Top 5 steps to insuring your Supply Chain

Written by Richard P. Lewis and Ann V. Kramer of Reed Smith LLP

The events of 2011 ― including the Arab Spring protests, the Sendai Earthquake and Tsunami and now, the Thailand floods ― have caused supply chain disruptions to 85 percent of businesses. Insurance coverage for supply chain disruptions is typically found in property insurance policies, which usually contain Contingent Business Interruption coverage (CBI). CBI covers your company’s losses due to damage suffered by either your suppliers or your customers.

Despite the importance of this coverage in our global economy, policyholders often do not focus on it. Based on experience with prior CBI claims, we suggest you review such coverage, focusing on a five crucial areas:

1. Typically, CBI covers loss sustained due to a "suspension" of operations. One must ensure the policy's definition of "suspension" makes clear that the policy covers slowdowns – i.e., partial or total suspensions. This is critical because insurance companies frequently assert that there is no coverage unless there has been a “total cessation” of all operations. In the CBI context, this is even more important. Even catastrophic loss to a supplier or customer is not likely to cause the policyholder to cease operations entirely. It will be able to find substitute, emergency suppliers or customers or will have sufficient inventory to continue operations for a period.

2. Absent negotiation, CBI coverage typically comes with a very low sublimit. The CBI limit should be highlighted with your broker to find the proper balance between premium cost and higher limits that reflect the supply chain risks the company faces.

3. The words used in policies defining the relationship between the policyholder and the customer or supplier vary greatly. Some policies limit coverage to named customers or suppliers, while “blanket” CBI policies can cover loss from damage to "direct” or "direct or indirect" suppliers or customers or suppliers or customers" of any tier." Limitations to named or “direct” suppliers or customers can present serious problems and should be avoided where possible.

4. In addition to physical damage to the property of your supplier or customer, other events can stop production or consumption, for example, a service interruption or orders from governmental authorities like the “frozen zone” in lower Manhattan after the 9/11 attacks. It is now possible to purchase Dependent Properties coverage for this type of risk. Called “Contingent Time Element Extended” (CTEE), it extends coverage for Civil or Military Authority, Ingress or Egress, Service Interruption. This is a major expansion of coverage that many of those affected by the Sendai Earthquake no doubt wish they had.

5. Many policies sold to domestic policyholders contain Coverage Territory provisions limiting coverage to the United States or North America. Insurance companies will resist paying CBI claims where the loss, even though it is suffered in the US, stems from damage to property of a supplier or customer elsewhere. Although there are defenses to this argument, try to get worldwide coverage territory in your policy.