# Loss Prevention in Transportation to Ensure Product Quality: Insights from the Cargo Insurance Sector

Alexander Skorna, Elgar Fleisch

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Alexander Skorna, Elgar Fleisch. Loss Prevention in Transportation to Ensure Product Quality: Insights from the Cargo Insurance Sector. International Conference on Advances in Production Management Systems (APMS), Sep 2011, Stavanger, Norway. pp.148-156, 10.1007/978-3-642-33980-6_18 hal-01524205

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# Loss prevention in transportation to ensure product quality: Insights from the cargo insurance sector

Alexander C.H. Skorna¹, Elgar Fleisch¹,²

¹University of St.Gallen, Institute of Technology Management,

²ETH Zurich, Chair of Information Management

{Alexander.Skorna; Elgar.Fleisch}@unisg.ch

efleisch@ethz.ch

**Abstract.** Transport operations are vulnerable to many types of risks due to an increasing dynamic and structural complexity of today's supply chain networks. Globally distributed sourcing and production lead to more transported goods in general but also to more high-value cargoes being shipped around the world. However, detailed information about the transport condition and integrity are not available in the end-to-end chain as transportation operations lack in full transparency. Therefore, this paper identifies causes and risks of cargo-related losses by an analysis of cargo insurance claims. Based on these results, appropriate preventive measures to improve the product quality during transportation are derived.

**Keywords:** Cargo insurance, claims analysis, loss prevention, quality improvement, supply chain risk management, transportation.

## 1 Introduction

Production and retail companies as shippers focus today on global distribution and local buying strategies to achieve comparatives advantages as well as to realize persistent growth. Shippers redesigned their transportation concepts to make themselves more flexible to customer needs and less vulnerable to market fluctuations as well as supply chain disruptions. Companies demand high levels of transport flexibility, customized transportation solutions, information systems integration, and short transit times at low costs. Therefore, today's transportation networks are highly complex and tightly-coupled systems that are vulnerable to many types of disturbances [1,2]. Transportation is thus mainly outsourced to logistics companies. On the one hand, this redesign results in a decreasing size of shipping units and higher transportation frequency to make the supply chains more agile. On the other hand, it leads to reduced dispensable safety stocks to follow state-of-the-art lean production programs [3].

Transportation is vulnerable to numerous types of risks such as loss or damages through temperature, humidity, tilt, and shock. Damages and losses mean problems for all supply chain actors, for instance due to business interruptions, lack of product availability and in consequence lost sales. Lately, new approaches of cargo insurance practices can be observed offering support and know-how to shippers for safeguarding their supply chains from these risks. These measures are preventive and aim at the
improvement of transport processes as well as product quality, for instance, by foster-
ing risk awareness among personnel employed in transportation and by the implemen-
tation of new devices to monitor and control transport conditions. Obviously, cargo
insurance companies recognized claims prevention as an instrument to handle chal-
lenges and risks proactively [4]. A cargo insurance contract covers usually goods in-
transit from the point of production to distribution and retail with all temporary stor-
ages in between. Thereby, the terms of contract (Incoterms) determine the liable actor
in case a claim occurs in a transportation network.

## 2 Related work on loss prevention and transportation

To gain a deeper understanding of the potentially conflicting topics of insurance and prevention we review insurance research and insurance theory literature considering the prevention concept in general. Smith [5] has investigated the optimal insurance coverage due to the basic mechanisms of insurance. He distinguishes between 'over insurance', when the insurer overcompensates the insurance holder in terms of the occurred loss, and 'insurance selling', when the insurer pays not the full compensation but a proportion of it. We focus on the latter case, in which the insurance holder is taking a short position in its own loss. This is sensible because in this case risk prevention leads to balance the 'short position' [6,7].

In terms of cargo insurance the insurer usually compensates the shipper with the insured value of the affected goods when the claim is proven. But consequential losses due to e.g., business interruptions or out-of-stock situations (OOS) are not insured, which constitute the main motivation to implement prevention ensuring product quality in transportation from the shipper side, too.

