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COVID-19’s wake-up-call for supply chain risk

Risk & Analytics|Risk Management Consulting
COVID 19 Coronavirus

April 21, 2020

This article looks at the impact COVID-19 has had on supply chains and explores some of the challenges risk managers could face in the future.

Although the COVID-19 pandemic threatens business operations everywhere, it is useful to remember that the virus was initially feared for its impact on global supply chains. Its first hot spot was Wuhan, China, a manufacturing hub that produces vital components for hundreds of companies, mainly in the technology, automotive and pharmaceutical industries.

Prior to COVID-19 risk managers were already having to think about new or evolving geopolitical and cyber risks impacting supply chain as well as the more familiar exposures. While these risks were bad enough, COVID-19 is on a different scale entirely. Among the reasons are the following:

  • The pandemic is forcing abrupt shifts to new business models in ways that will significantly alter company risk and resilience.
  • Supply chains, already a target of economic nationalism in some countries, now face new questions about risk concentration.
  • Company revenues are falling globally under twin blows of production disruptions and weakening demand with a ripple effect among third party vendors and contractors.

Business model changes are being accelerated because of COVID-19.

Business model changes are being accelerated because of COVID-19. To use a simple example, many restaurants are shifting from a sit-and-dine model to one of takeaway and food delivery. Larger companies are not immune. Think of retailers at the end of a supply chain who depend on high volume of foot traffic. How do you sell the latest fashion to customers no longer comfortable entering your premises?

The pandemic may also accelerate supply chain trends that were already underway. In countries where economic nationalism was growing for example, some companies had already come to question their dependence on current supply chain arrangements. This follows on the heels of other exposures, such as reputational risks arising from third party labour practices. In Europe instead the focus has been on working towards maintaining, where possible, the integrity of the upstream and downstream supply chains in the light of the UK departure from Europe, otherwise known as Brexit.

Apart from the human costs, revenue shortfalls might be the heaviest blow of all. Recession fears are climbing around the world as stores close their doors, production slows and financial markets appear some days to be in free fall1.

In other words, we’re not just seeing the rise of a new risk or two. We’re seeing a monumental change in the whole business environment. Some of the change will be permanent. Increasingly, COVID-19 can be considered a wake-up call for risk managers and other business leaders, as well as the insurance industry.

The Risk Management Dilemma

At this stage of the pandemic, the insurance industry and its clients are still attempting to gauge the impact. Business conditions change by the day. Government efforts to prop up suffering economies are taking on a scale not seen since the recession of 2008 with the outcome unclear. By common reckoning, the worst is yet to come in many countries.

Insurers, brokers and their clients are in the process of dealing with the immediate issues – loss control, coverage details, claims handling (e.g. event cancellation, or business interruption) and other particulars. A frequent question being asked by clients is straightforward: “Am I covered?”. Willis Towers Watson have written about the insurance implications in an effort to provide more information on the subject2.

The pandemic is revealing coverage gaps. While these gaps may prove to be costly, they are also instructive. One point of view is that we can learn as much from an uninsured loss as from an insured loss. The uninsured loss has 100% financial impact, of course. But the insured loss also has a financial impact, perhaps in the form of retention, the deductible or even through an increased premium at renewal.

Risk managers and their risk management partners need to start talking and planning now for a very different insurance landscape. Insurance companies will immediately look at previous claims history. If a claim has been filed, it’s important to put a well-documented story around it – for example, what was learned from the incident behind the claim, and remedial efforts that have been taken to avoid or mitigate a recurrence.

Looking towards the next renewal cycle, it should be assumed that it will take place in a hardening market. It’s also important to engage brokers and the markets early in order to get a reading on how the insurers are feeling. Within a company, the CFO and management team should be involved to determine how the company’s risk appetite may have changed because of the pandemic. Forecasting financial performance could be nigh on impossible in the current climate and there will be a definite need to make sure that is reflected in any rating charges.

It’s also important to begin thinking in the context of a total cost of risk as the business’ strategies and operations evolve. Say, for example, that a business plans to disperse its workforce with more employees working remotely. How does that affect exposure to a future incident? Will the business be spending more on business continuity planning after the pandemic?

For supply chains, it will be important to know how third-party vendors specified in the policy coverage change their risk profile, too. Will they be using different contractors in new ways? What efforts are they making to identify, quantify, mitigate and transfer their risks?

