The global supply chain: a thoroughly modern maze
There is a global technology revolution underway that is turning even everyday objects into complex products supported by highly connected and equally complex global supply chains. As Wendy Hopkins, Partner at DAC Beachcroft puts it: “This digital interdependency is creating new, unforeseen and often unmanaged supply chain risks and exposing gaps in information and understanding that need to be addressed by both insureds and insurers. It also brings a new focus on resilience and business continuity.”
Businesses have always looked to source as competitively as possible and in the modern connected world, the result is an international matrix of suppliers and service providers – of mind-boggling complexity – that can be all but impossible to trace, let alone monitor adequately.
The upshot is that mapping the potential risks along the chain around the world – fire, natural catastrophe, industrial action, regulation, trade wars, the spread of isolationism and cyber to name a few – is fraught with difficulty. And the potential information saviour – sophisticated digital connectivity – is itself vulnerable to cyber-attack, system failure and energy supply disruption.
It can be no surprise that, according to the 2017 Business Continuity Institute’s (BCI) Supply Chain Resilience Report (supported by Zurich), 69% of respondents do not have full visibility of their supply chains; and that unplanned IT or telecommunications outages (48%) are the main cause of disruption, with cyber-attacks and data breaches second. The rest, in order, are: loss of talent/skills, outsourcer failure (33%), transport network disruption (26%), adverse weather, fire, new laws and regulations, insolvency in the supply chain, and finally energy scarcity. Looking forward, cyber-attacks and data breaches (60%), unplanned IT or telecommunications outage (59%) and loss of talent/skills (34%) remain the main concerns for businesses.
Nick Wildgoose, Global Supply Chain Product Leader at Zurich Commercial Insurance UK, comments that when they started the survey, nine years ago, he nearly fell off his chair when there was a 70% incidence of significant supply chain disruption. “Sadly that figure has remained high, with 2011 marking the peak at 85%,” says Wildgoose.
Corporates and their supply chains
“Corporates are, however, increasingly having to get a grip on their supply chains,” continues Wildgoose, “as legal and regulatory pressures mount – including the Modern Slavery Act 2015 and incoming corporate social responsibility regulation. And while many do have the information, it is often not communicated across the company due to the existence of functional silos.”
This point is echoed by Jessica Collier, Partner at Wilson Elser, USA, a Legalign Global partner, who highlights the US Food & Drug Administration’s Food Safety Modernisation Act – with upcoming compliance dates over the next few years – which contains a host of supply chain transparency demands. Collier adds that the present lack of clarity and understanding along the supply chain is clearly linked to “a significant increase in product contamination and product recalls over the last two years, both in the number of claims and the size of the losses”.
Robin Shute, Partner at Wotton + Kearney, Australia, another Legalign Global partner, adds that product safety law around ingredients is surprisingly subject to little-detailed regulation in Australia – excluding nuts – and by and large, is left to the supplier/importer to comply with general provisions. “I had a case several years ago involving iodine, which is dangerous to those with iodine deficiency. It surprised me that there were no regulations about labelling products that contained a greater than anticipated level of iodine. Parties must assess issues by reference to the statutory provisions which give general relief. In consumer situations, the most important legislation is the Australian Consumer Law which gives protection against defective products."
A rise in claims is also attributable to the complexity of many modern products says Carsten Hösker, Partner at BLD Bach Langheid Dallmayr, Germany, a Legalign Global partner. “The complexity, in particular, of modern motor vehicles is a key reason why we have seen a noticeable increase in claims volumes and costs.” He says the risks of complicated software and parts from a vast array of different suppliers – accompanied by a squeeze in testing timeframes as part of a focus on reducing costs – together with the increase in the spreading of news about faults via social media are all exacerbating the problem.
This pressure on reducing costs is also picked up by Hopkins: “One of the emerging challenges is that the pressure to keep product prices down often results in the stripping out of cost from the supply chain. This ranges from sourcing cheaper components to simplifying distribution models and reducing vital processes such as quality assurance, which can have far-reaching consequences along the supply chain."
There are insurance products designed to protect companies against supply chain disruption outside standard property and business interruption cover. Policies now exist that provide broad, multi-tier cover, not just for physical damage events but a range of non-physical risks such as industrial disputes, transportation and logistics disruption, supplier insolvency, political risk and cyber – but take-up is low. Referring to the BCI survey results, over half (51%) do not insure for supply chain losses.
