De-risking supply chains: a deep dive into the automotive industry

At one of our 2022 P&C Business Management keynote webinars, Swiss Re's claims experts examined the complexity of today's global supply chains and zoomed in on the challenges faced by the automotive industry. This article captures the key insights and insurance implications from the webinar.

When the plant of a Japanese chip manufacturer caught fire in March 2021, the incident halted the production of nearly a third of the world’s microcontroller chips used in cars. With automotive chips already in short supply since the pandemic, many car makers had to drastically reduce output when securing an alternative component proved impossible.

In Asia, it is estimated that the economic loss for a car manufacturer could be multiple times their Contingent Business Interruption policy limit, if purchased. The stark protection gap means the exposed car manufacturers has to bear the bulk of the uncovered losses.

This supply chain crisis and ripple on effects beg the question: had the underwriter known that there was a single component in the manufacturing process with no alternative supplier, would they have considered the risk differently?

This episode taught the insurance industry a salient lesson about how new technology and products have redefined supply chains, particularly in the automotive sector, and saw insurers and reinsurers review their approach to supply chain risk management and protection.

A lot of advanced technology and parts are applied in our cars today, and the complexity of automotive software has also increased four-fold in the past decade. Because of this, we are moving from a linear to a more matrix-like supply chain.

On the other hand, new EV manufacturers like Tesla bypass the original tier-one suppliers and directly engage high-tech companies for chips or software. This gives them better control of design and cost but adds more complexity to the supply chain.

More broadly, when we talk about automotive supply chains, the risk mainly comes from their sophisticated supply networks. The interdependence of the parties in this network leads to further aggregation of risks, which may not be transparent to insurers. These aggregations include supplier aggregation, geographic aggregation, and industry aggregation.

McKinsey's research shows that on average, there are around 20,000 parts in a typical passenger car. As such, a global car manufacturer may have more than 18,000 suppliers involved in its production process, even more than an aeroplane manufacturer.

However, among many suppliers in the automotive supply chain, the tier-one suppliers who sell directly to car manufacturers only account for less than five per cent. Such lack of visibility complicates supply chain risk management.

Taking automotive chips as an example, many tier-one parts suppliers heavily rely on a small number of tier-two global semiconductor providers. In turn, these semiconductor providers rely on only a handful of high-end wafer manufacturers as tier-three suppliers.

A disruption to any tier-three suppliers will create a bottleneck in the supply chain and cause a widespread chip shortage where no replacement can be found. This is because those chips are usually tailor-made to meet the quality standard specified in the original supply agreement.

Geographic concentration is very common in the automotive supply chain. For example, 88 per cent of electrical steel, an automotive grid steel used for propulsion systems in electric vehicles, is made in China, Korea, and Japan.

Geographical concertation brings vulnerability; one major event can shock the entire automotive supply chain. The Russia and Ukraine war is a case in point.

While Ukraine produces 50-60% of the global neon gas needed for semiconductors, Russia supplies 15-20% of battery-grade nickel. The conflict also disrupted the wiring harness supply, hindering the weekly production of around 20,000to 30,000 cars at the beginning of the war.

With the significant accumulation risk brought by the concentration of suppliers, the question for re/insurers is whether underwriters have fully considered this exposure upon underwriting.

Other sectors also bring risk to automotive supply chains, especially the shipping industry.

Shipping lead time for raw materials reached a record high of 99 days in May 2022. This can create financial pressure on car manufacturers – a longer lead time for raw materials and spare parts means increased repair costs and an extended business interruption indemnity period. These are hidden costs difficult for underwriters to consider or even identify in their risk assessment.

An event in motor transportation can also wreak havoc. The cargo ship, Felicity Ace, shocked many prestige car lovers when it sank in the North Atlantic Ocean in early 2022, with 3,965 Volkswagen Group cars on board.

The accident left half of a billion US dollar insurance bill and taught us a lesson about how hidden aggregation risks beneath automotive supply chains make underwriting challenging. Underwriters must find a better way to assess these exposures.

Considering risk aggregation in the global automotive supply chains, how can we be more resilient?

For the insureds, it is all about the sound risk management of exposures. A useful tool is supply chain mapping, which visualises and identifies risk hotspots. OEMs can use alternate inventory strategies to implement agile stock management, while stress tests and early warning systems spot risks in a timely manner. Furthermore, contingency plans can be put in place to allow production continuity.

For insurers, risk mitigation tools can help identify inherent risks. For example, structured risk assessment is one form of mitigant. It uses solid models to interpret physical and nonphysical risks for more accurate underwriting of various exposure, such as Non-physical Damage Business Interruption (NDBI), Business Interruption (BI) and Contingent Business Interruption (CBI).

It is also critical to understand the supply chain network with tier-two and tier-three suppliers, as disruptions most likely occur beyond tier-one. According to research by the Business Continuity Institute in 2021, half of the 173 companies surveyed failed to carry out sufficient due diligence beyond their tier-one suppliers.¹

The use of data is another great form of prevention. Companies must ensure that supply chain disruption information is recorded diligently and stored with easy access.

Three aspects that we can act upon include:

1. Curate and integrate data by building standardised data ontologies to ensure quality and consistency and to provide replicability over time.
2. Use overlaying models to predict risks better, accurately quantify BI and CBI exposure and accumulation; and
3. Implement and test state-of-the-art methods to allow end-to-end data protection and secure data sharing among all stakeholders.

To navigate the automotive supply chain challenges, re/insurers must also incorporate comprehensive data analysis into their modelling and price considerations to close the protection gap driven by supplier, geographic and industry aggregation.