Resource Development
Why Worry?
The benefits of preparing for low-frequency, high-consequence events
By Daniel P. Hoffman
Industrial piping on fire
nightman1965 | iStock

risis management and contingency planning. Those five simple words can cause the most competent business executives to lose more than a few good nights’ sleep. Everyone is busy, and most managers and administrators tend to expend the majority of their focus and energies putting out the operational fires of the day (or week, month, quarter, et cetera). When asked to consider the dire consequences and ramifications of a potential event—especially for those that likely have a small chance of actually occurring—it’s often far too easy to place consideration for such matters on one’s to-do list, perhaps when things quiet down somewhat.

The problem, of course, is that things are never going to quiet down. A whole new set of problems and other “high-priority” issues invariably come to the fore, making it all too easy to push emergency management and contingency planning to the bottom of the pile. If a business or organization is lucky, there will be no real consequence realized from such inaction, as—by definition—the low-frequency event will likely never materialize. However, if such an event were to happen, the high consequence nature of such circumstances could derail an entire operation and perhaps even bankrupt one’s business. Given the high stakes involved, can you really afford to gamble when it comes to such planning?

The Good
Thankfully, most large businesses are supported by a team of insurance and risk professionals (either in-house or on a contracted basis) and are often served by a professional brokerage company. The broker who services the business helps to navigate the ins and outs of multiple insurance companies, policies, and overlapping lines of coverage, providing strong feedback and recommendations to the business’ senior leadership. This feedback then guides the purchasing decisions that map out a comprehensive array of policy coverage. If one has a knowledgeable and experienced broker, particularly within a specific sector of operations (e.g., oil and gas, mining, construction, et cetera), then the resultant group of purchased policies should provide sufficient coverage for most eventualities.
The Bad
Unfortunately, there seems to be a continuing and pervasive gap between “financial risk” professionals and “operational risk” practitioners. While the financially oriented actuary will likely reduce probabilities and outcomes of any given event to a list of formulas and percentages, thereby calculating potentials for loss and resultant recommendations for insurance coverage, a lack of boots-on-the-ground operational knowledge may result in a senior leader being presented with a false dichotomy when it comes to making hard decisions with respect to resource allocation. This is especially true when it comes to the purchase and stocking of critical spares.
The Ugly
In many industries—most notably those involved in resource extraction—entire operations often depend on a single piece of critical equipment. If a key pump or motor fails in a petrochemical plant, the entire facility may be taken offline. If a mill motor or ring gear fails in a mine’s ore processing facility, the consequences can quickly escalate beyond ore handling. The site’s water balance issues, stockpiling, and transportation can quickly lead to the prompt shutdown of an entire mining operation. Facilities and operations that generate millions of dollars’ worth of product every day may now lay idle. Worse yet, if the pump, motor, gear, et cetera isn’t a standard, commonly stocked item, it may take weeks—or even months—to get a replacement fabricated and delivered. Hint: if you’re relying on your property insurer’s business interruption coverage to kick in, good luck with that! This is one of the most convoluted areas of coverage out there, and the insurer will likely bring forth an endless array of justifications and excuses to avoid—and/or aggressively litigate—such claims.

Most knowledgeable underwriters in any sector are keenly aware of the potential for such operational bottlenecks. When conducting a facility inspection (often as an annual prelude to policy renewal), they will be quick to note any vital or unique pieces of equipment and will make the standard recommendation to stock critical spares on site, should a component failure call for an immediate replacement. Insurers often see failure to stock spares as exceedingly risky and/or downright reckless, and a decision not to stock spares will likely result in significantly higher premiums. The insurer may also create a specific policy exclusion, abdicating itself from any coverage responsibility if a critical component fails with no replacement on hand.

