Staying Ahead of Supply Chain Risk

Intro:
Hello and welcome to another episode of On Aon.

Supply chain risk has moved from the back office to the boardroom. And in today’s episode, Bianca McKenzie is joined by Richard Waterer and Lee Meyrick to explore how geopolitical uncertainty, hidden dependencies and evolving risk capital solutions are reshaping the way businesses build resilience.

Here’s Bianca to get the conversation going…

Bianca McKenzie:
Hello there and welcome to another Risk Capital Insight episode of On Aon. My name is Bianca McKenzie, Strategy and Execution Leader for Global Risk Consulting here at Aon. And today we're going to explore a topic that has been dominating boardroom discussions and headlines alike — supply chain risk.

With geopolitical uncertainty continuing to reshape global trade, there has never been a more important time for organizations to understand and manage their supply chain exposures.

To help us unpack this topic, I'm delighted to be joined by two of Aon's leading experts who will share their perspectives on the evolving supply chain risk landscape from a risk capital perspective. Richard Waterer, Global Risk Consulting Leader for Aon, and Lee Meyrick Merrick, who's Aon's Chair for Risk Capital for Transportation and Logistics.

Welcome both.

Richard Waterer and Lee Meyrick:
Hi Bianca.

Bianca McKenzie:
Richard, let's start with the big picture. The geopolitical environment has created considerable supply chain uncertainty. How have we seen this risk show up for businesses over the past few months and what's been the impact?

Richard Waterer:
Thanks, Bianca. So I think you teed it up pretty well in some of your opening comments there.

What we're seeing today is that geopolitical risk is hitting supply chains earlier, more frequently, and often in ways that businesses don't immediately anticipate. So traditionally, companies thought about geopolitical events as isolated incidents that affected a specific country or region. But today, because supply chains are so interconnected, the impact tends to spread much further and much faster.

So if we take those recent tensions in the Middle East, understandably most attention focused on energy markets and the potential impact on oil prices. But for many companies, the bigger challenge wasn't the direct energy cost, it was the knock-on effect across supply chains. So we saw concerns around petrochemical feedstocks leading to pressures on packaging materials used by consumer goods companies. There were constraints in specialty chemicals, and that created challenges for sectors ranging from healthcare to advanced manufacturing.

Shipping routes became less predictable, freight costs became more volatile, and longer transit times put pressure on inventory levels and working capital.

So, what's interesting is that many of the affected companies didn't buy from the Middle East directly, but the disruption often appeared two or three tiers away from the original event, which made it difficult to identify and difficult to manage. And we've seen a similar pattern with tariffs and trade tensions. So many businesses responded by diversifying their manufacturing footprints, shifting production into markets such as Vietnam, India, and Mexico.

And that's often sensible from a resilience perspective, but it doesn't eliminate the risk. It just changes its shape.

And then a final thing we're seeing is greater uncertainty around critical materials and components. So, organisations are asking whether access to semiconductors, critical minerals, specialist chemicals, energy inputs, key technologies, whether these could be constrained by export controls, sanctions, political tensions or regional, general regional, instability.

And the result is a growing focus on understanding dependencies that previously sat outside of traditional supply chain risk assessments.

So this impact then ultimately shows up in a few ways. And this is what we've seen. So higher costs, increased inventory requirements, longer lead times, delayed customer deliveries, greater earnings volatility, and management teams spending significant time responding to events rather than activities that drive growth.

So for me, the key takeaway is that supply chain risk is no longer linear. It's networked, it's dynamic, and it's often invisible until it shows up in margin revenue or customer service performance.

Bianca McKenzie:
And Lee, with this higher costs, longer lead times and delays, what role does insurance play in helping organizations navigate supply chain risks?

Lee Meyrick:
Yeah, thanks, Bianca. As Richard mentioned, supply chains are becoming increasingly dynamic and interconnected. And that brings new and different risks to the fore. I think it's important to separate the now in terms of insurance coverage and what might be needed going forward. The insurance market has traditionally provided various covers that were designed for historical and relatively independent supply chain issues.

Examples of such coverage are contingent business interruption, trade disruption, trade credit, marine cargo, political risk, cyber. I think the increasing dependency on the digital supply chain networks have made this a real key issue.

But they aren't necessarily entirely reflective of the fast-evolving risks that clients are currently faced with. We are seeing some emerging solutions, such as parametric insurance, but this is generally limited to defined catastrophe triggers, for example, climate.

