How Quickly Can You Apply These Supply Chain Risk Lessons from the Chemical Industry?
Some people may be aware that GE-brand light bulbs have not actually been made by General Electric in many years. Some may also know that the gasoline at a Shell station was likely not processed in a Shell refinery; even less likely that the crude oil came from a Shell well.
The same is true for many consumer chemicals and pharmaceuticals from dish soap to deodorant. The password is: disintermediation.
A significant part of the specialty, fine and custom chemical manufacturing sector relies upon toll manufacturing. That works well logistically and economically.
And usually in terms of liability and risk management. But there are higher stakes. If a light bulb doesn’t work, no one cares. If laundry detergent or skin cream causes a rash, there is going to be trouble.
Toll manufacturers are often small companies where the treasurer, CFO or general counsel are also the insurance buyers and risk managers. The smaller may be out-gunned by larger customers, often publicly traded chemical or personal-care companies that have whole legal teams and risk management departments. That is not to say that customers are out to take advantage of their suppliers. Quite to the contrary, the industry is founded on mutually beneficial business, often of many years’ success.
Some industry trade associations, notably the Society of Chemical Manufactures and Affiliates (Socma), are putting significant effort into compiling and sharing best practices. For Socma members, the basis is the association’s ChemStewards mandatory and audited codes of practice.
Industry groups are also enhancing their analysis of global supply chains. In mid-March, the Drug, Chemical, and Associated Technologies organization released a survey that found “as of August 2019, 28% of the manufacturing facilities making active pharmaceutical ingredients for U.S. markets were based in the U.S. The remaining 72% were outside the U.S., which includes 13% in China [see pie chart on page 40]. The analysis applies to all FDA-regulated formulations, which includes prescription drugs (branded and generic), over-the-counter drugs, and compounded medications.”
Some underwriters also provide support to their insureds: “One of the things we have seen success with is offering access to consultants as part of our services,” said Christine Marien, vice president and senior underwriter for crisis management at Swiss Re Corporate Solutions.
“Consultants that have expertise in those specific industries and help toll manufacturers communicate and negotiate with their customers, as well as navigate the regulatory complexities, better protect themselves from being out-gunned.”
Industry leaders encourage formal contracts rather than just phone calls and email messages to commission toll manufacturing. Underwriters have different requirements about those.
“While we do not require a formal contract, we definitely look for clarity on these issues in our underwriting process,” said Marien. “We encourage our policyholders to negotiate heavily with their customers, and we work closely with their legal team to make sure all indemnifications and hold-harmless agreements are as straightforward as possible.”
It’s in the Details
Despite such support, collaboration, due diligence and best intentions, the devil is still in the details.
One common source of misunderstanding is responsibility for retaining samples. Once the contract has been fulfilled, a toll manufacturer is likely to return any documents related to the job, but quality-control samples or off-spec batches may be discarded — in compliance with environmental regulations, of course, but gone nonetheless. Which is not a problem, until it is one day.
“Generally, as part of our underwriting process, we make sure to know how long the toll manufacturers keep their samples,” said Marien.
“When the customer does not retain samples, their liability becomes difficult to predict. That would have to be specified in the contract and possibly include a specification to retain samples for a given period. To better assess risk and reduce friction in case of an accident, it’s best for all parties to retain samples to determine the liability more clearly.”
Actual practices vary widely. Absent any formal agreement or instruction, it is not uncommon for a supplier simply to ship the samples to the customer along with the documents for the job. The opposite approach is also not uncommon: The manufacturer retains the samples and sends a bill for that storage to the customer. That invoice gets attention.
Other matters are not so simple. Intellectual property, in particular, is an increasingly fraught area. Customers are usually clear about formulations and processes, but expertise is a gray area.
Toll manufacturers often make small adjustments to recipes or practices to maintain quality over time. The same is often true in discrete manufacturing from garments to gadgets. Clients are often pleased that the maker is doing the work of quality control, but once the job is done, one question arises: Does that evolved intellectual property belong to the ones who did the work or the ones who paid for the work?
Other potential areas of dispute include packaging and labeling, as well as distribution and returns.
“Again, such scenarios when a product is mislabeled and/or stored incorrectly need to be clearly outlined in the customer contract,” said Marien.
“All parties need clarity on the responsibilities of each stakeholder. Who approves quality assurances, who prints the labels, and such. A strong list of standard operating procedures is an absolute must in mitigating such risks.”
Marien noted that Swiss Re Corporate Solutions has seen an increase in contract-specific requests: “Toll manufacturers requesting to protect themselves from contracts with customers. For example, if they have a customer for which they are making something new, or if a customer is an industry giant, we are seeing toll manufacturers wanting more protections from recall scenarios.”
And on the other side of that, she added, are “the customers who are more likely to require toll manufacturers to carry such recall protections. All of those actions ultimately help protect all balance sheets in case of a significant incident.”
It is not surprising that big underwriters like Swiss Re Corporate Solutions are proactive in risk management for small companies with complex exposures. It is also not surprising that levels of support from carriers to insureds vary.
“Underwriters understand what they can quantify,” said Christopher Alviggi, senior vice president of property and casualty at NFP.
“Supply chain risk is not capable of being put into a box the way, say, marine cargo can be,” he added, perhaps with the pun intended.
“Ultimately the onus is on the insured,” Alviggi explained. “What usually happens is that the parties have their standard hold-harmless and indemnification agreements and ask for certificate of insurance. But that certificate is only a snapshot of coverage at a given time. It does not indicate the depth or breadth of the coverage. What really matters is the ability to respond as risk moves through the supply chain.”
Another variable is jurisdiction. “It is important to know what territorial impediments, limitations or restrictions there are state to state and country to country,” said Alviggi.
Given that the onus is on the insured, Alviggi cautioned, “When I ask small companies about what coverage they buy from their regular provider, I often get the answer, ‘that is the way we have always done it.’ I tell them, ‘then you’ve been very fortunate.’ There are often significant gaps.”
He cited the lurid example of the multiple explosions that destroyed the port and industrial areas in Tianjin, China in 2015. “American companies used toll manufacturers in Tianjin. There were suits from all over the world.”
There are tocsins for carriers and brokers as well. “We have done a good job of siloing our coverage. It takes time to understand the macro risks to clients, and underwriters may not have the luxury of time for that in a hardening market. Still, with the advent of the global supply chain, we need to do more of that.” &