contingent business interruption (supply chain …...contingent business interruption (supply chain...

Contingent Business Interruption(Supply Chain Disruption)

PCS CATASTROPHE CONFERENCE

April 28, 2015 – Tampa, Florida

Presented by:Derek W. Royster, CPA / ABV / CFF, CGMA, CFERGL ForensicsPartner – Charlotte, North Carolina

4/28/2015

Overview

• Supply Chain

• Contingent Business Interruption Coverage

• Property Covered

• Coverage Triggers / Cause of Loss

• Scope of Damages

• Period of Interruption / Restoration

• Case Studies

4/28/2015 Contingent Business Interruption(Supply Chain Disruption)

Processor

Supplier Manufacturer Broker

Transporter Packer

Distributor

Retailer

Source

Supply Chain


Location, Location, Location

Japan – Thailand - ChinaThere may be several critical locationswhich, if damaged, can result in a fullinterruption of the production chain. Iffailure cannot be fixed quickly, a large BIloss will result.

Source: Swiss Re, Lessons from Recent Major Earthquakes, January 2012


Global Catastrophes(Significant Impact to Global Supply Chain)

• Japanese Earthquake / Tsunami / Nuclear Accident

• Thailand Floods

– Impacted areas included a high concentration of “High Tech” companies

– Impacted global supply chain of high-tech materials, components, products.

4/28/2015Contingent Business Interruption

(Supply Chain Disruption)

Contingent Business Interruption Coverage

• Contingent business interruption insurance (“CBI”) andcontingent extra expense coverage (“CEE”) is an extensionof first-party property insurance that reimburses lost profitsand extra expenses resulting from an interruption ofbusiness at the premises of a customer or supplier.

• The contingent property may be specifically named, or thecoverage may blanket all customers and suppliers.

• CBI insurance is also known as contingent businessincome insurance, contingent time element insurance, ordependent properties insurance.



Contingent Business Interruption Coverage(continued)

• Physical Damage to property

• Dependent Property

• Peril Causing CBI Loss – must be covered on own policy

• Results in inability to supply, deliver or accept goods and /or services

• Interruption of Insured’s business that results in a financial loss.



Contingent Time Element(Example A)

Time ElementContingent Time Element

This policy covers the Actual Loss Sustained and Extra Expense

• incurred by the Insured

• during the Period of Liability

1. directly resulting from physical loss or damage of the type insured;

2. to property of the type insured,

• at any location of direct suppliers or customers located within the Territory of this policy



Contingent Business Interruption(Example B)

ManuscriptContingent Business Interruption

The Company shall be liable for loss• resulting directly from necessary interruption of business• in whole, or in part• conducted on premises occupied by the Insured• caused by damage or destruction by the peril(s) insured against

during the term of this Policy,• to any of the real or personal property of the Insured's

customers, vendors or suppliers• anywhere in the world not operated by the Insured,• which results in the inability to supply, deliver, or accept goods

and/or materials, supplies, services or the like4/28/2015


Comparison of Coverage

Example A

• Loss incurred by insured

• During the Period of Liability

• Insured Peril

• Damage to type of property insured

• Any location of the insured’s DIRECT suppliers or customers

• Within the Territory of the policy

Example B

• Loss incurred by insured

• During the term of the policy

• Insured Peril

• Damage to any Real or Personal Property of the Insured’s suppliers or customers

• Anywhere in the world not operated by the insured


CBI Wording Variations: (Types of Dependent Properties)

1. “Dependent Property” means property operated by others whom you depend on to:

a. Deliver materials or services to you, or to others for your account (Contributing Locations). But any property which delivers any of the following services is not a Contributing Location with respect to such services:(1) Water supply services;(2) Power supply services;(3) Communication supply services, including services

relating to Internet access or access to any electronic network:

b. Accept your products or services (Recipient Locations);

c. Manufacture products for delivery to your customers under contract of sale (Manufacturing Locations); or

d. Attract customers to your business (Leader Locations).


