traditional hazard risks

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5 Hazard Risk

In.July.2011,.a.tsunami.off.the.coast.of.Japan.caused.human.tragedy.on.an. almost.unimaginable.scale,.killing.thousands.and.rendering.almost.a.mil- lion.people.homeless..Also.in.July,.flooding.in.Thailand.forced.the.closure. of. 9,800. factories. and. left. more. than. 660,000. people. unemployed.. An. untold.number.of.people.around.the.globe.were.impacted.by.this.natural. disaster,. both. personally. and. economically.. In. the. automotive. industry,. approximately. 6,600. autos. were. not. built. per. day.. In. the. camera. indus- try,. Nikon’s. net. loss. of. sales. equaled. $786. million,. while. Canon. experi- enced. over. $600. million. in. losses.. With. over. 45%. of. all. computer. hard. drives.produced.in.the.affected.area,.many.computer.manufacturers.had. to.delay.product.launches,.which.resulted.in.lost.sales.and.a.doubling.of. hard. drive. prices.1. Unfortunately,. examples. of. hazard. risks. are. not. hard. to.come.by.

Hazard.risk.pertains.to.random.disruptions,.some.of.which.involve.acts. of. God.. Additionally,. hazard. risk. has. traditionally. involved. liability. torts,. property.damage,.and.natural.disasters..In.this.chapter,.we.will.address.how. corporations.mitigate.hazard.risk,.whether.it’s.a.natural.disaster,.fire,.mali- cious.behavior,.product.tampering,.theft,.or.acts.of.terrorism..The.chapter. will. cover. definitions,. options,. and. variants. of. traditional. and. emerging. global.disruption.insurance.products..Later.chapters.will.present.other.tools. and.approaches.that.support.the.effective.management.of.hazard.risk.

the tRaditiOnal WORld Of hazaRd RiSk and inSuRanCe

With. global. supply. chains. expanding. to. support. growth. initiatives,. many.companies.are.entering.into.indemnity.and.other.types.of.partner.

Schlegel, Gregory L., and Robert J. Trent. Supply Chain Risk Management : An Emerging Discipline, Taylor & Francis Group, 2014. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/apus/detail.action?docID=1680353. Created from apus on 2021-06-09 03:57:35.

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88 • Supply Chain Risk Management: An Emerging Discipline

agreements.in.an.effort.to.mitigate.risk.through.risk.pooling,.sharing.risk,. and.disruption.insurance..Insurance.may.not.be.the.total.solution.to.miti- gating.risk.within.this.category,.but.many.new.and.improved.business.and. trade.disruption.insurance.products.and.services.are.emerging.every.day.

Before. we. move. into. definitions,. options,. and. variants. of. risk. transfer. packages,.we’ll.begin.with.a.glimpse.into.the.landscape.of.this.traditional. risk. mitigation. arena.. We’ll. use. Figure 5.1. as. a. reference. point. for. our. entire.chapter.discussion..This.figure.includes.three.columns..From.left.to. right.are.the.risks,.the.types.of.coverage,.and.finally.the.triggers.or.drivers. behind.traditional.hazard.event.mitigation.insurance.

The. first. risk. in. Figure 5.1. is. credit. risk.. The. trigger. event. is. normally. payment.default,.and.the.coverage.is.normally.geared.toward.mitigating. for. insolvency. or. protracted. default. by. a. partner. or. customer.. Next. are. political.risks..The.trigger.events.here.are.normally.sovereign.debt.default. or.asset.loss.and.coverage.that.revolves.around.contract.frustrations.and. expropriation.. Within. the. insurance. coverage. area. for. political. risks,. contract.frustration.tends.to.revolve.around.corporate.loans,.the.lenders’. interest,.or.project.financing.of.equity.and.debt..Also.within.this.coverage. area,.the.bulk.of.expropriation.revolves.around.fixed.investments.(equity). and.possibly.mobile.assets,.such.as.stocks.

Continuing. down. the. left. side. of. Figure 5.1. is. property. risk.. The. trig- gers. in. this. category. are. physical. damage. or. loss. and. additional. perils.

Risk

Credit Insolvency

Contract frustrations Expropriation

• Property replacement • Lost profit • Continuing & expediting expenses • Contingent loss

Sovereign contractual default Asset loss

• Physical damage • Certain perils

• Political • Natural disasters • Suppliers

• Loss/Damage

• Lost profit • Continuing & expediting expenses • Contingent loss

• Goods in transit • Customs delays

Protracted default Payment default

Political

Property

Trade Disruption

Logistics

Coverage Trigger

figuRe 5.1 Risk. transfer. tools—the. business. of. hazard. insurance.. (Source:. Eric. Wieczorek,. for- mer. risk. director-.navigant,. “Supply. Chain. Risk. Management”. presentation. at. MAPI,. Manufacturing.Alliance.for.Productivity.&.Innovation’s.Council.Meeting,.2013.)