Ehrlich and Becker [8] were the first to distinguish traditional 'market insurance'
from two types of protection against damages and in particular loss. These are today
typically referred to as 'loss reduction' and 'loss prevention' in insurance literature.
Both represent engineering-types of traditional insurance alternatives which Ehrlich
and Becker consider as 'self-insurance' and 'self-protection' respectively. Particularly,
self-insurance lowers the financial severity of any occurred loss, while self-protection
reduces the likelihood of loss [8,9]. An example of self-insurance is the installation of
a sprinkler system to protect buildings or warehouses against fire damages. Accord-
ingly, an example of self-protection is the equipment of doors with high security locks
to hinder potential thieves from entering.

Impulses related to risk mitigation and prevention in transportation can be as-
signed to the supply chain risk management literature. It summarizes all strategies,
measures, processes, and technologies to reduce supply chain risks [10-11]. As the
authors explain, this is mainly achieved by (1) the avoidance of risks through proac-
tive elimination of claims causes, (2) transferring risks to external parties through
outsourcing or cargo insurance contracts, and (3) handling risks through setting inter-
vention plans.

Identifying and assessing likely risks and their possible impact on operations across
the supply chain is a complex challenge [12]. However, to properly assess vulnerabili-
ties in a supply chain, firms should not only identify direct risks to their operations,
but also the risks to all other entities as well as those risks caused by the transporta-
tion linkages between organizations [11]. Risk itself is an elusive construct that has a
variety of different meanings, measurements and interpretations depending on the
academic research field. Following the theoretical prevention concepts in insurance
research outlined above, we use a hazard-focused interpretation common in risk man-
agement. Risk is defined as the probability of a given event multiplied by the severity
of a negative business impact [13]. Sources of risk are losses e.g., theft, damage due
to shock or tilt, spoilage of goods due to temperature or humidity as well as in-transit
or customs delays [14]. Usually, this goes in line with quality drops affecting the
transportation operations as well as the shippers' commitment to supply their custom-
ers. The causes of these risk sources can occur from inside and outside of a transpor-
tation network and vary greatly in their magnitude, attributes, and effects. Their con-
sequences can be very heterogeneous, especially considering the often global scales
of logistics operations [15,16] and networks [17] in which transportation is conducted.

Risk management related to the transportation chain includes processes which re-
duce the probability of occurrence and/or impact that detrimental supply chain events
have on the specific company. Typical risk management strategies rely on closer
partnerships among the transportation actors and risk sharing, e.g., outsourcing or
consignment stocks [18]. Christopher and Lee [19] suggest improved end-to-end
visibility as one key element in any strategy designed to mitigate supply chain risk.
The authors argue that supply chain confidence increases with the quality of supply
chain information.

The literature analysis reveals that first insights on quality improvements due to managing risks in supply chains exist. But, which particular impact a quality drop has on a transportation network remains still unclear. Moreover, the exact causes of claims and their impact on transportation processes are so far under researched. The following section provides first insights from the insurance sector.

3 Empirical analysis of cargo insurance claims

In order to impose proactive loss prevention measures, it is essential to have reliable
information on the major problem areas in transportation. Therefore, we investigate
original cargo claims reported to one of the largest cargo insurance companies in the
Swiss insurance market over a time period of four years (2005 - 2008). The sample
consisted in total of 7.284 claims. As claims reporting within cargo insurance usually
is delayed by several months, insurance data have been generated out of the insurer's
claims system in late 2009 and the analysis was conducted during 2010.

