Can we insure every link in the supply chain?

Supply chain disruptions have played an outsized role in the global economy since the start of this decade.

They were a major cause of the inflationary surge that struck both advanced and emerging economies starting in 2021, as the pandemic and then the Russia-Ukraine war created supply bottlenecks, overburdened transport networks and physically closed down or destroyed infrastructure. The ongoing Gaza conflict has created new risks to shipping in and around the Red Sea.

In a presentation in July, Kera McDonald, chief underwriting officer at Swiss Re Corporate Solutions, said “it is estimated within a 10-year timeframe, supply chain disruption could erode close to half a year’s profits for corporates”. The same month, a faulty software update released by US cyber security provider CrowdStrike caused global IT outages, especially for airlines and airports.

Some observers and business leaders say a shorter supply chain is a stronger one, calling for production to be moved nearer to consumers. Others focus on developing a wider range of suppliers or reviving the practice of keeping bigger inventories on hand.

Insurers are certainly alive to the risks posed by supply chain disruptions. However, as Stephen Smyth, head of marine at SiriusPoint, points out, insurance can only compensate for discrete, quantifiable risks. A supply chain is a complex system, embedded within a network of other complex systems – so, however much insurers may want to make them more robust, there is only so much they can do.

The meaning of resilience

Smyth, who also heads SiriusPoint’s Lloyd’s syndicate 1945, says any discussion about what constitutes a “resilient” supply chain is complicated by the fact there is no common definition of either resilience or supply chain. Any understanding of the terms will vary from industry to industry and business to business. “They have to understand what the drivers of their supply chain risk are and it will be different for all of them,” he says.

Other industry figures are willing to venture definitions, usually equating resilience to the ability to keep production going and quickly recover from stoppages.

International Union of Marine Insurance (Iumi) executive committee member, Matthias Kirchner, cargo committee chair, Mike Brews, and vice-chair, Howard Potter, define a resilient supply chain as one that is able to “quickly adapt to disruptions while maintaining continuous operations and safeguarding its key processes”.

“Resilience implies the ability to withstand, respond to and recover from disruptions efficiently. It is characterised by flexibility, agility and robustness,” they add.

Ricardo González, Mapfre Economics

Ricardo González, director of sectoral and regulation research at Mapfre Economics, gives a similar definition: “A resilient supply chain could be defined as one able to ensure continuity of operations, respond effectively to disruptions and recover to normal performance levels in a short period of time.”

González says there are several quantitative resilience metrics, including “time to recovery, inventory levels, supplier risk scores [and] supplier diversification”, and adds some insurers and consultants have developed qualitative evaluation tools as well.

Rainer Stark, senior corporate underwriter at Munich Re, says “resilience, as the ability to withstand or quickly recover from unexpected supply chain disruptions, is largely characterised by the availability of mitigation options for the affected companies”. These may include keeping ample reserves and using multiple suppliers.

“A resilient supply chain could be defined as one able to ensure continuity of operations, respond effectively to disruptions and recover to normal performance levels in a short period of time”
_{Ricardo González
Mapfre Economics}

Iain Willis, research director at the Gallagher Research Centre, emphasises the need for “redundancy”, meaning having substitute suppliers and supply routes. “You build [resilience] into supply chains to make sure [for] any critical points of failure… you have other choices, you have other supply chain routes or you have diversified suppliers,” he says.

Insurtech managing general agent Loadsure describes its role as “insuring the supply chain through its unique holistic freight protection offering”. Its chief executive, Johnny McCord, says one way to measure resilience is by the number of resources a company commits to managing risk. “What’s most important for us in defining that resilient supply chain is obviously looking at where investment has been made in that active risk management practice,” he says.

Risk assessments

The difference between risk and uncertainty is risk can be measured and mapped. Ed Parker, departmental head of special risks at Tokio Marine Kiln, says observers can easily identify a company with a fragile supply chain from loss statistics. “Those that did their due diligence and protected themselves by having a number of potential suppliers find themselves in a strong position from a risk management perspective,” he tells Insurance Day.

Alastair Blundell, head of general insurance at the British Insurance Brokers’ Association, says “a supply chain must be visible and mapped out” – insurers must look past their immediate supply partners. “The supply chain has to be measurable and quantifiable if adequate insurance is to be purchased,” he says.

Iain Willis, Gallagher Research Centre

Stark agrees firms must have a global view of their supply chain and all its components. “Knowledge of the entire supply chain at all levels from the raw material to the end product (so-called sub-tier visibility or end-to-end visibility) is a prerequisite for recognising potential bottlenecks and being able to react quickly to challenges,” he says.