CBI Wording Variations: (Unscheduled Locations) – CP 15 09 06 07

The following is added to Additional Coverages:

Miscellaneous Locations:

We will pay for the actual loss of Business Income yousustain due to direct physical loss or damage at thepremises of a “dependent property” not described inthe Schedule (miscellaneous location) caused by orresulting from any Covered Cause of Loss. A road,bridge, tunnel, waterway, airfield, pipeline or anyother similar area or structure is not a miscellaneouslocation.

Source: ISO CP 15 08 06 07Contingent Business Interruption


Contingent Time Element Coverage

Review the following:

• Local Policy

• Global Policy

• Limits

• Sub-Limits

• Deductibles

• Co-insurance

• Exclusions



Contingent Extra Expense (CEE)

• CEE coverage reimburses a policyholder for extra expenses incurred resulting from a contingent loss.

• Follows the same rules as CBI coverage.

• Like EE coverage, CEE coverage may include one of the following basic forms:

– Extra expenses to reduce loss

– “Pure” extra expense



Coverage Trigger / Cause of Loss

• Physical damage to property is required to trigger coverage

• Physical damage to type of property covered• Physical damage must be caused by an insured

peril• Damaged property must be a dependent property• Damage at the dependent property must be the

cause of the interruption


Cause of interruption-Covered Perils (Subject to Policy Wording)

• Fire, equipment failure, etc.• Earthquake• Flood• Utilities-electric, water, gas, etc.

- Service interruption (may include limitations)-Rolling blackouts

• Infrastructure-roads, ports, etc.• Ingress/Egress• Regulatory- government imposed restrictions: safety

issues• Availability of employees?


Define Scope of Damages

• Confirm the scope of physical damage to contingent business– May not be permitted physical inspection

• Confirm type of property covered• Confirm covered cause of loss / any exclusions• Verify supplier / customer status

– May have different limits, deductibles, waiting periods



Period of Interruption / Restoration and Indemnity• Typical Provision - “…interruption of business

for length of time that would be required with the exercise of due diligence and dispatch to rebuild, repair or replace the property that was damaged or destroyed.”

• Repair- some policies limit loss period to repair/replace damaged / destroyed physical property.

• Restoration- period limited to the insured restoring its business to pre-loss levels. Can be beyond the repair period (Extended Coverage)

• Indemnity- may end while the insured has not yet restored its business (e.g. 12 months following the event.)


Supply Chain

• Identify disruption to supply chain

• Who is a “Direct” supplier?

– Directly supplies insured?

– Supplier of the supplier?• Upstream - Suppliers• Downstream – Customers• Issues:

– Can customers wait?– When will inventory be back to

normal?– Reduced demand?

Upstream

Downstream



Who is a “Direct” Supplier / Customer

• Company that directly supplies or is a customer of the insured?

– What is the insured’s access to information?

– Does the supplier / customer need to be named in the policy?



Case Study - Background

• Insured is located in Florida• Prior to the loss the business consistently manufactured

approximately 100,000 units per month • It obtains materials from Supplier A and Supplier B • Supplier A provides 40% and Supplier B provides 60% of Part A; 1

unit of Part A is installed in each manufactured unit• Supplier A obtains raw materials to make Part A from Provider 1. The

insured has a supply contract with Supplier A and Provider 1.• Customers 1 & 2 “buy” the insured’s product & distribute the product

to the end user. The insured & Customers 1 & 2 have a contractual agreement for sales.

• All other customers buy product directly from the insured.• The insured’s profit margin $40/unit



Case Study

Loss Scenario

• Supplier A suffers building and equipment damage

• Due to supply/demand in the marketplace, Supplier B increases its price by $10/unit

• The insured is unsure when Supplier A’s operations will resume.



Case Study - Background

• Insured is located in Florida• It obtains materials from Supplier A and Supplier B • Supplier A provides 40% and Supplier B provides 60% of Part A; 1

unit of Part A is installed in each manufactured unit• Supplier A obtains raw materials to make Part A from Provider 1.

