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Business interruption: an invisible threat that causes very visible losses

  • Allianz study explores new risks for businesses from streamlined global supply chains
  • Natural disasters prompt companies to re-examine the trade-off between just-in-time logistics and supply chain redundancy

PRESS RELEASE - Munich. November 7, 2012

Manhattan’s streets and subways are under water, buildings have been severely damaged, millions of household and businesses have lost power for days. While it sounds like a scene from a fictional movie, the losses caused by hurricane Sandy are very real. For businesses, material damage is only one element of the loss; financial losses following operational disruptions and production shutdowns can far exceed those amounts.

The knock-on effect of such an event will be far-reaching. Business interruption and contingent business interruption (CBI) – which provides insurance cover in the event of a failure of a key supplier caused by physical damage – typically account for 50 to 70 percent of overall catastrophe losses in the corporate insurance segment, according to Allianz Global Corporate & Specialty (AGCS). In light of this, a new study “Managing Disruptions” released by the corporate insurance specialist explores how businesses and insurers are re-examining their exposures to business interruption and supply chain risk.

While insurance will provide cover for most of the financial losses that a business or key supplier suffers after a disruption, business interruption insurance can only partially offset the hit on companies' operating earnings. Also, it cannot mitigate long-term effects that might undermine corporate performance, such as a decline in investor confidence. “Getting back to normal business and restarting production as soon as possible is the key priority for any company suffering a business interruption,” explains Volker Muench, Global Head of Strategy and Development Property at AGCS.

If a fire or natural disaster puts a company out of business, the loss is calculable and relatively limited. However, if that company is a key supplier for a particular industry, the ripple effects could be felt globally across that whole industry and trigger multiple insured supply-chain related losses.

Global computer manufacturers faced this problem in November 2011 when flooding hit Thailand and key component suppliers were forced to shut down. Computer manufacturers in the United States experienced supply bottlenecks as global production of hard drives plunged by roughly one-third in the fourth quarter of 2011.“The Thai flood demonstrated how vulnerable global supply chains have become; we have seen a new dimension of CBI losses,” says Andreas Shell, Global Head of Claims Short-tail at AGCS.

Adding back redundancy
“The very flexibility that provides a modern supply chain with its cost advantages has also caused its inherent vulnerability,” says Paul Carter, Global Head of Risk Consulting at AGCS. He adds that today, companies are increasingly re-examining the trade-off between efficiency and operational redundancy. To improve supply chain resilience companies should consider adding back some redundancy into lean supply chains, even if this reversal of widely used single-supplier sourcing incurs additional costs.

AGCS recommends that companies identify and list critical suppliers, determine the location of their global production sites and then evaluate their susceptibility to natural disasters. “If the production facilities of a key supplier are located in regions of Asia which are prone to flooding or earthquakes, a company should look for a second alternative ideally in another region such as Eastern Europe,” the AGCS risk engineer explains.

Another essential step to prepare for disruptions and mitigate their effects is to develop and regularly test solid business continuity plans. Further, a company should not limit this contingency planning to its own operations; it should also involve its key suppliers as well. “Checking a supplier’s own business continuity planning should be embedded in the selection process and ideally include even the suppliers of the primary suppliers,” Carter says. However, companies today are not routinely making these checks, according to the Business Continuity Institute’s Supply Chain Resilience survey of 2011, which found that only 7 % of respondents confirmed that their critical suppliers had business continuity plans in place.

More information required
Insurance companies are also interested in receiving more information about their insureds’ supply chain risk management as a way of better managing their own portfolio. They are particularly concerned about supplier clusters in the automotive and semiconductor industries. “A natural disaster could hit many of our policyholders so we have to make sure that we do not write coverage for an excessive number of suppliers within a geographical cluster,” Muench explains. “With global supply chains and production networks, assessing the accumulation of risk is a lot more complicated than it used to be.”


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