Hazard Risk • 97
3. Any additional backup facilities identied will further reduce
the VAR.
4. Any contract penalties for service delays for existing and future cus-
tomer contracts are identied and will potentially increase the VAR.
5. Any continuing expenses during the recovery period are identied,
codied, and assigned to the overall VAR.
6. Any tax impacts are calculated based on the time- to- recovery (T- t-R)
metric identied in the business continuity plan or scenario plans,
which will also increase the VAR.
7. Any inventory in the pipeline and supply chain will reduce and miti-
gate the VAR during the T- t-R period.
8. Any new mitigation strategy costs to be incurred will increase the
overall VAR.
9. Finally, on the far right of Figure5.2 is the nal mitigated VAR for
that particular asset or product or division.
As the quantication project plays out, the ultimate goal is to identify
what the maximum foreseeable loss might be, compare that to the risk
appetite or tolerance of the organization based on their present level of
Value
at risk
(VaR)
Spain TPM
Ramp up 20%
Production
(60 Days)
Ireland
50% capacity
6 months to
come online
Contract
Penalties
($10 MM)
Expenses
Continuing
Boston & DC
($60 MM)
Tax
impact
($200 MM)
Inventory
($500 MM)
Mitigation
Strategy
Cost
($5 MM)
Mitigated
VaR
$675 MM
$675 MM
$670 MM
$970 MM
$910 MM
$900 MM
$1.4 BB
$600 MM
$500 MM
$200 MM
$500 MM
$1.17 BB
$2 BB
FIGURE 5.2
e risk quantication engagement. (Source: Eric Wieczorek, former risk director-
navigant, “Supply Chain Risk Management” presentation at MAPI, Manufacturing
Alliance for Productivity & Innovation’s Council Meeting, 2013.)
98 • Supply Chain Risk Management: An Emerging Discipline
insurance coverage, and decide if it’s prudent to increase coverage or
reduce coverage.
e output of this engagement is illustrated in Figure 5.3. e risk
levels are articulated on the le or Y axis, low to high, and the nodes or
assets within the scope of the project are identied on the X axis. e
units of measure normally used in these engagements are either annually
demonstrated prots or planned annual budgeted prots going forward.
ere are normally two pillars for each node or asset. e rst pillar, or
the darker shaded one, is the unmitigated exposure or VAR. Unmitigated
risk, in insurance terms, generally means that the prot plan for this par-
ticular asset has no risk response plan, as the insurance investigators see
it, in the event of a disruption and is therefore at risk. e second pillar,
the lighter shaded one, is the mitigated exposure or VAR. Again, in insur-
ance terms, this column represents the mitigated exposure for this asset,
which normally means a risk response plan has been developed to ensure
that prots continue in the event of a disruption and is supported by some
type of insurance coverage. Both columns prole the prot exposure and
neither eliminate risk. However, the lighter shaded, mitigated columns
depict a reduced exposure to risk for the organization. e line passing
horizontally across the entire graph is the present property, tort liability,
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
Plant 1 Plant 2 Plant 3 Contractor
Risk Exposure – VaR
Unmitigated
exposure
Mitigated
exposure
Risk Appetit
e
Coverage
FIGURE 5.3
Risk quantication output. (Source: Eric Wieczorek, former risk director- navigant,
“Supply Chain Risk Management” presentation at MAPI, Manufacturing Alliance for
Productivity & Innovation’s Council Meeting, 2013.)
Hazard Risk • 99
continuity business interruption, and other insurance coverage the com-
pany maintains at the time of the quantication risk engagement.
e nal, dicult portion of these engagements is to discuss what prod-
ucts, services, plants, or divisions have an exposure above the coverage
line or risk appetite line. e insurance industry regularly uses the term
risk appetite to denote the amount of insurance coverage a company has
paid for to recoup losses or damages, based on the risks the company sees
and how aggressive they want to be in terms of taking risks and support-
ing those risks with mitigation plans and insurance. As seen in Figure5.3,
when exposure or VAR lies above the coverage of risk appetite line, that
situation drives the dialogue between the organization and its insurer or
consultancy in an attempt to decide on the next steps. ose next steps
normally include spending time and funds to develop more robust miti-
gation policies, procedures, and programs or increasing coverage to miti-
gate the exposure and risk. A company can also elect to assume some risk
through self- insurance. And nally, scanning Figure5.3 and viewing the
dierences in column heights, we’ll attempt to provide a brief explanation
in the context of these quantication tools and techniques.
e dierence in column heights, which is prot exposure or VAR, per
asset, is the dierence between VAR exposure identied without or with
risk mitigation strategies in place by the company. For instance, for Plant 1,
there is obviously a set of mitigation plans in place to be used in the event
that the plant is disrupted, because the lighter shaded column (mitigated)
has much less VAR or exposure than the dark or unmitigated column.
