Gb629 Enterprise Risk Management

Chapter 1. Modern Risk Management 1. With respect to the story about Hurricane ndre! in "#orida$ !hat is the ERM #esson #earned% ns!er & Hurricane ndre! caused signi'icant damage to most o' the insurance companies in "#orida because "#orida (nsurance #a! did not hand#e '#ood and !ind damage proper#y. )hey #obbied and got these po#icies changed. Companies sa*ed money in subse+uent hurricanes because o' this #obbying e''ort. ,ut insurance companies did not share their #obbying e''ort and did not seek simi#ar changes in the po#icies in other states. )he resu#ts !ere big #osses and bad ne!s in 2--. in Georgia$ Mississippi$ /ouisiana or )e0as. "ai#ure o' one part o' organi1ation to share risk mitigation strategies !ith other units is a 'ai#ure o' enterprise risk management. 2. Why are the three de'initions o' risk inade+uate 'or modern organi1ations% ns!er & )raditiona# de'initions o' risk are 2ossibi#ity o' /oss or (n3ury 4 (t is something to #ose it through an accident or mis'ortune. 2otentia# 'or negati*e impact & 5omething cou#d go !rong. )he negati*e impact may be *ague or unkno!n but it !ou#d produce a negati*e outcome. /ike#ihood o' an undesirab#e e*ent & )his mo*es us into !or#d o' statistics and +uantitati*e ana#ysis. ,ut !hen 6rgani1ation engages in its acti*ities$ it accepts risk. ctua# resu#ts may not match e0pected resu#ts. Resu#ts may be better or !orse than e0pected. Enterprise risk considers both possibi#ities and upside o' risk is the reason 'or accepting e0posures and opportunities. 7. Ho! do the t!o characteristics o' enterprise risk add to our understanding o' risk management% ns!er &(n Enterprise Risk$ actua# resu#ts may not match e0pected resu#ts$ Risks has t!o characteristics. 8ariabi#ity & 6rgani1ation may spend considerab#e time strategi1ing$ p#anning and budgeting but e*eryone has contingency p#ans to anticipate and respond to changing conditions. )he !or#d is *ariab#e and that is a characteristic o' risk. )his *ariation 'rom e0pectations is 'undamenta# in concept o' risk management. 9pside o' Risk & )raditiona# de'initions dea# !ith #oss$ in3ury or other negati*e impacts$ but !hen enterprise engages in its acti*ities$ it accepts risk. (t may be positi*e or negati*e than e0pected. nd this is ca##ed an 9pside o' risk. (t is the reason 'or accepting e0posures and opportunities.

:. Which o' the three components o' enterprise risk can be mitigated by using insurance% Why does insurance not !ork 'or the others% ns!er & Enterprise risk has three components are ,usiness Risk$ "inancia# risk and Ha1ard Risk. ,usiness risk is a possibi#ity that organi1ation !i## not compete success'u##y in its operations. )he company may 'ai# to update a product or ser*ice. )echno#ogy being used may be

