Risk managers cover enterprise exposure

Risk managers cover enterprise exposure

Green, Paula

INSURANCE

ENTERPRISE RISK

Enterprise risk management is the latest tool corporate executives are using to help their companies ride out the financial losses on everything from economic recessions to droughts.

No longer a single manager sitting in a back office buying fire insurance for the factory and casualty coverage for accidents, the business of corporate risk management has evolved into a sophisticated assessment of companywide risks known as enterprise risk management. Analysts say the concept is luring more and more top managers intent on boosting shareholder value and satisfying their corporate boards and financial regulators.

"It [enterprise risk] is an overall plan that identifies a company's risks and then decides which ones a company should focus on," says Carl Groth, senior vice president and director of alternative risk transfer at Willis, an insurance brokerage and risk management consulting firm headquartered in London. "The concept is in its infancy but rapidly developing because it promises a new way to manage risk. It's also a new way of thinking and behaving. Most businesses can benefit."

In the old world of risk management, a company managed its risks separately. Traditional property and casualty risks were managed by the insurance manager in one department, while financial risks, such as fluctuations in foreign exchange and interest rates, were handled by the treasury officers. The attorneys handled lawsuits, and various business units handled their own risks, such as managing inventory. The goal of the various managers was to minimize risk.

"In the new world, risk is neither good nor bad.... You look at all risks like a portfolio from a central point. ... It opens up new possibilities," says Randy Nornes, a managing director at Aon Risk Services, part of the Aon Corporation. "In the old way, you had 10 departments looking at risk.At best, it was inefficient. At worst, it was like having 10 investment departments not talking to each other and then you find out they're all invested in oil stocks. By looking at one overall risk portfolio, you have a common language and better decision-making."

While some large corporations might do the work themselves, many are teaming up with an assortment of consulting firms that have created special enterprise risk management units.

After the risks are identified and assigned a priority, a plan for handling them is developed. The best risk management solution might be a single, integrated insurance policy to cover everything or a traditional insurance policy mixed with transactions placed in the capital markets, or perhaps no insurance at all for some risks.

"You can choose to have 60 days of inventory to minimize your risk, but that costs a lot of money" says Nornes, who works out of Aon's Chicago office. "And if you choose to have only six days of inventory, that's more risk but less capital tied up in inventory. You start to look at risk management as capital management."

Adds Ken Zignorski, managing director at MMC Enterprise Risk, an operating entity of Marsh & McLennan in New York City: "You want to optimize your risk. Risk can be good.You want to use risk creatively"

For United Grain Growers in Winnipeg, Canada, the answer, after an intense companywide review that began in 1997, was an integrated insurance program that covered all the company's risks-including drought.

While not a producer of grains, United Grain Growers culls 50% of its annual revenue from the volume of grain that passes through its system, says Mike McAndless, the company's corporate risk manager. The company, which now calls itself UGG, acts as a grain intermediary-buys grain from Canadian farmers and sells it to industrial users around the world. Less grain harvested means less grain flowing through its system.

Since demutualizing in 1993 and becoming a publicly traded company, UGG has taken the corporate governance guidelines of the Canadian regulatory agencieswhich require corporations to have a program in place to identify and manage risks-quite seriously, McAndless says.

"We decided we wanted to look at risk management in a broader way. So we ended up piling 20 people from all areas of the company from all over the country into a room and had a risk management love-in," McAndless says. "People from operations, insurance, treasury, audit-everywhere.We sat down and came up with a laundry list of 47 major risks. And at the top of it was the weather, which is another way of spelling drought. In a tight-margin business with high volatility in a fixed-cost environment, we thought we had to do something about it," he adds.

With analytical models and the data on grain production already maintained for decades by the Canadian government,Willis was able to analyze the financial risk that a drought created for UGG. Those numbers were enough to satisfy underwriters at Swiss Re, which underwrote an integrated insurance program for UGG that covered all its insurance needs-including losses stemming from weather-related risks.

Groth, who works in Willis's New York City office, says the program includes three basic pieces.The first layer of loss is retained by the company. A second layer of risk transfer covers losses above the two risk retention levels, one for losses stemming from low grain-handling volumes and the other level for other perils.A third layer of coverage is for catastrophic exposures, such as the destruction of one of the company's large grain storage silos.

The policy includes a predefined grain-handling threshold, or so-called strike price. If the company's total grain-handling volume falls below the strike price, the loss threshold is triggered, and the company is compensated dollar for dollar once its risk retention level is exceeded.

"The policy responds like a traditional insurance policy" Groth says. "This hadn't been done before. But it was possible because there was such a rigorous analysis of the risk"

McAndless says the company won't realize the true value of the policy, which became effective in December 1999, until the first drought hits. But it expects to benefit as it experiences less downside volatility in its revenues. "There's a drought every so many years, and up to now, we've been taking that right on the head," he adds. "Now we think we're lowering our average cost of risk going into the future!

Analysts say there are several factors bolstering the popularity of enterprise risk management among corporate executives in recent years, and a prime motivator is increased scrutiny by shareholders and corporate boards as well as government regulatory agencies. Another factor behind enterprise risk management's popularity is the technological advances of computer software and the growing sophistication of statistical and economic analytical models that can measure risks more precisely.

"There are now analytical models that can analyze the behavior of risk and the impact of risk," says Groth, adding that these models have been developed by the financial community over the past decade to manage interest rate, foreign exchange, and commodities risks for banks and other financial institutions.

A third factor is the breakdown in the regulatory barriers that formerly separated the insurance and capital markets for decades.

"There's a convergence of the capital markets and the insurance markets," says John Rathgeber, chief underwriting officer at St Paul Re, the reinsurance operation of the St Paul Companies in Saint Paul, Minnesota. "Now there's a layoff of insurance risk into the capital markets and a layoff of credit risk into the insurance markets.The concept makes sense. Risk is risk:'

Zignorski says that while many of his clients are in the Fortune 1000 range, MMC Enterprise Risk has helped smaller companies with $100-150 million in annual sales.

"Any organization should be looking at enterprise risk management for significant risks that impact its business.The scale of each company is different, so it makes it difficult to say what the cost of a study is, but a significant data-gathering and risk investigation would be on the six-figure side of the equation," Zignorski says.

Nornes says Aon has done some basic surveys for less than $100,000 that take 60 to 90 days, while more detailed studies can cost $200,000-250,000 and take a year to complete.

Paula Green is a New York-based contributor to Global Finance. E-mail: p/green I @msn.com

Copyright Global Finance Media Inc. Jan 2001
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