Canadian Underwriter
Feature

Aligning Sources & Exposures


September 1, 2003   by Perry Brazeau Canada division manager at FM Global


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The world has changed in countless ways over the past 18 months. Words like corporate scandal, catastrophe and terrorism have entered mainstream vocabulary. The public suddenly has a new perspective on risk: that the world is a much riskier place than it once was.

Front-page stories on corporate financial mismanagement and images of terrorism remain etched in many people’s minds. But what is the real state of risk? Has the world really changed? Have those responsible for managing risk addressed this change? Are companies better prepared for disruptions to their top revenue sources than they were a year ago?

Preparedness

According to the 2003 “Protecting Value” study (posted at www.protectingvalue.com), which surveyed nearly 400 financial executives (CFOs and treasurers) and risk managers at the world’s leading companies, more than one-third report their firms are not sufficiently prepared to protect their top revenue sources and clearly have room for improvement. The study was conducted by FM Global, the Financial Executives Research Foundation, and the National Association of Corporate Treasurers (NACT).

In contrast to last year’s study, this year’s respondents were most likely to cite improper management and employee practices as the leading hazard affecting top revenue sources, probably as a result of high profile news of financial mismanagement within several major corporations. Collectively, 59% of the companies reported the greatest impact on revenue sources would derive from property-related hazards, including fire or explosion, natural disaster, terrorism, theft, mechanical or electrical breakdown, service disruption, a supply shortage, employee strike or “cyber crime”. However, there were marked differences between financial executives and risk managers as to whether property or non-property related hazards constitute the greater threat to revenue, which suggests that business continuity planning may not be sufficiently aligned with top revenue sources at many corporations.

Differing viewpoints

Specifically, a slight majority of financial executives say non property-related hazards, including improper management and employee practices, product recall, pricing volatility and personal accidents, would pose greater threats to revenue. In contrast, risk managers overwhelmingly consider property-related hazards as posing the greater threat (see chart 1).

While financial executives and risk managers share a common pursuit of balancing risk and return, the study found, in addition to their differing views on the most threatening hazards, each party has different perspectives about their company’s top sources of revenue. For example, financial executives cited personnel and customer support as their top revenue source, while risk managers cited manufacturing, plant and process equipment. Among the study’s other findings, 100% of the companies surveyed reported a major disruption to a top revenue source would have a negative impact on earnings, with 28% stating such an event would threaten business continuity.

Good returns?

Approximately 85% of the survey respondents see risk management as an investment. In particular, those who hold this view attribute it to protection of business continuity. As a result, they believe there is a realized return on investment.

Conversely, those who view it as an expense do so because they see it as a necessary cost of doing business with no realized return. However, 86% of the respondents described their extent of preparation to recover from a major disruption to their top revenue sources as less than “excellent.” Likewise, 84% of all companies surveyed rated their contingency planning efforts as less than “excellent”. This begs a number of questions:

What should be a sufficient level of preparation for protecting a firm’s top revenue sources?

Are companies receiving a good investment return on their risk management efforts?” (see chart 2).

It is important to realize that, in the event of a major disruption, there are two significant outcomes: financial and customer loss. On the financial side, how long can your company endure operational shutdown in terms of cost? To answer that, look at each business unit. What is your budget for each and how would the overall business be affected by a major loss? Which units are most critical and how much will it cost to get them operational again? How long can you afford to have them out of operation?

On the customer side, what will be the impact on the quality of products and delivery of service to customers if there is an indefinite shutdown? What will customers demand on a daily basis? What can be put on hold? Prioritizing products or services in terms of customer demand is a good way to analyze this. The answers to many of the questions your business may need to ask are likely to be unique to your company.

Continuity spending

The World Trade Center (WTC) was a clear example of the outdated notion that insurance will cover all consequences of a loss. There are many studies that have highlighted the uninsurable costs, such as management time and corporate reputation, that can result from any loss.

So, it is encouraging to see that the corporate world is looking beyond insurance to further enhance their risk management efforts. In particular, the survey respondents suggest that more than one-third of any additional funding to protect their company’s top revenue sources would be spent on business continuity (23%) and contingency planning (14%) efforts (see chart 3).

Focused objective

The main objective of business continuity planning is simple – no matter what happens to your company, any disruption should be transparent to your customers. At the core of this objective is protecting the value created by an organization’s top revenue sources and its ability to profitably compete in the marketplace.

If a company is unable to meet its customers’ needs – in the event of a fire, flood, employee strike or other catastrophe – those needs will be quickly filled by a competitor. By not adequately protecting your company’s value, it stands to lose more than money. It also risks losing the intangibles, such as its reputation, marketshare and customer base.

As you assess your level of preparedness, be aware that risk management is a long-term proposition, and this requires sensitivity not only to internal risk management practices, but also to the broader realities of the global marketplace.

Also, it is important to understand your company’s business goals and management dynamics. Much of the financial executive’s world involves dealing with a broad portfolio of risks. The risk manager’s world, in contrast, revolves around developing and implementing optimal risk aversion practices while adhering to budgetary constraints.

Given this delicate balance, there must be communication between financial executives and risk managers regarding perceived threats and business continuity planning efforts in order to form a more complete strategic view of risk management. If this can be accomplished, companies should be able to effectively address the stable inventory of long-term risks, as well as the “threats-of-the-day” that command so much press attention.


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