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insights risk engineering conference ISSUE 2010 conference special Risk engineering that delivers resilience Also in this issue: • Global risk – a holistic view • Protecting your profitability if the supply chain breaks • Driving out marine risk • Statutory risk assessment – making it work Start » Here to help your world. insights 10 Introduction Welcome to the latest edition of insights. In this issue we have captured some of the key outcomes and learnings from our recent Zurich Risk Engineering Conference, held in Madrid, Spain. In this issue: 4 Global risk – a holistic view » 9 Zurich’s approach to Enterprise Risk Management » 13 Driving out marine risk » 18 Protecting your profitability if the supply chain breaks » ‘Risk engineering that delivers resilience’ was the overall theme of the June 2010 event. We define ‘resilience’ as having the ability to cope with the many challenges facing us. Recent market turbulence and instability has led to many businesses closing their operations. It has been a challenging time for all and with this has come industry changes and new strategies – potential downsizing, moving into emerging territories and implementation of new business models. During such times, only the most resilient organizations will survive. A resilient business has a sustainable strength that will survive and even thrive during periods of uncertainty. Achieving resilience is more than just managing risk and we want to demonstrate to you that risk identification, mitigation and relevant solutions can help you to find resilience and inner strength within your operations. I look forward to hearing your thoughts and hope you find these insights beneficial. 22 The silver tsunami – using ergonomics to address aging workforce concerns » 26 Protecting your customers...and your business » 30 Process safety – simplicity and complexity of performance monitoring » Robert Gremli Robert Gremli Global Chief Risk Engineering Officer Zurich General Insurance. 34 Statutory risk assessment – making it work » 38 Case study: Rentokil Initial – sustainable cost reductions through effective fleet risk management » 2 3 Previous Next insights 10 Global risk – a holistic view Questioning fiscal sustainability Public debt dynamics around the world Daniel Hofmann Daniel has been Zurich’s Group Chief Economist since 2001 after a long and productive career as a financial editor for the renowned Swiss daily newspaper, Neue Zürcher Zeitung (NZZ). Present Early 2009 Public debt in % of GDP Economic outlook, where are we coming from? The start of 2009 was a troubling time for all. The decline into a deep and long-lasting recession appeared to be a distinct possibility. Today, the world looks a lot brighter with growing signs of global health, a dramatic recovery in economic activity and an equally dramatic decline in financial stress levels. Let’s consider the risk of a double dip. We see this risk materialized recently in slightly increased financial stress levels since quarter one of 2010, and also in declining leading indicators. The signs that show we could be in a fragile situation include: • Banking systems continue to be dysfunctional – Excess reserves are still held by American and European banks at their home central banks. This tells us that rather than lending money to other banks or to customers, banks are instead choosing to hold their reserves at the central bank at a lower interest rate than they could normally earn. This is not typical behavior and is rather indicative of mistrust and risk aversion. It also reflects the poor health of the banking system. • Fiscal sustainability – Fiscal balance in a number of countries are depicted on the horizontal axis of the graph to the right, and overall debt-to-GDP ratios are depicted on the vertical axis. The bad news is that most Eurozone members, and also the USA, are in the upper right-hand circle – far away from sustainable fiscal health. We can also note that most emerging market economies are in much better fiscal shape than Europe, in the lower left hand rectangle. Fiscal deficit in % of GDP Advanced economies Emerging economies Source: International Monetary Fund, 2010 But the true fiscal situation is actually much worse. Fiscal deterioration caused by the financial crisis is actually minuscule. The financial crisis impact pales when we account for the future liabilities of our governments. The present value of uncovered future liabilities – mainly for social security and health care – is more than 650% of GDP in countries like Canada, Korea and Spain; and it is 410% of GDP for the average of our sample. “The bad news is that most Eurozone members, and also the USA, are in the upper circle – far away from sustainable fiscal health.” 4 » 5 Previous Home Next Global risk – a holistic view A wide spectrum of global risks The chart below depicts 36 risks in total. They are color-coded according to their expected riskiness, which in this case is defined as severity multiplied by likelihood of an event occurring over a time span of ten years. Economic Environmental Geopolitical Societal Technological Chinese hard landing Climate change Global governance gaps Chronic diseases Cil breakdown Fiscal crises Loss of fresh water Afghanistan instability Pandemics Cyber crime Asset price collapse Desertification Transnational crime and corruption Liability regimes Nanotechnology Food price volatility Biodiversity loss Israel-Palestine conflict Infectious diseases Oil price spikes Earthquakes Violence in Iraq Migration Major fall in US dollar Inland flooding Terrorism Retrenchment from globalization Cyclone Collapse of NPT Medium risk Burden of regulation Air pollution Iran conflict Low risk Underinvested in infrastructure It not only tells us which risks are connected. It also shows the strength of the connection or correlation and the importance of each risk or node. Risk interaction map High risk North Korea conflict The catalog of risks is really very large – we are looking at five broad risk categories, and each one of them comprises a number of sub-risks. Typically, country risk analysis is limited to economic variables. At times, The risk interaction map shown below is the result of an expert survey. The major point here is the complexity of the spider web, illustrating the interconnectivity of risk. insights 10 » Source: World Economic Forum Global Risk Report 2010 geopolitical risks are thrown in, but rarely does the analysis extend to environmental, societal or technological risks. This limitation bears a risk in itself. And the reason is that many risks are interconnected. Source: World