Could your business cope with a fire in the supply chain?

As the global economy becomes ever more connected and companies outsource more of their production to developing markets, a single fire can cause a company crippling financial losses. Candy Holland of JLT considers the implications.  

Fire and explosion ranks 3rd worldwide in the list of risks concerning businesses in 2015, according toAllianz’s annual Risk Barometer survey of 500 risk managers and corporate insurance experts.

In China, where a 2013 fire at SK Hynix's semi-conductor factory cost insurers an estimated $1.2 billion, it ranks as the top risk; likewise in Russia, where the Achinsk oil refinery fire caused one of the largest losses in 2014, estimated at $800 million. It ranks 2nd in Brazil, was in the top 3 risks in Spain, and top 5 in the US, France and Italy.

Claims data confirms this. Allianz’s analysis of 11,000 losses between 2009 and 2013 shows fire second only to vessel grounding in terms of value, despite a continuing fall in the overall number of fires.

The discrepancy between reducing volumes and higher value of losses is due to various factors but significantly, the impact of business interruption (BI) losses and supply chain disruption.

Tim Cracknell, Head of Consulting, JLT Specialty,says: “The nature of business means there is more potential business interruption from physical events than ever before because of the way assets are accumulated and interact with each other. You may have a £5–10 million physical damage event but you can lose £500 million of revenue.”

BI and supply chains were the top risks in the Allianz survey across every region with fire and explosion being the most commonly cited cause.

Falling short

“The biggest issue immediately after a significant fire is the continuation of the business” says Nick Entwistle, Partner at Echelon Claims Consultants.

Businesses suffering a fire face a sudden loss of revenue at the same time as a surge in costs to make good the damage and set up temporary facilities. “You get this immediate cessation of income with an increase in expenditure, so cash flow becomes a real problem,” Entwistle says. 

Fires can cause long-term effects that are not always immediately apparent, Cracknell says. A fire affecting the network of a mobile telecoms business may be quickly resolved, but customers can be lost for the duration of their new contract, which may be two years or more. 

BI underinsurance is a big issue with a 2012 study by the Chartered Institute of Loss Adjusters finding 40% of businesses underinsured, with an average shortfall of 45%.

Inadequate maximum indemnity periods (MIPs) are another problem says Candy Holland, Managing Director at Echelon Claims Consultants.

“You may have an indemnity period that covers lost business for one year, but the impact ends up being much longer than anybody foresaw. We recommend businesses stress test their BI coverage by running potential loss scenarios, mapping out realistic reinstatement timelines and evaluating how long the impact on their business might last”.

Broken chain

Supply chain risks have been highlighted in recent years by natural catastrophes such as the Thai floods of 2011, which exposed the fragility of complex, globalised supply chains.

Sonia Caamano, Senior Partner for  mining at JLT Specialty, says: “People would hear there was a catastrophe in a territory and think they had come away loss free because they didn’t have any assets in that region, but actually they then find out they have exposures to customers and suppliers based there who have been affected.”

The key difference between natural catastrophes and fires when it comes to supply chains is the geographical spread, with floods and storms capable of affecting entire regions, says Cracknell. 

 “Natural catastrophes cause insurers more difficulty because they may have an accumulation of risk where they are insuring ten factories in a location that are all affected by the same event. Fires and explosions are typically contained to a single site.”

This does not, however, necessarily help businesses, Cracknell says. To ensure the resilience of their supply chains to fire, they have to look at each supplier individually, without the benefit of mapping solutions to determine weather-related risks.

The 2013 SK Hynix fire in China prompted $300 million of CBI claims from US computer manufacturers alone.

What if?

A survey by Zurich Insurance found 73.5% of organisations do not have full visibility of their supply chains, with little more than 25% coordinating and reporting supply chain disruption enterprise-wide.  The survey found 40% do not insure supply chain disruptions at all and less than 20% insure at least half of them.

In this soft insurance market, buyers can often find limited CBI cover included within policy wordings.  “Wider cover can be secured at competitive rates – provided they can give insurers enough information for them to evaluate the risk of key suppliers and customers,” says Chris Stevenson, Senior Partner at JLT Specialty. “If they cannot at the moment, this can be remedied with time and effort.

“Understanding the risk of business interruption is basically assessing the full ‘what if’ scenarios”, Stevenson says. 

“Companies need to consider what could go wrong and what the impact of that event would be on the business. Focus can be applied to work out if the risks are controlled as well as they can be, and then where risk transfer is required should the financial impact be significant.”

Candy Holland is Managing Director at Echelon Claims Consultants - candy_holland@echelonccl.com

Candy Holland - Echelon Claims Consultants