Insurance coverage in the wake of a fragmented supply chain

February 11, 2022 – For the majority of modern industry, a well-designed and reliable supply chain is the foundation for operational success. This means that all portions thereof — from sourcing to manufacturing to distribution — work together reciprocally so that all components of an end-product meet necessary specifications and timely reach their destinations. In turn, this enables other participants in the chain to meet their own individual demands and fulfill their respective obligations.

But what happens when a portion of the supply chain encounters an unexpected delay, for example, a raw material shortage, unscheduled factory shutdown, transportation problems, or production issues? Disruptions at one part of the supply chain can, and often do, create ripple effects that grow in magnitude and severity further up the chain, culminating in delay or absence of the end-product in one or more essential markets. This can lead to a range of unexpected financial (and reputational) consequences for multiple, if not all, members of that supply chain.

Compounding supply chain disruptions across the globe

According to a recent report, U.S. business leaders ranked business interruption including supply chain disruption as the No. 1 risk for stateside companies in 2022. This comes as no surprise, as recent global events have caused, and continue to cause, substantial — and compounding — disruptions across industries.

COVID-19 pandemic. The pandemic, particularly in the first half of 2020, spurred government orders across the globe that forced facility closures across industries, sometimes for weeks. Even where full closures ended or were not required, businesses continued to impose capacity restrictions and quarantine requirements that curtailed operations and facility occupancy. This unprecedented event led to ubiquitous supply chain issues that affected almost all industries.

Winter Storm Uri. In February 2021, a weeklong winter storm (unofficially referred to by media outlets as Winter Storm Uri) battered the State of Texas and caused blackouts, road closures, loss of water service, and facility closures across the state. In addition to being a major transportation hub, Texas is the home of many major industries, including oil and gas, semiconductor manufacturing, and aerospace and defense, many of which experienced sudden disruptions as a result of the storm. The global shortage in semiconductors is expected to cost the automotive sector alone $210 billion in lost revenues.

Suez Canal blockage. In March 2021, the massive container vessel Ever Given was grounded for over six days in the Suez Canal, a key waterway for global shipping and transportation. It is estimated that more than 350 vessels were backed up during that time including container ships, bulk carriers, and oil tankers, adding substantial additional travel time to tightly scheduled routes. This six-day blockage created supply chain delays that rippled across industries globally.

These events only exacerbated the ubiquitous supply chain issues created as a result of the ongoing COVID-19 pandemic.

Supply chain disruptions, and disruptions of this magnitude and scale in particular, can have a devastating impact on a business’ expected profits and other financial metrics often with little-to-no warning. In fact, according to the “Allianz 2022 Risk Barometer Report,” 45% of businesses said they had suffered a large impact from recent supply chain issues. So, what steps can businesses take to minimize these financial impacts? The answer might be found in their insurance programs.

Adequate insurance can fill the gap

In the wake of a fragmented supply chain, companies should look to their business interruption insurance programs to determine if they might have coverage for resultant financial losses.

Business interruption insurance generally provides coverage for financial losses experienced by the insured to the extent physical loss of or damage to the insured’s property forced it to terminate, suspend, or reduce normal operations. Companies that purchase business interruption insurance alongside their property insurance protect themselves not only from the costs tied to repairing the damage or loss at issue, but also the financial losses that arise from associated operational impacts.

Business interruption insurance assumes that an insured risk directly impacted the insureditself. But what happens if a critical member of your supply chain experiences its own disruption? Because traditional business interruption insurance is usually limited to losses associated with the insured’s own damage or loss, this line of coverage may not be responsive. So, what now?

Fortunately, most business interruption insurance is purchased in conjunction with a similar but meaningfully different form of coverage: contingent business interruption. Contingent business interruption coverage is designed to protect a business from the financial impact of the termination, suspension, and/or reduction of its normal business operations as a result of one or more members of the supply chain experiencing physical loss of or damage to its property.

Using Winter Storm Uri as an example, consider a scenario where a member of a supply chain experienced a pipe burst that damaged its machinery thereby causing a delay in production of a critical component of the supply chain’s end-product. Other members of the supply chain may be able to secure payment for their losses under their contingent business interruption coverages, even though the property damage did not occur at their respective properties. Contingent business interruption coverage is a potentially invaluable component of a business’ insurance program in the wake of such supply chain disruptions.

Broader supply chain coverage

As an essentially standard offering across the insurance industry, most businesses purchase contingent business interruption insurance. But in the face of an unexpected supply chain disruption, is this enough?

As events like the COVID-19 pandemic, the Suez Canal blockage, and Winter Storm Uri have demonstrated, supply chain disruptions can have an endless array of causes. Although contingent business interruption coverage can provide a meaningful line of defense, it is generally limited to coverage for disruptions caused by loss of or damage to property, for example, flooding, fire, or wind damage. But what happens if a supply chain disruption is caused by another type of risk? In such instances, traditional contingent business interruption insurance may not apply.

Fortunately, many insurance companies offer broader coverage specifically tailored to supply chain issues. Supply chain insurance typically operates the same way as traditional contingent business interruption coverage, but it encompasses additional risks. For example, supply chain insurance may also cover disruptions as a result of labor strikes and shortages, production problems, war or political unrest, and disruptive civil action.

Depending on a business’ risk profile, purchasing this broadened coverage may be worthwhile. It is particularly important to take a close look at all members of the supply chain and identify risks inherent to their businesses.

Is a supplier located in a nation that is not politically stable? Are key raw materials subject to adverse impacts from climate issues? Is a business notoriously contentious with labor unions? Such questions are worth considering when determining if supply chain insurance is warranted.

Conclusion

As recent global events have demonstrated, supply chain disruptions can occur at any time, and can have devastating financial impacts on all members of the supply chain. Accordingly, it is important to work with trusted brokers, risk management professionals, and coverage counsel to review the impacted business’ insurance program and ensure decision makers understand the scope of coverages available. Although contingent business interruption insurance can prove invaluable in the wake of a supply chain crisis, best practices dictate that companies carefully evaluate their risk profile and consider whether broader supply chain coverage may be appropriate.

Ashley B. Jordan is a regular contributing columnist on insurance law for Reuters Legal News and Westlaw Today.