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Hazard Risk • 89

or. hazards. that. are. catastrophic.. Coverage. works. to. mitigate. property. replacement,. a. loss. of. profit,. expedited. and. continuing. expenses,. and. a. contingent.loss..Next.is.trade.disruption..How.is.trade.disruption.different. from.property.or.business.interruption?.It’s.a.bit.broader.in.nature,.such.as. the.Thai.floods.that.may.prevent.the.delivery.of.key.equipment.or.supplies.. Thus,.with.trade.disruption.solutions.in.place,.customers.can.attempt.to. recover. lost. profits,. and. potentially. expedited. and. continuing. recovery. expenses. and. contingent. expenses. as. well.. And. finally,. we. have. logistic. risks..The.trigger.events.are.straightforward,.such.as.physical.loss.or.dam- age.while.in.transit..Coverage.works.for.goods.in.transit.anywhere.in.the. world.and.especially.for.customs.delays.beyond.a.company’s.control.

As.our.discussion.moves.forward.within.this.traditional.risk.industry,.it. is.appropriate.to.provide.a.few.additional.terms.and.definitions:2

•. Hazard—a.game.of.chance;.a.source.of.danger;.a.chance.event.or.accident •. Liability—the.quality.or.state.of.being.liable;.pecuniary.obligations •. Liable—obligated.according.to.law.or.equity;.exposed.or.subject.to.

some.adverse.contingency.or.action •. Tort—a. wrongful. act. for. which. a. civil. action. will. lie,. except. one.

involving.a.breach.of.contract

The. following. summarizes. various. kinds. of. supply. chain. insurance. coverage.

first- party Commercial property insurance

This.is.by.far.the.most.common.form.of.coverage,.which.includes.business. interruption.coverage..It.typically.reimburses.the.insured.for.profits.that.it. would.have.earned.had.it.not.suffered.a.business.interruption..The.cover- age.normally.pays.for.lost.profits.resulting.from.some.type.of.interruption. in. the. supply. chain.. The. insured. does. not. necessarily. have. to. suffer. an. actual. loss. within. its. enterprise. or. supply. chain.. This. was. evident. dur- ing. the. Thai. floods.. Many. manufacturing. buildings. were. not. inundated. during.the.flood..However,.the.entrance.and.exit.for.almost.all.the.facili- ties.built.in.the.100-mile.flood.plain.were.not.accessible,.and.only.a.small. amount.of.material.got.into.and.out.of.the.facil.ities,.subsequently.affect- ing. downstream. contractors. and. original. equipment. manufacturers.. Be. aware.that.some.policies.only.cover.losses.due.to.disruptions.at.the.facility.

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90 • Supply Chain Risk Management: An Emerging Discipline

of. a. “direct”. supplier. or. customer.. This. implies. only. first-.tier. suppliers. or.direct.customers..Coverage.within.this.solution.should.be.thoroughly. evaluated.by.the.insured.and.perhaps.their.insurer.on.a.regular.basis.

Cargo insurance

This.coverage.is.common.considering.the.vast.amount.of.goods.that.are. transported..It.covers.damage.to.or.theft.of.the.goods.while.in.transit.via. air,.ground,.or.water..For.one.example,.containerization.has.grown.expo- nentially. due. to. global. trade. growth. across. all. industries. as. well. as. the. development. of. megaships. that. can. move. thousands. of. containers. at. a. time..One.of.the.most.frequent.claims.involving.containers.involves.theft,. with.an.estimated.$30.billion.in.losses.being.reported.annually.over.the. last.several.years..This.coverage.protects.goods.on.ships,.on.trains,.at.air- ports,.and.virtually.anywhere.goods.are.in.transit.

Cyber insurance

Cybercrime.is.increasing.in.frequency.and.is.a.growing.concern.for.supply. chain.managers,.CIOs,.and.CFOs.around.the.globe..Why?.Because.when. a.company’s.IT.system.is.down,.the.company.is.not.taking.orders,.making. products,.shipping.products,.or.billing.customers..In.short,.the.company. is.not.functioning..That.constitutes.a.disruption..And.let’s.not.forget.the. seemingly.endless.stories.of.cybertheft.

This. form. of. coverage. is. still. in. its. infancy. but. has. been. used. already. with. high-.profile. incidents. with. retail. and. consumer. goods. companies.. The. key. to. reviewing. this. type. of. risk. coverage. is. to. not. only. consider. the.impact.on.the.insured.organization,.but.also.the.impact.on.suppliers,. customers,. and. their. customers.. These. insurance. packages. will. grow. in. stature.and.complexity.for.many.years.to.come.

Business interruption insurance

According. to. the. American. Insurance. Association,. business. interruption. coverage. is. part. of. broader. commercial. insurance. policies.3. This. coverage. is.most.commonly.found.in.commercial.property.insurance.policies.and.is. triggered.when.one.of.more.of.the.following.conditions.are.met:.First,.physi- cal. damage. to. the. premises. is. of. such. magnitude. that. the. business. must. suspend.its.operations..Second,.the.physical.damage.to.property.caused.by.a.

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Hazard Risk • 91

loss.is.covered.under.a.company’s.insurance.policy,.and.that.damage.totally. or. partially. prevents. customers. or. employees. from. gaining. access. to. the. business.. And. third,. the. government. shuts. down. an. area. due. to. property. damage. caused. by. a. peril. covered. by. the. company’s. insurance. policy. that. prevents.customers.or.employees.from.gaining.access.to.the.premises.

