The Climate Change Impact on the Insurance Industry: Understanding Business Interruption Threats and Finding Solutions

Climate change is a slow-moving crisis that could one day overshadow current complex supply chain risks. In fact, a large number of insurers and clients may not fully realise the value of climate-related exposures already building in supply chains and business interruption (BI) portfolios. However those who choose to ignore the climate change impact on the insurance industry, do so at their own risk.

In line with Taskforce on Climate-related Financial Disclosures (TCFD) recommendations, since April 2022, it has been a legal requirement for over 1,300 of the UK’s largest public and private companies to quantify and disclose the climate-related financial risks and opportunities they face. This includes many large insurers, who must prove they understand how climate change risk might affect their insurance portfolios. The BI exposures alone – for example for the increased number of severe individual natural catastrophe events – could be extremely significant.

Supply chain risk management tools such as SCAIR® can help businesses quantify the impact of climate change on supply chains

So How Big is the Potential Problem?

The climate change impact on the insurance industry is finally being quantified. Reinsurance and insurance provider Swiss Re Institute recently highlighted climate change as the biggest long-term threat to the world economy. They claimed it could reduce global GDP by 18% by 2050 if no mitigating actions are taken; 11% if global warming is kept to a 2°C increase on pre-industrial temperatures; or 4% if Paris Agreement targets are met (under 2°C).

Asian economies would be hardest hit, it said, with China – a massive producer of components vital to the global manufacturing supply chain – at risk of losing nearly 24% of its GDP in a severe scenario. The US, meanwhile, could lose close to 10% of its GDP and Europe almost 11%.

However, climate change isn’t just projected to impact (re)insurance. The industry has already experienced the direct financial impact of climate change-related weather events: according to Swiss Re, six of the costliest years ever for weather-related insured losses occurred between 2011 and 2021.

Business insurance has significantly exacerbated the financial fallout from these events, and risks to global supply chains become greater as climate change worsens. For example, McKinsey projected that the likelihood of a hurricane sufficiently powerful to disrupt semiconductor supply chains may grow by two to four times by 2040.

The Intergovernmental Panel on Climate Change (IPCC) also warns extreme weather and global warming will increase prices for essential goods. In 2022, we were given some indication of how that feels. Inflation could get worse if floods, droughts, wildfires and extreme weather leads to new energy shortages, political upheaval and trade disruptions.

Why Finding an Answer is Complex

It requires complete supply chain transparency to identify a high-risk supplier sitting in a hazard zone. However, the more difficult part is identifying how loss patterns will evolve over time; for instance, which new sites and suppliers could be exposed to climate-related perils in 10-, 20- or 30-years’ time? A place that may only have limited exposure to physical peril today could, a few years down the line, be in a drought, flood or wildfire zone.

Working out which sites and suppliers in supply chains could be impacted, and the financial implications, is paramount for insurers and supply chain-dependent clients alike. But make no mistake: it is not an easy task.

Quantifying BI exposures in supply chains and insurance portfolios is already complex. Many multi-billion-dollar industries, including batch and complex manufacturing, pharma, biotech and medical devices, rely on complex multi-supply chains, with interdependent suppliers situated across the globe. The shortage or delay of an input component costed at a few dollars manufactured in one region, can result in millions in lost profits and BI claims downstream.

Developing a Methodology to Identify, Manage and Track Supply Chain Exposure

First, it is important to discover which supply nodes are critical to the manufacture of goods and what physical and non-physical threats they are exposed to. Improvements in the granularity and availability of data is helping to identify geocoded property attributes such as elevation, building materials and transport links – or even non-physical factors like political or compliance risks – to further refine the risk assessment.

Once risks are correctly identified, mitigations should be put in place to manage those risks (such as stock redundancies, alternative suppliers and adaptive protective measures). This then feeds into a projection of the total profit at risk from any supply chain disruption. These exposures and outage values must be monitored continually and revisited at both a client and portfolio level.

It is good practice to overlay climate change scenarios onto those calculations, because the profit at risk in these scenarios will vary significantly. With their modelling capabilities, insurers are in a good position to help clients with these assessments. Not attempting this will increasingly be seen as negligent – illegal even – though it is not as straightforward in practice as it sounds.

Supply chain risk assessment software solutions such as SCAIR® incorporate natural catastrophe alerting to help businesses identify major geographical risks within their supply chains.

Climate Scenario Modelling that Integrates with Supply Chain Risk Assessment

As loss patterns evolve, traditional weather and catastrophe exposure models based on historical losses become more and more redundant. Consequently, insurers need reliable predictive models so they can project future losses across various global warming scenarios.

The biggest and most sophisticated carriers and cat modelling firms are indeed making good headway on this; many insurers already use Munich Re’s NATHAN, for example, or other third-party modelling tools for their predictive climate scenario capabilities, though many are still figuring out how best to embed climate change risk into their processes.

Soon, it will be possible to integrate climate scenario models from leading providers straight into supply chain risk assessment tools. With this in mind, insurers must recognise the value this will bring – from enabling reporting and compliance and helping clients manage risks more effectively, to selecting and pricing risks more accurately, setting appropriate limits and avoiding unmanageable BI exposures aggregating.

