Understanding external dependencies
In this article we take a look at external dependencies, focusing on third-party factors from outside of the company. Dependencies on suppliers and partners, or any other parties outside the company can be impacted by perils such as fire, machinery breakdown or natural hazards, which can have an impact leading to serious business interruption, losses and increased costs.
Defining external dependencies
External partners are considered to be companies, service providers or other stakeholders supporting the client in delivering their business products and solutions to the market.
Be aware, the insurance industry uses a variety of terms to refer to the same things, these include but are not limited to e.g. unnamed and named dependencies, contingent business interruption, as well as first tier or multiple tiers insurance.
Tiers below 1st Tier (supplier’s suppliers) are not commonly part of the insurance program and are considered on a case by case basis.
It is common for companies to be dependent upon some suppliers directly, sometimes these can be combined into one category, for example Public Utilities (water, electricity and data), Named Supplier's and Customer's, etc. Another example is Denial of Access, where no physical damage has occurred at the insured location, however there may be business interruption losses due to other circumstances (e.g. inaccessibility to premises due to fire in a neighbouring facility).
As an example, finding a secondary supplier may be more expensive, may have an impact on the quality and can cause possible delays in production and/or delivery. In the worst case, this can lead to a loss of market share or even bankruptcy.
External dependency claims are commonplace
As companies manufacture increasingly complex products, they also require more and more levels of suppliers. In addition to this, lean production methods enable cost savings by way of on-demand production, reducing the size of inventory and therefore cutting the stocking of products which in normal situations will save costs in the short-term. However, the downside to this is that in case of a serious business interruption when production is impacted, there can be an immediate consequence by way of suppliers and companies having an insufficient amount of products available in stock to fulfil orders.
External dependencies can also play out as a chain reaction. Delays and issues with one supplier can have a ripple effect across the entire market. In cases where a few suppliers are maintaining the availability of specific components or resources to support production, there is little room for interruptions. When these basic materials or services are not available, the impact of this shortage can be substantial.
Insurance solutions to help manage risks
Insurers must estimate what could be the ‘worst case scenario’ in the case of a claim. External dependency issues are often more expensive and take longer to process, when comparing with interdependencies that occur within the Group. This is due to not having direct access to all parties involved which can delay the initiation of loss mitigating actions.
To keep up to date with external dependencies, it is recommended that a thorough business continuity management plan is in place. This should be regularly updated and maintained to stay on top of potential Business Interruption risks coming from external partners. Following a thorough assessment, you are better positioned to face possible external dependency losses. Only then can mitigating these risks begin in earnest.
Examples of reducing single source supplier dependencies are:
- deep collaboration with your network
- continuity planning
- diversifying customer network
Consider the following:
- Who are your most critical suppliers from a business continuity perspective?
- What are the financial implications of these relationships?
- How much of your suppliers’ capacity does your normal order account for?
- Are you an important customer to your supplier?
- Are you using single source supplier strategy?
- What is the likely duration of the interruption in potential scenarios?
- Do you have knowledge of alternative suppliers, if your current suppliers are not able to deliver on-time or up-to-standard quality products, raw materials and/or services?
- In case you need to change the supplier, what certifications are required by relevant authorities and how long will this take to complete?
- What can you do now, that will improve the risk standard in critical processes?
When you understand the risks, know their potential financial implications, and have plans in place to mitigate these, a clear and transparent starting point will support discussions on selecting the right insurance solutions for your business.
Preparation is key to managing business interruption risks
At If, external dependency effects can be included in a business interruption solution for your company. When both parties understand the types of risks we mutually face, we will be able to serve you better, offering the solutions that best meet your specific business needs. We seek to understand the risks and we write the risks we understand!
Property Underwriter, If