Last month, Aon released new findings on the risks of doing business globally, so we asked John Minor, director of crisis management and political risk at Aon, about the effects that a potential trade war with China could have on insurers.
What effects does a supply chain disruption have on companies and insurers?
Supply chain disruption has the potential to result in material financial losses for companies, such as a decrease in sales or earnings; extra costs and expenses; and, in certain circumstances, contractual penalties for delays or non-delivery. A supply chain disruption that occurs ahead of a new product launch or a critical point in the sales cycle could have a material impact on earnings.
To mitigate the hit to earnings, some companies will incur significant extra costs to expedite shipment or source replacement products or materials from alternative suppliers. Some of these losses may result in insurance claims under the contingent time element section of a property insurance program, for example, if a supplier or customer is directly impacted by a property peril. If the supply chain disruption results from an event that occurs somewhere along the delivery route—for example, a hurricane that washes out roads, bridges, and ports; an earthquake that paralyzes a country’s transportation infrastructure; or a military blockade or embargo imposed against a key trading partner—traditional insurance policies will not typically respond. A niche insurance product has been designed specifically to address these gaps in coverage, called trade disruption insurance, which is offered by a subset of the political risk insurance market.
How could a trade war affect insurance claims departments?
The political risk insurance market is watching closely for signs of an escalation of tensions between the U.S. and China, as this could potentially result in a sharp increase in claims. Trade barriers imposed by China could result in cancelled contracts or projects, for example, if a company is unable to sell its products into China or source critical components from Chinese suppliers.
For companies that depend critically on trade with China, a trade war could inflict severe damage on company earnings and, in the most extreme circumstances, force some companies into bankruptcy. Another area of potential concern for companies with local operations in China is the possibility of being targeted by government officials with time-consuming regulatory reviews, perhaps resulting in arbitrary fines, penalties, or even plant closures for alleged violations of safety, health, and environmental standards. Where this regulatory burden increases operating costs to unsustainable levels, companies may be forced to cease operations, which may result in expropriation claims for the political risk insurance market.
What are some risk management strategies for preventing supply chain disruptions?
The most robust strategies for preventing or mitigating the impact of supply chain disruptions involve an element of redundancy on the supply side and market diversification in one’s source of revenue, for example, eliminating sole source suppliers as much as possible and diversifying sales geographically to lessen the impact of the loss of a single market. Companies should also stress test their supply chains to determine their supply chains’ resilience to geopolitical conflict or the introduction of trade barriers that prevent trade with a single country.
Where these strategies are impractical or impossible, companies should make sure the contingent time element coverage limits are adequate to address these vulnerabilities in the supply chain. As mentioned previously, trade disruption insurance is also available to fill in some of the gaps in these traditional insurance programs, providing a source of funds to cover the extra costs incurred to mitigate the impact of a supply chain disruption on a company’s earnings. Political risk insurance is also available to cover government actions that result in the cancellation of a contract or a project, including selective and discriminatory regulations that render the operations of a local enterprise commercially unviable.
What other claims-related impacts do companies face in a world with increased risk of terrorism and political upheaval?
There is little doubt businesses will face complex challenges from political risk, political violence, and terrorism in 2018. Given this heightened level of risk and the geopolitical uncertainties facing businesses around the world, it is imperative that companies evaluate their risk management and insurance programs to ensure they provide appropriate levels of protection against a wide range of political risks, violence and terrorism threats, both in high-risk environments as well as in more comparatively benign countries and regions.