Risky Business: Risk Assessment and Planning for GCs
GC California Magazine
Douglas Barlow, a Canadian executive at equipment manufacturer Massey Ferguson, once said, "All management is risk management." Mr. Barlow made his remark in 1962 and it could never be more true than it is today.
Risk assessment and risk management should be omnipresent concerns for all general counsel. Everyone assumes that their businesses are insured and that, in the event of a calamity, insurance will be available to respond. This may be — and probably is — true, but there can be serious limitations on the availability of coverage for certain events. Knowing the scope of available coverage in the event of a catastrophic event is critical to risk assessment and planning.
But effective risk management involves more than simply maintaining an adequate insurance program. The best risk managers — and every general counsel should get involved in the risk manager role to the extent possible within the company — constantly keep their eyes open to changing circumstances that may present new or increased risks — and prepare accordingly. The insurance industry itself, whose business depends on accurate risk forecasting, often provides important cues to business leaders in this regard. Or they could be red flags, in the case of the industry's recent actions with respect to global warming.
A great deal of attention has lately been paid to the issue of global warming. From former Vice President Al Gore's movie "An Inconvenient Truth" to Tom Brokaw's recent television special, the topic has been featured prominently in the media and popular culture. While the issue is somewhat politicized, no one seems to disagree that global warming, as an environmental phenomenon, is occurring. And the insurance industry is recalibrating its risk assessments accordingly.
Lloyd's of London in June published a very sobering report, "360 Risk Project — Series 1, Catastrophe Trends," which discusses the impact of climate changes on risk assessment. Its observations and conclusions include:
"Climate change means exposures are changing and new ones emerging. Insurers must regularly review and communicate conditions of coverage."
"Failure to take climate change into account will put companies at risk from future legal actions from their own shareholders, their investors and clients."
"Climate change must inform underwriting strategy — from the pricing of risk to the wording of policies."
"Effective partnership with business and government will be key to managing risk."
To put the Lloyd's report in context, let's consider, for example, the possibility of a serious flood or earthquake. All businesses in California are aware that they operate under constant threat of earthquakes. We accept this risk because of the tremendous benefits of living and working here. At the same time, we typically think of flooding as being related to hurricanes in Florida and elsewhere around the Gulf Coast. However, numerous cities in Pennsylvania and other mid-Atlantic and New England states have suffered severe flooding in recent months. In January 2005, horrible rainstorms in Southern California created havoc for businesses and resulted in a tragic landslide at La Conchita, not far from Santa Barbara. This past winter and spring was one of the rainiest seasons in memory in Northern California.
Many business centers in California rely on California's levee system to protect the land on which their office buildings, factories and warehouses are constructed. Sacramento and other Central Valley cities are built behind levees. As global warming becomes a more prominent issue, all California businesses located near water — and obviously this includes major financial centers up and down the coast as well as along the state's major rivers — need to think about the prospect of flooding and the impact of floods on their businesses.
Another risk factor that perhaps is not considered as frequently as a direct loss to our own businesses is our interdependence on other businesses. A manufacturing business may be located far away from a flood zone but may be exposed if the supplier of one of its key components is located next to a levee in Stockton. A provider of computer consulting services in a less-earthquake-prone area of the state may be exposed if its biggest customer sits in an office tower atop the San Andreas or Hayward faults.
Knowing that we live under these threats, it is only prudent, when conducting business, to think about "the day after." A company needs to know what risks have been transferred to an insurer, what risks have been contractually transferred to a third party and what risks are maintained by the company. Some questions worth pondering:
Does your company maintain earthquake or flood insurance? This coverage is usually not afforded under a typical commercial property policy and must be obtained through a product known as "difference in conditions" insurance. Difference in conditions insurance would generally provide coverage for property damage caused by a flood or earthquake and also business interruption and extra expense from such catastrophes, subject, of course, to the terms of the policy.
If your company does not have this insurance, was it a conscious decision or an oversight? Can your business afford to purchase it? Can your business afford not to purchase it?
If your company does maintain this type of insurance, what are the trigger provisions and the deductible? The business interruption and extra expense provisions in many of these types of policies provide for a waiting period of 24, 48 or 72 hours before the coverage kicks in. This means that your business would have 1 to 3 days of uninsured loss of business income. Likewise, there may be a substantial deductible. Are the trigger provisions and the deductible appropriate for your company?
Are there different deductibles, limits or sublimits that apply to the coverage for damage to property as opposed to business income or extra expense coverage?
Does your company maintain contingent business interruption insurance? This type of insurance affords coverage (again, subject to its terms, triggers and deductibles) for your company's loss of income when, for example, a customer or supplier is the victim of a catastrophic loss.
Is the company named as an additional insured on a third-party policy that would provide coverage for these risks? Should the company require this in future business agreements?
Is your company transferring uninsured risks via indemnity clauses? Should it be doing so? Should the language of those clauses be reworked in light of increased potential liabilities? If such indemnity clauses are in place, are the companies that have agreed to provide the indemnity in a financial position where they will be able to deliver following a flood, earthquake or other calamity? If not, or if there is some question about this, what contingency plan does your company have in place to handle the financial loss?
It might make sense to run a number of pro formas to determine how much your company might recover in business income or extra expense coverage under its insurance policy in the event of a calamity such as an earthquake or a flood. Various scenarios should be contemplated — the time the company is unable to operate, the impact of deductibles, the impact of waiting periods, the nature of the suspension of the operations necessary in order for coverage to be triggered in the first place — to name a few.
Risk management analysis inevitably focuses on the negative: the catastrophic losses, the future perils. But, as they say, with change comes opportunity. Even the Lloyd's of London report is able to point to a bit of blue sky: "Society will adapt to change and new technologies will be developed. The economy will require insurance for these innovations."
California businesses, long vanguards of innovation, will undoubtedly be calling on their general counsel for advice in crafting proactive, constructive responses to change as well as for advising as to its potential liabilities.
This article is reprinted with permission from GC California. © 2006 ALM Properties Inc. Further duplication without permission is prohibited. All rights reserved.