obso#ete. Customer pre'erences may change. )hese things can not be contro##ed by insurance. "inancia# risk is a possibi#ity that an entity !i## not ha*e ade+uate 'unds 'or its operations. )he prob#em may be because o' inade+uate initia# capita# or cash '#o! prob#ems$ in operations. )his a#so can not be contro##ed by insurance. Ha1ard risk cou#d be mitigated by using insurance. Ha1ard risk is an e0posure that can cause #oss !ithout the possibi#ity o' gain. )hese are insurab#e e0posures !ith no upside. Company may su''er physica# damage to assets as !hen 'ire or e0p#osions destroy bui#dings or machinery. Ha1ard Risk is re#ated to business and 'inancia# risk because it can cause business and 'inancia# damage. .. With respect to the ;aim#er merger !ith Chrys#er$ !hat is the ERM #esson #earned% ns!er & (n 199<$ ;aim#er e0changed stock !orth =7< bi##ion to merge !ith Chrys#er. 'ter in*esting bi##ions o' do##ars in Chrys#er o*er 1- year period$ ;aim#er so#d the bu#k o' the 'irm to Cerberus 'or #ess than =< bi##ion. ;aim#er 'ai#ed to merge the distinct German corporate cu#ture !ith the proud but troub#ed e0ecuti*es and !orkers in Chrys#er. ;aim#er su''ered a business risk #oss. 5o #esson #earned is ,usiness risk can destroy the upside o' risk >accepting e0posures and opportunities ?. 6. With respect to ma1on and Web*an$ !hat is the ERM #esson #earned% ns!er & ma1on started its operations se##ing books on#ine and then di*ersi'ied to se## other products. Web*an !as an on#ine 'ood business that accepted internet orders and de#i*ered grocery products to customers. n ERM ana#ysis identi'ied some key di''erences. Web*an had serious prob#ems !ith distribution. (t had to bui#d its o!n distribution system. ma1on used the e0isting distribution channe#s #ike 925$ 9525. Web*an o''ered daytime de#i*ery !ithin 7- minute !indo! to customers !ho used the ser*ice because they !ere too busy to shop. )hey !ere not home in the daytime so the 'ood !ou#d spoi#. ma1on cou#d de#i*er its nonperishab#e products anytime and #ea*e them on the doorsteps. ,oth companies needed considerab#e capita#. ,ut 'inancia# risk !as greater 'or Web*an. (t signed bi##ion4do##ar contract 'or bui#ding !arehouses$ purchased a '#eet o' de#i*ery trucks and spent #arge sum o' money on computers and other e+uipment. )he e0pensi*e de#i*ery structure s+uee1ed the pro'its 'rom the business. Web*an su''ered tight cash '#o! and capita# inade+uacy resu#ting into going out o' business. ERM recogni1es the di''erence bet!een business and 'inancia# risk !hi#e recogni1ing that they can merge to produce either good or bad resu#ts. @. With respect to 2hi#ips$ Aokia$ and Ericsson$ is it reasonab#e to think that Ericsson cou#d ha*e 'oreseen the crisis and take steps to mitigate it% ns!er & (n March 2---$ #ightning struck 2hi##ips p#ant. 2hi##ips a#erted its customers inc#uding Aokia and Ericsson that production had been stopped. (t estimated one !eek o' de#ay in production but actua# de#ay !as much more than that. Aokia beha*ed in accordance !ith the indi*idua#ists and aggressi*e cu#ture o' "in#and. (t put the search 'or Microchips into critica#4risk category and #ocked up a## the microchips 'rom the market. 5o there !as no disruption o' de#i*eries to customers. ,ut Ericsson beha*ed more in accordance !ith the consensua# and #aid4back cu#ture. /o!er #e*e# emp#oyees did not te## the head o' production about the de#ay 'or se*era# !eeks. Resu#t !as =2.7 bi##ion #oss in its mobi#e phone di*ision accompanied by a !ithdra!a# 'rom market in 2--1. 6*era## Ericsson 'ai#ed to rea#i1e the impact o' the de#ay on the production and act upon it.

