Management Accounting

Supply Chains in Katrina’s Wake

Even for companies far from the storm, Katrina may eventually result in billions of dollars in lost revenue. Business-interruption insurance may he...
David KatzSeptember 22, 2005

Finance executives working outside the Gulf Coast need only to have been watching television in the aftermath of Hurricane Katrina to be moved by the devastation of human lives and to grasp the catastrophe’s potential effects on energy costs and the environment. But even for companies far from the storm, the impact is likely to be more direct: lost profits resulting from broken supply chains and absent business customers, as well as from the lengthy disruption of one of the country’s largest commercial ports.

This secondary toll on businesses could stretch into the billions, experts say; in insurance terms, the losses are likely to represent “a substantial exposure,” says Robert Hartwig, chief economist of the Insurance Information Institute. They’re likely to affect a “wide swath of Corporate America,” he adds, and may surpass the losses spawned by the September 11 attacks because New York is less of a manufacturing and marine hub than New Orleans.

In particular, revenues are likely being slashed by the disruption of shipping through the Port of New Orleans, the country’s fourth-largest port in terms of metric tonnage, and to a lesser extent by disruptions at the Port of South Louisiana, the second-largest. The Port of New Orleans did come back into service by the middle of last week, months earlier than some had predicted, and the Port of South Louisiana was almost fully operational the week before. But according to press accounts, a fair number of companies had already rerouted exports and imports through other ports after the storm. Those changes probably increased supply-chain costs, according to Gene Long, president of UPS Consulting. Assuming that the Gulf Coast ports were on the most direct route, he says, rerouted cargoes “have to travel further to go the same distance.”

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Other companies, however, found rerouting impractical. Minneapolis-based grain supplier Cargill Inc., which buys soybeans, corn, and wheat from Midwestern farmers and ships the crops on its barges to four Louisiana export facilities, saw those hubs go out of commission for two weeks after the hurricane struck.

Instead of sending its cargoes by rail or truck to other ports, Cargill chose to wait out the crisis, to track down its 300 employees in the region, and to restore its facilities, according to company spokesman David Feider. In any event, rerouting wouldn’t have made economic sense, he notes; Cargill would need 15 rail cars or 60 semi-rig trucks to carry the same volume of cargo as a single barge.

Particularly hard-hit by the loss of suppliers was the chemical industry, which relies heavily on petroleum-based products, says Finley Harckham, a lawyer with Anderson, Kill, & Olick who represents corporate policyholders. For example, companies that depended on the Dow Chemical Co.’s St. Charles Operations in Hahnville, Louisiana for polypropylene — which is used in textiles, food containers, automotive parts, lab equipment, and many other products — had to scramble to find other suppliers.

Like many other companies with plants in the affected area, Dow declared that because of the action of a “force majeure” (a “greater force,” i.e. the hurricane) it was excused from liability for failing to provide 30 polypropylene products. About 37 percent of Dow’s North American production capacity, which totals 1.35 billion pounds of polypropylene annually, was affected by Katrina.

Executives at other companies focused on their customers — that is, on how many had been put out of business. At Henry Schein Inc., a distributor of disposable office equipment to many doctors and dentists, finance officials are trying to determine how many of its clients’ offices were in the affected area, according to treasurer Graham Stanley. The purpose is not only to assess lost revenues, says Stanley, but also to determine “how our [insurance] policies will support us.”

The support in question, for Schein and many other companies, comes in the form of “contingent business-interruption” coverage. Available in many commercial property-insurance policies, the coverage reimburses companies that didn’t suffer physical damage themselves but lost revenue because of property damage suffered by major suppliers or customers, according to Harckham.

The Risk of a Single Source

Ubiquitous as that coverage is, however, many companies may find that they can’t collect from their insurers because of exclusions written into their policies. In an odd kind of symmetry, a common provision states that a company can recover under contingent-business-interruption coverage only for those damages that would have been covered if the company had been directly affected.

For example, says Harckham, in many policies, “if you don’t have flood insurance, and the loss by the supplier is a flood loss, then you might not have coverage.” Executives might instead file claims under the wind and wind-driven-rain clauses commonly included in policies, he says, adding that much of the damage inflicted by Katrina is likely to be covered under such provisions.

Some companies are faced with the formidable challenge of digging out enough information even to file payable claims. Since insurers are inclined to turn down claims that they deem aren’t submitted in a timely way, says Harckham, companies that might have a contingent-business-interruption exposure should notify their carriers now. He also notes that many property-insurance policies set time limits on policyholder lawsuits against insurers; a company that waits too long to file might be unable to contest the matter if their insurer refuses to pay.

Beyond the insurance issues, Hurricane Katrina has refocused attention on managing the risks of catastrophic damage to supply chains, especially when sources of supply are limited to a single company or region.

At Henry Schein, Stanley notes, claims made under the company’s contingent-business-interruption coverage won’t reflect any revenue lost as a result of damage to a major supplier. The company has consistently relied on diverse sourcing, says the treasurer, with one prominent exception: As a distributor of flu vaccine, Henry Schein found itself without supplies last October when British and American regulators unearthed contaminated lots of vaccine in Chiron Corp.’s plant in Liverpool, England.

In many cases, companies can secure alternative supplies from a different subsidiary of the same provider, as long as that subsidiary is in an unaffected location. But to do so, says Marc Musikoff, a consultant with GE Global Asset Protection Services, executives need to get assurances from the supplier — in advance — that the alternative subsidiary hasn’t committed its stockpiles to another client.

More broadly, Katrina has revived the discussion of “just-in-time” production, which demands that as few materials and finished products as possible should be held at any one time to wring storage costs out of the system. To be sure, says Long of UPS, companies aren’t likely to give up the idea that supply chains must be run as efficiently as possible. However, he cautions, “there is a limit to lean and fast if you want to have any flexibility” when disaster strikes again.