Insurance Implications of the Supply Chain Crisis ~ Insurance Academy

Global supply chains are under pressure throughout 2021 as a side effect of the COVID-19 pandemic. While many sectors of the economy have recovered from the sudden shutdown in the first half of 2020, the logistics and supply chain industries continue to operate at reduced capacity. Governments of major economies, such as the US and China, expect the crisis to continue into 2022.

Corporate Risk and Insurance spoke with Robyn Anderson (pictured above), an attorney in the insurance and recovery practice of US law firm Lathrop GPM, about how businesses affected by supply chain issues can cope with the crisis.

“Initially, massive shutdowns and quarantines meant a reduction in production capacity and supply,” Anderson said. “At the same time, consumer behavior is changing, with many people working from home and consuming goods in private spaces. This creates an immediate disconnect between supply and demand, and the disruption is felt by almost everyone. However, even as supply and demand gradually resynchronize over time, there are still kinks to work out in distribution. Major ports are still sometimes closed due to the outbreak, labor shortages persist, and operating costs skyrocket, all of which can add pressure and delays to a tense global system.”

It’s just a supply chain problem caused by the pandemic. “Typical” supply chain disruptors, such as floods, droughts, wildfires, and hurricanes, still exist and may actually worsen due to the effects of climate change.

According to Anderson, the first step to avoiding supply chain risks is to fully understand the supply chain and its vulnerabilities. Some companies are leveraging technologies like artificial intelligence to better understand real-time details and risks. Anderson also suggests that, where possible, businesses simplify their supply chains. Due to the pandemic, some businesses are also shifting away from “just-in-time manufacturing”, while others are turning to temporary employees to address the labor shortage.

“When disruptions do occur, businesses can also try to shift risk either through contractual risk transfers or insurance coverage placements,” Anderson said. “The classic insurance option, for example, would be contingent business interruption coverage in a property policy. The insurance applies even if the insured does not suffer direct property loss or damage. This is triggered if a supplier or customer suffers physical property damage which then causes disruption along the supply chain, impacting the insured’s business. This type of coverage works well when a physical event such as a flood or fire causes a disruption in the supply chain.”

However, in light of the pandemic, contingent business interruption coverage is not an open and closed matter, and it is left to the courts to decide whether the coverage remains in effect.

“Due to COVID-19, many courts have been tasked with answering whether the presence of the virus in a business could cause “physical” damage to property,” Anderson said. “Some courts have said yes, or at least probably, but many others have said no, meaning contingent business interruption coverage would not apply if the disruption was solely due to the COVID-19 outbreak and shutdown, for example.”

In September 2020, the UK Supreme Court ruled that companies that provide business interruption insurance and were forced to cease operations due to the pandemic are entitled to compensation from insurance companies.

“There are other potential insurance options available to businesses, which don’t require proof of physical damage, but these coverages are less common, less standardized, and often more expensive,” says Anderson. “As always, speaking with a knowledgeable broker and carefully reviewing any proposed policy language is key to ensuring coverage is appropriate for the company’s needs.”

Despite the court ruling, business interruption protection amid the pandemic remains largely uncharted territory, with uncertainty about whether claims can be covered, as well as the extent of compensation.

“Operational policy terms and exceptions are extremely difficult to decipher, and courts have grappled with their interpretation and application,” Anderson said. “This means that how a policy will be interpreted may very well depend on what the law provides. While coverage litigation may be unavoidable in some situations, it is wise to consider non-litigation options. Sometimes the insured and the insurance company will enter into a standstill and toll agreement to allow time for the presentation and discussion of claims, without having to worry about either party filing a lawsuit. Additionally, enlisting the services of a knowledgeable mediator to assist with settlement discussions can also be a good investment, and a cost-effective alternative to reaching a compromise without litigation.”

To anticipate supply chain incidents, Anderson advises businesses to proactively review their contracts with business partners and their own insurance policies to determine what rights or remedies they may have.

“Pay close attention to reporting deadlines and evidence of losses and have procedures in place to document losses and efforts to mitigate losses,” he said. “Many good accounting firms specialize in calculating and documenting property, business interruption and loss and contingent business interruption claims.”

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