Supply Chain Breakdown The Crisis in Japan

Understanding the Complexities of Contingent Business Interruption Insurance April 2011

The impact of the crisis in Japan quickly made its way stateside, highlighting vulnerabilities in the automotive industrys global supply chain. As expected, the compounded effects of the earthquake, tsunami and nuclear crisis led to immediate shutdown of many local Japanese production plants. However, less anticipated was the speed with which the balance of the automotive industry began to feel the impact of parts shortages from suppliers and original equipment manufacturers unable to conduct business as usual. Many OEMs and suppliers are asking Are we insured for our lost production during a shutdown? The short answer: Coverage may be available, but the details are complicated in light of the complex loss unfolding in Japan. Many property insurance policies have a coverage extension known as Contingent Business Interruption (Contingent Extra Expense/Time Element) designed to address these types of exposures. Contingent Business Interruption (CBI) provides coverage for an interruption of business operations (loss of sales) resulting from a disruption of customer or supplier operations (unable to receive or ship product), due to an insurable event. Contingent Extra Expense (CEE) provides coverage for additional expenses (above normal) incurred by the insured resulting from a disruption of customer or supplier operations (due to an insurable event). Contingent Time Element (CTE) would be a broader application of the above two coverages in a single clause.

Coverage may apply to loss realized from both downstream suppliers and upstream customers. Referencing the crisis in Japan as an example, a supplier would want protection for multiple direct and indirect loss scenarios, such as: Your customer (upstream supplier or OEM) is impacted due to direct damage Your supplier is impacted due to direct damage Your customer is impacted due to direct damage at a peer supplier Your supplier is impacted due to direct damage at a lower tier supplier

It is important to note that coverage may not be automatically included in property insurance policy as contingent coverages need to be tailored to address your exposures.

Policy Language Varies:

Policy limitations and exclusions can impact your recovery under the policy due to an insurable event. Availability of coverage can be summarized as follows:

In the event of:

Physical loss or damage At insured locations To property of the type insured Within the coverage territory From an insured risk of loss Where no exclusion or restriction applies Which results in an interruption of operations (most common coverage trigger) (Customers/suppliers as insured locations) (excluded property may not trigger coverage - piers, docks, wharves?) (excluded countries/areas/zones may not trigger coverage) (Earthquake/Flood must be insured) (Earthquake/Flood must not be excluded, Nuclear, other exclusions apply?) (inability to produce/sell product)

The policy covers:

The defined loss For the defined indemnity period Subject to the applicable deductible (Business Interruption and Extra Expenses on an Actual Loss Sustained* basis) (As defined by the policy) (based on peril, location/zone)

*Actual Loss Sustained typically recognizes make up capacity and offsetting demand surge.

Multiple causes of loss and coverage restrictions:

If a loss was strictly due to a single cause, it would be relatively easy to identify property damaged, the cause of loss, territory/area/zone, potential exclusions, coverage and applicable deductible. However, as in the case with Japan, we have multiple causes of loss that may apply to the same event (earthquake, flood (tsunami) and nuclear incident). Each to some degree could have an effect on the ultimate insured loss. Different deductibles, limits or exclusions could potentially apply to what may appear to be a single event. Further complicating the adjustment process could be specific restrictions within the CBI coverage extension itself. Many CBI clauses restrict coverage to direct customers and suppliers. This is commonly defined as any entity that has a contractual obligation to supply or receive services from the insured. This would restrict coverage to only those suppliers and customers to which you directly receive or sell products (Tier 1). This could be very limited coverage for some

manufacturers who are in multi-tiered supply chains, where any interruption in the chain could cause an interruption at all related customers/suppliers. Some CBI clauses even restrict coverage to specific suppliers (named). CBI clauses can often be broadened to include indirect customers and suppliers (often at a reduced limit). This extends coverage to customers of customers and suppliers of suppliers providing a much broader approach to insuring the supply chain. Unnamed customers and suppliers also offer some broadening of coverage but may not provide the breadth of coverage desired. For example, if a loss were to occur at a supplier to your customer resulting in an interruption of your operations, this could also be covered by a CBI clause that includes Indirect coverage. What about a manufacturing shut-down caused by lack of power supply? Most property insurance policies provide a coverage called Service Interruption (Utility Interruption). Service Interruption (SI) provides coverage for an interruption of business operations (loss of sales) resulting from a disruption of incoming services (electric, gas, water, etc.), due to an insurable event. Because coverage must be triggered by an insurable event, coverage determination for production shut-downs attributed to rolling blackouts will be carefully evaluated to determine the source cause of the power interruption direct damage to the power source or rationing of available power. Nuclear exclusions may have a direct impact on these losses. Interruption by Civil Authority, Ingress/Egress, Impounded Water, and Waterway Access are other common coverages. Each of these would require a similar evaluation of policy language as mentioned above to determine whether coverage would apply. It is important to note that many insurance policies have coverage restrictions under Contingent BI for Service Interruption. This may further complicate any potential recovery for a Contingent BI loss. Lastly, how could the concurrent nuclear crisis in Japan affect coverage? All policies have exclusions that could affect CBI or other coverage extensions. For example, most property policies have a nuclear exclusion. This exclusion typically nullifies coverage regardless of any other cause or event, contributing concurrently or in any other sequence to the loss. This exclusion is expected to complicate the determination of coverage for losses that involve locations that were in the nuclear evacuation area or experienced production shut-down contributed to by an interruption of power. The complex situation in Japan highlights the need to discuss your supply chain exposures with a qualified risk advisor or insurance broker who can help develop coverage terms and conditions and a mitigation plan designed to address your organizations needs.

Aon Contact:
Mike Stankard Managing Director Automotive Industry Practice 248-936-5353 mike.stankard@aon.com Bill Novak Director Aon Brokerage Group 248-936-5257 bill.novak@aon.com Aon Risk Solutions 3000 Town Center, Suite 3000 Southfield, MI 48075 aon.com