Earthquake Preparedness: How Parametric Insurance Prevents Supply Chain Collapse

Imagine a major earthquake strikes one of our major shipping ports and airports, where essential goods are transported through. How does the supply chain continue on?

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Paper products, clothing, diapers and food: just a few of the necessities that we as a society rely on, which arrive in vast quantities at shipping ports and airports throughout the world. Now imagine a major earthquake strikes one of these locations, causing immense physical damage and resulting in a cession of operations at the port or airport. Funds for repairs and resumption of operations, from either traditional insurance or government sources, trickle in slowly. This leads to a backlog of ships and planes unable to leave or piling up at other locations, slowing the unloading and transit of goods and cargo to their end destination. The supply chain and economy seize, with individuals unable to attain necessary items, and corporates unable to generate anticipated revenue and effectively run their operations. However, there are insurance solutions, namely parametric insurance, that can help shipping ports and airports manage their financial exposure to earthquakes more efficiently and provide the necessary liquidity to prevent the worst-case scenario from occurring.

Given the current circumstances, the above hypothetical situation is not necessarily beyond the imagination. The ongoing global supply chain crunch has exposed the fragility of the manufacturing and transport of goods and services which our economies and societies rely on. Tied to the COVID-19 pandemic in a variety of ways the supply chain challenges are affecting prices and inventory stock for a variety of sectors and business sizes, from car dealerships to mom-and-pop bookshops. This includes, but is not limited to, worker shortage, outbreak-related facility closures, reallocation of manufacturing capabilities to medical equipment and a disconnect between actual and expected supply and demand for goods.

With all the inconveniences and interruptions to that which we expect at our fingertips, the major infrastructure components of the supply chain, like ports and airports, remain largely operational and continue to play a critical role in the receipt and delivery of physical goods. Among the most important infrastructure components along the chain are ports on the West Coast of the United States and Canada, located in Los Angeles, Long Beach and Vancouver. The volume of goods that arrive at these ports from Asia is tremendous and cargo ships’ ability to offload containers in a timely fashion is a critical piece of the supply chain. In fact, the number of containers that the average cargo ship transports to Vancouver has increased 12% since 2019, while in Long Beach, this has increased by over 70%.

The staffing issues at ports and trucking companies late last year meant that dozens of cargo ships, and containers full of goods, sat idle off the West Coast; in early October 2021, fleets of ships were parked off the coast of Los Angeles, causing widespread shortages in the continental U.S. However, the ports remained operational, permitting ships to come to shore and unload their cargo.

Given their coastal locations, ports are commonly built on soft soil or landfill that is susceptible to enhanced ground shaking and liquefaction during an earthquake. A major earthquake can obliterate or severely damage a physical port, as we saw in the aftermath of the 2010 earthquake in Chile, the 2011 and 2016 earthquakes in New Zealand and the 2011 earthquake in Japan. The end result of such damage would mean that a West Coast port is unable to operate for weeks, months or even years, depending on the extent of the damage and the timing and volume of funding (FEMA, traditional insurance, rainy day funds), none of which can be sorted out quickly. At any time, such earthquake-related closures and re-routes would be disruptive to the global supply chain, and the inability to recover from an earthquake in a timely fashion and would be catastrophic to the currently fragile global economy.

The critical nature of our ports and airports in earthquake-prone areas means that the operators need fast access to some liquidity in the immediate aftermath to allow them to resume operations. Furthermore, corporates that operate into and out of the ports need funds to protect balance sheets against contingent business interruption losses, a line of business that is notoriously difficult to insure in the traditional market, given the requirement of physical damage for insureds to make claims on their BI policies. This is where parametric insurance can play a role. Parametric insurance settles on the intensity of the ground shaking, not the ultimate damage caused by the earthquake, and can be purchased by both the owners/operators and corporates with a financial interest in continuing operations of the asset. Settling the claim is highly transparent - the more the ground shakes during an earthquake, the more the parametric insurance policy pays (as determined by the terms set forth in the policy).

Since earthquake-related ground shaking intensity is published by the United States Geological Survey in the days after an earthquake occurs, the claims settlement is rapid as well – parametric insurance claims are settled in a matter of days to weeks, instead of weeks to months.

The quick and transparent claims settlement features of parametric insurance means that any port or airport that opts to buy it could have cash in hand days after an earthquake, allowing them to resume operations much faster than expected, and not cause a bottleneck on the global economy. The fast liquidity will not magically make the damage go away, but companies get a quick cash injection to help them cover for all the expenses that rack up (such as higher cost of transportation, plus post-event inflation in general – unfinished goods, labor etc.) and allow for the payment of rerouting and redirecting ships into another port.

As a society, we don't necessarily know what the next disruptive event is going to be or exactly when it will occur – be it an earthquake, a pandemic or a war. However, in the case of earthquake, there are insurance solutions available to blunt their financial impacts and ensure a more seamless business operation, no matter what ground shaking may come.