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Avoiding underinsurance in the supply chain

At a glance

  • Underinsurance can lead to reduced claims settlements and can make it harder for businesses to recover from a loss
  • Complex global supply chains can present a major business interruption and underinsurance risk
  • We look at some of the main causes of underinsurance in the supply chain, and discuss how brokers and their customers can work to mitigate the risk

This article counts towards accumulating your annual CII CPD structured learning hours for Underinsurance.

By reading this article, and correctly answering the three questions underneath, you will have achieved the following learning outcome: Summarise the importance of professional valuations in helping to prevent underinsurance.

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Underinsurance can have significant consequences. The most serious cases of underinsurance can prevent businesses from recovering to the position they were in before a loss – or recovering at all.

With most companies today relying on a network of suppliers and sub-suppliers spread across the globe, supply chains can present a major underinsurance risk if not managed correctly.

As Otto Kocsis, Principal Engineer Business Resilience, Zurich, explains: “While standard business interruption (BI) policies typically provide cover for premises going offline – in the event of a fire, for instance – it is much more challenging to mitigate risk across an entire supply chain.

“To do this, policyholders, brokers and insurers need to estimate how much business is at risk if a supplier is not delivering as expected. As most businesses don’t rely on just one supplier, but on hundreds spread across the supply chain, underinsurance is a real risk.”

Causes of underinsurance in the supply chain

One of the most common causes of underinsurance is a loss further down the supply chain. While contingent BI policies exist to soften the financial impact of events outside a policyholder’s control, if only tier-one suppliers are named on a policy, then a business won’t be covered for losses further down the chain.

For example, if a fire destroyed the manufacturing premises of a tier-one supplier named on a policy, the insured would be covered for losses caused by the resulting disruption. However, if the fire had instead destroyed a factory that made components used by the named tier-one supplier – and the business that operated that factory was not named on the policy – the insured would typically not be covered.

Losses resulting from non-physical damage also need to be considered. Following the 2010 Icelandic ash cloud, for example, many companies suffered supply chain interruption, but because the damage did not relate to physical damage at a supplier, most weren’t covered under extensions to their BI policies.

Loss of goods in transit or storage, or hold-ups in delivery, can also cause significant disruption. The 2015 explosions at the port of Tianjin caused months of disruption for many businesses across the globe – preventing the delivery of raw materials to factories in China, and slowing the movement of goods heading the other way.

“In all these cases, it is important to understand the extent of the risk,” explains Otto. “How much business is at stake if a supplier doesn’t deliver as expected? For some of these scenarios, there may not always be an appropriate insurance product available – making risk mitigation strategies essential.”

Challenges in mitigating supply chain risk

The way businesses approach procurement often complicates mitigation efforts, says Otto. “At many companies, procurement success is viewed on the basis of cost-cutting – but this view needs to be broadened.”

Businesses need to consider not just how cheap their suppliers are, but also how vulnerable they are to factors that could cause disruption. For example, are they based in a part of the world prone to industrial action or extreme weather?

“If a big supplier goes down, the financial impact of the disruption can be significant, not to mention the potential reputational damage, which is itself not insurable. To reduce the chances of supply chain interruption and subsequent underinsurance, it is important to break down the silos separating risk management and procurement, and get them sitting at the same table.”

Overcoming the underinsurance challenge

“Ultimately, companies need to develop detailed understanding of the role of their suppliers, prioritise them, and develop appropriate risk mitigation,” says Otto. “Zurich has a detailed understanding of the risk landscape, and can provide a range of tools and guidance to help brokers and their customers minimise the likelihood and impact of underinsurance in the supply chain.”

Zurich Risk Room is a tool that analyses and interprets risks in more than 170 countries, from political, financial and economic risks to climate change and human capital.

While not all companies are expanding internationally, most have global supply chains – making this sort of insight invaluable.

Otto concludes: “Risk management goes beyond tools, however. Zurich risk engineers can provide strategic risk management guidance, and help brokers and customers undertake impact assessments, undertake business resilience testing, and design risk mitigation techniques in the event of a major supplier or supply route going down.

“The risk of supply chain underinsurance is significant, and businesses need to consider smart solutions. Zurich has a detailed understanding of the risk landscape, and can help brokers and their customers minimise the likelihood and impact of supply chain underinsurance.”

For more information on the issues discussed in this article, please get in touch with your local Zurich contact.

Image © Getty

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