As Japan continues to count the human cost of the Tohoku earthquake, attention is turning to the impact on the global supply chain. Deborah Ritchie reports

A massive, magnitude 9.0 earthquake struck the Japan Trench megathrust fault off the eastern coast of Honshu on 11 March, about 80 miles off Japan’s eastern coast, and approximately 240 miles north-east of Tokyo. Chiba, Ibaraki, Tochigi, Fukushima, Miyagi, Iwate and particularly the city of Sendai were quite helpless in the face of the resulting tsunami. Meanwhile, a tragedy was beginning to unfold at the Fukushima Daiichi plant after efforts failed to cool down the overheating fuel rods inside two of its nuclear reactors. This was just the beginning of a series of calamitous events that would have Japan trying to cope with one of the costliest natural disasters the world has ever seen. At time of press, the catastrophic human loss resulting from the quake and subsequent tsunami was close to 14,000.

Early indications were that UK insurers would not be “unduly stretched” by these tragic events, according to the Association of British Insurers. The ABI’s acting director-general, Maggie Craig said that UK insurers will want to do all they can to assist the people and businesses of Japan as they seek to recover from this terrible tragedy.

“Events in Japan are first and foremost a human tragedy on a scale which is unimaginable. The absolute priority is to focus on the urgency of the humanitarian response; assessing the business impact is not the first priority until people have got the help they need.

“But some facts are becoming clearer. Early indications are that this event will not be a major issue for the UK insurance industry. Inevitably there will be differences in exposure from insurer to insurer but UK insurance companies are well capitalised and therefore claims from the Japan disaster should not be expected to stretch balance sheets unduly.”

For insurers the main exposure will be commercial losses. A government-backed earthquake insurance scheme means that only seven per cent of homeowners take out earthquake cover in Japan. “This will have an impact in the overall picture, as it did following the 1995 earthquake in Kobe when despite total damage costs in the region of US$102bn, the insured losses were US$3.4bn,” Craig added.

In recent global history, the current earthquake becomes the fifth most powerful since 1900 and one of the strongest tremors ever recorded. Since the issuance of its preliminary loss estimates just 24 hours after the quake, catastrophe modeling firm AIR Worldwide revised its insured loss estimate at between US$20-30bn.

“This is an unprecedented event in the history of seismology and earthquake engineering never in history has a magnitude 9.0 earthquake been so well recorded instrumentally,” said Dr Jayanta Guin, senior vice president of research and modeling at AIR Worldwide. “With this update AIR has taken real-time loss estimation to the next level by incorporating an unprecedented quantity of data. By independently estimating the loss due to the tsunami, the combined loss estimate avoids double-counting in the affected areas.”

AIR’s loss estimate includes payouts from the Japan Earthquake Reinsurance scheme and is net of government recoveries. Fitch Ratings says that while the catastrophe will be among the largest insured losses in history, such losses can be absorbed by the insurance and reinsurance industries “without widespread solvency problems, or undue financial strain”.

Lloyd’s of London issued the following statement: “Our thoughts are still with those affected by the major earthquake and tsunami events in Japan. Lloyd’s is committed to providing cover to the Japanese market and our first priority is handling claims swiftly and supporting the local insurers. It is far too early for us to comment on any potential business impact.

“Lloyd’s routinely stress tests individual syndicates and the market as a whole for large-scale natural catastrophes of this nature and we are confident the market can respond to any claims in the normal course of business.”

Lloyd’s insurer Chaucer said in early April that it anticipates at least £27.5m (US$44.8m) in claims from this event alone. The company, a specialist in nuclear risk insurance, said that while the ultimate costs were still uncertain, it expects total claims of £27.5-35m, based on an estimated insured market loss of US$20-30 billion. Chaucer added that it was asking for better terms across most of its business classes with a “marked” rise sought for catastrophe exposed business, following recent natural disasters.

“With two thirds of Syndicate 1084’s premium income still to be written for the 2011 year of account, Chaucer expects that the majority of this business will be written at improved terms,” the company said in a statement.

In March, the company announced that it provided property cover to a nuclear power plant at Onagawa, but its policy excluded damage from earthquakes and tsunamis. It added that the Japanese Nuclear Act of 1961 absolves nuclear plant operators of liability for damage caused by major natural disasters.

Insurance aside, the resulting nuclear crisis, electricity shortages and suspension of work at manufacturing plants will affect hundreds of businesses in the US and Europe that use Japanese parts – be they consumer electronics, automotive industry parts, chips or other components. Many of these businesses will have begun to prepare for the possibility of an extended disruption to global supply chains taking into account the potential length and type of any disruptions identified, some of which will be months; others years.

Japan is one of the world’s most export-oriented countries. At the time of writing, Honda may have to close its plant in Swindon because of the disruption. Certainly, after a few weeks, it had cut production at its UK plant by 50 per cent due to the impact on its supply chain. Indeed, reports suggest that motor parts manufacturers are struggling in Japan locally, impacting purchasers in the supply chain worldwide – particularly in the USA, and where parts are unique to those sources, General Motors, Peugeot, Ford and Toyota were both impacted, and reports of component delays for tablets and smart phones abound. The impact of a shortage of parts on local employment will be seen over the coming weeks and months. How can companies find alternate suppliers quickly and what are the cost factors involved in this?

“When considering risk appetite in general, there is a continuum from ‘no risk at any cost’, to ‘lowest cost at any risk’, and very few well-run businesses would be at either extreme,” says Lyndon Bird FBCI, technical director, the Business Continuity Institute (BCI). “However businesses need to think about where they are comfortable sitting along the continuum, where comfortable means being able to explain the decisions made to key stakeholders when a disruption and crisis occurs. A very aggressive risk appetite is likely to mean that the business is very vulnerable to inevitable, increasingly frequent but unpredictable events, such as the recent earthquake.

“In the context of supply chain, decisions can be made around local sourcing, dual-sourcing and increasing buffer stocks. Risk appetite will determine the extent that lean strategies are pursued without consideration of the unintended downstream consequences.

Gary Lynch, head of supply chain risk management at Marsh Risk Consulting, adds: “Given that the immediate priorities in Japan are likely to be social not economic, the aftershocks to the global economies from this disaster may unfold very slowly; many of the economic consequences have yet to be seen. A multinational company whose supply chain could be impacted by the catastrophe should start now by assuming that its business is severely disrupted for an extended period and develop an effective mitigation strategy.”

He believes the most significant initial impact will be to the hi-tech, steel and auto industries quickly followed by those that depend on these industries such as medical devices, communications equipment suppliers, car dealerships, solar, ship building, aviation and consumer electronics. Further, he believes it may be something of a challenge for some of those firms to do so.

“Despite substantial supply chain disruption losses from past events, many companies operating in the global marketplace continue to manage the risk of supply chain disruption ineffectively,” Lynch adds. “Multinational companies need a thorough understanding of their supply chain, including the markets they sell to, the suppliers they rely on and the critical dependencies that exist along the supply chain.”

Mitigation strategies should be flexible, as situations change quickly throughout the recovery process, with constant monitoring and potentially modification going through. With an event of this magnitude it will be quite some time before a reasonable estimate of the supply chain impacts are known. Organisations will be impacted differently depending on factors including size and number of sources for critical supplies and services, what was in the pipeline, inventory levels, seasonal demand, and how quickly primary suppliers can get back up and running and delivering, or whether alternate sources can be found.

Resuming operations locally will require time, power and supply chain continuity, and while this is the case across most organisations, the way Japan and its people come out of it will be defined by their attitude and aptitude toward risk management. How the rest of the world responds within its own supply chain should be a simple matter by comparison.

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