So there's not currently a huge amount of appropriate risk transfer solutions, insufficient experience in data and fear of significant sideways aggregation has thus far led to the traditional market unable to provide the widespread, fully encompassing solutions that we think clients may need going forward.

And as a result, companies have tended to use a portfolio of insurance products to address supply chain risks in the absence of a single, all-embracing supply chain product.

Bianca McKenzie:
Yeah, it's clear that supply chain disruption isn't just an operational issue, it's ultimately a financial resilience issue.

On that, Richard, supply chain risk is certainly not a new challenge. And even before the recent events in the Middle East, it ranked as the fourth-highest risk on the multinational companies in Aon's Global Risk Management Survey.

Beyond geopolitics, why do you think business leaders have elevated supply chain risk within their enterprise risk management frameworks?

Richard Waterer:
I think that's a really relevant question, Bianca. And I think the reason why supply chain risk has risen so high is leaders have realized that this isn't just a short-term issue that's driven by a particular crisis or a particular geopolitical event.

There's some much more or deeper, if you like, structural factors at play. And I'm going to call out four of them.

Firstly, concentration risk. So many organizations have discovered that their supply chains are far less diversified than they thought. On paper, they may have hundreds or even thousands of suppliers. But when you look deeper, those critical products, components, raw materials, they often depend on a small number of suppliers, facilities, logistic hubs, or transport routes.

And the shortages that we saw in the semiconductor industry a few years ago highlighted this perfectly. So many industries believe they diversified their supply chains, only to discover they were dependent on a handful of advanced manufacturing facilities located in a relatively concentrated geography.

Second thing that we observe is visibility beyond that first tier of the supply chain. And most companies have a reasonably good understanding of their direct suppliers.

But the challenge that can be significant is that exposure can sit much deeper in the supply chain. And it's not uncommon to find multiple suppliers relying on the same subcomponent manufacturer or specialist chemical producer or critical raw material source without anybody fully appreciating that dependency. And again, as a result, organizations can think they're diversified when in reality they have hidden concentrations several tiers below the surface.

The third thing I I'd observe is that the nature of the disruption has changed. We've talked a little bit about that already on this podcast. So historically, supply chain risk was often associated with big events, natural catastrophes, factory fires, transport interruptions. And those are all relevant today. But the risk landscape today is also much broader. So if you think about organisations today, they're managing geopolitical instability, cyber attacks, financial distress of key suppliers, regulatory change, sanctions, labour shortages, climate related events, and many of these events can spread across interconnected supply chains very quickly.

So we've seen some examples where a cyber incident at a relatively small supplier has interrupted production for multiple global manufacturers simultaneously. So the disruption doesn't need to happen at your organization to affect your business.

And then lastly, supply chain risk has become a board-level balancing act really between efficiency and resilience. So, for decades, many supply chains were optimized around cost, speed, and efficiency. Now today leaders are increasingly asking whether they have enough resilience built into the system. And that's very easy to say but it's much harder to do in practice.

A procurement leader might be measured on delivering cost savings while an operations team want the security of supply and a risk leader want resilience. Now, these objectives don't always point in the same direction.

And this is why supply chain risk has become such an important enterprise risk management theme. It sits across procurement, operations, finance, risk, and of course the executive team. And each group naturally views the problem through a different lens.

So ultimately, Bianca, I think supply chain risk has moved up the agenda because leaders now recognise that it can directly affect revenue, earnings, customer service and reputation. It's no longer an operational issue that's buried in the supply chain function. As you said in your opening comments, it's a strategic business risk.

Bianca McKenzie:
Yeah. And just building on that, Lee, and then going back to some of the points you made earlier around insurance, can you elaborate on where the most significant challenges are for carriers and just share a little bit about the protection gaps for clients across insurance products?

Lee Meyrick:
So if we look at the coverage gaps between the current solutions, which I referred to earlier, and what clients may need going forward. As Richard said, real-world events tend to involve multiple causes. And which policy should respond may not be immediately clear, and there may be insufficiency in terms of limits and coverage and conditions, et cetera. So, this can lead to complex claims processes, which you know full well given your background.

Non-damaged supply chain disruptions have historically been very hard to insure with events such as labor strikes or pandemic-related shutdowns usually excluded from a traditional BI-CBI policy.