The average loss per incident was US$ 19.265 indicating the great potential of
possible quality improvement and loss prevention activities. The five largest incidents
involved trucks as transportation mode and pharmaceuticals as affected goods. At this
point it is important to note that the sample is not fully representative for the entire
cargo insurance industry, as the customer portfolio is focused on the typical Swiss
industries as pharmaceutical, chemical, and machinery as well as banks. Still, it pro-
vides some valuable insights for the identification of the current problem areas in
transportation.
The analysis follows two different perspectives. (1) The *insurance view* focuses on the effective claims handling costs per incident. This reveals areas for possible reductions in payments and resources as well as premium adjustments. (2) The *client view* focuses on the claims frequencies in order to identify possible areas to optimize transportation processes and product quality with cargo related loss prevention measures. The following two figures demonstrate these two perspectives and the related differences by analyzing causes and transportation mode relevant for claims incidents. As shown, frequent losses are not always simultaneously expensive ones.

<figure><img src="image_2.png" /><figcaption>**Fig. 1.** Average loss given per incident and number of incidents by causes.</figcaption></figure>

We investigated the claims causes in detail and compared the average loss given incident and number of incidents shown in Figure 1. Overall more than 90 percent of the claims can be allocated to the following six causes: rough handling, theft (includes pilferage), delivery failures, environmental impact (includes condensation, moisture, fire, and oxidation), collisions, and temperature. More precisely, about 60 percent of the claims incidents are related to rough handling, but only 20 percent of the claims costs involve rough handling. Thus, the average loss given in terms of rough handling with US$ 6.237 is relatively low.

Theft in particular of high value cargo is a serious threat to the profitability of companies. According to the claims statistic a third is spent on theft incidents, which account in terms of loss incidents for 20 percent of all claims. In this case we identified that especially high value air cargo shipments and full truck loads in Eastern Europe and the Russian Federation are a special target for organized crime. Moreover, and in comparison to Western Europe, the claims data sample indicates that cargo theft is also a major concern in North America.
The impact of temperature as the cause with the highest average loss given per in-cident involved primarily food, special chemicals, and pharmaceuticals. The restric-tive handling advices and close temperature corridors, in which the shipments have to be distributed, makes cool chain transportations a complex task. Besides the main causes of loss rough handling and theft, the analysis also demonstrates a need for action for environmental and temperature related impacts.

<figure><img src="image_3.png" /><figcaption>Fig. 2. Average loss given per incident and number of incidents by means of transportation.</figcaption></figure>

Extending the view of claims causes with the detailed analysis of the transportation mode Figure 2 shows that the main incidents occur in road transportation, sea as well as air freight. Hereby, it is remarkable that the average loss given incidents for truck and ship are about identical, while it is distinctly higher in case of air cargo. Imports and exports due to trade volumes in Europe are dominated by sea (72%/73%), but according to the trade value we see an increase of air cargo shipments which account for 23% (import) and 29% (export) [20]. Air cargo shipments focus on high value cargo such as consumer electronics, spare parts, pharmaceutical, and chemical products which also explains this shift in terms of average loss given.

The high average loss at storage is particularly tightened by the impact of environmental conditions, while changes in temperatures pose a significant threat to transportation, too. Remarkable is the extreme average loss related to cash-in-transit. These rare events are related to secure transportation and theft cases and a particular problem for the cargo insurance industry in general. Insurance companies have to hold funds available when insuring these 'big loss' risks in the form of financial reserves which are not eligible for investment purposes. This has a comparably high
impact on the investment strategy of an insurance company and makes cargo insur-
ance a complex niche market due to the ever possible big loss threat.

According to the above considerations, we derive suitable areas for quality im-
provement and claims prevention measures. In terms of claims frequency these are
related to rough handling and theft as well as to the main transportation modes truck,
sea, air, and its related transportation concepts. Due to the high average loss given we
particularly focus on theft and high value shipments which are often also affected by
environmental and temperature conditions.

In the following section we provide useful loss preventive measures to improve
product quality and avoiding losses during transportation.

4 Measures to improve product quality and prevent cargo losses

In general, the installation of a supply chain wide risk management is sophisticated. The more supply chain actors need to be integrated into risk management and the more risk situation, risk bearing ability, and risk management approaches differ from each other, the higher the implementation complexity. We distinguish *technology-oriented* and *organizational measures*, which both are suitable to prevent cargo losses and in parallel retain product quality as well as the retail shelf live.

