Trends in the risk management

Risk management deals with avoiding losses,  fire prevention, fleet auto safety and favorable contractual indemnity terms. Speculative risk management involves seeking the best passive results for events usually beyond the company's control, such as geopolitical or macroeconomic events that could cause unpredictable currency value swings.

These risks are best managed by judgment, prudent hedging and, in some cases, just good luck. Clearly, these two areas of risk management are different animals, and the danger of having one generalist staff address both functions is that they'll do neither well.

Insurer and service provider consolidation. Several recent insurance acquisitions - instead of creating bigger, more capable survivors - have resulted in disoriented bureaucracies that are trying to eliminate their competition in hopes of increasing their pricing profile. This is happening among both insurers and insurance brokers, in the United States and in Europe.

Although insurance companies tell you the customer will continue to drive competition among the remaining suppliers, many risk managers are skeptical. The good news is the merged entities seem to have healthier balance sheets, which should make them more able to accept business without the need to spread the risk to reinsurers. This could reduce prices for the insurance consumer. We'll see.

Insurers know corporations want to operate globally, so they market themselves accordingly. Unfortunately, when you read the fine print, almost no insurers can consistently deliver in far-flung countries. For example, only one or two Western insurers are licensed to operate in China. Many have cooperative agreements in smaller countries with local insurers, but the cooperation seems to wane after you pay the premium.

Other insurers say "global" and mean "North America and most of the European Union." For example, take a look at your directors and officers liability insurance policy. It probably says it protects your officers for covered events anywhere in the world. But under most policies, "covered events" are those covered by U.S. laws, which excludes theories of liability in Germany, France and other countries. Make sure you examine your policy and ask questions about exposures in the countries where you operate.

Business interruption is an increasingly complex exposure. An increasingly tangled web of manufacturing and distribution can cause significantly larger losses than in past eras, when manufacturers had redundant production and inventory capacity to absorb demand swings. The concept of just-in-time inventory and other efforts to reduce working capital means that when even one small part of a facility has unscheduled downtime from a fire or machinery breakdown, it creates significant ripple effects throughout the corporation, as well as its customers and suppliers. This has been clearly demonstrated over the past year in the auto industry, which had several strikes at single facilities. These dramatically affected the companies' overall manufacturing networks.

In one case widely discussed in risk-management circles, a fire broke out in a carpet-manufacturing facility that was part of a large multinational corporation and had an estimated exposure of $25 million. After the fire, it turned out that because of the interrelationship among the company's facilities, which neither the insurer nor the manufacturer had fully appreciated, the total damages, including lost sales, were eventually valued at over $500 million! Developing a thorough understanding of the downstream effects of a production stoppage is a difficult task. Again, it requires a focus on pure risk management factors, such as manufacturing processes, logistics and building construction characteristics.

Each of these trends indicates corporations will continue to rely on specialists to lead their pure risk management programs to truly reduce their long-term cost of risk, in a separate endeavor from the speculative risk efforts. The more sophisticated the program, the more the corporation will rely on dedicated professionals to fine-tune their programs to improve the cost profile. Finally, the more things change, the more they stay the same. It's just as true as ever that losses are preventable and aren't necessarily inevitable. That's the key difference between managing pure and speculative risks.