Interconnected risks put global businesses in path of extreme weather events

Zurich Insurance Group Limited

By Iwan Stalder

Much like the captain of a ship, a captain of industry doesn’t have the luxury of assuming his or her enterprise will prove itself seaworthy in challenging conditions. Last year was the most expensive hurricane season on record, especially in the United States, which was pummeled by three high-impact storms (Harvey, Irma and Maria) in less than a month. The damages ran to a staggering $US 202.6 billion, according to Bloomberg Businessweek.

The 2017 Atlantic hurricane season was a costly stress test for global businesses, since the impact of each hurricane was felt far beyond its landfall. For example, Harvey shut down the concentrated energy infrastructure that sprawls along the Gulf of Mexico, bottling up at least 13 percent of U.S. refining capacity and raising energy prices in Europe and Asia. In Puerto Rico, Maria disrupted the U.S. biomedical industry, as 8 percent of the medicines Americans take are manufactured on the island, according to the FDA.

The shift toward global supply chains and just-in-time inventory has reduced corporate costs and inefficiency, but it has also reduced the buffer between extreme weather events and corporate boardrooms.

The economic impact of extreme weather is no longer confined by geography or industry—environmental risks are a burden shared among every business that relies on a global network of suppliers, says Nick Wildgoose, Global Supply Chain Product Leader at Zurich Insurance Group.

“Most companies in our interconnected world depend fundamentally on their supply chain. There's hardly anybody running industry now that doesn't,” Wildgoose says. "And I'm afraid to say that many of these companies still fail to understand where their critical suppliers are, from an extreme-weather point of view."

This lack of awareness of global supply chain vulnerabilities can have a high price tag for business leaders. For example, the 2011 tsunami in Japan shuttered an auto factory in Louisiana, 6,000 miles away.

The World Economic Forum’s Global Risks Report 2018 shows that extreme weather events have displaced traditional economic concerns as the world's top risks in terms of likelihood and potential impact. So how many companies have engineered sufficient resilience for these threats?

Too few, according to the Business Continuity Institute’s 2017 Supply Chain Resilience Report, which found that 69 percent of companies lack full visibility on supply chains, despite two-thirds having experienced at least one disruption. The costs incurred by those disruptions aren’t restricted to productivity or reputation: 23 percent of companies reported losses in excess of €1 million in a single incident. Yet more than half of businesses surveyed do not adequately insure against supply chain losses, too often relying on traditional insurances to protect them.

Compounding this challenge is the increased severity and interconnected effects of these extreme weather events, according to Eugenie Molyneux, Zurich’s Chief Risk Officer for Commercial Insurance.

“It's easy for business leaders to get an assessment of economic and geo-political risks. Environmental risk is much tougher because the patterns are changing,” Molyneux says. “A traditional risk management technique that you apply to economic risk cannot effectively address an environmental risk. Businesses need to introduce new techniques. The most useful one with regard to environmental risk is scenario planning.”

The more seemingly outlandish "What if?" scenario one considers, the more effective such an exercise will prove, Molyneux says, “not because you necessarily believe that the most extreme example will come to fruition, but it helps you start to prepare in that direction.”

As ever, in business, the old maxim applies: Past performance is not a predictor of future events. “We may experience something that hasn't happened yet. It can be more extreme than a 100-year event,” says Iwan Stalder, Zurich’s Head of Global Cat Management. “It's important that we look at the risk beyond the historical record. If we believe nothing worse can happen than what we have seen so far, we will miss the worst event.”

Zurich's Natural Catastrophe (NatCat) models eliminate the blind spot that only looking at the historical record creates. By quantifying catastrophe risk with sophisticated models that estimate the probability and severity of an extreme event occurring, these models give businesses a better understanding of how they could be impacted by extreme weather events, the likes of which haven't been seen before.

"That is the very reason we have the NatCat model is because these events can become more extreme than what we have experienced," Stalder says. "The historical record is a good starting point, but for NatCat it is not enough."

Mitigating the risks posed by extreme weather events isn’t a straightforward exercise for companies that compete in a global economy, where supply chain vendors are often as geographically widespread as they are numerous. Wildgoose suggests the first step toward building resilience into supply chains should be prioritizing the profit source.

“Where is the value in their supply chain? Where are they making most of their profit?” Wildgoose asks. “What are the risks to those high-value, critical supply chains? It's understanding where those key production sites are and their exposure to weather.”

Scenario planning uncovers vulnerabilities, but it also helps engineer solutions, like maintaining an inventory of crucial components found to be at risk, or ensuring that a facility can ramp up production if another is disrupted. Wildgoose cites a division of a major U.K. food group whose scenario planning revealed that 80 percent of its value was shipped through a single port in Thailand. An incident at that port exposed the company to ruin. A decision was immediately made to mitigate the risk by sourcing goods from more locations.

Scenario planning is akin to peeling an onion for executives: You need to keep removing layers, even if it makes you feel like crying. Probing the vulnerability of a supply chain can’t be limited to only the most critical tier of suppliers. How resilient is the secondary tier that supplies your vendors? Their exposure can become yours. The BCI study on supply chain resilience reported that almost 40 percent of companies have 21 or more key suppliers, but fewer than half could claim those suppliers have business continuity arrangements in place.

“If there are 15 suppliers critical to your most profitable product, then it is no longer good enough to make them more resilient on their own; you have to understand the suppliers to them that are critical,” says Wildgoose, who explains that supply chain resilience isn’t a defensive position, but rather a competitive advantage. One of his clients was immediately responsive in securing vital inventory after the Japanese tsunami. “Their quarterly results weren’t too badly affected,” he remembers. “Most of their competitors were still trying to work out how they were impacted, and found out they had no more product and were in deep trouble, and put out quarterly profit warnings.”

Committing resources to planning for unpredictable and never-before-seen weather events is a daunting ask of executives, but Molyneux cautions that the difficulty of possible solutions doesn’t justify dismissing seemingly implausible threats.

“Companies need to reassess every risk management technique and look specifically for indirect impacts,” she says. “They need to avoid putting risks in the ‘too hard’ basket. The risks that might be potentially put in the ‘too hard’ basket are probably the ones you need to address.”

Key Takeaways:

  • The shift toward global supply chains and just-in-time inventory has reduced the buffer between extreme weather events and corporate boardrooms.
  • 69 percent of companies lack full visibility on supply chains, despite two-thirds having experienced at least one disruption.
  • Scenario planning uncovers vulnerabilities, but also helps engineer solutions.
  • When scenario planning, the more seemingly outlandish "What if?" scenarios considered, the more effective the exercise will prove.
  • The risks that business leaders might put in the “too hard” basket are probably the ones they most need to address.
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