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Aon Benfield Scholarship 2012

Full Name: Emma Coppin

Date of Submission: 26th April 2012

Global Integration of Business and its reliance on the Insurance Industry

Introduction

The Insurance industry began as the business of risk transfer. In the modern age it was about the

physical division of goods between ships or the agreement between owners of cargo to share the risk

between them, in the event of a loss.

In modern capitalist economies with monetary currency and other financial instruments the insurance

industry adapted and enabled the development of a sophisticated economy. It became possible to

transfer the risk to an unrelated party, being an insurer, in exchange for payment. In many communist

countries there was no industrial property insurance and the main function of the state insurance

monopolies was to administer a range of chosen compulsory classes that were generally viewed as

'taxes' by the population.

The economic markets operating were homogenous politically, economically and socially. Economic

integration was largely unheard of and countries operated within their own national economies. They

were structured in a way that protected manufacturing and trade within the country. The importance of

insurance was focused largely on the financial protection it provided in relation to physical assets.

Insurance was mostly seen as a convenience and not a matter of urgency or necessity.

But what has happened over the years, and particularly since the 1990's with the fall of communism

and the harmonisation and global economic integration, is that insurance on physical assets is probably

the least of the problems the insurance industry confronts - and the industry has accommodated this

with ease. A sophisticated, globally reliant economy needs to mitigate risk in the first instance and

protect its’ profits if it can't. If the profits are not protected, the economic downturn that may result, may

also compound in effect. Losses generated by currency fluctuations, natural disasters and political

flare-ups in other countries and regions whom are our trading partners are a lot tougher to find solutions

which protect us..

So let's have a look at how the Insurance Industry has adapted to some recent events and trends and

look at where it is perhaps heading in the future.

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The Automotive Industry

Let us take the automotive industry as an example. The removal of trade barriers in the international

arena and changes to the political landscape in communist and socialist countries such as China and

India have opened up an ‘all new’ global manufacturing, import and export enterprise. The automotive

industry is a truly globally integrated industry that relies on supporting industries from all over the world

to produce a vast array of materials and components.

So how has the insurance industry adapted with the automotive industry to meet the challenges set by

this truly global industry? It would be fair to say that the insurance industry’s appetite for adaptation into

new and more complex products, such as supply chain insurance, are a balance between the industry's

ability to design and supply a product, and the business world’s demand for it. Insurance is an

intangible product and its’ benefit is only felt when there is a loss. Until the recent natural disasters in

Asia, there has been little demand for comprehensive supply chain insurance.

The insurance industry has been dabbling in the complexities of providing comprehensive supply chain

insurance products to the automotive industry, and other globally integrated industries for some years.

We know that businesses buy insurance for business interruption, and even if they suffer no physical

damage themselves, they generally purchase insurance cover in the event that key suppliers suffer

physical damage and they lose profit as a result. But is it possible to insure thousands of key suppliers,

when vital risk information is scarce? And what about the suppliers of their key suppliers? And their

suppliers?

The insurance industry has attempted to increase the supply chain insurance products offered to the

market, yet in a truly globally interactive and interdependent industry such as the Automotive Industry,

such a complex offering is still largely a new and underestimated area of insurance. It wasn't until the

March 2011 Japan earthquake and tsunami and then the Thailand floods that began in July 2011, that

the actual exposures the automotive industry faced began to be addressed by business. Similarly to

the Great Fire of London in 1666 in which 13,000 houses were wiped out, insurance cover for

comprehensive supply chain risk was still seen as a convenience and not a matter of urgency or

necessity.

Whilst most of the main Japanese manufacturers had little or no damage to their own manufacturing

plants, their supply chains were severely affected. According to the Japan Automobile Manufacturers

Association (The Motor Industry of Japan 2011, p. 2), there are generally between 20,000 and 30,000

parts in any one automobile. Although there are many manufacturing facilities all over the world, there

were vast numbers affected by the interdependence on parts procured from around the world.

Automotive Dealerships globally were unable to meet demand as supply of vehicles both stopped

coming into the country, and local manufacturing either slowed down or ceased due to the lack of parts.

There was also the problem of the transportation system being shut down or reduced dramatically and

a vast reduction in the supply of electricity also caused disruptions.

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The cost of the 2011 Japan earthquake and tsunami was estimated at USD35 Billion in insured losses

and approximately USD210 Billion in economic losses1. If there was a sophisticated and highly

adopted supply chain insurance product in place that would have picked up all these aspects of supply,

how much of that economic loss would have been borne by the Insurers? Additionally, what would

have been the impact to the insurance industry as a whole? The potential exposure on such a massive

accumulative scale could threaten insurance market stability . Adaptation by way of 'expansion' into the

area of comprehensive supply chain insurance could see the industry 'adapting' itself into extinction as

insurance would become more expensive and supply restricted. Insurance should be the last line of

defence when it comes to risk management of supply chains.

