chain network. Second, determine the potential impact should one or more of them fail. And third, develop contingency plans in the event that this does happen in order to minimise damage and ensure that the business can get back to normal as quickly as possible.

However, this should serve as a precursor to a more thorough risk management assessment that will help identify where the company should be investing in strengthening its supply chain and how it may ultimately utilise supply chain risk insight to help meet client expectations and improve market competitiveness.

AL: What kind of technology is available to identify and measure this risk?

KT: Analytic models are the best way to assess supply chain risk. At AIG, our specialist team can provide assessment and quantification using our proprietary Visualization and Risk Assessment Model, which requires a strong understanding of the overall ‘network’ of the insured’s revenue stream, internal and external dependencies.

As with any modelling tool, the quality of the output depends on the quality of the input. With large multinational organisations, especially at the outset, the sheer volume of data can be overwhelming. Our experience shows that the best approach is to begin by focussing on an overall assessment of the company’s top-three products or product lines. This will generally enable the gathering of a manageable amount of data and information, and will usually include the risks that create the largest potential impact on a company.

AL: How can insurers help their customer more effectively manage this risk and prevent disruptions and losses?

KT: Until now there has been a limited ability in the market to properly quantify supply chain risks and subsequent contingent business interruption (CBI) because of a lack of tools and processes, both in the insurance industry and on the client side.

However, things are changing. At AIG, supply chain risk modelling is a key area of investment for our Client Risk Services team. We are currently working with several global manufacturing companies, as well as setting up strategic partnerships with a number of data providers. The aim is to develop new risk modelling tools and solutions that incorporate real-time data gathered from GPS, such as cargo tracking capabilities for shipments and road transportation of goods.

At the moment, the project is still in the development phase but multiple pilots are underway. The focus at this point is on simulating the impact of low-frequency, high-impact events such as natural catastrophes on supply chain networks to evaluate business downtimes and associated CBI losses.

Looking forward though, other applications of technology that could help manage supply chain risk include smart monitoring systems and meters, connected devices via the Internet of Things, drones, wearables and even sensors in the body.

AL: Is supply chain risk insurable or is it something that just needs to be managed? What elements of this risk are insurable and how? What products and capacity are available?

KT: Insurance for supply chain risk has traditionally been provided by CBI cover, wrapped up into a property policy. Over time this approach has demonstrated its importance. However, as supply chains have evolved, modern policies haven’t changed to cover economic loss from damage at an insured’s supplier, customer or other business partner.

Cover in this area is developing and the market has started to see the arrival of all-risk supply chain policies, offered by the larger commercial insurers and created to fill the gaps in coverage. Insureds typically need to name the suppliers they deal with directly, known as tier-one suppliers, or the businesses that supply their suppliers, known as tier-two suppliers, or suppliers even farther down the chain. This is vital as research shows about 40% of supply chain disruptions involve problems that occur at suppliers below tier one.

AL: Is this a risk that is best transferred using a captive?

KT: Captives can have a key role to play in mitigating supply chain risk. They can be used as a central point for gathering the data needed for loss-prevention work or managing an incident. This data can also be used to improve supply chain resilience. In addition, the presence of a well-managed captive can make a risk more attractive from an insurance market perspective. Evidence of the increasing popularity of captives came in a 2016 report by Marsh which showed a dramatic 133% increase in captives writing supply chain risk.

AL: What evidence are you seeing that supply chain risk is now appropriately recognised at board level?

KT: Managing supply chain risks can be challenging. In our work with companies over the years, we have found that the many of them do not have a clear understanding of their supply chains, nor an enterprise-wide approach to managing these risks. While the needle is moving in the right direction in terms of awareness, there is still some way to go.

This year’s Supply Chain Risk Management 2018 – Collaboration in a Connected World conference has been extended to two days and will take place in London on 10 and 11 December.

Supported by the Business Continuity Institute and UK risk management association Airmic, the conference will bring together business leaders, supply chain experts, procurement, business continuity and risk professionals to discuss the threats of connected risk and the need for coordinated resilience programmes. The event is free for risk professionals, and an early bird delegate rate of £300 (+VAT where applicable) applies for all other delegates. For further information please go to: www.commercialriskonline.com/event/scrm18/