Business Interruption and the Interconnectivity of the Supply Chain

Over the past several years, a number of independent reports have been published detailing the biggest, most egregious risks facing businesses. Whether we're talking about a "top 10" list or a "top 5," the real constant across the board was business interruption and its devastating impact.

Businesses that've had the unfortunate experience of having their business stall can attest that the interconnectivity of supply chains is often to blame—if a nor'easter shuts down a production plant in New York, shipping operations could be affected, begging the question of if or when products will reach their destination in Georgia. A fire or explosion might shut down a manufacturing plant (or other vendor), and create a costly situation for businesses who are expected to bring these products to market.

The oil and gas industry is another example. Transporting product requires special equipment, strict regulatory compliance, and extensive safety procedures. It often requires multiple modes, involving everything from supplying materials for oil rigs to moving extremely heavy equipment and hazardous materials. Shell Canada utilizes more than 80 local carriers at its drill sites. Local truckers (not large carriers) are taking on the work.¹

"If an oil rig goes down as a result of not having the proper materials in place, it can mean the loss of $1 million every day," said Brian Murphy, director of business development for San Francisco-based Menlo Worldwide Logistics.² The many moving pieces of the supply chain equate to risks that should not be ignored.

The Largest Causes of Business Interruption

According to an analysis by Allianz,³ the top causes of business interruption were fire and explosions at 59 percent, storms at 6 percent, machinery breakdown at 5 percent, and faulty design/material/manufacturing. Other causes included riots and vandalism, flood, collapse, and power interruption, and human/operating error. According to the survey, the average large business interruption property insurance claim is now in excess of $2.4 million, 36 percent higher than the corresponding average property damage claim of just over $1.7 million. The numbers show that risks to the supply chain could have dire financial consequences to the overall operations of a business.

Mitigating risks requires sound logistical planning and making provisions for possible breakdowns in the supply chain. It also means that businesses should veer away from putting all of their eggs in one basket—redundancy with vendors is essential to a complete suspension of operations. Putting all of these steps in place doesn't guarantee that hidden risks won't sabotage your efforts. Business owners can't account for every single variable across their entire supply chain. This is why risk transfer via insurance is necessary to fund risks on the back end. Most commercial carriers will carry some level of coverage for business interruption. However, other risks may require additional (and likely more expensive) coverage for risks that might occur less frequently, or for risks that are unique. Forming a captive insurance company ensures that broader coverages address risks at every rung in the supply chain, cost-effectively.

Examples of Captive Insurance Coverages

Coverages written through a captive are a kind of safety blanket, funding potential losses when commercial policies fall short (i.e., when gaps exist). Rather than paying for additional (and likely, more expensive) coverages through a conventional insurer, more business owners are opting to fund losses through their own captive insurance companies. Certain coverages directly address vulnerabilities in the supply chain and consequent business interruption.

Here are some potential coverages that address supply chain risks, which could be written through a captive.

Cargo/transit (including shipping, wholesale, and retail manufacturing): Covers losses resulting from loss or damage to property in transit in owned or leased vehicles, common carriers or goods shipped by freight forwarders. Seven out of ten global shippers lack the visibility in their supply chains needed to prepare and respond to disruptions—whether they are port labor slowdowns, natural disasters, or something else, according to the Zurich Business Continuity Institute's Supply Chain Resilience Report.⁴ The company's global small- and medium-sized enterprise survey found that 55 percent of SMEs did not think a supply chain disruption would interrupt their daily operations. This disconnect could have a devastating impact on businesses who are not proactive about their supply chain risks.

Special risks: Geophysical resources. This coverage protects the insured against business interruption resulting from damage to the geophysical resources it requires to conduct normal business operations. Industries such as oil and gas, agriculture, manufacturing, and construction could benefit from writing these types of coverages through a captive insurance company.

Loss of a major supplier is another special risk coverage that homes in on the supply chain. This protects the insured against business interruption and extra expense that would result from the loss of a major supplier while the insured establishes a suitable replacement to resume normal business operations. A supplier may end a contract if their clients insist on more generous payment terms. It's becoming more common for businesses to ask for more than 3 months to pay on their invoices, squeezing suppliers financially.

Loss of services. Provides protection for the insured against the ensuing business interruption that would result from an involuntary loss of services of a covered key person (such as a resignation, extended illness, loss of license, etc.) and further coverage for legal expenses involved in employment disputes and intellectual property or non-compete disputes following the loss of services of the covered key person.

Trade disruptions are another option for coverage through a captive as the trigger initiates coverage for expenses resulting from any event or incident that causes an adverse impact on the insured's supply chain. War, embargo, increased tariffs, or trade restrictions could all be covered under this coverage.

Weather-related business interruption addresses losses stemming from catastrophic events such as earthquake, tsunami, flood, hurricane, windstorm, tornado, or snowstorm. The claim trigger typically does not require a direct loss to property.

Taking Charge with Smart Planning

Logistical planning can help alleviate stalled or stopped operations that are a direct result of breakdown in the supply chain. Businesses that are insured via a captive can offset losses stemming from business interruption while strengthening the integrity of their operations.

Captive insurance arrangements provide owners of closely held businesses with comprehensive risk coverage as well as planning benefits, unseen with other risk management programs. Unlike "self-insurance," which refers to monies set aside for funding losses, captives are actual insurance companies, regulated by the domiciles (or jurisdictions) they're created in. Under favorable loss conditions, business owners may be able to secure loans through the captive, or make use of dividends. Additionally, premiums paid to the captives (under Internal Revenue Code 831(b)) are made on a tax-deductible basis.

The integrity of the supply chain relies on a potent cocktail of redundancy, smart contract negotiations with suppliers and distributors, and a sound risk management plan, should losses occur. By putting supportive measures in place and planning ahead, businesses in the private sector can remain functional and profitable, despite any breakdown in the supply chain.

1. "Fueling the Oil and Gas Supply Chain," by Justine Brown, Inbound Logistics, July 29, 2014.
2. Ibid.
3. Global Claims Review 2015: Business Interruption in Focus, Allianz Global Corporate and Specialty SE, released December 9, 2015.
4. Business Continuity Institute Supply Chain Resilience Report, produced in association with Zurich Insurance Group, November 2015.