Finance and the economy: Managing risk – after the crisis

Managing risk is not just about risk avoidance. It is also about embracing risks that improve profitability and increase shareholder returns. Good risk management practices and policies can militate against perceived and obscure eventualities and, robust risk planning can ensure operational stability in the event of catastrophe.
Risk management is linked to practically every business activity – from insurance, currency or interest rate hedging, capital funding, health and safety management, investment strategies, environmental practices, to deploying technology and guarding against the potential dangers of social media in the workplace. Companies that create, test and implement sound risk management practices undoubtedly fare better than those which do not or which have only fleeting commitment to assuring or insuring against loss.
The importance of creating scenarios to test how an organisation might react in any operational eventuality, such as disaster or market collapse, have been sharply reinforced by the Global Financial Crisis (GFC) and recent earthquakes. The two Christchurch earthquakes that have impacted massively on the cultural, social and economic stability of the Canterbury region and the country as whole provide sad and striking example of the need for serious scenario planning, particularly in an earthquake-prone country like New Zealand.
Grant Milne, chief executive of insurance group Marsh, knows first hand of the heavy personal and commercial loss the city’s citizens and its organisations have experienced. Marsh’s Christchurch office was housed in the levelled Pyne Gould Guinness building and three company colleagues died in its collapse. The day’s events tested Milne’s leadership on many levels, having to deal with the business ramifications for his company while at the same time, deal with his employees’ and his own deep sense of personal loss.
The company did, of course, make the most of the risk management plans it had in place before the earthquake to ensure the business was up and running again as quickly as possible. “Business continuity planning is essential to survival,” says Milne. “Organisations must plan for all eventualities. We had comprehensive plan and it worked very well.”
Milne’s plan contained three essential ingredients.
• Know what employees will be doing in the event of an emergency.
• Ensure the enterprise has up-to-date contact details of clients, colleagues and business partners and restore internal and external communication systems as quickly as possible.
• Assign clear leadership responsibilities.
“And plans must be constantly tested,” he says.
QBE Insurance’s New Zealand general manager Ross Chapman says his Christchurch branch was affected by both earthquakes but the company’s business continuity planning ensured prompt restoration of its business operations. “We moved into temporary premises and some employees worked from home wirelessly,” Chapman says.
Earthquakes and other massive natural disasters, many the result of changing global climate conditions, are taking their toll on the global insurance and re-insurance industries which are central to high percentage of general risk management planning. Japan’s massive earthquake and tsunami has, for instance, so far cost the industry an estimated US$150 billion.
Milne is reluctant to focus too much on the negative impacts of these catastrophes. But he admits they will increase insurance premiums and deductibles. “For insurance buyers, the key message has been that natural disasters such as these are insurance market changing events and insurers are taking second look at the cover they can provide and offer.”
So risk managers will need to prepare for significant premium increases. “We expect increases of maybe 30 percent in premiums depending on [an organisation’s] risk profile.
“There is also change in earthquake deductibles,” Milne says. “Insurers are looking for the insured to contribute more toward earthquake loss.” Canterbury earthquake insurers had excesses of 2.5 percent of loss with minimum of $2500. “That’s changing – it’s now around five percent of site value,” says Milne. “If brokers can show their clients their business risk profile in good light and prove the action they’ve taken for earthquake proofing, then these are reductions in overall risk exposure that will be reflected in lower premiums.”

The positive side of risk
The current economic climate may be dominated by risk’s adverse qualities, but there are also benefits to be had if risk is adequately assessed and managed. Faris Azimullah, leader of global accounting and business consultancy Deloitte’s Enterprise Risk Services team, thinks concentrating on risk downsides creates negative mindset that sometimes fails to optimise the opportunity upsides.
“There is an upside to risk management,” he says. “By focusing on the downside companies miss opportunities. By looking at risks worth taking, for instance, and applying good risk management techniques, there is the capacity for generating profits. Insurance companies make good money from managing risk. There’s the opportunity to increase and maximise shareholder value by looking at what risks are worth taking,” Azimullah says.
Enterprise-wide risk management strategies are increasingly important. Risk management across organisations works at various levels. There are functions which let the front line of business embrace good risk management techniques and ensure that, across the organisation, appropriate risks are taken or avoided, or transferred.
“Another way of treating risk is to assure it,” says Azimullah. “Some organisations will assure against the risk; it may be too expensive to insure particular risks so they will accept them and face it.”
Well researched and implemented risk management policies are generally more far reaching than those that rely on insurance as the sole solution. “Organisations tend to see incidents [they experience] from singular perspective. After the Christchurch earthquake for example, clients asked for business continuity insurance. But that is just one type of risk. We provide internal audit services that cover financial, operational, health and safety or even sales and marketing risks,” he adds.
The GFC, the volatile New Zealand dollar and rising oil prices are key causes for concern in the financial risk management business. On the other hand, the right strategies can take advantage of these issues and deliver fiscal strength and sustainability. Roger Kerr, director Asia-Pacific Risk Management, says risk management is “just another management process”.
How companies respond to an uncertain market and currency conditions can mean the difference between doing well and doing badly, he says. “In terms of liquidity and funding risk – company directors recently were asking if their banks were really there and whether large borrowers were sufficiently funded,” says Kerr. The GFC showed just how dependent companies were on banks and when banks withdrew their credit lines it caused mayhem. “If those companies had non-bank funding they would not have been so exposed. That particular risk – debt/funding/liquidity – was not always well managed. Those that had policies in place fared much better,” he adds.
More companies are now accessing capital from other sources which means they will not be so exposed to restricted capital lending from banks. “Major corporates have learned not to rely so heavily on banks. The US private placement market has been good option, energy companies like Vector and the Auckland Airport company have used that market as source of funds and there has been more (use) of that (market) in the last 12 months. There has also been more access to corporate bonds in the domestic market. The market for alternative funding has improved with more investor demand.”
A flexible approach to managing interest rates can also create opportunities. “New Zealand’s sho

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