Something. to. keep. in. mind. is. that. business. interruption. coverage. is. limited..After.a.mandatory.waiting.period,.coverage.provides.for.lost.net. income,. relocation. expenses. to. a. temporary. site,. and. ongoing. expenses. such.as.payroll..Coverage.is.available.only.for.as.long.as.it.is.necessary.to. get.a.business.running.again,.usually.not.longer.than.12 months.

Contingent Business interruption insurance

According. to. Zurich. Insurance,. contingent. business. interruption. (CBI). insurance.“reimburses.a.company.for.lost.profits.and.other.possible.trans- ferred.risks,.such.as.necessary.continuing.expenses,.due.to.an.insurable.loss. suffered.by.one.or.more.of.its.suppliers.or.customers.”4.Recall.that.traditional. business.interruption.insurance.compensates.policyholders.for.losses.result- ing. from. damage. to. their. own. property.. Contingent. business. interruption. insurance.allows.a.policyholder.to.transfer.certain.risk.losses.to.a.third.party.. This.type.of.insurance.is.also.commonly.referred.to.as.dependent.properties. coverage..Similar.to.business.interruption.insurance,.CBI.is.triggered.by.cer- tain.events.such.as.a.direct.physical.loss.or.damage.to.a.dependent.property. (supplier.or.customer),.the.loss.or.damage.is.caused.by.a.covered.cause.of.loss,. and.the.loss.results.in.a.suspension.of.operations.at.a.covered.location.

trade disruption insurance

Trade.disruption.insurance.protects.against.lost.profits.caused.by.disrup- tions.in.the.supply.chain.where.there.is.no.physical.loss.or.damage.to.the. insured’s.or.its.suppliers’.assets..It.normally.covers.property,.marine,.and. political. risk.. Again,. physical. loss. is. not. required. and. the. loss. does. not. need.to.be.location.specific..It.normally.covers.a.loss.for.up.to.12 months. resulting.from.termination.of.a.project.or.nondelivery.of.goods,.in.areas. such. as. loss. of. profits,. extra. costs,. and. expenses.. This. product. normally. fills. gaps. in. coverage. left. open. by. other. solutions. such. as. business. inter- ruption.or.cargo.insurance..It.also.tends.to.cover.losses.from.political.and. economic. exposures. such. as. confiscation,. expropriation,. or. nationaliza- tion.of.the.insured’s.assets.

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92 • Supply Chain Risk Management: An Emerging Discipline

Also.included.in.trade.disruption.insurance.is.a.law/.order.decree.result- ing. in. something. called. selective discrimination—forced. abandonment. of. a. provider;. forced. divestiture;. and. cancelation. of. licenses,. operating. permits,. or. concessions.. And. finally,. it. tends. to. cover. political. violence,. including.war,.insurrection,.strikes,.riots,.terrorism,.and.civil.commotion.. If.the.insured.purchases.or.produces.product.overseas.and.if.payments.are. made.locally.in.that.country,.coverage.can.include.currency.inconvertibil- ity. (currency. conversion. and. exchange. transfer). that. can. protect. against. repatriation.of.profits,.dividends,.and.other.remittances.

This.product.has.been.well.received..It.provides.many.benefits.in.terms. of.risk.mitigation,.including.immediate.protection.for.emerging.markets. with.a.global.scope.of.coverage.5

global logistics insurance

A.final.coverage.we’d.like.to.address.is.global.logistics.insurance,.a.deriva- tion. of. the. cargo. insurance. profiled. earlier.. Because. most. supply. chains. are. now. global,. coverage. packages. have. expanded. to. insure. additional. threats.or.points.of.peril.due.to.worldwide.operations..Just.as.contingent. business.interruption.insurance.has.expanded.beyond.the.original.scope. of.regular.business.interruption.insurance,.so.too.has.insurance.expanded. to. include. additional. elements. and. activities. within. a. worldwide. supply. chain.. A. sample. of. the. additional. kinds. of. global. logistic. insurance. that. are.available.includes.the.following:

•. Importers.and.shippers.can.purchase.insurance.for.cargo.and.for.cus- toms.bonds..A.customs.bond.is.a type of insurance that.someone.who. is importing goods must.have,.in.which.they promise to pay any nec- essary taxes and obey the rules for importing goods.6

•. Factories.can.acquire.property/.casualty.insurance.along.with.bailee. liability.protection..A.bailee.is.a.person.or.party.to.whom.goods.are. delivered.for.a.purpose,.such.as.custody.or.repair,.without.transfer.of. ownership..A.bailee.possesses.property.that.belongs.to.someone.else.

•. Freight.forwarders.and.shipper’s.interests.can.be.covered.along.with. the.availability.of.cargo,.bailee.liability.protection,.and.professional. liability.protection.

•. Consolidators. can. purchase. cargo. liability. for. bills. of. lading. and. warehouse.receipts.

