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The Ins and Outs of Supply Chain Insurance

There are a number of insurance products available to protect supply chains from losses, and it’s important to understand the basics and the pitfalls associated with each.

J. Paul Dittmann, Ph.D. | University of Tennessee

Third in a Six-Part Series. Click here to read part one and part two.

There are a number of insurance products available to protect your supply chain from the losses described in my last post– and it’s important that you understand the basics and the pitfalls associated with each.

The more common include:

  1. Self-insurance
  2. Business owner property and casualty
  3. Cargo insurance

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The financial responsibility for the loss may be borne by the shipper, the carrier or the recipient.

Before describing each of the three areas, it is important you first take stock of just how much liability you have.

Who has the liability: INCO terms

It is critical to understand who has the liability for goods in transit. The financial responsibility for the loss may be borne by the shipper, the carrier or the recipient.

These are spelled out by INCO (International Commerce) terms. A few common examples of the 11 INCO terms are:

  • FOB destination: Seller owns goods in transit and therefore has the risk in transit.
  • FOB origin: Buyer owns goods and therefore has the risk in transit.
  • CIF: Seller is responsible for procuring and paying for some insurance coverage during the voyage to the named destination and has the risk to that destination. The buyer assumes risks from this destination onward.

In one recent conversation, a consumer packaged goods company executive told us that he believes it is a best practice to take control of inbound freight from his suppliers.

We agreed with him, and knew of numerous examples where that practice saved millions of dollars through commanding better rates and eliminating inflated freight costs from sellers.

But a major caveat is in order. When that’s done, the firm must fully understand that it now has the liability for any loss or damage, where the supplier had assumed that responsibility in the past.

Even in a CIF case, when the seller is responsible for the in-transit risk, one firm found that the insurer used by their Chinese supplier was a Chinese insurer, and could not get the claim resolved for more than nine months.

The key here is to know your terms and your insurer.

It is important that you have expertise within your company regarding INCO terms, and understand exactly who has the liability at each stage of the supply chain. This can be a challenge as liability may change from supplier to supplier and buyer to buyer.

Now, let’s consider each major type of insurance coverage for goods in transit.

[Also by J. Paul Dittmann: Managing Risk in the Global Supply Chain]

info button 1Self-insurance

Self-insurance is a risk-management method in which a calculated amount of money is set aside to compensate for potential future loss.

If self-insurance is approached as a serious risk management technique, an actuarial analysis is used to set aside enough money to cover the future uncertain loss; otherwise, you are effectively uninsured.

Click to download whitepaper

Click to download whitepaper

Self-insurance makes more sense for risks that are more predictable and measurable based on a documented loss history.

Normally, catastrophic risks are not self-insured, as they are highly unpredictable and high in loss impact. Self-insurance lacks the advantage of pooled risks for catastrophic losses that threaten the existence of your business.

Companies that self-insure must ponder a few critical business questions:

  1. Is setting aside funds for loss or damage the best way to use free cash flow?
  2. Could we receive a better return on investment elsewhere?
  3. What will happen in the event of a catastrophic loss and how will the company survive?

While self-insuring may make sense for some situations, it undoubtedly begs for assessment and further risk mitigation tactics. One tactic could be to combine self-insurance with a high-deductible insurance policy to cover specific events that would be highly damaging to a firm.

info button 2Business owner property and casualty

This is the standard property and casualty liability (P&C) insurance coverage held by all business owners covering property and accidents. Riders can be added to cover losses for inventory in transit. People who buy and sell these policies often have little sensitivity to supply chain issues.

Often these P&C policies have an in-transit piece included. But, this additional rider is rarely based on any real supply chain needs analysis. And it is almost never used for cargo loss, simply because a claim in this area could negatively impact the rate for the entire policy.

A business owner’s policy serves a purpose in that it simplifies the insurance-buying process and aggregates many risks into one policy. It can cover risks such as property insurance on owned buildings and warehouses, crime, vehicle coverage, liability coverage and flood insurance.

However, these policies may come at a premium because they are covering so much and may not meet a specific need, such as in-transit inventory. Even with the rider, the coverage may not fully contemplate the complexities of your supply chain.

[Also by J. Paul Dittmann: An Up-to-Date Twist on Supply Chain Risk: The Survey Says…]

info button 3Cargo insurance

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Self-insurance lacks the advantage of pooled risks for catastrophic losses that threaten the existence of your business.

This is the oldest form of insurance going back almost 500 years, and can be provided as an add-on by the transportation carrier or from a third party. It can be transactional, i.e. purchased for each shipment where it is needed.

Or, it can be an annualized blanket, all-risk policy covering all transportation carriers and all modes of global transportation (road, rail, air and ocean).

Cargo insurance covers goods in transit, including the period when the vehicle is unattended or housed in a warehouse temporarily.

The process of evaluating and purchasing cargo insurance can itself be valuable, and can help a company think through the risks to its supply chain.

The research done for our last white paper confirmed that most firms (nearly 90%) do not have a robust risk management process.

A good insurance partner can help develop one.

Unfortunately, the CFO or a risk management department in the company often buys this insurance without really understanding the supply chain as a supply chain professional would; and the opportunity to develop a comprehensive risk management strategy for the supply chain is lost.

Because of this, supply chain professionals must play a strategic role in helping company decision makers understand the importance of a protected supply chain. In my next post, I will do a deeper dive into cargo insurance—explaining its benefits and the various factors affecting its cost. goldbrown2

Dittman’s white paper, Will you be ready when a loss happens to you? can be downloaded here.

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JPD3
J. Paul Dittmann, Ph.D. is the Executive Director of the Global Supply Chain Institute at the University of Tennessee. Dittmann comes to the University of Tennessee after a 30-year career in industry. He has held positions such as vice president, logistics for North America; vice president global logistics systems; and most recently served as vice president, supply chain strategy, projects, and systems for the Whirlpool Corporation.

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Reprinted with permission of Longitudes, the UPS blog devoted to the trends shaping the global economy.

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