The insured has a supply contract with Supplier A and Provider 1.• Customers 1 & 2 “buy” the insured’s product & distribute the

product to the end user. The insured & Customers 1 & 2 have a contractual agreement for sales.

• All other customers buy product directly from the insured.• The insured’s profit margin $40/unit



Case Study #1 – Scenario 1

Loss Scenario – additional information

• Supplier A expects to be down for eight months

• Insured has 140,000 units in inventory at time of loss

– Plus 10,000 units of safety stock

• Insured uses 110,000 units of inventory per month

– based on loss period and pre-loss demand

To do – compute the expected loss amount and loss period.



Analysis of Inventory Change –8-Month Outage

4/28/2015

Month

Monthly Beginning Inventory Supplier A Supplier B

Sales / Use(A)

Monthly Ending Inventory

(B)

0 150,000 40,000 60,000 (110,000) 140,000 1 140,000 - 60,000 (110,000) 90,000 2 90,000 - 60,000 (110,000) 40,000 3 40,000 - 60,000 (90,000) 10,000 4 10,000 - 60,000 (60,000) 10,000 5 10,000 - 60,000 (60,000) 10,000 6 10,000 - 60,000 (60,000) 10,000 7 10,000 - 60,000 (60,000) 10,000 8 10,000 - 60,000 (60,000) 10,000

Note (A): Sales Demand is 110,000 units per month.

Note (B): Insured maintains 10,000 units of safety stock.


Available Inventory – 8-Month Outage

4/28/2015

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

0 1 2 3 4 5 6 7 8Monthly Beginning Inventory Supplier A

Supplier B Monthly Ending Inventory

Sales / Use


Contingent Business Income Loss –8 Month Outage (No Mitigation)

4/28/2015

MonthSales Demand

(Units)Actual

Sales / UseLost Sales

(Units)BI Loss

($40 Margin)EE

($10 / Unit) Total

0 110,000 110,000 - -$ -$ -$ 1 110,000 110,000 - - 600,000 600,000 2 110,000 110,000 - - 600,000 600,000 3 110,000 90,000 20,000 800,000 600,000 1,400,000 4 110,000 60,000 50,000 2,000,000 600,000 2,600,000 5 110,000 60,000 50,000 2,000,000 600,000 2,600,000 6 110,000 60,000 50,000 2,000,000 600,000 2,600,000 7 110,000 60,000 50,000 2,000,000 600,000 2,600,000 8 110,000 60,000 50,000 2,000,000 600,000 2,600,000

Total 990,000 720,000 270,000 10,800,000$ 4,800,000$ 15,600,000$


Mitigation

• Safety Stock

• Seek alternative Sources –multiple suppliers

• Delay in sale / “make-up”

• Product substitution

– Alternative product

– Higher margin product





• Supplier C

– can provide 30,000 units to the insured.

– can start providing insured with units in Month 5

– Cost is $1.5 million to prepare plant and qualify product




Analysis of Inventory Change – 8 Months(Supplier C - Mitigation)

4/28/2015

Month

Monthly Beginning Inventory Supplier A Supplier B Supplier C

Sales / Use(A)

Monthly Ending Inventory (B)

0 150,000 40,000 60,000 - (110,000) 140,000 1 140,000 - 60,000 - (110,000) 90,000 2 90,000 - 60,000 - (110,000) 40,000 3 40,000 - 60,000 - (90,000) 10,000 4 10,000 - 60,000 - (60,000) 10,000 5 10,000 - 60,000 30,000 (90,000) 10,000 6 10,000 - 60,000 30,000 (90,000) 10,000 7 10,000 - 60,000 30,000 (90,000) 10,000 8 10,000 - 60,000 30,000 (90,000) 10,000