And we've seen both of those things many times quite recently.

And as Richard mentioned before, there is limited visibility beyond that Tier 1 supplier, which gives a risk and gaps in coverage, but also lends insurers to be more cautious about putting capital against it.

I think the big issue is the aggregation risk, which insurers would then tend to look at given limits and pricing a lot more conservatively than if they really knew the full extent of the risk that they were exposed to.

So bearing all that in mind, the challenges to the insurers are quite evident.

My view is that the accumulation, the systemic risk of supply chain is the the biggest issue of them all. We have evolving and correlated risks versus what insurance companies have historically liked, the diversification of risk. And a single event can trigger losses across multiple policies, and these can involve potentially thousands of insured at any one event. So the numbers can rack up quite quickly. And there hasn't been many complicated claims thus far. But so there's going to be a complexity of understanding how these things actually shake out at the end of the day. And a big part of all this is their difficulties in risk modeling. You know, insurers, and most of my crew was on the carrier side, like to have see what's in front of them. And they get a lot of comfort by seeing what's happened in the past.

You don't necessarily get that with supply chain and some of these evolving risks, particularly underscored by the increase in geopolitical uncertainty. And then if you layer on top of that cyber and climate risk, which are relatively new to the insurance market anyway, I just think it makes historical data, claims data, much less reliable than insurers would like. And therefore, we need to help them along the journey to providing more capital.

Bianca McKenzie:
Yeah. Effective supply chain management isn't simply about identifying critical suppliers as it once was. It's more about truly understanding the dependencies, building response plans and ensuring data is available when it's needed. As is the case with all complex risks, the entire organization needs to be involved if a situation is to be managed effectively.

So Richard, on this, it sometimes looks as though procurement takes priority over risk management when it comes to the ownership of supply chain risk. Why is that the case then? What can risk leaders do in these circumstances?

Richard Waterer:
I actually don't think it's surprising that procurement often ends up owning supply chain risk. If you think about a procurement lead, they're closest to the suppliers. They own many of the commercial relationships, they oversee contracts, they monitor performance, they generate a huge amount of supplier data. So if you ask who has their hands on the steering wheel day to day, it is often procurement. But the challenge is that procurement and risk functions typically look at the problem through different lenses.

So procurement tends to focus on supplier management. So is the supplier performing? Are they meeting service levels? Are we getting the right cost and quality outcomes? Whereas risk leaders should be asking a different set of questions. So, what could stop us achieving our objectives? Where are our critical concentrations? Which failures would have a material impact on the organization?

And how does that align with our risk appetite? And that's an important distinction because good supplier management does not automatically equal good risk management. In my view, supply chain risk is too important to be owned by a single function.

So procurement should absolutely be a critical participant. But the risk leader should be at the centre of the conversation, not sitting on the periphery looking in.

And I think the role of the risk leader, and I say this quite a bit, but it's to create what I would call one version of the truth. So where are our critical exposures? How material are they? What risks are we prepared to accept? Which risks do we need to reduce? And when should be financed or transferred?

Without that common alignment across the business, I find that organizations often fall into a trap of both overreacting to highly visible risks and at the same time underinvesting in the exposures that could genuinely threaten their earnings, their operations, or their reputation.

And the most effective risk leaders that I've seen aren't trying to take ownership away from procurement, but what they are doing is convening procurement, operations, finance, and leadership around a common view of risk.

They're standardizing how risk is assessed and they're acting as the custodian of the data and analytics that underpin that subsequent decision making.

So when that happens, the conversation shifts from how are our suppliers performing to how resilient is our business, and that's where we see better decisions, clearer trade-offs, and much more targeted investment in resilience.

So I guess I'd finish my reflections on this by saying if procurement owns the suppliers, but nobody owns the exposure, you've created a blind spot. And so the risk leader's job is to make sure that never happens.

Bianca McKenzie:
Let's turn our attention to what's on the horizon for business leaders when it comes to supply chain risk. Lee, where are we seeing innovation in risk capital to drive better financial resilience outcomes for clients? What factors do you think would encourage capital providers to drive greater capacity and coverage relevance for supply chain?

Lee Meyrick:
As I mentioned earlier, a large part of the carrier's mindset would be around understanding the risk and understanding the data and how those may translate into financial outcomes.