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Hazard Risk • 93

•. Foreign.ports.and.terminal.operators.can.secure.coverage.for.work- ers’. compensation,. terminal. operator. liability,. property. coverage,. and. stevedore. liability. (a. stevedore. is. a. person. employed. or. a. con- tractor.engaged.at.a.dock.to.load.and.unload.cargo.from.ships).

•. Ocean.carriers.can.obtain.hull.insurance. •. Customs.brokers.can.obtain.customs.bonds. •. U.S..ports.and.terminals.can.obtain.coverage.for.stevedore.liability,.

operator.liability,.and.property.protection. •. Trucking. companies. and. rail. lines. can. add. motor. truck. liability,.

shipper’s.cargo.insurance,.and.bailee.liability.protection.

Before. we. provide. additional. context. into. how. insurers. evaluate. and. quantify.the.coverage.we.discussed.earlier,.we.felt.it.would.be.beneficial.to. explore.the.level.of.underinsured.nations.exposed.to.disasters..The.Center. for.Economic.and.Business.Research.(CEBR).and.Lloyd’s.of.London.col- laborated.on.a.research.project.to.identify.insurance.coverage.associated. with.countries.rather.than.companies.7.The.research.methodology.focused. on.the.amount.of.money.spent.on.insurance.premiums,.which.was.then. subtracted. from. the. expected. loss. from. natural. disasters.. That. outcome. was. then. adjusted. to. account. for. differences. in. gross. domestic. product. (GDP).levels.and.then.benchmarked.as.a.percentage.of.the.country’s.GDP.

This.research.revealed.that.17.countries.were.“significantly.underinsured”. and.that.these.countries.had.a.combined.average.annual.insurance.short- fall.of.more.than.$168.billion..Of.the.17.countries.on.Lloyd’s.underinsured. list,.8.are.in.Asia..China.alone.is.underinsured.by.more.than.$79.billion,. making.it.the.largest.underinsured.country.in.the.study..Table 5.1.profiles. the.outcome.of.the.research.in.terms.of.the.worst.underinsured.countries. to.the.most.insured.

This. research. revealed. additional. troubling. issues. as. it. pertains. to. reviewing.natural.disasters.and.their.impacts.on.both.businesses.and.the. public..The.death.toll.from.the.2004.Indian.Ocean.tsunami.was.220,000. people,. but. the. cost. to. the. insurance. industry. was. only. $1. billion.. A. Lloyd’s. of. London. insurance. chief. executive. stated. that. he. hoped. this. research.would.stimulate.a.debate.on.how.governments,.businesses,.and. the.insurance.industry.manage.the.risks.of.a.natural.catastrophe,.particu- larly.on.the.merits.of.risk.transfer.versus.the.use.of.public.funds.to.cover. costs..Lloyd’s.made.an.explicit.comparison.between.how.different.coun- tries.fund.disaster.recovery.and.concluded.that.countries.have.drastically.

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94 • Supply Chain Risk Management: An Emerging Discipline

different. approaches. to. disaster. readiness.. The. greatest. difference. is. the. amount.of.money.paid.by.taxpayers.toward.each.country’s.recovery.from. catastrophic.events.versus.funds.paid.by.insurance.carriers.

Quantifying tRaditiOnal hazaRd RiSk inSuRanCe ReQuiReMentS

As. we. mentioned. in. Chapter 1,. risk. appetite. reflects. the. degree. of. risk. that.an.organization.or.individual.is.willing.to.accept.or.take.in.pursuit.

taBle 5.1

Underinsured.Countries

Country Insurance Coverage Country

Insurance Coverage

Bangladesh –2.6 Russia 0.3 Indonesia –1.7 Japan 0.4 Vietnam –1.4 Israel 0.4 Philippines –1.4 France 0.4 Egypt –1.4 Sweden 0.4 Turkey –1.3 Argentina 0.4 India –1.2 Italy 0.6 Nigeria –1.1 Ireland 0.8 China –1.1 South.Africa 1.0 Chile –1.0 Taiwan 1.0 Saudi.Arabia –0.9 Spain 1.1 Mexico –0.7 Denmark 1.4 Brazil –0.5 Australia 1.4 Thailand –0.4 UK 1.6 Colombia –0.2 Austria 1.7 Poland –0.2 Germany 2.1 Hong.Kong 0.0 USA 2.5 Singapore 0.1 Canada 2.5 UAE 0.1 South.Korea 2.6 Malaysia 0.2 New.Zealand 3.1 Norway 0.3 Netherlands 8.0

Source:. RIMS Magazine,. “Underinsured. Nations. Exposed. to. Disasters,”.Emily.Holbrook,.March.2013.

Note:. These.are.relative.rankings:.Negative.values.mean.signifi- cantly. underinsured. as. a. country;. positive. values. mean. better.insured.

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Hazard Risk • 95

of.its.objectives..This.can.be.measured.in.terms.of.both.quantitative.and. qualitative.dimensions..Some.also.refer.to.this.concept.as.risk tolerance or. risk propensity,.a.topic.that.is.well.grounded.in.the.financial.community.. Finance. experts. view. risk. appetite. as. reflecting. the. type. of. risk. that. an. institution. or. individual. is. willing. to. undertake. in. pursuit. of. a. desired. financial. performance.. Calculating. a. risk. appetite. in. financial. terms. is. what. the. insurance. industry. calls. a. risk quantification engagement.. This. engagement.is.a.key.element.of.the.insurance.industry’s.approach.to.decid- ing.whether.a.client.has.too.much.or.not.enough.insurance.based.on.an. assessment.of.that.company’s.risk.tolerance,.risk.policies,.and.programs.