Insurers have recognised and adapted to this potential exposure. Insurers generally recommend that

the first step in managing supply chain risk is to map the specific supply chain and to add a value to

each supply within the chain to work out where energy and resources need to be concentrated. The

insurance industry is not only providing comprehensive supply chain products, it is also partnering with

the companies to identify their exposure, mitigating it where possible and providing leadership in the

importance of undertaking “due diligence” on their supplier network. This can include ensuring that key

suppliers have done their own “due diligence” on their own supplier network. Additionally, checking the

contingency and disaster recovery plans that can be put in place should a crippling event occur. A risk

management perspective is also encouraged to be taken in the evaluation of capital deployment when

expanding into new geographical areas.

Perhaps the big question is: Should businesses be structured in a way that reduces their exposure to

such risks in the first place? Many automobile manufacturers structure their business to hold minimal

stock based on a ‘just in time’ inventory system designed to increase cash flow, reduce storage costs

and thus maximise profits. They also centralise the production of certain parts meaning that fewer

factories are producing specialised parts for vehicles This means that natural disasters (such as the

Japan earthquake and tsunami or the Thailand floods) and economic and political events have the

potential to greatly affect the Automotive Industry more than other industries who are less sophisticated

and rely less on specialised centralised part production or who choose to run their operations on fatter

stocks and supplies.

So the insurance industry needs to ask itself: Are these risks that a company needs to carry if it is

structured in this manner? Is it desirable for that risk to be transferred to the Insurance Industry? What

is the price? What are the other potential losses an automotive manufacturer could face as a result of

such an event? Should the Insurance Industry provide cover for those events? Brand loyalty is tested

as buyers decide whether or not to 'wait out' the shortage in supply or switch to another supplier and

potentially incur additional costs of ‘short orders’ and higher transport costs, plus the ‘unknowns’ of

dealing with less known suppliers.. The automotive dealerships may emphasise a strategy to multi-

franchise to ensure a wider protection of their own profits to reduce their risk. Does this dilute the

manufacturer’s brand further? Is there an insurance product that could be sold to protect brands? How

would it be measured? Again, is this something that is financially viable?

1 Annual Global Climate and Catastrophe Report - Impact Forecasting - 2011, Aon Benfield pg 3

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The Insurance Industry has adapted in both supply and innovation in relation to supply chain risks faced

in the global environment. As more businesses review and take out comprehensive supply chain cover,

it will be interesting to see if the risk mitigation strategies employed alongside the insurance will be

enough to ensure the long-term continuity of this class of insurance.

The Shipping Industry

The insurance and shipping industries have collaborated to deal with the physical risks faced by a fast

growing industry where increased global trade means shipping channels have become more crowded

and vessels themselves are becoming larger and faster and carry more stock. Therefore the physical

risks have increased but predictably, within the evolved insurance industry, the physical risks are fairly

straightforward to insure, and whilst preventing loss in the first place is most important, the shipping

industry is really no different in managing the physical risk surrounding other transport industries.

However, it is the new and bespoke policies relating to piracy risks and the efforts made by the

insurance industry to mitigate the risk in the first instance that are glowing examples of how the

Insurance Industry has adapted to the global environment that it now operates within.

Whilst there has been an expansion in Kidnap and Ransom insurance cover, this has generally been

accompanied by a well researched and implemented risk mitigation programme. This includes studies

by various insurance industry participants on the lowest and highest risk times of the year, weather

related risk, what time of the day an act of piracy is most likely to occur and where it is most likely to

occur. Studies have also been undertaken by experts in the industry and data compiled to work out

what speed vessels should travel above and what the height of their freeboard means for their risk.

It could be argued that Kidnap and Ransom insurance encourages the act of piracy by providing a

reimbursement mechanism for the owners of vessels. But Kidnap and Ransom cover is unlikely to be

offered, or to be affordable to a shipping business which has not increased security and kept up with

the changes to risk management required by specialists in this area of the insurance industry. Owners

and operators of vessels also owe a ‘duty of care’ to their employees, so it could be argued that not

taking Kidnap and Ransom cover could put them more at risk should the company be unable to meet

ransom demands themselves. Crisis response services are also offered and they assist the industry in

dealing with such situations. In short, Kidnap and Ransom cover usually includes specialised services

to assist in the negotiation and extraction of crew and other personnel from a kidnap situation.