And building forward-looking models that allows the carriers to understand both their per risk and their aggregated risk is really helpful in them coming to the fall when it comes to providing capital. I think this is of real value to both clients and the carriers, because there is an increase in demand.

Not only will it supply the solutions now to the risks that are needed, but I think it will help build a new and resilient market — very similar to what we've seen in the past in terms of terrorism and cyber risks that were up until that point not fully understood.

At the same time, as we evolve into that and as we work with clients and carriers, we are working day to day with clients, including some quite a few government entities and trade bodies, to provide them with solutions combining, as I said before, traditional and new and alternative solutions to help them with their current situation.

There may be captive arrangements, parametric covers to address their current needs, but as we're doing that, we're also gathering more data to help build out these forward-looking models.

Bianca McKenzie:
Yeah, and I want to double-click into that data point a little bit more. Understanding supply chain exposure is historically often relied upon assumptions and manual mapping and analysis.

And as you've said, today businesses have access to far more sophisticated data and analytics capabilities.

Richard, I'll turn to you. Where are you seeing data and analytics add value more specifically? And what emerging approaches can enhance these capabilities?

Richard Waterer:
Yeah, I first of all I'd say I agree with everything that Lee's just said. So I'll probably come back and double click on one or two of the points in in a moment.

I think for a long time, organizations and insurers have known that supply chain risk exists, but they've often struggled to answer some fundamental questions. So where exactly does the risk sit? How concentrated is it? Which suppliers, locations, dependencies really matter? And if something goes wrong, what could it actually cost us?

And data analytics is playing a really important role in helping to answer these questions in a much more robust way. They allow companies to identify critical vulnerabilities, to quantify potential business interruption impacts, and to build a much clearer picture of their overall risk profile. And as Lee certainly alluded to, that that clarity is valuable not only for the client, but also for the insurer.

And in some cases, we've seen that translate into broader coverage discussions or improved limits because some of that uncertainty has been reduced. But I think the real value comes when analytics is combined with a clear view of risk appetite. So once an organization understands where its major exposures sit and what the potential financial consequences are, it could then make deliberate choices about which risks it's prepared to retain and which it wants to mitigate or to transfer.

And that then helps to focus investment and management attention on the thing that things that matter most. So whether that's improving supply resilience, diversifying sources of supply, increasing inventory buffers, strengthening monitoring capabilities, or using risk financing solutions for those larger, gnarly, less frequent events that could have a truly catastrophic impact.

However, I do think it's important to avoid what I would call analytics for the sake of analytics. We've seen organizations become so focused on mapping every tier of their supply chain or modeling every possible scenario that they almost lose sight of the objective and what you could end up with is almost analysis paralysis rather than actually better decision making.

So, I guess in summary, Bianca, the goal isn't to create more data per se, it's to create better decisions. And analytics are most powerful when they turn supply chain uncertainty into actionable risk management.

Bianca McKenzie:
Okay, Lee, Richard, let's wrap up with some advice for those listening. What's the one key piece of takeaway for businesses looking to improve their supply chain risk management program? What should they be doing to optimize their risk finance strategy for supply chain risk, including the use of their own balance sheet?

Richard Waterer:
I'll pick that one up first, Bianca, and probably surprise listeners to hear me answer the question this way, but don't start with the supply chain.

Actually, start with the business. So identify what drives revenue and operations in the business and work backwards to the critical dependencies.

So focus your risk management resources where a disruption would really matter to your business, because that's where resilience will deliver value.

Lee Meyrick:
Given the dynamic nature of what we've been talking about, I would say review frequently and as often as possible with your insurance professionals that the risk transfer is a really important part of the solution, of the client solution.

But this will be augmented by, and actually capacity will be fueled by better understanding of risk, the clarity that Richard mentioned too, visibility and the ability to adapt their network design to prevent and better manage disruption.

This will help them both in the immediate now, but will also help bring in increased and focused capacity into the market.

Bianca McKenzie:
That's our show for today. Thank you all for listening and thanks to Richard and Lee for their insight and expertise on this crucial topic. Until next time, thank you.

Outro:
Thanks for tuning into the latest episode of On Aon. If you’ve enjoyed this episode, don’t forget to like, share and subscribe wherever you get your podcasts and be sure to visit Aon.com to learn more about Aon.

We’ll be back next week with another episode — our Human Capital Insight — when we’ll be taking a deep dive into the health, wealth and talent issues impacting businesses.