However, few businesses can do this effectively. Carlos Gomez, head of insurance at Generali Corporate & Commercial, and Pedro Ruano, head of claims, say: “Large companies generally understand who their tier 1 suppliers are, meaning those they buy from directly.” But understanding the supply matrix beyond this is “weaker”. “Few major companies know the reliance and possible impact of their full supply chain,” they say.

“You build [resilience] into supply chains to make sure [for] any critical points of failure… you have other choices, you have other supply chain routes or you have diversified suppliers”
_{Iain Willis
Gallagher Research Centre}

Although businesses may map their supply chains differently, Smyth says there is a common method for evaluating operational threats to them. He is referring to the Pestel framework, which examines political, economic, social, technological, environmental and legal risks.

Willis and his team map risks at a macro level before calculating the vulnerabilities faced by a single firm. His approach is to map risk by mapping potential threats, and then the supply infrastructure as a whole, data which he can then apply to assess the weaknesses in a single supply chain.

Where are risks greatest?

Smyth says supply chain risks are universal. “Resilience affects every business sector,” he says. Every business and organisation must “plan and then test the plan”.

However, some industries are more vulnerable than others. Multiple respondents mention the automotive industry as especially sensitive to supply chain disruptions. Iumi mentions industries that source parts from multiple international sources, like technology and automotive production; those which rely on “just-in-time” deliveries rather than inventories, like retail; and those where both conditions apply, like some kinds of manufacturing.

González mentions the automotive and retail sectors, alongside energy, construction and food and beverages processing, while Stark says the automotive sector is “the most vulnerable”, followed by electronics, pharmaceuticals and chemicals.

Amelia Lorenzo, head of foresight risk and modelling at Swiss Re, says “all sectors with long, complex and global supply chains are vulnerable”. McCord agrees. “The disruption primarily occurs in that sort of complex, multi-layered supply chain, where production is reliant on multiple suppliers across different locations around the world,” he tells Insurance Day. If production must be co-ordinated among different suppliers providing complementary components – McCord gives the example of a semiconductor for a car alarm – any failure in one part of the system can cause other parts of the production circuit to break down.

How to compensate

There are many ways to reduce supply chain risks. Some experts recommend using multiple suppliers for various components – the “redundancy” Willis mentions. Smyth gives the example of a UK mango chutney producer obtaining all its fruit from Madagascar, which then transports the crop with a single freighter.

The Iumi experts mention a number of strategies companies use to make supply chains more dependable, including contracting with suppliers in multiple countries or regions, increasing inventories of key inputs and the “increased use of automation and advanced manufacturing technologies to make local production more viable”.

Johnny McCord, Loadsure

But McCord points out automation carries its own risks, leaving key production, transport and administrative systems vulnerable to system failures or cyber attacks. He highlights the number of ransomware attacks on manufacturing and logistics concerns and hackers targeting energy company infrastructure.

Diversification may also be problematic, as some materials largely come from one country or supplier. Willis points out the war-torn Democratic Republic of the Congo, for example, provides most of the world’s cobalt. He adds global production and trade are often highly concentrated – one-quarter of China’s exports are from a single megalopolis: the Pearl River Delta area.

“What’s most important for us in defining that resilient supply chain is obviously looking at where investment has been made in that active risk management practice”
_{Johnny McCord
Loadsure}

Some observers believe companies will be able to address supply chain vulnerabilities through “nearshoring”, which is the practice of either moving manufacturing or obtaining inputs nearer to the home market. This avoids some transport disruptions and allows businesses to avoid potential geopolitical risk – for example, a firm may move production from China because of fears of trade wars or possible conflict with Taiwan.

González says many firms are adopting a “China plus-one” strategy, adding new manufacturing sites without abandoning China altogether. US firms are moving some production to Mexico. “However, this transition faces challenges such as underdeveloped infrastructure and transition costs, including the need for skilled labour and managing the transition from existing suppliers to new ones.”

Lorenzo agrees nearshoring is happening due to US-China trade disputes, but this has not had an appreciable impact on the co-dependence of the two global economic superpowers. “Besides, a full disentanglement, if at all possible, would be very costly,” Lorenzo adds, saying many potential destinations for firms exiting China are themselves becoming costlier places to produce. That cost, Willis says, means nearshoring or reshoring are more often strategies for very large companies, like automakers or tech giants such as Apple.

Most companies have looked into nearshoring production, Smyth says, and some have moved their production. However, moving production can be enormously costly, given the need for new capital investments, workforce training and the potential that quality could at least temporarily decline. “It’s something that I think we will continue to see, but I can’t see it being widespread,” Smyth adds.