Ao #oss is sma## !hen an organi1ation does not understand the re#ationships among risks. <. With respect to catastrophic$ critica#$ signi'icant$ and minor #e*e#s o' risk. What #e*e# shou#d be *isib#e to the CE6% E0p#ain your reasoning. ns!er & catastrophic #oss in*o#*es the destruction o' a ma3ority o' assets$ an unbearab#e 'inancia# #oss$ and an inabi#ity to continue operation. (t produces a near4term$ i' not immediate$ bankruptcy and a disso#ution o' the enterprise. critica# or ma3or #oss serious#y hampers a companyBs abi#ity to do business. n e0amp#e is the co##apse o' a ma3or operation unit or product #ine$ 'o##o!ed by a substantia# 'inancia# setback that cou#d #ead to bankruptcy. /esser #e*e#s o' risks might be signi'icant$ or minor hurting an operating unit but not impacting 'inancia# statements. Catastrophic and Critica# #e*e#s shou#d de'inite#y be *isib#e to the CE6. 9. With respect to the attack on the Wor#d )rade Center$ i' you !ere on the 3ury$ !ou#d you ha*e *oted that the attack !as a sing#e occurrence% E0p#ain. ns!er & ( !ou#d ha*e *oted 'or one occurrence 'or some insurers and t!o occurrences 'or some 'or both the to!ers. 6ut o' 22 insurance companies that !ere origina##y in*o#*ed$ 17 insurers !ere determined to be go*erned by a CWi#2ropD 'orm that had speci'ic #anguage de'ining occurrence. )he e*ent 'its to the contents o' that 'orm so 'or them one occurrence !ou#d 'it. ,ut rest o' the other insurance companies that didnBt ha*e any speci'ic #anguage or can not c#ear#y de'ine !hether it cou#d be considered as sing#e occurrence or mu#tip#e shou#d be ob#igated to pro*ide more e0pansi*e co*erage. 5o rest shou#d ha*e paid as t!o occurrences. 1-. 6' the 'our sources o' ha1ard risk >physica#$ Mora#$ beha*iora#$ and #ega#$ gi*e one e0amp#e o' each that is not taken 'rom the te0tbook. ns!er & 2hysica# ha1ard re'ers to situation !here the rea# !or#d creates a danger. )sunami$ Windstorm$ open e#ectric !ires !hen in motion may be some o' the e0amp#es o' physica# ha1ard. Mora# Ha1ard arises 'rom a #ack o' honesty or integrity. )aking bribe$ using po#itica# E !ork po!er 'or persona# monetary gain$ #eaking insider stock ne!s to other peop#e 'or monetary bene'it may be some o' the e0amp#es o' mora# Ha1ard. ,eha*iora# ha1ard deri*es 'rom care#essness as !hen peop#e do not e0ercise a proper degree o' caution in per'orming acti*ities. )a#king on phone E te0ting !hi#e dri*ing may be e0amp#es o' beha*iora# ha1ard. /ega# ha1ard is an increased #ike#ihood that a #oss !i## occur because o' court actions. E.g. /a!suits

11. With respect to the story o' G#oba# 2etro#eum$ !hat is the ERM #esson #earned% ns!er & G#oba# petro#eum 'aced oi# spi## crisis. Within 2: hours o' the crisis$ a team consisted o' team #eader$ systems specia#ist$ 'inance specia#ist$ a petro#eum engineer$ and #ogistics specia#ist and pub#ic re#ations manager arri*ed at the scene. )eam #eader had 'u## authority to take any decision to contro# oi# spi## and keep #oses minimum. 1.- more !orkers 3oined them. )eam #eader immediate#y rea#i1ed there is no much p#ace to keep a## these peop#e. )here !as on#y one resort and it !as 'u##y booked and o!ner may not *acate the resort. )o mitigate a## these risks $ )eam #eader bought the hote# and disp#aced