The past 12 months have shown us climate change is not a risk coming our way – it is already here. Insurers must start mapping and quantifying the risk this poses to supply chains today, or the financial implications they and their clients could face tomorrow will be more and more severe.

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Technology Will Transform US Pharma Supply Chains: and Data and Analytics are Central to a Government Drive for Resilience

There seems little doubt that regulation is coming for the pharma industry’s supply chain. As previously discussed, the Department of Health and Human Services (HHS) Essential Medicines Supply Chain and Manufacturing Resilience Assessment published on May 23 stems from one of the early acts of the Biden-Harris administration. Indeed, the writing has been on the wall from the moment Covid struck and limited supplies of essential drugs globally – even if that was sometimes more of a product of soaring demand than disrupted supply.

In fact, the seeds of a broader, more interventionalist approach to critical supply chains predate even that. In the early weeks of Trump’s presidency, the US was already looking at a more protectionist future, with the head of the President’s National Trade Council outlining its intention to repatriate international supply chains.

“It does the American economy no long-term good to only keep the big box factories where we are now assembling ‘American’ products that are composed primarily of foreign components,” the Financial Times reported him as saying.

“We need to manufacture those components in a robust domestic supply chain that will spur job and wage growth.”

Given the shock to supply chains from Covid, it would be surprising if moves towards reshoring were not seeing a renewed sense of urgency – particularly of what it has determined are “critical goods, products, and services”, as Biden’s Executive Order 14017 puts it. That’s all the more so when 87 per cent of API facilities for the generic drugs (which represent 90 per cent of US prescriptions) are overseas.

Supply Chain Challenges

But if the HHS report is part of a longer-term move toward a more prescriptive approach to supply chain resiliency, that doesn’t mean it’s nothing new. What it gives us is significant on what the US government sees as the key challenges and potential solutions to the resiliency of the pharma supply chains. It’s worth taking these in turn.

In terms of the challenges, it identifies at least six:

What’s noticeable about this list – and explicit elsewhere in the report – is that while some issues may be for the government, much is going to be down to the private sector. Most obviously, regulatory matters and perhaps STEM education might be primarily down to legislators (although even here, there will be a role for business). For much of the rest, businesses have a significant role to play – and, as we’ve said, are increasingly likely to have regulatory obligations.

Supply Chain Risk Assesment Tools Boost Visibilty

That’s perhaps particularly true of the first solution strategy the report puts forward: increased supply chain coordination, security and transparency. 

The benefits of this are apparent. As it states, “Improving supply chain visibility will offer a greater ability to anticipate, prioritize, and respond to critical issues, demands, and potential disruptions.”

It says this can be achieved in several ways. One is “Expanding [the] use of data, analytics, and predictive tools to mitigate and manage risk.”

It goes on to suggest several strategies to pursue, with, again, a mix of public and private sector efforts involved. These include improving data sharing and standardisation, strengthening public-private collaboration and coordination and establishing a more comprehensive “centralised control tower platform”, including developing a national critical drug tracking, monitoring and alert system. It also emphasises the importance of physical and cyber security throughout the supply chain.

Quite a number of these plans – particularly those involving the public sector will take time. Strikingly, though, some are readily achievable in the near term. It will probably take time to create the shared data infrastructure for government agencies and supply chain stakeholders that the report suggests.

However, the private sector can already start to gather that data and – at least for their own business, use data analytics to identify the key risks and vulnerabilities in their supply chains.

Solutions like SCAIR® already exist to map, monitor, and analyse critical supply points and relationships. This can help create more resilient supply chains and better business decisions around mitigation and contingency plans.

The HSS report makes it clear this is the direction of travel in efforts to boost pharma supply chain resilience. The winners, as the US and other countries reshape their critical supply chains, will be those that start on the journey now.

Stick and Carrot: Through Regulation or Choice, Change is Coming to Pharma Supply Chains

On May 23, the Department of Health and Human Services (HHS) released the US’s first government Essential Medicines Supply Chain and Manufacturing Resilience Assessment report. Addressing pharmaceutical supply chain constraints identified in the Biden-Harris Administration’s 100-day supply chain review report from 2021, it’s particularly focussed on a group of critical drugs on the Food and Drug Administration’s essential medicines list.

The report offers a variety of “strategies and implementation actions” to address vulnerabilities to the supply of these drugs including:

It’s likely to be the last time anyone asks nicely. In fact, legislation to force pharma businesses – and those in other critical sectors – now looks inevitable. As the report itself noted, “Many of the solutions proposed will need to be combined into an integrated strategy to achieve the end goal of a more resilient pharmaceutical supply chain. A long-term commitment from the government, through budgetary, regulatory, or policy actions, is needed to change the current paradigm.”

If businesses have not already invested in technology like SCAIR® to evaluate, map and strengthen their supply chains, they may soon wish they had.

The Long March to Regulation

As it is, the writing has been on the wall for a while. The resilience assessment is only the latest development following growing pressure throughout the pandemic, culminating in President Biden signing Executive Order 14017 on America’s Supply Chains.