Available Inventory –8-Month Loss with Added Supplier

4/28/2015

‐

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

0 1 2 3 4 5 6 7 8Monthly Beginning Inventory Supplier A

Supplier B Monthly Ending Inventory

Sales / Use Supplier C


Contingent Business Income Loss –(Supplier C – Mitigation)

4/28/2015

Month Sales Demand Sales / UseLost Sales

(Units)BI Loss

($40 Margin)EE Supplier B

($10 Unit)EE Supplier

(Tooling Cost) Monthly Total

0 110,000 110,000 - -$ -$ -$ -$ 1 110,000 110,000 - - 600,000 - 600,000 2 110,000 110,000 - - 600,000 - 600,000 3 110,000 90,000 20,000 800,000 600,000 - 1,400,000 4 110,000 60,000 50,000 2,000,000 600,000 - 2,600,000 5 110,000 90,000 20,000 800,000 600,000 1,500,000 2,900,000 6 110,000 90,000 20,000 800,000 600,000 - 1,400,000 7 110,000 90,000 20,000 800,000 600,000 - 1,400,000 8 110,000 90,000 20,000 800,000 600,000 - 1,400,000

Total 990,000 840,000 150,000 6,000,000$ 4,800,000$ 1,500,000$ 12,300,000$




• Supplier D

– can provide 25,000 units per month to the insured

– Beginning month 2

– Costs per unit $15 greater than Supplier A




Analysis of Inventory Change – 8 Months(Supplier D - Mitigation)

4/28/2015

Month

Monthly Beginning Inventory Supplier A Supplier B Supplier D Sales / Use

Monthly Ending Inventory

0 150,000 40,000 60,000 - 110,000 140,000 1 140,000 - 60,000 25,000 110,000 115,000 2 115,000 - 60,000 25,000 110,000 90,000 3 90,000 - 60,000 25,000 110,000 65,000 4 65,000 - 60,000 25,000 110,000 40,000 5 40,000 - 60,000 25,000 110,000 15,000 6 15,000 - 60,000 25,000 90,000 10,000 7 10,000 - 60,000 25,000 85,000 10,000 8 10,000 - 60,000 25,000 80,000 15,000




Contingent Business Income Loss –(Supplier D – Mitigation)

4/28/2015

Month Sales Demand Sales / UseLost Sales

(Units)BI Loss

($40 Margin)EE Supplier B

($10 Unit)EE Supplier D

($15 Unit) Monthly Total

0 110,000 110,000 - -$ -$ -$ -$ 1 110,000 110,000 - - 600,000 375,000 975,000 2 110,000 110,000 - - 600,000 375,000 975,000 3 110,000 90,000 - - 600,000 375,000 975,000 4 110,000 60,000 - - 600,000 375,000 975,000 5 110,000 90,000 - - 600,000 375,000 975,000 6 110,000 90,000 20,000 800,000 600,000 375,000 1,775,000 7 110,000 90,000 25,000 1,000,000 600,000 375,000 1,975,000 8 110,000 90,000 30,000 1,200,000 600,000 375,000 2,175,000

Total 990,000 840,000 75,000 3,000,000$ 4,800,000$ 3,000,000$ 10,800,000$


Comments / Issues

• Can customers wait? How long?

• At what level is inventory back to expected?

• Would Supplier C be necessary anyway? When? At what cost?

• When to stop paying extra expense for Supplier B

• When does the loss period end?

• Spend more $ on A to bring A online sooner

• What would production / sales projections have been?

• Reduced demand for product post loss

• If production / sales are limited, would average selling price increase?

• Could insured shift production to a higher margin product?



Record Keeping by Insured

• Logs / Diaries of Activity

• Supplier Investigation

– Understand supply chain

– Know the key contacts for the insured / supplier

– Identify critical suppliers

– Identify large suppliers / customers

– Review contracts with suppliers



Documents to Request

• Business Continuity Plan / Business Recovery Plan

• Contracts with Key Suppliers

• Contracts with Key Customers

• Supplier Force Majeure Letters

• Information from Suppliers (if available)

4/28/2015

Questions

