The story of Fire at Philips Chip manufacturing facility in US in the year 2000 & its effect on Mobile phone manufacturers’ operations & profitability highlights the importance of Contingent business interruption insurance policy.
This classic case is of the year 2000 when Mobile phone market was booming & all plants were using their full capacity, so as not to miss any chance of making profit in the buoyant market. Philips, USA was the supplier of radio frequency chips to quite a few mobile manufacturers globally, including Nokia (not a market leader at that time) in Finland & Erikson in Sweden.
A fire in Philips factory put an abrupt halt to the production of chips; which they estimated to be rectified in about a week. Erikson preferred to wait for a week for supply resumption. Unfortunately, the Philips factory took longer than the initial estimate. As a result, Erikson lost a lot of its potential market & resultant profit.
Nokia interestingly had a “chip in the flow” management system, which forewarned it of any future disruptions in supply. Armed with this input, Nokia took pro-active steps at finding other suppliers & continued production- almost uninterrupted.
And soon was the market leader globally.
Let us try to understand this from the perspective of Insurers offering a Business interruption (BI) / Loss of profit (LOP) insurance cover.
A BI/ LOP insurance cover has two basic norms:
- Consequential loss is excluded from a material damage (MD) insurance policy in general. It is available as an independent cover.
- At the same time, the BI policy requires a material damage cover to be also available on the same property. The material damage proviso in a BI policy mentions- that a BI claim is admissible only after the liability under material damage policy is established.
Let us explore the implications further:
A business may be interrupted by causes other than the material damage to building or machinery of a manufacturing unit. These may also be triggered by a disruption of the business supply chain at either end:
- A raw material/component-supply chain disruption can bring the whole manufacturing unit to a halt. (as in the case above)
- Similarly disruption at the customer end may also affect the business profits of the manufacturer ( say a Car dealer not accepting vehicles from the Car manufacturer due to floods in his city; forcing cut down in production)
It is to be noted that in either of the above two situations- no material damage to the manufacturing plant has occurred. Hence the existing material damage proviso, as a precondition to the BI claim, cannot be applied here.
Insurers offer a special cover for these events – called Contingent business interruption (CBI)/ No material damage (NMD) interruption.
Just as the BI policy is dependent on a material damage policy, NMD also require the interruption impact on the turnover and profit of the manufacturing unit. The difference is – the material damage loss in case of CBI/ NMD is at the Supplier/ Customer end.
Several real life situations in the connected global village, reinforce the importance of global supply chain interdependence.
To cite one example, 2011 floods in East Asia disrupted component supply to auto assembly plants in Japan. This was further accentuated by the fact of Japanese auto plants following the principle of JIT (just in time) inventory system (To prevent capital being locked in maintaining inventory levels, the component manufacturers are encouraged to follow a strict supply schedule, which is taken straight to the assembly line). Thus, they were affected both by loss of supply from the component suppliers and lack of availability of spares at their end to continue production. This caused production to be stopped, resulting in No Material damage (NMD) business interruption.
The disruption in the global economy due to the current pandemic is there for all to see. Business Interruption insurance is being debated across the globe. Business owners are clamouring to be compensated for their loss of earning. With US President joining the chorus, the liability for Covid related BI claims has acquired political overtones. A plethora of insurance claims and suits have been filed all over.
A key issue in this debate is – if Covid 19 causes/ has caused “direct physical loss of or damage to property” or is it a case of Contingent Business Interruption. Let us take this discussion further in the next blog.