“The United States needs resilient, diverse, and secure supply chains to ensure our economic prosperity and national security. Pandemics and other biological threats, cyber-attacks, climate shocks and extreme weather events, terrorist attacks, geopolitical and economic competition, and other conditions can reduce critical manufacturing capacity and the availability and integrity of critical goods, products, and services,” it began.

It kicked off a review of supply chains for four critical products: semiconductors and advanced packaging; high-capacity batteries, including electric-vehicle batteries; critical minerals and materials, including rare earth elements; and pharmaceuticals and active pharmaceutical ingredients (APIs).

That was followed by the 100-Day Supply Chain Review and, in February, marking the anniversary of the Executive Order, the White House’s “capstone” report, detailing progress to date. The latter was also supported by seven more details sector reports – from the Departments of Energy, Transport, Agriculture, Commerce, Defence, Homeland Security and, crucially for pharma, Health and Human Services (HHS) published the same day.

Again, the anniversary review was clear that progress was being made. The Supply Chain Disruptions Task Force (SDTF) established by the administration had helped bring down the long-dwelling containers in the docks at the country’s two largest ports by more than 70 per cent, for instance. It was equally clear, though, that there was still much work to do.

A Need for Supply Chain Visibility

With medical supply chains, specifically, the capstone report noted that the pandemic had exacerbated long-standing vulnerability in supply chains. This weak position was reflected in the rising number of new US Drug Shortages pre-pandemic, and formed the subject of a study performed by a consortium of UK companies and leading universities back in 2018.

“Factors that contribute to the lack of security in public health supply chains include reliance on foreign sources for components of public health supplies, focus on lowest-cost reducing diversity across the supply chain, workforce shortages, financial barriers to entry and expansion, and lack of visibility and coordination across the supply chain,” it stated.  

These challenges existed prior to the COVID-19 pandemic, but were brought to the fore when the United States faced challenges in procuring enough supply and effective distribution of personal protective equipment early in the pandemic response.

The HHS report, meanwhile, had more detail on the challenges facing various different product groups, including vaccines and pharmaceuticals.

This stressed the importance of pharmaceuticals to public health and outlined the characteristics of a robust pharmaceutical supply chain:

“At present, the US Government has limited visibility into the supply chain for most pharmaceuticals,” it added. It’s questionable how long that situation will be allowed to last.

As consultant PwC noted back when the Executive Order was made, “C-suite executives should recognize that the ground is shifting in supply chain planning. Improving your organization’s abilities to anticipate supply shocks and policy changes, and then coordinate your response, is crucial.”

SCAIR®: Getting Ahead of the Game

Of course, change won’t come overnight. Many of the February plans require legislation, while other parts require international cooperation. If legislation does come, it may prove a blunt tool.

“The plan at times also oversimplifies the complexity of global value chains, whether in rare earth minerals, semiconductor products, or APIs [active pharmaceutical ingredients,” warns the Centre for Strategy & International Studies (CSIS). It also remains unclear exactly what might be required and the extent to which government will opt for regulation, against guidance, encouragement or incentives.

There are good reasons to make a start now, though, and not just for those in the US. First, and most obviously, the risk and impact of supply chain disruptions – whatever their cause – is clearer than ever following the pandemic and subsequent issues. Responsible businesses can no longer ignore them.

Related to this, it’s not just regulators that businesses will answer to, but investors and other stakeholders. As a Morningstar analyst notes, “’[S]upply chain issues’ are front and centre in most investors’ vocabulary”.

The pressures are also here to stay. That’s true for the short term in other industries, with issues expected to persist through 2022, but particularly for pharma. As the US reports noted, the problems in the pharma industry predate the pandemic and won’t disappear with it. Rather, traditional problems will again come to the fore. The May HHS report, for instance, noted that almost at least 63 per cent of US drug shortages between 2013 and 2017 could be traced back to quality issues.

Finally, of course, the reason to embrace it now is that those who do will gain a competitive advantage – boosting the resilience of their supply chains, keeping investors happy, and being better prepared for legislation and increased regulation when it does come.

Of course, we don’t know exactly what will be required, and some of the proposed solutions require industry-wide or state action or both. The HHS, for instance, calls for better information sharing, integration and standardization across supply chains and to “leverage public-private partnerships to create a shared data infrastructure”.

But, even here, there’s value in individual businesses making a start. They can’t, after all, share information and data that they don’t have. SCAIR®can help them capture the information they will need on their suppliers and vulnerabilities. Likewise, the report calls for the development and use of predictive tools and risk assessments. It seems a fair bet they’re going to increasingly expect that from businesses in future.

SCAIR® can help with this: identifying value at risk, calculating potential business interruption losses, estimating the impact of different threat scenarios, and mapping critical supply points, for example.

Regardless of what regulation demands, this is information businesses increasingly can’t do without – and increasing numbers recognise it. The benefits and competitive advantage it brings provide a powerful incentive to embrace it. And for those who take the carrot, there’ll be no need for the stick.

Contact us to find out how SCAIR® can help increase the visibility of your business' supply chain.