Protecting Your Business Against the Next Global Catastrophe: Contingent Business Interruption and Supply Chain Insurance
A recent confluence of events from the Suez Canal crisis, COVID-19 pandemic, and emerging just-in-time logistics models present ongoing global business challenges. In a world where it is not a matter of if, but when, the next global crisis will occur, this article will discuss the scope of commercial insurance coverages currently abuzz, including supply chain and contingent business interruption, and offer proactive business protections from these unexpected events.
Anatomy of a Global Crisis
In March 2011, Japan was ravaged by the Great Tohoku earthquake and tsunami, causing setbacks in global markets. That same year, Thailand suffered disastrous flooding with similar impact on trade. In 2017, groundwater invaded two high-speed rail tunnels in Germany. This caused Europe’s busiest main line to close for seven weeks while all alternate routes from Germany to Switzerland were also closed for engineering and electrification work, resulting in diversion of significant daily traffic to France or through Austria.
Since early 2020, extended supply chain and travel disruptions have taken shape during the COVID-19 pandemic, resulting in global manufacturing shortages of masks, ventilators, and toilet paper; trip cancellations, cruise ship quarantines, and the grounding of airplanes; as well as epic unemployment and the rollercoaster closures of businesses and international borders.
Most recently in March 2021, a Taiwanese registered cargo ship, the Ever Given, owned by a Japanese company and carrying 18,300 shipping containers of Chinese cargo destined for Europe, lodged itself in a narrow stretch of Egypt’s Suez Canal, blocking all traffic between the Red Sea and the Mediterranean Sea for six days, and disrupting an estimated $10 billion of trade daily. Notably, the Suez Canal was inadvertently blocked as recently as 2004, 2006, 2016, and 2017.
These disruptions may only directly impact some, but their impact is indirectly felt by all. And protecting a business, large or small, from the fallout of a global crisis can mean the difference between keeping the doors open and shutting them for good.
Insuring Your Next Global Crisis
One protection for risks associated with a global crisis is contingent business interruption (CBI) coverage. In relying upon third parties for manufacturing, supplying, and consuming, entities purchase CBI coverage to protect against property risks outside of their physical operation or control that their business depends upon. CBI coverage typically covers losses resulting from physical damage to the property of those entities relied upon by an insured.
Where regular business interruption insurance replaces profits lost following physical damage to the insured’s property, CBI coverage protects the insured from damages to its suppliers’ or customers’ properties. CBI coverage provides an extra layer of protection where the type of physical damage sustained at a designated contingent property matches the risks of loss covered for the insured’s own property. In the event of a covered loss, CBI coverage expands traditional business interruption coverage for a defined period of time.
For example, the entire state of Texas experienced unprecedented winter weather earlier this year, causing pipes to freeze and wreaking havoc on communities ill-prepared for the conditions. If your company’s sole supplier of widgets was a Texas manufacturer whose pipes froze and burst, you might wind up on ice yourself if unable to find an alternate widget source solution. Under CBI coverage, if the supplier was designated as a dependent property, you are afforded coverage for a defined duration of time for lost business income as a result of the supplier’s misfortune. CBI coverage is essential for businesses that rely heavily upon one source of anything; materials, products, purchases, or otherwise.
“CBI coverage sounds great, but my customers and suppliers are fine. Our losses were caused because a boat—a big one—just got stuck in the Suez Canal. Now what?”
Without physical damage disrupting the operations at your supplier or customer’s property, CBI coverage is not the solution. But there’s hope. Supply chain insurance is designed to cover losses suffered due to a disruption in the supply chain itself, without requiring physical damage to property. (IRMI, April 2019). This more comprehensive coverage provides broad application to supply chain disruptions from events like the COVID-19 pandemic and border closures, bankruptcies, labor strikes, civil unrest, military actions, or other significant delays in fulfillment from natural disasters such as an earthquake, flood, or volcanic eruption.
In a 2015 article, David Klein and Silvia Babikian of Herrington & Sutcliffe provide an example of the relative breadth of supply chain coverage. (10 No. 25 WJIBF 2). In 2014, a leading iron ore producer declared force majeure resulting from an Ebola epidemic in Liberia that required removal of its workers from the country. Those authors opine that “[a] supply-chain policy might cover losses from this kind of supply-chain disruption, even without property damage[,] … because the producer has interrupted operations due to the contagion itself or has become unable to transport product because shipping companies have halted operations in Liberia.”
Klein and Babikian’s example took on new meaning in 2020. In the wake of the COVID-19 global pandemic, litigation has flooded the courts regarding physical damage limitations associated with business interruption insurance. However, those companies that purchased broader supply chain insurance coverage likely saw claims handled much differently. Those policies without a virus exclusion likely resulted in any number of covered supply chain disruptions across the economic landscape resulting from the COVID-19 pandemic.
Using the recent Suez Canal crisis as another example, suppose your business requires raw materials to be transported from India to various production facilities in the Mediterranean Sea. You rely upon the ability to use the Suez Canal to save time and money by avoiding hauling these materials over land, across various international borders, or around Africa’s Cape of Good Hope by sea. Understanding that your shipping costs are extremely dependent upon the Suez Canal, you purchased supply chain insurance that provides you with extra security. If the Suez Canal were to be closed due to a civil or military disruption, natural disaster, or misplaced boat, your business can claim business income losses associated with the cargo’s trip around Africa.
The moral of the story is that great care should be taken to identify the risks and choke points confronting your global supply chain and ensure those pieces which you cannot afford to lose.
Assessing and Addressing Your Supply Chain Risk
Risk managers for businesses reliant upon a global supply chain must identify and understand those entities inherently relied upon, including the risks and limitations confronting them. This is especially true where your business relies upon one key supplier or customer.
The global economy and just-in-time delivery models carry inherent risks and vulnerabilities that require prudent risk assessment and proactive loss mitigation. Broadly speaking, the process entails four strategic steps: identification of risks, a review of existing protections, crunching the numbers, and developing a loss prevention strategy.
First, you must carefully evaluate and identify your dependent entities top to bottom and front to back. Ask yourself the following:
What would it cost me today if my key customer were to burn down tomorrow and how could I replace that source of revenue in the near and long term?
What if my sole supplier of raw materials was seized by a foreign government for wartime production; how can I replace those materials and at what cost?
What alternative supplies and inventory exist and how long can resorting to those alternatives take to implement or last in duration?
How can I mitigate these risks?
Your next task is to review your existing protections, including insurance policies and contracts. Will they provide you any protection or compensation in the event of delays, disruption, or loss due to a global or national event?
Subsequently, you should examine the potential costs of CBI, supply chain, and other coverage options and compare them to the potential damages your business might incur in the event of a loss. A request for business interruption coverage generally requires an accounting for the scale and scope of an insured’s business. The process is exponentially more difficult when attempting to procure CBI or supply chain coverage, since an insurer will need to explore the scope of operations associated with an outside entity and how their risks might impact the insured’s business. Having a thorough understanding and accounting of those risks prior to procuring insurance will assist the insurance company in understanding the coverage you are looking for, while allowing you to ensure that the scope and scale of risks you confront during a global crisis are covered. As a cautionary tale, do not forget to review the policy language with your insurance professional in light of your understanding of the risk involved. Cutting corners at this step may mean the difference between a covered and non-covered claim.
Finally, you must implement your plan. Your plan includes not only strategic application of the steps outlined above, but periodic revisitation and reassessment for evolving global risks.
Andrea Schillaci is a shareholder of Hurwitz & Fine, P.C., a law firm headquartered in Buffalo, and a member of the International Association of Defense Counsel. Ryan P. Maxwell is an associate at the firm.