What to Do?
For those who haven’t had much experience in this area, the simple and straightforward solution seems obvious: stock the critical spares when it’s recommended! The challenge, unfortunately, is that some of these components may cost hundreds of thousands (or even millions) of dollars, representing an exceedingly costly inventory to purchase and keep idle, especially if there’s a low probability that such equipment will ever be needed. This is where the false dichotomy arises. If your company isn’t being served by knowledgeable staff within the realm of operational risk and contingency planning, then it’s highly likely that you’re missing out on a third option when it comes to the choice of paying high insurance premiums versus stocking an excessive inventory of cost-prohibitive critical spares.
If your company isn’t being served by knowledgeable staff within the realm of operational risk and contingency planning, then it’s highly likely that you’re missing out on a third option when it comes to the choice of paying high insurance premiums versus stocking an excessive inventory of cost-prohibitive critical spares.
If your operational risk manager has cultivated an open and sincere relationship with your insurer’s inspectors and underwriters (i.e., the folks that do risk assessments and make recommendations on behalf of the insurance company), then he/she should be comfortable with proposing and negotiating comparable mitigation strategies in lieu of stocking critical spares, asking for credit or adjustment to the site’s risk score upon compliance. At a mine where I previously worked, we garnered hundreds of thousands of dollars in premium reductions by demonstrating that we were fully aware of our potential vulnerabilities when it came to critical components and conscientiously and thoroughly documenting the proactive, positive steps we were taking to substantially reduce the risk of unanticipated, catastrophic failures. Further, if such failures ever occurred, we had solid, documented contingency plans ready, designed to minimize the disruption, expedite replacement supply chain mechanisms, and minimize any business interruption.

There are several specific actions that I highly recommend, all of which require full explanation and documentation being provided to underwriters:

  • For large drive motors, particularly for those with long replacement times, employ and thoroughly document a strong predictive maintenance program, including oil and lubricants analysis that will detect contaminants and other changes indicative of a forthcoming failure in motors, pumps, and gear assemblies.
  • For large gears, metal tanks, et cetera, employ and document scanning technology to detect micro-cracks. Such detection could provide several months’ head start in getting a replacement ordered, fabricated, and shipped.
  • Especially in light of recent COVID-related events and worldwide supply chain issues, it’s critical to maintain a roster of manufacturers and suppliers of critical components, along with related transport elements, updated on a regular basis. When I took over the risk management and contingency planning functions at a major mining operation, I was shocked to discover how many “planned-for critical suppliers” were no longer in business (or no longer dealing the specific equipment/component needed) when I called to verify the “verbal plans” that had been passed down from previous maintenance supervisors.
  • As related above, don’t trust verbal history! If your maintenance superintendent is telling you, “Oh, there’s a spare mill gear of this same size and specifications that’s over at another site, and we have a handshake deal in place to have it shipped over if we ever really need it,” as Ronald Reagan famously said when dealing with Soviet disarmament, “Trust, but verify.”
  • If a site’s operations or a process circuit can be reconfigured upon the loss of a critical component, even if it will result in substantially less output, then develop a strong, written contingency plan to do so. The plan should identify the equipment, contractors, and supply chain elements necessary for such a conversion, all determined ahead of time to minimize downtime. Expected changes in output should be thoroughly quantified in the plan so that all parties are fully aware of the true impact of such an event. Such an analysis may be just what’s needed to convince a company’s senior leadership that—in certain cases—the purchase and storage of a critical spare onsite is the most prudent course of action.

The investment associated with stocking a complete inventory of critical spares can range from the somewhat unrealistic to the completely cost prohibitive, particularly for those components with a very low probability of failure. However, before you allow an insurance company’s inspector to frame your decision in terms of “stock-it or pay,” be sure to speak with maintenance supervisors and your own operational risk specialists. Chances are you can take specific, documented actions that may satisfy your underwriter’s concerns, perhaps freeing up some inventory replacement capital for other, more pressing needs.

After retiring from two careers in public safety and mine industry risk management, Daniel Hoffman now serves as principal for Hoffman Consulting, an Alaska-based firm specializing in emergency preparedness, crisis response, and contingency planning.
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