Insurance Can Reduce the Financial Repercussions to Your Supply Chain of Superstorms, Wildfires, Climate Change, and Global Economic Disruptions

Welcome to “California Corner,” dedicated to posts authored by our new team of Insurance Recovery attorneys based in our Los Angeles office. Partner Linda Kornfeld, who serves as vice chair of the Insurance Recovery group, Partner David Thomas and Of Counsel Julia Holt focus on national and California-specific issues, including property and weather-related business interruption issues, data breach and privacy issues, and professional liability, asbestos, and environmental liabilities. Their clients include telecommunications companies, universities, real estate developers, manufacturers, and nonprofit organizations around the country. We hope you find their perspectives informative and insightful!

Linda Kornfeld, David Thomas, and Julia Holt

Many companies in today’s global economy are dependent upon the efficient and disruption-free operation of their multinational supply chains. Unfortunately, such supply chains are vulnerable to numerous physical and non-physical elements, including natural disasters, information technology failures, cyberattacks, pandemics, climate change, and civil and political unrest. These vulnerabilities can, and often do, result in the disruption of business operations resulting in significant financial losses.

Hurricanes Irma and Maria in Puerto Rico are an example of how a natural disaster can significantly impact the supply chain within a single industry causing substantial losses. Puerto Rico is vital to the medical device industry. According to the Food and Drug Administration, Puerto Rico has more than 50 medical device manufacturing plants, which “manufacture more than 1,000 different kinds of medical devices,” including surgical instruments, dental products, and “highly complex devices such as cardiac pacemakers and insulin pumps.”[1] Some of the manufacturers are the sole manufacturer of a certain medical device.[2] The aftermath of Hurricanes Irma and Maria—the lack of power, connectivity, transportation, and clean water—has caused manufacturers to be unable to return to pre-hurricane production levels, even months later resulting in significant financial losses. For example, one medical device company with four plants in Puerto Rico is expected to suffer an estimated $55 to $65 million dollar loss alone.[3]

Another example is the tsunami that hit Japan in March 2011. The tsunami caused an estimated $40 billion in economic losses due to interruptions in global supply chains. Toyota and Honda experienced a 30 percent and 60 percent decline in profit, respectively, which both attributed to production lags caused by limited supplies of parts after the tsunami. Toyota estimated it took six months for it to fully recover from the supply chain disruption it suffered because of the tsunami. Honda’s recovery took even longer because in the fall of 2011, its supply chain recovery was halted when it suffered further disruptions caused by the historic flooding in Thailand. In addition to the disruption to Honda, the Thai floods from July 2011 until January 2012 closed down dozens of hard drive manufacturing and supply plants, interrupting computer supply chains to the tune of $40 billion. As bad as these natural disasters were, many scholars predict that a natural disaster-related supply chain disruption in China would be even more disastrous.

However, not all business interruptions are the result of natural disasters. In fact, there is growing concern regarding the vulnerability of supply chains to technology failures and cyberattacks, and with good reason. Damages from cyberattacks in 2017 alone are estimated to exceed five billion dollars as compared with only $325 million in damages in 2015. For example, in May 2017, there was a cyberattack using the WannaCry ransomware cryptoworm that locked computers in more than 150 countries and demanded payment to restore the files. Entities affected by the WannaCry cyberattack included major corporations in multiple industries, governments and related departments and entities, universities, and hospitals. The attack was estimated to have resulted in damages ranging from hundreds of millions to billions of dollars, most of which were not attributable to the ransoms paid, but to downtime, loss of productivity, forensic investigation, restoration of systems, and other costs.

These recent world events demonstrate the vulnerability of supply chains and the companies that rely upon them. Many companies enter into indemnity and other agreements with business partners to mitigate against this risk. However, indemnity agreements are not enough in a global economy where one weak link in the supply chain can bring business to a screeching halt. Companies should re-examine their insurance portfolio to determine whether their existing policies adequately protect against supply chain risks.

First-Party Commercial Property Insurance

Most companies have first-party commercial property coverage, which includes business interruption coverage. Such insurance typically reimburses the company for the profits it lost due to an interruption in its business. From a supply chain disruption perspective, the contingent business interruption provision may be the most relevant coverage within this type of policy. This coverage pays for lost profits resulting from a break in the supply chain caused by a physical event that impacted a company’s customers or suppliers. The company need not suffer any actual loss or damage at its own facility to trigger coverage. However, since the major losses caused by the tsunami in Japan, 2011 Thai floods, and Superstorm Sandy, insurers have sought to narrow the coverage. In some instances, the policy now only covers losses for disruptions at the facility of a “direct” supplier or customer. In other instances, when the coverage is not so limited, insurers have regardless sought to impose a narrow interpretation. At least one court has rejected this approach, concluding that the term “supplier” is ambiguous and finding coverage for the lost profits even though the event that caused them took place at a supplier further down the supply chain. Thus, companies should carefully review their policies and upon renewal, negotiate to obtain policy language that provides maximum protection.

Cargo Insurance

Cargo insurance covers the loss, damage, or theft of goods while in transit. Loss during transport occurs regularly caused by containers shifting, transport vessels capsizing, transport containers being damaged or destroyed, and weather harming goods and interrupting travel. Theft also can be a major risk for supply chains. For example, theft as a result of organized crime is estimated to cause over $30 billion in losses a year. Cargo insurance can offset all of these risks, whether on ships, at airport terminals, on trains, or in trucks, as long as the goods are being transported between their point of origin and their final destination.

Trade Disruption Insurance

From a supply chain risk management perspective, contingent business interruption and cargo insurance may not be enough. Depending on the policy language, that coverage may do little to protect against supply chain disruptions caused by a workers’ strike, technology failure, or cyberattack that negatively impacts the supply chain but does not cause any physical damage. However, trade disruption insurance may provide important protection in these circumstances.

This coverage is designed to protect against, among other things, lost profits caused by supply chain disruptions where there is no resulting physical loss or damage to the insured’s or its supplier’s assets. However, it is important to scrutinize the policy language and make a careful assessment of the company’s specific risks. Some policies provide coverage for political events, such as an embargo or terrorism, while many others do not. Similarly, some policies provide coverage for commercial events, such as strikes or the bankruptcy of a key supplier, while others do not. These policies are specialty coverage and can often be tailored to the needs of a particular business and its specific risks.

Cyber Insurance

Given the growing technological sophistication of supply chains and the globalization of companies’ information systems’ infrastructure, supply chains are at an increasing risk of cyberattacks. One way of mitigating against that risk is cyber insurance, which is a relatively new product on the market. However, it is important to review the policy language to ensure coverage not only for cyberattacks against the company, but also against its suppliers.

Conclusion

Given recent current events that have exposed significant vulnerabilities in global supply chains, companies should review the insurance policies in their portfolios, and consider purchasing additional coverage if necessary.


[1] “Statement by FDA Commissioner Scott Gottlieb, M.D. on medical device manufacturing recovery in Puerto Rico” available at www.fda.gov/NewsEvents/Newsroom/PressAnnouncements/ucm581436.htm (October 20, 2017).

[2] See id.

[3] See “Puerto Rico’s Medical Manufacturers Worry Federal Tax Plan Could Kill Storm Recovery” available at www.npr.org/sections/health-shots/2017/11/27/566771228/puerto-ricos-medical-manufacturers-worry-federal-tax-plan-could-kill-storm-recov (November 27, 2017).