The motivation of pirates can be political, ideological or financial. Whichever their motivation, the

outcome is the same. Jardine Lloyd Thompson PLC compile data from industry, military and security

sources and have been working on setting up a ‘Convoy Escort Program’ with Lloyd’s. This program is

to be funded by many industry participants and is proposed to include a fleet of armed escort vessels to

travel with ships through the notorious Gulf of Aden. This financial and time heavy investment is an

example of the expertise provided by the Insurance Industry to other industries to adapt to the risks

faced in our increasingly globally interactive world. Another risk mitigation step includes the

employment of security teams – both armed and unarmed, to be on-board vessels travelling through

what are considered to be treacherous waters for piracy. This risk mitigation step opens up another

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area of insurance embraced by Bellwood Prestbury International, to provide personal accident

insurance (called ‘pirate insurance’) to teams whilst deployed into these highly volatile and potentially

hostile situations.

So the shipping industry is a good example of how the evolution and adaptation of the insurance

industry has meant it has been able to stay relevant and at the forefront of the risk side of doing

business.

Conclusion

The Insurance Industry's focus historically was the management and transfer of risk in a simple

homogenous environment with little or no regulation and basic trading conditions.

The Insurance Industry is an 'enabler' in the increasing complexities of a globally interactive and

interdependent environment and has adapted to introduce new insurance products as demanded by the

market. There is now a more holistic view of the 'risk industry' and whilst still seeing insurance as an

important and protective way of financing the transfer of risk of any business, there has been a

fundamental change in the management of risk that first and foremost begins with understanding the

risks faced by complex businesses, mitigating the risk as best they can, and seeking insurance cover

for the risks that cannot be easily controlled.

The importance of the financial protection of physical assets has become less of a priority as

fundamentally, aside from the various compliance and regulatory frameworks that the Insurance

Industry operates within, there have not been a lot of changes required to successfully insure physical

risks. However, in the global environment , there has been a realisation that the financial compensation

provided to a global company who has suffered a large loss will not stop the ripples of reduced profits

reverberating through a business and their supply chain, nor compensate for the potential long term

damage to brand and reputation.

The biggest adaptation that has occurred within the Insurance Industry in this increasingly global

society is the need to focus more on risk mitigation, and less on straightforward financial risk. Mitigating

the risk and taking structured action with the intention of reducing the magnitude of the economic and

insurance losses is a far better way to adapt to an increasingly integrated and interdependent global

environment. By mitigating risk, companies may be able to avoid having to rely on their ‘loss of profits’

being compensated whilst still eroding their market share and that of their distributors/retailers who may

not have the same ability for compensation.

The capacity to integrate specialised and structured risk mitigation strategies to dovetail with the

financial instrument of an insurance policy will allow the insurance industry to further evolve into a vital

part of protecting, enabling and advancing global commerce and industry.

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References

• Allianz Global Corporate and Specialty, Piracy: An ancient risk with modern faces, 2009

http://www.agcs.allianz.com/assets/PDFs/risk%20insights/Allianz%20Piracy%20Study%20-

%20June%202009.pdf

• Aon Benfield, Annual Global Climate and Catastrophe Report: Impact Forecasting - 2011

http://thoughtleadership.aonbenfield.com/ThoughtLeadership/Documents/20120110_if_annual_glob

al_climate_cat_report.pdf

• Bellwood Prestbury, Case Study: Pirate Insurance - Protecting the Protectors, 2012

http://www.bellwoodprestbury.com/case-studies/case-study/pirate-insurance-protecting-the-

protectors-57/

• Business Insurance, Losses to property, income still rising in Thai Flooding, 2011

http://www.businessinsurance.com/article/99999999/NEWS060101/399999815?tags=%7C331%7C

306%7C64%7C329%7C76

• Business Insurance, Supply chain risks grow more complex, 2011

http://www.businessinsurance.com/article/99999999/NEWS060101/110809901?tags=%7C331

• Business Insurance, Supply risks take priority, 2011

http://www.businessinsurance.com/article/99999999/NEWS060101/399999894?tags=%7C331

• FM Global, The New Supply Chain Challenge: Risk Management in a Global Economy, 2006

http://www.fmglobal.com/pdfs/ChainSupply.pdf

• Japan Automobile Manufacturers Association, Inc. The Motor Industry of Japan 2011

• Jardine Lloyd Thompson PLC, Piracy: Coverage and Response, 2009

http://www.jltgroup.com/content/UK/risk_and_insurance/White_papers/261543_Piracy_Paper_FINA

L.pdf

• Sachs, Jeffrey D; Warner, Andrew; Brookings Papers on Economic Activity; 1995 1; ABI/INFORM

Global

• Time, Why the Somali Pirates Keep Getting Their Ransoms, 2009

http://www.time.com/time/world/article/0,8599,1892366,00.html