The Move to Outsource Supply Chains Now Under Pressure
As inflation, the war in Ukraine, climate change, and the lingering effects of the pandemic continue to cause problems for global supply chains, insurers and their clients are likely to come under increasing pressure to reconsider long-established methods of procurement and delivery.
Royston Ford, strategic portfolio manager – marine, at RSA, cites the effects of decisions made in Western Europe and the United States to outsource such critical, high-skilled supply chain functions as specialty steel and specialty chemicals to Ukraine. “They are the kind of industries that have fallen out of favor and popularity in Europe and the U.S.,” Ford explains.
Such activities, Ford adds, have the added disadvantage of not being easily replaceable. Not only do key Ukraine-based manufacturers have relatively easy access to vital metals and chemicals, he says, but they have workforces that bring unique skills. Ukraine, for instance, provides much of the specialist wiring found in modern vehicles, Ford points out.
“You can’t instantly find an alternative,” Ford says. “You have to rebuild the outsourced supply chain.”
Ford, who believes the disruption “is going to be playing out for a good few years to come,” argues that supply chains themselves will have to become more diverse.
In a report issued in June 2022, the International Monetary Fund said global supply chains were disrupted by the closures of factories as a result of the pandemic—at a time when demand for communications-focused technology was rising among homebound consumers. Semiconductors became scarce, the reportsaid, and key ports became clogged with merchandise. “Few links in the global supply chain were spared,” the IMF said in the report.
In announcing plans for a virtual “Supply Chain Ministerial Forum,” in July (2022), the U.S. Commerce Department said efforts by the Biden administration to tackle the issue had already included the establishment of a structure to monitor the global supply of microchips; moves to attract foreign investment into U.S. supply chains, and an initiative —with the cooperation of the State Department — to maintain the flow of critical minerals to users. “There is no silver bullet when it comes to solving our supply chain challenges,” Secretary of Commerce Gina Raimondo told the delegates.
Guillaume Faury, chief executive of airplane manufacturer Airbus, has offered a gloomy outlook for supply chains within the global aerospace sector. “We have difficulties to believe that in two years from now it’s not going to be resolved,” Faury told the Financial Times in an interview from the Farnborough Air Show near London in July (2022).
Ford points to the effects of climate change on the ability of businesses to send and receive goods. In addition to early summer heat waves this year in Europe, he cites “almost unheard of” heat in the Indian capital of New Delhi. Not only have there been food shocks on the Indian subcontinent, Ford says, but there has been disruption in the generation of power that is only bound to worsen as the world continues to get warmer. He also points to worrying drops in the water levels of navigable rivers in both Europe and South America.
“A lot of industries are finding it increasingly difficult to export heavy equipment in the summer months,” Ford says.
Andy Jones, director of risk consulting at RSA, suggests that the push for single-sourcing by procurement departments has made things difficult for businesses that might want to diversify their supply lines. The picture, Jones notes, is complicated by the “unnatural stress” created by rapid technological change.
Jones says his property perspective lends itself to an “end to end” approach to supply chain issues. This can mean going right back to investment decisions, and the design and construction of factories. One goal, he suggests, should be to remove some of the complexity from the manufacturing and design process.
In its report, the IMF stressed the importance of maintaining resilient supply chains in the face of shocks. Suggested options, the IMF notes, have included pulling back from the global supply chain by “reshoring” business functions; accepting the prospect of higher costs that would come with diversifying foreign supply chains; and increasing inventories.
“Diversification and overstocking are essentially insurance strategies,” the IMF report said. “Countries and companies have to decide how high an insurance premium they are willing to pay.”
Tim Prince, director, analytics at AM Best in London, says the significant increase in supply chain disruption in recent years has driven up the cost of insurance claims.
“Initially, disruption was fueled by the COVID-19 pandemic and associated lockdowns,” Prince says in an email. “But more recently, it has been worsened by the conflict in Ukraine and subsequent Russian sanctions.”
Other factors, Prince says, have included the extended blockage of the Suez Canal in 2021; the referendum in 2016 that took the United Kingdom out of the European Union, and the spread of “just-in-time” supply methods. Prince says the Suez Canal bottleneck, which occurred when a giant containership became wedged in the waterway, “highlighted the interconnectedness of the global economy.”
Problems within supply chains can generate unwelcome replacement costs, Prince notes, while sudden disruptions to deliveries can make it more difficult both for insurers to impose offsetting premium increases, and to settle claims quickly. “Whether premium rate increases will ultimately be sufficient to offset the impact on claims inflation is yet to be determined,” Prince says.
Prince says insurers in the highly competitive personal lines markets may feel particular pressure when called upon to replace vehicles or to provide emergency accommodation to householders who have been flooded out.
With the broader range and greater complexity of their products, Prince says, commercial insurers are called upon to deal with supply chain risks across international borders. Local events, he notes, can create widescale business interruption losses.
While noting the general success of commercial insurers in raising their rates in recent years, Prince warns that those who cannot continue to do so “will suffer over time.”
“Predicting the magnitude and longevity of supply chain disruption and claims inflation is an impossible task, therefore stress-testing and risk management considerations are also important factors,” Prince says.