When the insurance experts complete the engagement, they calculate the
total company VAR or exposure versus the amount of insurance cover-
age the company maintains at the time of the engagement and use the
horizontal line to “make a point” about what assets have more VAR or
exposure than the amount of insurance coverage. e bottom line of a risk
quantication engagement is to discern whether a company has too much
or not enough insurance based on the risks identied, mitigation plans in
place and the company’s risk appetite, which is indicative of their existing
coverage level.
Outcomes from this type of nancial risk quantication engagements
and the benets tend to be as follows:
• e calculation of maximum foreseeable losses
• A root cause analysis that highlights risk exposure
100 • Supply Chain Risk Management: An Emerging Discipline
• A denitive picture of risks and a compelling reason to act to either
mitigate those risks, temporarily or permanently, by buying more or
less insurance, better prepare for disruptions or other risks, or con-
tinue to investigate how to mitigate the risks
• Assistance in obtaining capital funding for building redundancy
and resiliency within the supply chain
• A positive restructuring of the insurance portfolio
LOOKING AT THE THAI FLOODS THROUGH
A RISK QUANTIFICATION PRISM
Let’s nish this chapter by revisiting the oods in ailand that were men-
tioned at the start of the chapter, looking through the prism of risk quan-
tication of what insurers might have recommended if they were asked to
review the supplier base by the original equipment manufacturers (OEMs).
First, let’s focus on the event itself. e disaster followed with precision the
four stages of a disaster, which are denial, severity, blame, and resolution.
During the denial phase, several days aer the event, the media were
told that minor disruptions would occur due to logistical issues. Aside
from that, business would continue thanks to inventory in the supply
chain. Next, about a month later the media began to hear and report on
the severity of the situation. It became evident that industries would see
supply shortages cause by the destruction of the work- in- progress inven-
tory at the time of the event.
In the next phase, the media heard about blame as industries faced
further shortages due to reduced production capacity as a result of pro-
duction assets destroyed, factories being unable to restart due to power
supply limitations, or a lack of raw materials from their own suppliers.
Finally, industry members were saying aer six months from the initial
event that we would see further constraints while destroyed assets and
factories got repaired or replaced and new capacity came online. is is
the resolution phase.
What was going on during this event behind the scenes? Firms directly
hit by the supply disruption were frantically canceling orders and attempt-
ing to book orders from alternate suppliers. Unfortunately, manufacturing
capacity was already scarce before the event. And, qualifying and testing
Hazard Risk • 101
parts from new suppliers is time and resource intensive. Many alternate
suppliers identied aer the ood were, unfortunately, also located in
the same ood plain region of ailand (Chapter12 will discuss the dark
side of these industrial clusters). Furthermore, manufacturing yield and
quality with new suppliers proved not to be the same as with qualied,
incumbent suppliers. e inevitable outcome from this scarcity of supply
was a dramatic increase in prices across a range of industries.
With the benet of hindsight, what could insurers or consultancy
organizations have done if they were asked to exercise a risk quantica-
tion engagement? Prior to the event, insurers or risk consultants would
have exercised a risk identication, an as- is analysis, and a quantication
engagement. ey would have performed a thorough evaluation of the
supply base and would have seen the exposure in terms of capacity, asset
liability, and especially the geography and location of the entire industry
supplier base.
As the event unfolded, the OEMs, at the insistence of their risk experts,
could have rapidly activated a previously tested business continuity plan,
which would have included secondary suppliers identied through the risk
quantication exercise. Presumably, these suppliers would be located out-
side the impact zone. ese companies would have also leveraged certain
articles inside their newly purchased contingent business interruption and
trade disruption insurance coverage packages that emanated from the risk
quantication exercise.
Aer the event the OEMs would also have performed a post-event anal-
ysis and improved their initial risk plans through lessons learned. ese
companies might also have bolstered their mitigation plans and insurance
coverage as well.
CONCLUDING THOUGHTS
Traditional hazard risk has been with us since the dawn of time and will
be present until the end of time. One of the best ways, but not the only
way, to mitigate these risks has been insurance coverage. Many existing
and emerging packages are becoming available every day. Between the
coverage instruments and the sophistication of insurers’ risk quantica-
tion capabilities, it might be wise to consider these mitigation packages
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