Economic Forum Global Risk Report 2010 The more important nodes sit in the center of the graph; they are connected to many other, if not all, risks. And the larger a node, the more important it is for the system. understand quite well that rising oil prices can have many implications ranging from other economic risks such as recessions all the way to geopolitical risks. » For example, if we look at the oil price risk node, it sits very close to the centre of the spider web. We intuitively 6 7 Previous Home Next Global risk – a holistic view insights 10 » The Zurich Risk Room – a structured insight into the complexity of global risks By using The Zurich Risk Room, risks and their interactions can be visualized in an intuitive way. The Zurich Risk Room is a fact-based management tool, that can help facilitate strategic decision-making and risk mitigation in the face of difficult and constantly changing business conditions. Zurich’s approach to Enterprise Risk Management Companies today want and need to know: • Where are our sales and profitability at risk? • Where should we make our next investment and what problems do we have to reckon with? • What risks are out there that we may not be thinking about? • How can we evaluate our strategic direction in an everchanging risk landscape? By using The Zurich Risk Room, risks and their interactions can be visualized in an intuitive way. The Risk Room is helping boards and strategic advisors cut through the fog of country risk. To find out more visit www.zurich.com/insights Risk Managers, whether Risk Engineers or Chief Risk Officers, have a responsibility to manage many aspects of risk. This may involve practical solutions to property loss prevention, health and safety risks or other risks related to a broader range of business and strategic issues. In many large organizations there are broader risks that need to be managed across the enterprise such as business risks, strategic risks, operational or investment risks. Senior management in our organizations must ensure that these enterprise wide risks are well managed in order to protect the balance sheet and enable the business to grow in a sustainable and profitable way. This is the world of Enterprise Risk Management (ERM). The risks we face At Zurich, we identify, assess, manage and monitor not only strategic and business risks, but also other risk types. These risks may be related to the liabilities we take on to our balance sheet on behalf of our customers, for example property risks associated with the perils of earthquake, flood, windstorm, or liability risks such as product or general liability. In addition, across the enterprise there are other external economic factors that may affect our investment and risk portfolios such as interest rates, the performance of equity and bond markets, credit spreads and inflation. As well as this, we must deal with typical operational risks such as IT risks or business interruption risks related to events like pandemics. 8 » 9 Previous Home Next Zurich’s Enterprise Risk Management framework Strategic risk management Risk quantification Risk assessment and mitigation Risk transparency Risk governance and risk culture Key questions • Is the expected probability of an annual loss or reduction in the financial strength rating in line with the perception of the risk your company takes? • What level of earnings volatility can you afford? • What level of economic capital volatility are you ready to accept? • How frequently will you accept being forced to access capital markets? • For what type of risk-taking do you want to use the balance sheet? • What needs to be done to manage the company within an agreed risk tolerance? – Can you afford to take more risk? If yes, where should you do this? – Should you further de-risk? Where? 10 Strategy and risk tolerance To manage all the risks across the enterprise, Zurich deploys a comprehensive risk tolerance framework. This links risk taking with strategic and operational planning through a comprehensive risk limit system. The goal is to enable active risk taking within a consistent framework across the Zurich Group. Of course it is critical that this risk tolerance is linked to strategy and it helps to answer key strategic questions posed at board level. Questions such as, how much capital should we employ and where should we deploy it for the optimum balance of risk and reward? Within Zurich, we have made carefully considered risk tolerance statements at top management level regarding the acceptable level of risk of being downgraded below a certain credit rating, or the risk of experiencing a year with earnings failling below a certain threshold, i.e. risk tolerance statements about capital at risk and earnings at risk that underpin our financial stability and franchise value. Zurich’s Enterprise Risk Management framework A top level statement of risk tolerance alone would not be sufficient to deliver enterprise wide risk management. A framework is needed that incorporates the statements of risk tolerance and appetite with strategic risk discussions on risk aggregation, risk profiles, risk/return trade offs and risk optimization. This needs to be embedded across all levels of the Zurich Group in a way that supports a sound awareness of risk. Zurich’s strategic risk management approach is underpinned by two other key components of the ERM framework, namely risk quantification and qualitative risk assessment and mitigation. The former provides a stable and consistent infrastructure and methodology for measuring risk and assessing capital adequacy. The latter allows all segments, business divisions, business units and functions to identify, assess and mitigate risks as they occur. insights 10 » Capital and risk Finally the ‘foundation’ for the overall ERM framework is based on risk transparency and risk governance, which together help embed a culture of risk management. Risk transparency is essential to disclose information about risk profiles to internal and external stakeholders and ensuring compliance with regulatory requirements. Zurich’s risk governance and risk culture are driven by clearly defined responsibilities and accountability for risk management and risk taking. This is supported by clear documentation and the maintenance of policies and guidelines for risk management – the Zurich Risk Policy (ZRP) contains chapters on all aspects of risk that need to be managed by the business and Group functions. The ZRP is just one part of a comprehensive risk management architecture fostering this integrated view of risk. Risk quantification helps us to target capitalization at a specific level. In