On April 16, 2016, a 7.8 magnitude earthquake struck western Ecuador, killing more than 600 people, injuring another 27,000, and causing $3 billion in damage. At around the same time, two quakes shook Japan, leaving 49 people dead, 3,000 injured and billions of dollars in damage.
In addition to the human and economic cost in these two countries, the disasters impacted businesses around the world. Ecuador exports more bananas and plantains than any other country, shipping them to more than 50 countries. The Japanese quakes suspended production of camera chips, image sensors, motorcycles, cars, electronic display devices, and steel. Businesses in the U.S. rely on imports of these products to meet the needs of their customers. When disasters like these occur, businesses around the world feel the effects.
In addition to making advance arrangements for alternate suppliers, businesses can protect themselves by purchasing two types of insurance: Contingent business interruption and supply chain insurance.
Contingent business interruption, also called business income from dependent properties, pays for a business’s lost profit plus continuing expenses when it must slow or stop operations because of damage to another business’s property. These other businesses can be customers or suppliers. For example, if a motorcycle dealership was left with no bikes to sell because its supplier in Japan suffered a fire, this insurance would make up part of the lost income.
The damage must be caused by a cause of loss that the insurance policy covers, such as fire or a hurricane. This is important because standard property insurance policies do not cover losses caused by catastrophes such as floods and earthquakes.
Supply chain insurance takes contingent business interruption a step further. It covers income lost because of damage to a supplier’s or customer’s property. However, it also covers losses resulting from events that do not cause physical damage. These may include:
• Labor disruptions
• Production process problems
• Trade disputes
• Political turmoil
• Closed roads, bridges, railroads and shipping channels
• Public health crises
• Actions by regulators
• Financial difficulties
Businesses often have different tiers of suppliers, with key suppliers in the top tier and less important ones in the lower tiers. It is common for them to insure only the top tier. However, insurers are increasingly offering multi-tier coverage. This applies to the business’s entire supply chain. Multi-tier coverage provides a more comprehensive solution for the business while also spreading out the insurer’s risk.
Some insurers offer options. One lets policyholders choose between measuring losses in terms of gross earnings or number of units from the supplier. Some also offer agreed value coverage, which eliminates penalties for buying amounts of insurance less than the amounts of value at risk.
Businesses should determine where they are vulnerable to supply chain losses and develop backup plans for dealing with unexpected disruptions. These could include reserves of the needed supplies and contracts with alternate suppliers. Insurance can help the business recover from a supply chain loss after the fact. Advance planning can help make that loss as small as possible.