This. section. of. the. chapter. discusses. what. a. typical. quantification. engagement. looks. and. feels. like. and. the. outcome. from. those. types. of. assessment.projects..The.integrated.insurance.cycle.includes.an.“as-.is”.or. risk.quantification,.leading.to.a.potential.new.set.of.insurance.solutions,. possibly. through. stress. testing,. then. an. execution. phase,. and. finally. an. operational.mapping.and.risk.identification.phase..For.purposes.of.illus- tration,.we’ll.concentrate.on.the.first.phase,.which.is.risk.quantification.

The.backdrop.to.this.engagement.normally.begins.with.an.internal.dia- logue,.sometimes.driven.by.the.chief.risk.officer.or.the.CFO’s.office,.revolv- ing.around.the.question.of.enterprise.risk.exposure.and.the.review.of.total. insurable.values..This.dialogue.pits.the.total.insurable.values.against.the. amount.of.interruption.and.other.insurance.coverage.the.company.has.in. place.. The. dialogue. is. basically. driven. by. whatever. discipline. or. depart- ment.is.responsible.for.enterprise.risk.management.

The. initial. in-.house. meeting. usually. moves. quickly. into. a. set. of. ques- tions. of. discovery. such. as,. Is. there. a. difference. between. our. reporting. values.to.our.underwriters.and.our.reporting.exposures.to.management?. The.dialogue.should.cover.additional.points.such.as,.What.is.our.present. premium.expense?.What.are.our.present.policy.limits.and.sublimits?.Have. all.our.exposures.been.identified?.These.exposures.are.generally.discussed. and. can. address. areas. such. as. a. company’s. global. markets,. divisions,. products.and.services,.facilities.within.the.supply.chain,.the.supplier.base,. IT. systems,. and. intellectual. property.. The. discussion. then. migrates. into. additional.executive.questions.such.as,.What.does.our.business.continuity. plan.(BCP).look.like?.Have.we.exercised.our.BCP,.and.if.we.have,.how.did. it. play. out?. Do. we. need. to. update. our. BCP?. When. these. questions. have. been.answered,.the.CFO’s.office.or.a.divisional.controller.might.make.the. injection.that.an.existing.insurer.or.another.third.party.should.be.brought.

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96 • Supply Chain Risk Management: An Emerging Discipline

in.to.provide.a.risk.quantification.analysis..When.that.decision.is.made,. the.as-.is.portion.of.a.risk.quantification.engagement.commences.

The. complexion. of. a. typical. risk. quantification. engagement. often. involves.a.kickoff.meeting.with.executives.from.several.disciplines.or.divi- sions..The.meeting.objectives.and.agenda.are.not.at.all.trivial..In.fact,.this. process.can.be.quite.complex..This.process,.starting.at.the.kickoff.meet- ing.but.extending.into.subsequent.meetings.and.assignments,.will.involve. a.review.of.existing.insurance.coverage.across.an.enterprise.or.division,.a. review.of.product.sales.and.margins.through.forensic.accounting.of.profit-. and-.loss. statements,. a. discussion. of. new. products. and. services. and. for- ward.marketing.strategies.for.the.next.several.years,.and.the.identification. of.products.or.portfolios.with.the.highest.contribution.and.risk.

This. part. of. the. quantification. process. should. include. what- if. scenar- ios. to. stress. test. a. company’s. operational. processes.. Frequent. meetings. occur. to. report. on. evaluations. and. recommendations.. Risk. quantifica- tion. engagements. can. take. anywhere. from. 8. to. 15 weeks,. based. on. the. scope. and. scale.. A. divisional. analysis. will. invariably. be. shorter. than. an. enterprise-.wide.analysis.

The.focus.again.is.normally.to.first.establish.a.maximum.foreseeable.loss. (MFL).for.the.division.or.enterprise..The.MFL.equals.the.worst.scenario. from.the.what-.if.scenarios..The.typical.MFL.includes.five.key.components:. the. products’. contribution. margin,. existing. mitigation. plans,. finished. or. work-.in-.progress. inventory,. tax. impacts,. and. expected. continuing. expenses.for.the.duration.of.a.loss.

Upon.agreement.on.and.analysis.of.the.MFL.definitions,.the.next.step. in.the.engagement.is.normally.the.detailed.examination.of.a.plant,.a.divi- sion.with.all.its.facilities,.or.the.entire.enterprise..For.illustration.purposes. we’ll. discuss. an. engagement. involving. a. division. with. several. facilities.. We’ll.use.Figure 5.2.as.a.reference.to.describe.the.basic.elements.of.a.risk. quantification.engagement.