“One of the emerging challenges is that the pressure to keep product prices down often results in the stripping out of cost from the supply chain. This ranges from sourcing cheaper components to simplifying distribution models and reducing vital processes such as quality assurance, which can have far-reaching consequences…”
Members of risk manager association Airmic say that take-up is low outside pharmaceutical, motor and food manufacturing. They claim supply chain insurance is too costly, collecting the relevant risk information is over-complex and there is a lack of clarity over when and under what circumstances policies will pay out.
It is the issue of the relevant risk information that sits at the very centre of the global supply chain and insurance challenges. If companies do not know – or are not asked – who their second, third or fourth tier suppliers are, how can insurance underwriters correctly assess, measure and price the risks? If underwriting is challenging, then handling claims and identifying liability in this hyper-connected world is also fraught with difficulty.
Martin Alexander, Partner at BLD Bach Langheid Dallmayr, adds that another issue he is seeing is a rather lax approach to underwriting. “In product liability and recall, policy terms have become broader and wider in response to the soft market, with a trend for brokers to push for more generic clauses,” says Alexander. “Most insurers are simply not asking many questions about companies' supply chains and they are not learning from and passing on experiences gained by their claims teams. We have seen many examples of underwriters only being asked about clauses once a claim is made – and it is quite typical for that underwriter to have left the company, so they cannot say what they meant or the answer they provide is not legally usable.”
Shute adds that he has always been surprised underwriters are not more prescriptive about asking for details of contractual recourse with a view to recovery down the contractual chain in the event of a problem. “One of the perennial problems, of course, is China, due to non-reciprocation of enforcement of judgments, and one of the solutions I’ve seen is insisting Chinese suppliers take out insurance with a reputable company that has the ability to pay in the event of a claim. Even that is of dubious protective value."
The gap between underwriting and claims is also highlighted by Collier who sees a clear disconnect between the two. “Insurers’ focus is on winning the business and they are failing to be rigorous during the application process, in terms of gathering relevant information about the client’s supply chain,” she says. “Questions are left blank, and no or little information is recorded on who in the supply chain has insurance, where they are located and what potential risks they face.”
Wildgoose responds with a focus on the companies themselves, with concerns that even some of the larger corporates have not always undertaken basic research into their critical supply chains – something insurers can and are helping with. “We and other insurers are helping corporates understand their critical supply chain risk better – including with regard to non-property damage risk,” insists Wildgoose. Leading companies in respect of supply chain risk management are also increasingly investing in technology and big data to help them.
Collier agrees that insurers are now really trying to grapple with the issue and demonstrating an appetite to embrace innovation, be proactive and help spread the risk – for example exploring how blockchain technology and data-driven analytics could be used to track and map their customers' supply chains themselves. However, she believes insurers are struggling to embrace digital transition – even for their own loss information and databases – and are facing a steep learning curve.
Wildgoose agrees that blockchain does have some potential but says presently big data and artificial intelligence (AI) are more advanced. Zurich, for example, which already offers the self-service risk engineering service Risk Advisor app and geo-political analysis tool Risk Room is developing prototypes to help corporates manage their critical suppliers' risk profiles using, for example, social media and machine learning. There has, he says, been a flurry of investment in technology start-ups using AI and big data to provide tools to help companies drive transparency across their supply chain risks. These also offer significant opportunities to insurers to work alongside their customers.
Wildgoose concludes that both insurers and the larger firms have learnt much from case-by-case underwriting, with some of the latter developing their own comprehensive supply chain risk assessment processes. The next step is to extend that learning to develop viable solutions for mid-market companies.
Insurance is increasingly critical “as the glue that sticks international transactions together,” adds Shute, who believes coverage gaps are now few and far between. “Product policies and particularly product recall policies are inching ever closer to product guarantee through, for example, loss of use as part of the definition of property damage.” The issue, however, confirms Shute, is that if products are below the specified standard and do not cause damage then it is unlikely that insurance will offer protection.
Supply chain risk remains a key issue for business; and as complexity and interconnectivity of both the supply chains and the products themselves increase, together with prescriptive legislative and regulatory oversight, it is imperative that insurers and insureds work together to develop innovative solutions. These will have to demonstrate new layers of resilience to ensure business continuity. Technology in the form of big data, AI and blockchain provides a major opportunity to drive forward innovation and to help trace, identify, monitor and mitigate risks around the globe, but equally important are transparency and communication.