Managing risk is critical when working with vendors

The relationships between a business and third-party vendors and suppliers are incredibly important. Relying on third-party vendors can help enhance efficiency, but also introduces financial, legal, and reputational risks. 

For insurance agents, understanding vendor risk management (VRM) can be crucial for advising clients and protecting their own operations. The article will explore the various types of vendor risks, explore why vendor risk management is important and look at strategies businesses, alongside their insurance professional can utilize to help manage vendor risks. 

What is vendor risk management?

Vendor risk management involves assessing and managing risks associated with engaging third-party vendors, suppliers or business partners throughout the entire contract life cycle. The goal is to identify and mitigate risks that could disrupt operations, cause financial loss or damage the company’s reputation. 

Effective VRM includes setting clear expectations, relying on contractual risk transfer and continuous monitoring of a vendor’s performance and risk posture. For instance, if a business outsources IT services to a vendor lacking effective cybersecurity measures, it could lead to data breaches and legal liabilities. Regular risk assessments and monitoring of the vendor’s cybersecurity practices help mitigate these risks. 

VRM also addresses compliance with labor laws, fraud prevention and minimizing disruptions caused by a vendor’s financial instability. 

Why is vendor risk management important?

Vendor risk management is critical for businesses to protect against potential disruptions, financial losses and reputational damage that can arise from vendor-related issues. As organizations increasingly rely on third parties to manage and support critical functions, the associated risks also increase. 

Vendors often gain significant access to important systems and sensitive data, including personally identifiable information (PII), protected health information (PHI) and other confidential details. When these data sets or systems are negatively impacted at a vendor, through an incident such as a data breach, natural disaster or another type of event, the businesses who work with that vendor often have their services disrupted as well.  

Looking at cybersecurity concerns in particular, the impact of third-party security breaches is significant. For example, the average cost of a data breach involving third-party vendors is $370,000 higher than breaches originating within the organization, totaling an adjusted average of $4.29 million.¹ This shows the importance of having effective VRM practices to safeguard sensitive data and minimize exposure.  

Businesses should ask questions, such as: Who are my high-risk vendors? Do these vendors have sufficient measures in place to protect my business, its data and its operations?  

Different types of vendor risks

VRM is multifaceted, encompassing various types of risks that can impact business operations, finances and reputation. Here’s an overview of key vendor risks and how to address them:  

Compliance risk 

Compliance risk arises when vendors fail to adhere to regulatory requirements, which can include data protection laws like the General Data Protection Regulation (GDPR), the Health Insurance Portability and Accountability Act (HIPAA) and the California Consumer Privacy Act (CCPA). Noncompliance can result in penalties, legal liabilities and reputational damage. Insurance agents can help businesses evaluate whether vendors have proper measures in place to meet regulatory obligations, ensuring they mitigate compliance-related exposures. 

Reputational risk 

Reputational risk occurs when negative media coverage or vendor misconduct, such as unethical practices or poor product quality, reflects poorly on the companies they serve. Insurance agents can advise clients on conducting thorough vetting and ongoing monitoring of vendors to minimize these risks. 

Cyber risk 

Cyber risk is a growing concern, as vendors often have access to sensitive data and systems. Cybersecurity breaches can disrupt operations and compromise information. Insurance agents can help businesses assess vendors’ cybersecurity protocols and advise on the monitoring of third-party security practices. 

Fourth-party risk 

Fourth-party risk extends beyond direct vendors to include the partners and suppliers those vendors rely on. If a vendor’s subcontractor experiences a failure, it can ripple up to affect the primary business. Insurance agents can help clients understand the broader risk landscape by identifying and assessing the security practices of fourth parties connected to their vendors. 

Economic risk 

Economic risk refers to external factors, such as currency fluctuations or economic instability, that can affect a vendor’s ability to deliver services or goods. For instance, a vendor in a country with a volatile economy might face unpredictable costs, affecting pricing stability. Agents can guide businesses on diversifying vendor bases and establishing contingency plans to mitigate these uncertainties. 

Financial risk 

Financial risk emerges when vendors experience financial instability or fail to meet contractual obligations. This can disrupt supply chains and impact business continuity. For example, if a supplier faces bankruptcy, it can halt deliveries, causing operational delays. Insurance agents can support businesses in assessing vendors’ financial health through credit checks and financial performance reviews. 

Environmental risk 

Environmental risk involves vendors whose operations may cause environmental harm, such as pollution or unsafe waste disposal. Agents can assist businesses in screening for environmentally responsible vendors and ensuring compliance with environmental regulations to reduce this risk. 

Political risk 

Political risk affects vendors operating in regions with unstable political climates. Changes in government, regulatory shifts or civil unrest can hinder a vendor’s ability to maintain reliable service. Insurance agents can advise businesses to consider political risk insurance and diversify their vendor base geographically to minimize exposure. 

Vendor risk management best practices for businesses

Effective vendor risk management requires a strategic approach that encompasses various practices to safeguard against potential risks. While there are numerous best practices businesses can implement, the following key strategies can help build a framework.  

• Set guidelines and policies – Establish clear VRM policies that outline expectations, assessment criteria and protocols for engaging and managing vendors. This includes defining roles and responsibilities within your organization for monitoring vendor performance and compliance with contractual and regulatory requirements.

• Do the research – Conduct thorough due diligence before entering into a partnership. Evaluate vendors not only on their services and costs but also on their financial health, ethical practices and compliance with relevant regulations. 

• Assess cybersecurity risks – With cyber threats on the rise, it’s essential to evaluate vendors’ cybersecurity practices rigorously. This includes reviewing their data protection policies, access controls and incident-response plans. 

• Monitor continuously – Vendor risk management doesn’t end when a contract is signed. Continuous monitoring of vendor performance, financial stability and compliance with contractual obligations is key. 

• Implement automation – Utilizing automated tools for vendor risk assessments and monitoring can streamline the process, making it more efficient and less prone to human error. Automation helps maintain up-to-date insights into vendor risks and ensures that businesses can respond quickly to potential issues. 

• Consider insurance solutions. –There is always a risk that a vendor or supplier may be unable to deliver a critical part or service due to various factors. Agents should assist their clients in identifying which risks they can transfer through insurance.   

Help your clients mitigate other commercial risks

Managing vendor risks is vital for protecting business operations, finances and reputation. By understanding key risks and applying best practices, businesses can better safeguard their vendor relationships. 

To help customers reduce risks to their workers, property and operations, you can share industry-specific resources from our Risk Management Solutions Center. There, you’ll also find a wide variety of materials on the Resource Library such as driver training, employee safety, contractual risk transfer and more.