Supply chains with lesser turnovers and direct deliveries have advantages in terms
of successful operational process improvements. Thus, the choice of transportation
routes so that the smallest possible amount of turnovers is necessary is a first obvious
step. Henceforth, the choice or change in the transportation company because of their
higher transportation quality or better damages and losses record in comparison to the
existing one may be considered. The reduction of the transportation time e.g., by
express deliveries or air freight reduces the exposure of the goods to loss risks. The
implementation of special packaging concepts e.g., air cushions or foam pads increas-
es the goods resilience to shock and drop events. Logistics companies so far only rely
on mandatory trainings for their personal related to freight securing as well as han-
dling dangerous and sensitive goods. Several authors mention the poor training level
in these operations [11,21,22].

The problem of above mentioned organizational measures is their poor transparen-
cy. Shippers can hardly control if the requested and paid special handling of goods
complies with the actual operating procedures. Due to standardization efforts and
decreasing prices for electronic parts, localization and condition monitoring has be-
come a widely common service proceeding to even make risk monitoring and control-
ling autonomously possible. The assessment of changes in environmental conditions,
e.g., temperature, humidity, and shock is a most important task for risk monitoring
and controlling in transportation. This is also closely linked to detect quality losses by
taking the changes in environmental conditions into account. According to Jedermann
and Lang [23] only few sensor types are suitable for integration into transportation
because of cost and energy consumption constraints. Temperature and humidity sen-
sors consume the least energy as measures have to be taken only in intervals of sever-
al minutes. But shock and acceleration sensors have to operate permanently; other-
wise they might miss a shock event.
However, cargo insurance companies begin to integrate prevention measures into their business and try to motivate clients implementing these accordingly. We developed together with a Swiss cargo insurance company a new technology-based prevention approach to be implemented at the insurance clients. The suggestions range from the implementation of very basic but inexpensive and easy to use prevention measures as indicators and data-loggers to compound sensor-telematic devices. All trigger the relevant risks derived in the previous section but achieve different levels of transparency and monitoring capabilities. Thus, basic indicators are in general more appropriate for frequent losses, telematic devices in turn are suitable for expensive losses with high loss amounts per incident. Shipping and handling monitors such as impact, tilt or temperature indicators are effective, highly regarded devices which can be considered as "low-tech" sensors. Once the goods are subjected to an impact exceeding a specified range, the indicator changes its color creating a permanent and immediate indication of mishandling. In contrast, telematic devices can be equipped with various sensors measuring i.e., temperature, humidity, and acceleration. The devices are capable for GPS localization and real-time data transmission through mobile and/or satellite networks. The devices are usually linked to web portals, which summarize the actual cargoes' status of integrity and transport conditions. Thus, damage and theft locations can be exactly pinpointed enabling fast corrective actions to be taken at any time. In between of indicators and telematic devices, data-loggers record the conditions during transportation which can be analyzed after the final delivery.

## 5 Conclusion

Integrated risk management in the insurance industry focuses so far on claims management and risk transfer through underwriting. Addressing risks in the supply chain requires the identification of risky events and vulnerabilities. The results shown in the claims analysis proofs the potential of risk preventive measures in transportation. These measures and related operative risk management principles expand the traditional risk management approach regarding loss prevention, consulting, implementation of risk controlling, and cooperation in the field of technology-supported early intervention to avoid or at least minimize losses. Risk prevention should consequently be based on continuous monitoring of the transport and warehousing conditions aiming to confine claims amounts. Implementing such technologies creates transparency and supports to identify and control cargo claims as well as vulnerabilities in transportation operations. In parallel, shippers, distributors, and retailers can improve packaging as well as adjusting the transportation processes according to their respective conditions and supply chain risks. This eventually leads to quality improvements of shipments as fewer claims in terms of cargo damage and losses occur.

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