the guest$ !eeks #ater he so#d it back to the origina# o!ner at a #oss that !as much #ess than the resu#t o' indecision or inaction !ou#d #ike#y ha*e been. /esson #earned 'rom this is prepare 'or a #oss react to it !ith an e''ecti*e mitigation strategy. 12. What is a speci'ic e0amp#e o' a risk that might be identi'ied by each o' the 'our areas o' modern risk management >ha1ard$ interna# audit$ interna# contro#$ and comp#iance?% ns!er & Ha1ard Risk Management 4 Risk managers 'o##o! 'i*e4step process to assess ha1ard risk. (denti'y e0posures$ assess 're+uency and se*erity$ identi'y a#ternati*es$ choose an option to imp#ement and make ad3ustments as needed. )his particu#ar process is used 'or pre*enti*e and crisis risk management. (nterna# contro# & Companies ha*e processes ca##ed interna# contro#s to pro*ide reasonab#e assurance that po#icies are being 'o##o!ed. (t seeks to impro*e e''ecti*eness and e''iciency$ increase re#iabi#ity o' 'inancia# reporting and ensure con'ormity !ith #a!s and regu#ations. (nterna# udit & (nterna# auditors pursue assurance that interna# contro#s are !orking. )his is not a risk management rather it 'ocuses on the cost$ e''iciency and e''ecti*eness o' processes inc#uding risk management. "rom risk management perspecti*e$ interna# audit 'ocuses speci'ica##y on !hether a risk is actua##y being a*oided$ reduced$ or trans'erred. (nterna# audit team e0amines operating acti*ities$ consistency o' procedures$ and comp#iance !ith directi*es. report !i## be generated 'or management that identi'ies !eaknesses and 'ai#ures to 'o##o! po#icies. Comp#iance & )he e''orts to ensure con'ormity !ith o''icia# re+uirements imposed by statutes$ pub#ic agencies or courts. E.g. mandates$ ru#es go*erning sa'ety$ en*ironment etc. 17. With respect to the story o' the Hote# Europa in 5t. 2etersburg$ !hat is the ERM #esson% ns!er 4 company had a pro3ect to e0port 'ro1en chicken 'rom 8irginia to 5t. 2etersburg Russia. ,ut 5t 2etersburg had no shore side re'rigeration to a##o! +uick un#oading o' the pa##ets. )he company !ou#d incur signi'icant demurrage charges i' the ship !aited 'or containers or rai#road cars so that pa##ets cou#d be #oaded on them. 6ne option !as to bui#d !arehouse but risk manager identi'ied an e0propriation risk as she spotted an action against Hote# Europa !hich !as part#y o!ned by European in*estors. Hote# opened a 'oreign bank account to hand#e do##ar transactions$ Russian banking #a!s prohibited such accounts and go*ernment #e*ied a hea*y 'ine on the hote# and 'ina##y getting con'iscated by the go*ernment. 6ther a#ternati*es !ou#d be to get e0propriation insurance$ buying a o#d ree'er *esse# 'or storage or 'ind strong Russian partner !ith high4#e*e# go*ernment connections an a##o! the partner to accept the e0propriation and storage e0posure. Company decide on the #ater option and 'ound such Russian partner. /esson #earned is in*estigate a## options 'or risk mitigation$ ;o not assume that the traditiona# insurance approach is the ans!er. 1:. (n the 'ro1en chicken case$ !hat is the risk management #esson #earned 'rom the mechanism to 'orce the Russian partner to pay each time 'or the product% ns!er & )o mitigate risk o' de'au#ting payment 'rom Russian partner$ ,oth parties agreed that the Russian partner !ou#d ha*e to pay 'or one cargo be'ore it cou#d recei*e a subse+uent cargo. )he stream o' pro'its 'rom a series o' cargos !as signi'icant#y #arger than the 'unds 'rom a de'au#t on payment 'or a sing#e cargo. /esson #earned is gi*e other parties incenti*es to he#p your organi1ations mitigate risk. 1.. (n the 'ro1en chicken case$ !hat is the risk management #esson #earned 'rom the mechanism to protect rai# shipments 'rom the't%

ns!er & "ro1en chicken !as shipped by rai#road 'rom 5t 2etersburg $ Mosco!$ Fekaterinburg and beyond. 6n the 'i'th 3ourney$ one o' the containers !as empty !hen it arri*ed in Mosco!. t this time Russia partner !as 'acing Risk management prob#em. )!o strategies !ere discussed$ 6ne is to purchase insurance but this !as immediate#y e#iminated as the premiums !ou#d be *ery high 'or cargo !ith high chance o' #oss. 5econd option !as to keep door4to4door containers on '#atbed rai#cars. 5o the doors cou#d be opened i' the #ocks !ere broken. ,ut a'ter 'e! more 3ourneys another container arri*ed empty$ someone had a crane on a siding !hen train stopped in the midd#e o' the night. )he prob#em !as 'ina##y so#*ed by p#acing bo0car !ith security guards !ith !eapons. Whene*er train stopped$ these guards stepped out to protect the containers. (t !as simp#e but e''ecti*e risk management strategy. /esson #earned 4 5tay !ith it unti# a risk management strategy !orks. 5ometime it takes a 'e! tries to get it right.

16. (n the 'ro1en chicken case$ is it rea#istic 'or the Russian partner to o''er insurance to third parties to protect rai# shipments 'rom the't% ns!er & )he story o' guards on the train is per'ect e0amp#e to i##ustrate upside o' risk. Russian partner cou#d o''er insurance ser*ices to third parties to protect their cargoes as !e## as the chicken. )he partner !ou#d incur sma## costs 'or the guards but cou#d be con'ident that the train !ou#d e0perience no #osses. Modern risk management does not end !ith the mitigation o' an e0posure. #!ays #ook 'or an upside.