The.basic.steps.are.exercised.for.every.fixed.asset.in.the.project,.which. Figure 5.2.illustrates..Let’s.take.a.more.detailed.walk.through.this.figure:

. 1.. Calculation.of.value-.at-.risk.(VAR).first.takes.place..This.is.normally. the.annual.profits.for.the.asset.or.division.under.scrutiny.

. 2.. A. primary. backup. plan. or. site. is. usually. identified. if. the. asset. is. a. plant. or. a. contractor.. This. backup. plan. tends. to. reduce. the. over- all.VAR.

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Hazard Risk • 97

. 3.. Any. additional. backup. facilities. identified. will. further. reduce. the.VAR.

. 4.. Any.contract.penalties.for.service.delays.for.existing.and.future.cus- tomer.contracts.are.identified.and.will.potentially.increase.the.VAR.

. 5.. Any.continuing.expenses.during.the.recovery.period.are.identified,. codified,.and.assigned.to.the.overall.VAR.

. 6.. Any.tax.impacts.are.calculated.based.on.the.time-.to-.recovery.(T-.t-R). metric. identified. in. the. business. continuity. plan. or. scenario. plans,. which.will.also.increase.the.VAR.

. 7.. Any.inventory.in.the.pipeline.and.supply.chain.will.reduce.and.miti- gate.the.VAR.during.the.T-.t-R.period.

. 8.. Any. new. mitigation. strategy. costs. to. be. incurred. will. increase. the. overall.VAR.

. 9.. Finally,.on.the.far.right.of.Figure 5.2.is.the.final.mitigated.VAR.for. that.particular.asset.or.product.or.division.

As. the. quantification. project. plays. out,. the. ultimate. goal. is. to. identify. what. the. maximum. foreseeable. loss. might. be,. compare. that. to. the. risk. appetite. or. tolerance. of. the. organization. based. on. their. present. level. of.

Value at risk (VaR)

Spain TPM Ramp up 20%

Production (60 Days)

Ireland 50% capacity 6 months to come online

Contract Penalties

($10 MM)

Expenses Continuing

Boston & DC ($60 MM)

Tax impact

($200 MM)

Inventory ($500 MM)

Mitigation Strategy

Cost ($5 MM)

Mitigated VaR

$675 MM $675 MM

$670 MM

$970 MM

$910 MM

$900 MM

$1.4 BB

$6 00

M M

$5 00

M M

$2 00

M M

$5 00

M M

$1.17 BB

$2 BB

figuRe 5.2 The. risk. quantification. engagement.. (Source:. Eric. Wieczorek,. former. risk. director-. navigant,. “Supply. Chain. Risk. Management”. presentation. at. MAPI,. Manufacturing. Alliance.for.Productivity.&.Innovation’s.Council.Meeting,.2013.)

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98 • Supply Chain Risk Management: An Emerging Discipline

insurance. coverage,. and. decide. if. it’s. prudent. to. increase. coverage. or. reduce.coverage.

The. output. of. this. engagement. is. illustrated. in. Figure 5.3.. The. risk. levels.are.articulated.on.the.left.or.Y.axis,.low.to.high,.and.the.nodes.or. assets. within. the. scope. of. the. project. are. identified. on. the. X. axis.. The. units.of.measure.normally.used.in.these.engagements.are.either.annually. demonstrated.profits.or.planned.annual.budgeted.profits.going.forward.. There. are. normally. two. pillars. for. each. node. or. asset.. The. first. pillar,. or. the.darker.shaded.one,.is.the.unmitigated.exposure.or.VAR..Unmitigated. risk,.in.insurance.terms,.generally.means.that.the.profit.plan.for.this.par- ticular.asset.has.no.risk.response.plan,.as.the.insurance.investigators.see. it,.in.the.event.of.a.disruption.and.is.therefore.at.risk..The.second.pillar,. the.lighter.shaded.one,.is.the.mitigated.exposure.or.VAR..Again,.in.insur- ance.terms,.this.column.represents.the.mitigated.exposure.for.this.asset,. which.normally.means.a.risk.response.plan.has.been.developed.to.ensure. that.profits.continue.in.the.event.of.a.disruption.and.is.supported.by.some. type.of.insurance.coverage..Both.columns.profile.the.profit.exposure.and. neither. eliminate. risk.. However,. the. lighter. shaded,. mitigated. columns. depict. a. reduced. exposure. to. risk. for. the. organization.. The. line. passing. horizontally.across.the.entire.graph.is.the.present.property,.tort.liability,.

0.5

1.5

2.5

3.5

4.5

Plant 1 Plant 2 Plant 3 Contractor

Ri sk

E xp

os ur

e –

V aR

Unmitigated exposure Mitigated exposure

Risk Appetite Coverage

figuRe 5.3 Risk. quantification. output.. (Source:. Eric. Wieczorek,. former. risk. director-.navigant,. “Supply. Chain. Risk. Management”. presentation. at. MAPI,. Manufacturing. Alliance. for. Productivity.&.Innovation’s.Council.Meeting,.2013.)

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continuity.business.interruption,.and.other.insurance.coverage.the.com- pany.maintains.at.the.time.of.the.quantification.risk.engagement.