Role (and limitations) of insurance

Insurance is a vital guard against specific adverse events. In Smyth’s mango chutney example, should the mangoes go down with the freighter, the insurers can provide cash to purchase more mangoes. What insurers cannot do is cover the myriad contingent and systemic risks that collectively threaten the resilience of a supply chain or the diffuse losses that may – often indirectly – result from them.

Iumi’s experts, for example, point out marine insurance is only proof against physical losses. It does not apply “for purely economic losses such as those caused by supply chain interruptions” without some connection to tangible damage to hull or cargo.

Amelia Lorenzo, Swiss Re

Stark agrees insurance cannot provide total protection against a systemic supply chain failure. “If ‘sufficient insurance’ is taken to mean a full cover for worst-case scenarios, the insurance cannot usually compensate for the full financial impact of such an event,” he says.

Some categories of risk are simply beyond what insurers can cover. “For example, cyber war and conventional war are largely excluded. Pandemic risk [is] also uninsurable,” Blundell says.

Willis says business interruption insurance – which corporations commonly buy – will pay out for prolonged stoppages if there is a direct cause and effect relationship between the peril and the stoppage. This is useful when a storm hits a factory.

“The disruption primarily occurs in that sort of complex, multi-layered supply chain, where production is reliant on multiple suppliers across different locations around the world”
_{Amelia Lorenzo
Swiss Re}

However, business interruption insurance will not cover indirect perils and supply chain disruption often falls into this category – that is, if a storm knocks out a supplier’s factory, tough luck. In those cases, businesses need contingent business interruption insurance, but many companies “don’t purchase it because they’re not aware of their policy terms as well as they could be”, he says.

Willis adds: “I think definitely there’s an educational piece there for the insurance industry and for advisers like us.”

There is also trade disruption insurance, Smyth adds, but it is very rare, with “very limited appetite in the market”. There are almost innumerable ways a supply chain can get tangled, so this kind of cover is “very hard to model”.

Thus, broadly speaking, companies will often lack sufficient cover to secure their supply chains. “We don’t think in general terms major companies will carry enough insurance to compensate for supply chain disruptions,” Gomez and Ruano say. “All markets could be undersubscribed because of the complexity of the supply chain.”

Blundell adds a warning: “The gap between ‘economic risk’ and ‘insurable risk’ is widening as some supply chains become more unwieldy and new perils like cyber attacks and climate change emerge.”

Nudges and whispers

Insurers can encourage their existing or potential clients to fortify their supply chains in a number of ways – through advice, investment and, as in any insurance transaction, through pricing and terms.

Returning to the chutney manufacturer example, Smyth says an insurer might advise it to charter a newer freighter or ship some of its cargo by air. “There’s various ways and means and so we can, of course, advise and give our opinion,” he says.

Alastair Blundell, British Insurance Brokers’ Association

Parker also stresses the role of insurers as sources of good counsel. “Insurers need to maintain an open dialogue with clients, share examples of best practice and ensure businesses are aware of emerging threats before they become full-blown risks,” he says.

As part of its ambition to provide “holistic freight protection”, Loadsure also offers risk management advice to clients. “We want to ensure our clients are aware of their exposures and identify those exposures with them and give them what we refer to as active risk management, first and foremost, supported by the risk transfer mechanism,” McCord says.

“The gap between ‘economic risk’ and ‘insurable risk’ is widening as some supply chains become more unwieldy and new perils like cyber attacks and climate change emerge”
_{Alastair Blundell
British Insurance Brokers’ Association}

Lorenzo stresses carriers can employ premium rates and policy terms to influence clients, being stricter with firms that fail to secure their supply chains. “By adding an adequate price tag to the risk, the insurance industry can demonstrate that not investing in supply chain resilience also comes at a price,” she says. McCord says Loadsure incorporates risk-assessment measurements into its pricing algorithm.

Carriers can tailor their offerings to cover protection gaps. The Iumi experts mention “policies that cover specific supply chain risks such as cyber disruptions or political risks”. However, as Willis points out, many corporate clients are unaware of such products.

Insurers can also use their balance sheets and underwriting to buttress supply chains. González says insurers can use the asset side of their portfolios to encourage good supply chain management as well, “prioritising companies that demonstrate strong supply chain resilience” and declining to invest in those that do not. “Ecologically sound investment policies will speed up the march to net zero” and thus mitigate global warming and reduce pressure on supply chains from severe weather, the Iumi experts say.

Gomez and Ruano say insurers can “quantify savings on insurance premium by demonstrating the business has a resilient supply chain in place”. Insurers can also provide funding for improvements directly, through “bursaries for improved resilience – that is, technology solutions for supply chain management”.

More generally, insurers and other financial firms can reduce supply risks by funding infrastructure and green investment. McCord mentions the financial sector plays a major role generally in investing in infrastructure hardening, disaster preparedness and green enterprises and projects.