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3 January 2017 | PropertyTopics Online homepage
It all started in August 2013 when additional process gas lines for the production area were being laid and connected in the semiconductor factory. The subcontractor responsible for this work mixed up the nitrogen and hydrogen connections to a distribution cabinet. As a result, the control unit in the distribution cabinet, located beneath the clean room production halls, was rinsed with highly explosive hydrogen instead of being rendered inert with nitrogen. When the production machine supplied by the distribution cabinet was commissioned over a week later on 4 September, an explosion occurred which caused a fire. The fire spread to the clean room area and onto the roof via the gas ventilation system. The fire was extinguished by the sprinkler systems and the fire service in just under four hours.
Even though only small areas of the clean rooms
were directly affected by the fire, smoke
and soot damaged extensive areas of the
manufacturing systems and production area.
The highly technical production process for
manufacturing these chips comprises numerous
steps where special machines are used (see
diagram on next page). Since even the
slightest impurity can affect the production
yield and reliability of the chips, the air
is kept virtually dust-free.
The two clean rooms contained a total of more than 1,400 special machines and appliances, many of which were destroyed by the fire or damaged by smoke, soot and the resulting corrosion. There was also the risk that the abrupt power cut that followed the explosion could have damaged the sensitive electronics in the devices. For this reason, even machines and equipment that displayed no outward signs of damage had to be checked for error-free functionality within extremely narrow tolerances. An additional concern was that – aside from the direct consequences of the fire – the large number of expensive wafers that had remained in the production process might be lost because of uncontrolled exposure time to chemical substances (see diagram below). Despite the localised impact of the fire, property damage to equipment and buildings and the costs for the business interruption in the semiconductor factory amounted to US$ 860m.
In view of the complex production process, it quickly became apparent that valuing the loss and exercising any loss-minimisation options could only be achieved by bringing in external specialists. It needed to be established which machines and equipment could be cleaned or repaired, and which needed to be replaced with new purchases. Special expertise was required in this area on account of the precision machinery and the extremely low error-rate tolerances for the final product. The views of insurers and policyholders often differ significantly with regard to such assessments. A further aspect was that help from the external specialists would make it easier to estimate when production could be ramped up again to achieve the normal level.
Whenever chip production is started, a certain
period of time is required before it has
warmed up to the point where the yield of
error-free chips has reached an acceptable
level. This ramp-up process can take up to
two months and, under certain
circumstances, extend the phase covered
under a business interruption policy.
Because there are only a small number of memory chip manufacturers worldwide, the production stoppage affecting this one producer had massive ramifications around the world. Immediately after the loss became known, the price of memory chips rose sharply in line with the reduced supply, as the facilities affected by the fire were responsible for a substantial portion of global memory chip production. In addition, OEMs (original equipment manufacturers) who had concluded long-term contracts to purchase the memory chips from the manufacturer concerned had to fall back on other means of supply at very short notice. Not only was this difficult to do, since every OEM affected immediately began looking for alternatives, but it also involved high costs on account of the increased prices for memory chips.
Memory chips are not only used in computers for dynamic random access memory (DRAM) functions, but also as flash memory chips which store data permanently. A large number of electronic devices, such as mobile phones, cameras, navigation systems and USB sticks, cannot operate without these components. The situation was particularly dire at one US customer in the IT sector. At the time of the fire, it was in the critical phase of bringing out a new game console in time for the lucrative Christmas market. The just-in-time production at the contract manufacturer had already started when the supply of memory chips suddenly stopped. Given the time pressure involved, the company saw no alternative but to purchase the relevant components on the spot market at significantly higher prices. There were also air freight costs in the tens of millions to launch the game consoles on schedule despite the delay.
Because the console segment was not part of
the group’s core
business, not enough attention was paid to
the risks emanating from globally networked
supply chains. For example, the company had
omitted to split procurement of critical
components like the memory chips between at
least two suppliers in order to reduce or
eliminate any potential bottlenecks. Particularly
in the case of memory chips, which as bulk
products feature no special specifications,
it is very easy to fall back on different
suppliers. Ultimately, the loss from the
contingent business interruption came
to almost US$ 500m, although the insurers
had to pay a much smaller amount thanks to
the agreed sublimit of US$ 150m and the
of US$ 25m.
A further problem arose at a different OEM, which had also concluded a long-term supply agreement with the semiconductor manufacturer concerned. This OEM was still not being supplied with chips by the manufacturer even as late as the following January, despite production being up and running again by this point. One could speculate that the chip manufacturer had seized the opportunity and preferred to sell its chip components on the spot market at a higher price, rather than sticking to the long-term supplier agreement (at lower prices). The ultimate losers were the insurers, who had to refund the price difference to the OEM under the CBI cover. They would only have been freed from the obligation to indemnify if there had been a break in the causal chain that led to the financial loss. However, there was no evidence for this.
Once again, a seemingly minor slip triggered a major loss that cost insurers dear. This was not only due to the special production conditions in the industry, but also because risk managers have not yet fully grasped the significance of CBI – despite the large number of losses. CBI losses resulting from the globalisation of supply chains pose a particular threat if a specific component is used in a variety of products and that component is made by just a few manufacturers. This could be memory chips, as in this case, or even unbreakable glass for mobile phones, which is only produced by a handful of companies around the world. In the automotive industry, drive technology, tyres and electronic components are likely causes of bottlenecks.
For underwriting, the challenge is to identify
critical weak points and to make allowance
for these in the contract design. The
problem here is that underwriters depend on
the information provided to them. They can
never hope to know more than the
customers themselves, and it would be an
illusion to believe they could identify all
the different cogs and wheels that intermesh
in complex production processes. For
this reason, CBI losses can never be
completely ruled out given
today’s international division of labour.
The location, date and extent of CBI losses
cannot be controlled, something they share
in common with natural catastrophe
In such a case, sublimits are the most effective way of limiting exposure. In this context, it is sensible to distinguish between named suppliers and second-tier unnamed suppliers. The named suppliers are expressly listed in the policy. Since it can be assumed that named suppliers apply higher standards to avoid production breakdowns, higher sublimits can be agreed for them than for unnamed suppliers. Furthermore, for risks involving complex supply chains, the underwriter should form a clear picture of the quality of continuity management.
Following a loss, the topic of recourse should
be examined since, in the area of CBI, it is
usually third parties (in this instance the
subcontractor responsible for the gas
connection) who trigger the loss.
However, policyholders often agree to waive
recourse action under the policy against
their named suppliers because they do not
want to put a strain on future business
relations, and because the insurer will
pay for the loss anyway. In this situation,
the insurer has no means of taking action
against the party responsible for the damage
without the consent of the
policyholder. Insurers should therefore take
care not to needlessly surrender their
rights to recourse claims. When assessing
the loss, insurers should also make
a realistic assessment of their expertise
and options, as was done so successfully in
this case. External expertise was expensive
but worth every penny. After all, it made it
possible to significantly reduce the loss
amount and also shorten the overall
Last but not least, underwriters should consider what options the policyholder has in terms of alternative production sites. For example, the Asian semiconductor manufacturer operated facilities in other countries that also produced memory chips. Ideally, the extent to which a breakdown in one factory could be made up for by other production sites should have been specified when drafting the policy conditions.
This publication is available exclusively to Munich Re clients. Please contact your Client Manager.