The.final,.difficult.portion.of.these.engagements.is.to.discuss.what.prod- ucts,. services,. plants,. or. divisions. have. an. exposure. above. the. coverage. line.or.risk.appetite.line..The.insurance.industry.regularly.uses.the.term. risk appetite.to.denote.the.amount.of.insurance.coverage.a.company.has. paid.for.to.recoup.losses.or.damages,.based.on.the.risks.the.company.sees. and.how.aggressive.they.want.to.be.in.terms.of.taking.risks.and.support- ing.those.risks.with.mitigation.plans.and.insurance..As.seen.in.Figure 5.3,. when.exposure.or.VAR.lies.above.the.coverage.of.risk.appetite.line,.that. situation.drives.the.dialogue.between.the.organization.and.its.insurer.or. consultancy. in. an. attempt. to. decide. on. the. next. steps.. Those. next. steps. normally.include.spending.time.and.funds.to.develop.more.robust.miti- gation.policies,.procedures,.and.programs.or.increasing.coverage.to.miti- gate.the.exposure.and.risk..A.company.can.also.elect.to.assume.some.risk. through.self-.insurance..And.finally,.scanning.Figure 5.3.and.viewing.the. differences.in.column.heights,.we’ll.attempt.to.provide.a.brief.explanation. in.the.context.of.these.quantification.tools.and.techniques.

The.difference.in.column.heights,.which.is.profit.exposure.or.VAR,.per. asset,.is.the.difference.between.VAR.exposure.identified.without.or.with. risk.mitigation.strategies.in.place.by.the.company..For.instance,.for.Plant.1,. there.is.obviously.a.set.of.mitigation.plans.in.place.to.be.used.in.the.event. that.the.plant.is.disrupted,.because.the.lighter.shaded.column.(mitigated). has. much. less. VAR. or. exposure. than. the. dark. or. unmitigated. column.. When.the.insurance.experts.complete.the.engagement,.they.calculate.the. total. company. VAR. or. exposure. versus. the. amount. of. insurance. cover- age. the. company. maintains. at. the. time. of. the. engagement. and. use. the. horizontal. line. to. “make. a. point”. about. what. assets. have. more. VAR. or. exposure.than.the.amount.of.insurance.coverage..The.bottom.line.of.a.risk. quantification.engagement.is.to.discern.whether.a.company.has.too.much. or.not.enough.insurance.based.on.the.risks.identified,.mitigation.plans.in. place.and.the.company’s.risk.appetite,.which.is.indicative.of.their.existing. coverage.level.

Outcomes. from. this. type. of. financial. risk. quantification. engagements. and.the.benefits.tend.to.be.as.follows:

•. The.calculation.of.maximum.foreseeable.losses •. A.root.cause.analysis.that.highlights.risk.exposure

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100 • Supply Chain Risk Management: An Emerging Discipline

•. A.definitive.picture.of.risks.and.a.compelling.reason.to.act.to.either. mitigate.those.risks,.temporarily.or.permanently,.by.buying.more.or. less.insurance,.better.prepare.for.disruptions.or.other.risks,.or.con- tinue.to.investigate.how.to.mitigate.the.risks

•. Assistance. in. obtaining. capital. funding. for. building. redundancy. and.resiliency.within.the.supply.chain

•. A.positive.restructuring.of.the.insurance.portfolio

lOOking at the thai flOOdS thROugh a RiSk QuantifiCatiOn pRiSM

Let’s.finish.this.chapter.by.revisiting.the.floods.in.Thailand.that.were.men- tioned.at.the.start.of.the.chapter,.looking.through.the.prism.of.risk.quan- tification.of.what.insurers.might.have.recommended.if.they.were.asked.to. review.the.supplier.base.by.the.original.equipment.manufacturers.(OEMs).. First,.let’s.focus.on.the.event.itself..The.disaster.followed.with.precision.the. four.stages.of.a.disaster,.which.are.denial,.severity,.blame,.and.resolution.

During. the. denial. phase,. several. days. after. the. event,. the. media. were. told. that. minor. disruptions. would. occur. due. to. logistical. issues.. Aside. from. that,. business. would. continue. thanks. to. inventory. in. the. supply. chain..Next,.about.a.month.later.the.media.began.to.hear.and.report.on. the. severity. of. the. situation.. It. became. evident. that. industries. would. see. supply.shortages.cause.by.the.destruction.of.the.work-.in-.progress.inven- tory.at.the.time.of.the.event.

In. the. next. phase,. the. media. heard. about. blame. as. industries. faced. further. shortages. due. to. reduced. production. capacity. as. a. result. of. pro- duction. assets. destroyed,. factories. being. unable. to. restart. due. to. power. supply. limitations,. or. a. lack. of. raw. materials. from. their. own. suppliers.. Finally,. industry. members. were. saying. after. six. months. from. the. initial. event. that. we. would. see. further. constraints. while. destroyed. assets. and. factories. got. repaired. or. replaced. and. new. capacity. came. online.. This. is. the.resolution.phase.

What.was.going.on.during.this.event.behind.the.scenes?.Firms.directly. hit.by.the.supply.disruption.were.frantically.canceling.orders.and.attempt- ing.to.book.orders.from.alternate.suppliers..Unfortunately,.manufacturing. capacity.was.already.scarce.before.the.event..And,.qualifying.and.testing.

