The O-Ring in Your Supply Chain

Whether political perils arise far afield or close to home, the consequences for your supply chain can be catastrophic. Here's how finance executives can manage the risk.

Another step is to make custom-tailored designs a tad less tailored. In a previous job, Hauser worked for a large food company that found itself locked in to a single supplier because of the company’s own rigid specifications for a key ingredient. But by working with other suppliers, she found that a slight change in specs afforded her company a few different ingredients to choose from.

Still another step, according to insurance industry experts, is to pay close attention to contracts with suppliers. One clause to insist on, says Dunford of Chubb and Sons, is a force majeure provision that enables the company to void a supplier contract in the event of war or civil strife. Dispute-resolution clauses are also a good idea, he adds, to enable the parties to settle differences out of court. The “must-avoid” clause: any sovereign-immunity provision that would allow government-owned suppliers to assert that companies have no legal standing to make claims.

More broadly, finance executives should know which legal system holds sway in their supply-chain contracts. “Is it the state of New York or the federal government of Ghana?” says Dunford. “There’s a big difference.”

When All Else Fails…

A company’s best efforts notwithstanding, sometimes the goods arrive too late or not at all. To protect themselves against the ensuing loss of revenue, U.S. manufacturers can buy a form of political risk insurance called “trade disruption” or “contract frustration” insurance. Policies, which cover specific trade arrangements, typically last three to five years but can run as long as a decade, according to Dunford. Coverage usually includes reimbursement for supply-chain losses associated with embargoes, import and export curbs, and other government actions that bar the free flow of goods.

Terrorism coverage can be included, but rarely is. “It would be hard for me to imagine a terrorist attack interrupting trade flows in any way,” says the underwriter. “Terrorists are usually looking for headlines, and they usually go after people rather than things.”

Then there are individually tailored policies, generally called “supply-disruption insurance.” Usually underwritten by Lloyd’s of London syndicates, the coverage aims to fill the gaps in standard property-casualty policies. According to the Aon white paper, supply-disruption policies can cover such perils as non-arrival or late arrival of just-in time deliveries; shipment delays or non-arrivals; and ship reroutings.

Now isn’t a terribly bad time to think about buying political risk coverage. Unlike property-and-casualty coverage, which most big companies can’t really do without, political risk insurance is a discretionary buy, maintains Harry Palumbo, a vice president with AIG WorldSource. Underwriters know this, too, and so political risk insurance tends to be cheaper.

Indeed, in the softening market for commercial insurance, buyers of political risk coverage are enjoying small premium increases — and sometimes, no increase at all. What’s more, insurance is in fairly abundant supply: Under Chubb’s contract-frustration policy, for instance, companies can secure up to $37.5 million in coverage for each trade arrangement.

Insurance can provide only limited, monetary solace for a broken supply chain, however. That’s why Intel focuses on planning for contingencies with its overseas suppliers rather than buying insurance, according to Labrador. The company’s risk-management goal isn’t to receive compensation for a supply chain gone awry, “it’s getting us back to market as quickly as possible.”

Country Risk: Brazil “Behaving Well”

The country-risk ratings of the Economist Intelligence Unit (a sister firm of CFO.com) take account of 77 indicators of political stability and other measures of credit quality. The EIU’s ratings show that Brazil has become less risky in the past year, thanks in part to better-than-expected economic policies.

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