Rethinking Risk In An Interconnected World

Rethinking Risk In An Interconnected World In days past, risk managers were mostly responsible for procuring coverage. Their knowledge base confined to a specific skill set. No more. Globalization, with all its accompanying opportunities and headaches, is here to stay. Organizations are more interconnected than ever, both internally and in collaboration with their suppliers, partners and customers.

A dramatic risk reassessment is under way, one that is likely to have a profound impact on businesses, their customer relationships and the livelihood of risk practitioners.

Protecting the organizations physical and financial integrity demands a thorough understanding and effective synchronization of all its moving parts. It requires a proactive strategy that is holistically driven and focused not on putting out fires but on building a fireproof structure. And it will thrust risk management professionals into what for many will be unfamiliar roles.

Welcome to the world of “enterprisewide risk management.”

The questions can come from all directions: How are the goods being shipped? How is inventory managed either in normal times or in the event of a natural or man-made disaster? How are the goods financed? Can acceptable advance rates be obtained if inventory is resting outside the United States? How are receivables insured?

And there are more issues, such as are you protected if your customer, or your customers customer, files for bankruptcy protection or ceases operations? Will credit risk protection come through a letter of credit, credit insurance, or another hedging or reserving strategy? Is coverage for goods in transit sufficient to protect against the consequences of events such as a terrorist attack or a prolonged labor dispute?

Many risk managers settle for basic cargo coverage with large deductibles and numerous exclusions, only to find, as during last falls West Coast port dispute, their policies didnt cover losses related to strike-related shipment delays.

As this list illustrates, risk managers can no longer be content with their encyclopedic knowledge of how things used to work. And they may not be able to rely on their credit managers or CFOs, since neither may have extensive insurance expertise.

Here are some figures to contemplate. Globally, supply chain management is a $3 trillion industry. Exports today account for one-quarter of world gross domestic product. Ocean freight volumes have doubled in less than 30 years. Until Sept. 11, 2001, global air cargo revenues had doubled just from 1996 levels. The Internet now has more than 300 million regular users worldwide. And $10 billion of foreign exchange transactions occur every second.

This breathtaking pace of throughput underscores the relentless growth of global trade. As commerce grows, so do the opportunities. So, too, do the risks.

To add value in todays global economy, risk professionals must be cognizant of the synchronized interaction between the movement of goods, the exchange of informationwhether electronic or on paperabout the goods, and the exchange of funds to pay for the goods.

Understanding how trading partners are interconnected and managing the processes that enable the safe and swift flow of product, data and capital will be critical to success.

It is now acknowledged that proper risk management cannot be achieved without a cohesive supply chain management program in place.

In fact, risk professionals tell us their biggest regret is not having programs in place sooner to mitigate the damage that terrorism, recession and warsreal or threatenedhave wreaked to their balance sheets during the past three years.

But acknowledgment is only half the battle. The other half is execution. Therein lies the core dilemma. Corporate risk professionals find it difficult to take their programs to the next level because of the limitations imposed on them by their traditional insurance partners.

Why is this the case? Because insurers dont move goods for a living.

A well-conceived and executed physical distribution strategy spawns tangible financial benefits. It reduces inventory costs, optimizes capital utilization, and identifies and reduces physical and financial risk.

Simply put, there is a powerful link between the visibility of product, the velocity of money and the reduction of risk. A streamlined supply chain means expedited cash flow and a less-bumpy ride for your risk relationships.

This is where traditional insurers fall short, however. They lack the infrastructure and the knowledge to ship, manage and track product movements across the globe. They have no visibility of the products whereabouts and would still have a difficult time retrieving the goods even if they had the knowledge.

Fortunately, new providers are coming to market with fresh ideas on how to leverage supply chain tools to reduce risk. They see beyond the balance sheet and probe into a companys business processes. This has led to innovations that not only help mitigate risk but have also become enablers of an efficient enterprise.

A U.S. manufacturer of apparel accessories needed to expand its borrowing base so it could supply products to clients who sourced material overseas. However, it could not find a traditional financial partner that would lend against the value of its overseas inventory and receivables. The reason: No lender had the capabilities to ship and track the collateral once it moved beyond the United States.

Its new, nontraditional lender had a solution: Shift inventory from the manufacturers warehouse to the facility of the lenders sister company skilled in managing the physical flow of goods outside the United States.

With that company controlling the physical and information flow, much of the original lending risk was effectively mitigated. As a result, the manufacturer was able to secure a revolving credit line from the “nontraditional” lenderbacked by its foreign receivables. It also obtained a term loan backed by the value of its machinery, equipment and real estate, as well as credit insurance to safeguard its receivables against loss.

By leveraging this end-to-end strategy, the manufacturer attracted the additional working capital needed to grow its global footprint. It drove down operating costs by collapsing its warehousing network and outsourcing to a third-party specialist. And it reduced its exposure to the risks associated with holding inventory in a foreign country.

The manufacturer benefited from a “holistically thinking” partner with the knowledge and capabilities to analyze operating processes, identify areas of improvement and build cost-effective solutions that strengthened the entire business.

This is the niche that new era providers will carve. They will not be pure-play insurersthe field is already saturated with highly skilled companies. Their role will be to build and execute supply chain strategies to strengthen a customers risk profile. If they succeed, their clients will gain organizational scalability, strengthen their capital structure, and reduce, if not eliminate, much of the risk associated with expanding beyond their traditional borders.

Mike Plourde is president, UPS Capital Trade Protection Services, UPS Capital Insurance Agency Inc., in Atlanta, Ga.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, May 26, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.