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Hazard Risk • 101

parts. from. new. suppliers. is. time. and. resource. intensive.. Many. alternate. suppliers. identified. after. the. flood. were,. unfortunately,. also. located. in. the.same.flood.plain.region.of.Thailand.(Chapter 12.will.discuss.the.dark. side. of. these. industrial. clusters).. Furthermore,. manufacturing. yield. and. quality. with. new. suppliers. proved. not. to. be. the. same. as. with. qualified,. incumbent.suppliers..The.inevitable.outcome.from.this.scarcity.of.supply. was.a.dramatic.increase.in.prices.across.a.range.of.industries.

With. the. benefit. of. hindsight,. what. could. insurers. or. consultancy. organizations. have. done. if. they. were. asked. to. exercise. a. risk. quantifica- tion. engagement?. Prior. to. the. event,. insurers. or. risk. consultants. would. have.exercised.a.risk.identification,.an.as-.is.analysis,.and.a.quantification. engagement.. They. would. have. performed. a. thorough. evaluation. of. the. supply.base.and.would.have.seen.the.exposure.in.terms.of.capacity,.asset. liability,.and.especially.the.geography.and.location.of.the.entire.industry. supplier.base.

As.the.event.unfolded,.the.OEMs,.at.the.insistence.of.their.risk.experts,. could.have.rapidly.activated.a.previously.tested.business.continuity.plan,. which.would.have.included.secondary.suppliers.identified.through.the.risk. quantification.exercise..Presumably,.these.suppliers.would.be.located.out- side.the.impact.zone..These.companies.would.have.also.leveraged.certain. articles.inside.their.newly.purchased.contingent.business.interruption.and. trade.disruption.insurance.coverage.packages.that.emanated.from.the.risk. quantification.exercise.

After.the.event.the.OEMs.would.also.have.performed.a.post-event.anal- ysis.and.improved.their.initial.risk.plans.through.lessons.learned..These. companies.might.also.have.bolstered.their.mitigation.plans.and.insurance. coverage.as.well.

COnCluding thOughtS

Traditional.hazard.risk.has.been.with.us.since.the.dawn.of.time.and.will. be. present. until. the. end. of. time.. One. of. the. best. ways,. but. not. the. only. way,. to. mitigate. these. risks. has. been. insurance. coverage.. Many. existing. and. emerging. packages. are. becoming. available. every. day.. Between. the. coverage. instruments. and. the. sophistication. of. insurers’. risk. quantifica- tion. capabilities,. it. might. be. wise. to. consider. these. mitigation. packages.

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102 • Supply Chain Risk Management: An Emerging Discipline

and.processes.on.a.regular.basis.as.supply.chains.become.more.uncertain. and.complex.

Summary of key points

•. Traditional.hazard.risk.pertains.to.random.disruptions,.liability.torts,. property.damage,.and.natural.disasters.that.are.outside.of.our.control.

•. Many.of.these.traditional.hazards.can.be.mitigated.through.the.pur- chase.of.insurance.coverage.

•. Many.insurance.packages.are.in.existence.today.that.cover.risk.events. such.as.credit,.political.risk,.property,.trade.disruption,.and.logistics.

•. Many. of. these. risk. transfer. instruments. will. compensate. compa- nies.for.loss.of.profits,.supplier.insolvency,.payment.default,.contract. issues,. expropriation. of. assets,. property. replacement,. continuing. expenses.in.the.wake.of.a.risk.event,.and.damage.to.or.theft.of.goods. in.transit.

•. Insurers. traditionally. utilize. a. methodology. called. risk. quantifica- tion. to. rigorously. evaluate. a. company’s. as-.is. state. of. risk. exposure. versus. their. present. amount. of. insurance. coverage. in. an. effort. to. evaluate.the.company’s.risk.appetite.and.then.provide.insurance.rec- ommendations.for.action.to.mitigate.those.risks.

endnOteS

. 1.. Adapted. from. several. Reuters. articles,. Japan. Automakers. Association,. Nissan. Manufacturers.Association,.and.the.BBC.Co.,.UK..

. 2.. Accessed.from.Webster’s.Dictionary..

. 3.. Adapted.from.the.American.Insurance.Association,.accessed.from.http://www.aiadc. org/.AIAdotNET/.docHandler.aspx?DocID=287081..

. 4.. Adapted. from. http://www.zurichcanada.com/.internet/.can/.SiteCollectionDocuments/. English/.Contingent-.Business-.Interruption-.Canada..pdf..

. 5.. Adapted. from. AON. CSCMP. Roundtable. Discussion,. 2012,. and. Supply Chain Management Review.blog.with.Linda.Kornfield,.Supply.Chain.Insurance,.2013..

. 6.. Accessed.from.http://dictionary.cambridge.org/..us/..dictionary/..business-..english/. .customs-.bond..

. 7.. Holbrook,. Emily.. “Underinsured. Nations. Exposed. to. Disasters.”. RIMS Magazine,. March.2013.

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