Build a strategy to safely manage risks in the supply chain

Maintaining the integrity of the supply chain is a rigorous act with a small network, buttressed by countless exposures from basic quality assurance and control to conflicts, coups and disasters in faraway countries.

Add macroeconomic factors, such as inflation and labor shortages, and the process of aligning all the variables productively and profitably becomes exponentially more difficult, experts say.

The construction sector, because of its size and scale, is more prone to supply chain issues that could cause concern for insurance companies than industries that do not consume similar volumes of raw materials or require as much skilled labor.

Building insurance programs that include contingencies for supply chain disruptions and related risks can help protect contractors and others, they say.

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Kevin Bates, group head of risk and insurance for Australian construction company Lendlease Corp. in Sydney, said a robust supply chain should include secondary and tertiary supply options and capabilities, creating a “strong competitive edge” that translates into improvements in quality, speed to market and safety.

“There’s a need for everyone to raise their game. It’s competitive. People want to win the work and they know that things like safety, quality and reliability are points of differentiation,” said Mr. Bates, who is also a director of Risk & Insurance Management Society Inc.

Redundancy and contingency planning should be part of a well-designed supply chain, says Dallas-based Cheri Hanes, who leads the subcontractor standard insurance risk team at Axa XL, a unit of Axa SA.

To meet challenges, “you really have to understand your supply chain, because it’s a lot more complex than you think. If it’s simple, it means it’s not redundant,” and potentially more prone to disruption, she said.

“Where possible, redundancy is always a good idea, or at least having contingency plans in place,” said Cincinnati-based Pat Stoik, chief risk officer for Overhaul Inc., which specializes in transportation supply chain risk management. “Route planning, proper security protocols for transit and storage, visibility of goods while in the supply chain, and contingency plans all contribute to successfully navigating supply chain challenges.”

“The risk manager and the supply chain team should work very closely to ensure that risk management matches the supply chain activities being followed,” said Mr. Stoic.

Larger companies should have risk management capabilities within the supply chain management function, said David Shillingford, a consultant with Troisdorf, Germany-based Everstream Analytics.

“There is an opportunity for insurers to work more closely with companies mapping their end-to-end supply chain to develop or expand supply chain risk transfer mechanisms,” he said.

Interruption

Common causes of supply chain disruptions include price increases for a wide range of inputs. In a recent risk survey conducted by the Association of General Contractors of America and management consulting firm FMI Corp., material and equipment price increases surpassed shortages of skilled workers and tradesmen to become the top risks among contractors.

“With material costs fluctuating so much month-to-month, contractors remain wary of committing to projects with unpredictable costs and lead times. While inflation in the broader economy is coming back down to earth, construction costs continue to climb,” said Ken Simonson, chief economist at AGC in Arlington, Virginia, in a recent statement on construction costs.

Cost volatility is one of the top challenges facing the construction industry, said Danette Beck, director of industry verticals and national construction leader for USI Insurance Services Inc. in Valhalla, New York.

Early and frequent communication combined with contractual clarity, such as cost escalation clauses in the developer’s risk policy, covering building during the construction process, can help avoid flashpoints later. “You have to be able to get ahead of some of these challenges,” Beck said.

A material escalation clause allows adjustments in contract prices to account for changes in material costs or availability,
said Kansas City, Missouri-based Michael Campo, national construction practice director for IMA Financial Group Inc. He also suggested that project owners could include a delay damages clause that specifies the damages a contractor will be responsible for in the event of a delay in the project schedule.

Careful inventory control can help reduce cost exposures but must be managed to avoid creating additional exposures, Beck said. Stock materials may seem to make sense to control procurement costs and delivery times, but may have implications for property exposure. Sublimits for off-site storage in builders risk policies can average between $5 million and $10 million, so policyholders should be careful not to exceed coverage limits with inventory, Beck said.

“Contractors have pre-ordered materials and stored them for future use in response to the risk of suppliers not delivering materials or equipment on time. This results in an inventory risk both by holding too much, which results in storage costs, but also the risk of damage during storage, says Mr. Campo.

Many of the products and components used in construction are manufactured on a just-in-time basis, an inventory management method where goods are received from suppliers only when they are needed. The main objective of this method is to reduce inventory costs and increase inventory turnover, says Blanca Berruguete, global industrial solutions director for construction in Madrid for Allianz Global Corporate & Specialty, a unit of Allianz SE.

Andrea Blair, Nashville-based director of business resiliency and business continuity management services for Zurich Resilience Solutions, part of Zurich North America, recommends that general contractors incorporate pricing thresholds into their procurement contract language to help mitigate potential upward price exposure due to market volatility.

Tracking material lead times can help avoid procurement delays, Blair said. In addition, rigorous quality assurance and controls when materials reach a job site can help avoid further delays and complications.

The recent surge in demand in the construction sector could also put supply chains and resources under further pressure at a time when costs are being closely monitored, which could affect quality and increase susceptibility to failure, Berruguete said.

Credit risk

Credit risk is another potential source of supply chain disruption, and exposure has increased with rising borrowing costs, said Doug Collins, head of trade credit in New York for Ascot Group Ltd.

For example, a metal fabricator or parts supplier can easily be caught and squeezed between a spike in a commodity price, such as aluminum or copper (see related stories here and here) and working within the confines of a fixed price agreement with a customer. If that supplier sends net payment terms of 30, 60 or 90 days, it can further exacerbate the problem and damage a company’s financial position and credit rating, or even threaten its survival.

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The AGC/FMI survey found that nearly 40% of respondents reported an increase in subcontractor defaults compared to a year ago. Mr. Collins said there is evidence of increased business bankruptcies and restructurings this year and that new filings for trade credit insurance, which covers payment risk, are up significantly, perhaps twice as much as this time last year.

Jon Handen, Hunt Valley, Maryland-based vice president, specialty products, for Atradius Trade Credit Insurance Inc., said small and medium-sized businesses are particularly sensitive to supply chain financing risks. He said such businesses could benefit from support from large corporate buyers, financial markets, governments and insurers.

Mr. Bates, the risk manager, said he has heard of larger contractors extending support to key suppliers to avoid failures that could potentially escalate into larger events with greater potential exposures and losses.