COVID-19 Changes the Rulebook

Remember the risk management basics: identification, quantification, mitigation and transfer. COVID-19 is reason to look at a business fresh from each perspective, with a heightened need to make more effective use of data and analytics.

COVID-19 is reason to look at a business fresh from each perspective

For supply chain risk identification, there was a time when the primary focus was on physical risks. We’ve already noted that geopolitical, cyber and reputational risks have become more challenging in recent years. While pandemics are not new, COVID-19 shows that many companies (and governments, for that matter) were caught off guard by its rapid spread and intensity.

Virus-driven changes to your business model – some made on the fly – may create new risks while perhaps diminishing others. More companies may choose to disperse manufacturing and production. More employees may be working remotely.

Quantification issues will also become more extreme. For one thing, it may be necessary to delve into third party vendors to better understand their exposures and efforts at mitigation and transfer. But is known about the supply chain below that? Who supplies a business’ supplier? If this wasn’t a consideration before COVID-19, it must be now.

Quantification must also engage other risk analysis processes such as enterprise risk, that is linked to a company’s strategic objectives. Business continuity preparations require a close look, including a business impact analysis. Among media businesses, for example, many supply chain issues are not for physical products, but for large swathes of expert freelance labour. Risk managers will need to look at the deployment of talent with a fresh eye on the threat of contagion.

COVID-19 could force many companies to diversify.

Mitigation flows from this. As noted earlier, COVID-19 could force many companies to diversify. To use the restaurant example, in the UK Government emergency planning rules are allowing restaurants to convert easily to food delivery3. There will be other technology based companies, especially start-ups ,that handle change at a greater rate and indeed diversification is part of their success. As an example, Amazon have delivery and a significant cloud computing platform, Uber have Uber Eats for food delivery and are exploring logistics analysis.

Risk transfer will also face new challenges in wake of COVID-19. Uncertain business conditions will make for a difficult discussion with an underwriter who can’t see certain risks and has little data or claims history with which to discuss terms, conditions and the pricing of new policies. Risk managers may want to test their coverage, not through claims but by having conversations with their brokers and insurers. An expectation could be discussion scenarios that deal with varying degrees of future uncertainty, always with the context of corporate strategy, enterprise risk management and business continuity. This would engage several once disparate areas of risk management tools into a tighter process.

Further hardening in insurance markets is also likely to be observed in major coverage areas as insurers seek to offset the impact of interest rates and equity returns on liquidity and reserves. The Insurance Information Institute, in its 2020 first quarter Global Macro and Insurance Outlook, expects greater event frequency among insurers providing supply chain coverage such as business interruption with comparatively higher impact on general liability and D&O coverage4.

Risk managers and their insurance partners have been through traumatic events in the past, notably including terrorism, wars, natural catastrophes – even pandemics. But the uncertainty seen currently should serve as a wake-up call, not just for insurance professionals but for corporate finance executives, other senior management and boards.


Footnotes

1 https://www.db.com/newsroom_news/2020/deutsche-bank-economists-forecast-severe-recession-due-to-covid-19-en-11507.htm

2 https://www.willistowerswatson.com/en-gb/Insights/2020/03/the-insurance-implications-of-the-coronavirus-catastrophe as-takeaways-as-part-of-coronavirus-response

3 https://www.gov.uk/government/news/government-to-grant-permission-for-pubs-and-restaurants-to-operate-as-takeaways-as-part-of-coronavirus-response

4 https://www.iii.org/sites/default/files/docs/pdf/global_macro_industry_outlook_q1_2020.pdf


Disclaimer

Each applicable policy of insurance must be reviewed to determine the extent, if any, of coverage for COVID-19. Coverage may vary depending on the jurisdiction and circumstances. For global client programs it is critical to consider all local operations and how policies may or may not include COVID-19 coverage.

The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal and/or other professional advisors. Some of the information in this publication may be compiled by third party sources we consider to be reliable, however we do not guarantee and are not responsible for the accuracy of such information. We assume no duty in contract, tort, or otherwise in connection with this publication and expressly disclaim, to the fullest extent permitted by law, any liability in connection with this publication. Willis Towers Watson offers insurance-related services through its appropriately licensed entities in each jurisdiction in which it operates.

The information given in this publication is believed to be accurate at the date of publication shown at the top of this document. This information may have subsequently changed or have been superseded and should not be relied upon to be accurate or suitable after this date.

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