As labor rates rise in China, shipping costs increase, the dollar weakens and supply chains grow more complex, many industry analysts are suggesting U.S. manufacturing activity will increase over the next five years.

And while some risks such as supply chain failures may be reduced if manufacturing firms are closer to operations and manage them more effectively, other risks — such as medical cost inflation for workers’ compensation and nonoccupational injuries — are on the rise, says Mike Stankard, managing director and  Industrial and Materials Practice leader at Aon Risk Solutions.

“High-frequency, low-severity type risks, such as workers’ compensation or fire prevention, need to be managed on a day-to-day basis to prevent and mitigate losses,” says Stankard. “Businesses simply can’t overlook those because they face them every day. They also need to control losses that would prove catastrophic, such as large liability claims or the financial impact from natural disasters. Those risks can be managed with insurance because they are largely unpreventable, and businesses have an obligation to protect shareholders’ capital.”

Smart Business spoke with Stankard about how to manage risks facing the industrial and materials sector.

What are some risks that can impact the industrial and materials sector?

Aon Risk Solutions recently conducted a survey of business leaders in the industrial and materials sector to gauge their concerns, which included the economic slowdown — in both the U.S. and abroad, uncertainly surrounding raw materials and commodity pricing, and future innovations to keep up with customer needs.

In addition to the broad risks that drive macroeconomic issues affecting supply and demand, leaders must consider specific risks and manage them on a day-to-day basis to ensure efficient and effective execution of their business plan. In this area, risks include business interruption and supply chain failures, keeping up with emerging market opportunities and the risks and rewards of globalization.

What are some of the major drivers of risk?

The recession has had a profound impact on manufacturers that were forced to quickly adjust to changing demands for their products. The challenge was that no one knew just how low the economy was going to go. Some manufacturing employers reduced their work force by 40 to 60 percent and closed plants, although some of those reductions are starting to reverse. Many companies, especially automotive, used bankruptcy as the ultimate risk management tool to make long-term fixes to their macro-business models in the areas of labor contracts and raw material purchasing, shutting down inefficient plants and dropping marginal product lines.

Escalating health care costs continue to affect the work force both in terms of group medical insurance costs and workers’ compensation. When workers are injured, an employer is affected by wage replacement, medical costs and productivity leakage.

There’s also been reaction to all of the production moved offshore in the past 10 years. In 2011, natural disasters, such as the earthquake and tsunami in Japan, flooding in Thailand and earthquakes in New Zealand and Chile, put stress on the global supply chain, forcing companies to re-examine the vulnerabilities around their supply and customer chains. Many are now considering whether they were shortsighted when they moved production to low-labor rate countries that could potentially result in larger issues than just how much per hour they are paying employees.

How can mid-sized employers minimize their risks?

Mid-sized employers may want to consider increasing workplace safety to avoid injuries that may result in expensive medical costs. As not all accidents are preventable, effective claims management practices on post-accident behaviors can help control medical costs and get workers back on the job as quickly as possible, even if it’s for light duty work.

When looking at the supply chain, manufacturers need to re-examine their supplier base to look for potential bottlenecks, single-source suppliers that could cause problems down the road. To minimize the risk, contingent business interruption coverage insurance around supply chain failure is available, which can cover loss of revenue.

However, it is important to note that underwriters have changed their business practices to limit their exposure in this space. They want to know about your suppliers — where they are located and how much business you do with them. For example, they might reduce your limits or restrict coverage so it only applies to direct suppliers rather than indirect ones, even though both can have just as much impact on your business.

Once risk management practices are in place, how can you measure them for effectiveness?

Your insurance broker, who optimally deals with your industry, knows it well and works with your peer companies, should be able to provide best practice benchmarks and performance metrics that can be continually updated. They can give you guidance on how to prevent and minimize claims as well as advice on the quality of insurance, how much you should purchase, how you should measure and value business interruption losses, etc. For example, your broker could perform a comprehensive evaluation of your workers’ compensation processes and losses, analyzing your environment and all of the losses you had on a granular basis. After determining the root cause of those losses, the broker would make recommendations such as ergonomic corrections, improvement in communications around losses and reporting lags. These kinds of precise adjustments and the best practices associated with them could add up to millions of dollars in savings over time.

Mike Stankard is a managing director and Industrial and Materials Practice leader for Aon Risk Solutions. Reach him at  (248) 936-5353 or email mike.stankard@aon.com.

Please visit aon.com/industrialandmaterialsreport to download a copy of the 2012 U.S. Industrial and Materials Industry Report.

Insights Risk Management is brought to you by Aon Risk Solutions

Published in Detroit