addition there are multiple risk identification processes that give a management view of operational risk and control. This ERM and control framework is well embedded in Zurich through a ‘Three Lines of Defence’ approach. Business management (risk takers) form the first line of defence by deploying the many risk management activities defined in the ZRP. Risk management as a function forms the second line of defence by ensuring adequate risk control and finally internal and external audit provide independent assurance as a third line of defence. In addition, at different levels of the organization, a number of formal groups of assurance providers and audit committees report on this process to the Board audit and risk committees. In this way, senior management not only understands enterprise wide risks but directs and manages these risks as well. In Zurich we have taken some tough business decisions since 2003 to change our risk profile, reflecting the fact that our core business is insurance and not asset management or financial products. More than 60% of our Risk-Based Capital (RBC) is allocated to insurance compared with 40% five years ago. We consciously reduced our market/ALM and credit risk from over 40% of RBC in 2003 to below 30% of RBC in 2009. Our investment portfolio is conservative and balances risk and return. Zurich’s customers have the assurance that they have a well managed insurance partner who has the financial strength and ability to pay claims when needed and to help manage the risks they face. There has also been significant de-risking and a shift in RBC by segment, with General Insurance (GI) RBC up from 45% in 2003 to 56% in 2009. Within GI we have consciously increased our net exposure to natural catastrophe risk, seeking and accepting this risk and the volatility it brings as long as it stays within our risk tolerance. In addition we have also increased our overall exposure to GI premium and reserving risk. This is based on our disciplined approach to underwriting i.e. well diversified limits and highly selective underwriting strategies limiting exposure to events such as the recent global financial crisis. » 11 Previous Home Next insights 10 » Benefits and lessons So what are the lessons for all of us? • Risk management without understanding the aggregation of risk is not of high value. It is very important to take into account interdependencies between risks and to understand remote possibilities. • You can not live without risk quantification tools, but if you rely on them alone, they can be dangerous – models have their limits. • Discussions on risk tolerance belong on the strategy agenda and need to take place regularly. ERM is a strategic function and helps to determine at a strategic level the trade offs between risk and reward. • We need to re-think the way we deal with extreme events. The world does not follow a normal distribution with regards to risk and `black swans’2 can appear at any time. • Embedding a true risk culture is essential. Top-down risk assessment and risk management capability must be applied across the organization. The benefits apply in different ways to different stakeholders. For Zurich’s shareholders, their view of shareholder value i.e. future earnings and the sustainability of these earnings is impacted by the perception of risk and its management. For regulators, it’s the understanding of the impact that Zurich’s risk management is having on the level of capital (regulatory capital) required to manage the business. For rating agencies, who are now looking at ERM effectiveness, it is the impact of risk management on the cost of funding capital, expressed as an overall rating for the entity. Last of all but certainly not least of all, for our customers it is the assurance that they have a well managed insurance partner who has the financial strength and ability to pay claims when needed and to help manage the risks our customers face. This is the key differentiator that Zurich’s ERM delivers and it is the foundation of long-term, sustainable business success for both us and our customers. Driving out marine risk In today’s world, ensuring your product safely reaches your end customer can pose numerous challenges. With ever more complex logistics chains and increasingly demanding customers, pressures are now leading to higher levels of cargo theft and damage. » Summary • Risk management of the future means making and keeping our companies agile, flexible and adaptive to change. • The dimensions of risk have become more complex and that complexity is a risk in itself. • Enterprise risk must be managed to maximise resilience, the risk/return profile and strategic growth. • Our own ERM function has become a strategic driver that underpins profitable growth, resilience and customer value. John Scott Chief Risk Officer, Zurich Global Corporate 2 The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb. 12 13 Previous Home Next Driving out marine risk Managing change – such as shifting global markets, entering new markets, moving manufacturing location, greater sophistication in products, high value electronic goods and more demanding quality requirements – are giving rise to a whole series of new trends within marine. Shifting global markets and entering new markets Opportunities created by entering emerging markets can be great – but how aware are you of the potential marine risks your business could face? Shifting manufacturing locations and new transportation routes could open up higher risk to your operations. Increasing cargo theft and damage In the past, most marine insurance claims were due to physical damage resulting from rough handling or faulty transportation equipment. Today we are seeing claims arising often of a larger scale and more costly, having both a direct and indirect impact on business operations. Top tips • It is crucial to collect as much information as possible in advance of entering a new market. Marine claims trends • Always work closely with your insurer to undertake a full risk assessment. • A movement from low value pilferage claims to an increase in full container loads hi-jacking and theft. • Work out tailor-made solutions, and learn from the mistakes other companies may have made. • A growth in the trade of sensitive computerized equipment and more sophisticated commodities, reducing the opportunity of salvage/repair. • Find out which transportation companies are security minded and those which have a poor incident record before you sign any contracts. • Increases in theft by deception. Criminal gangs are becoming more sophisticated in their efforts to steal cargo, with a rising number of scams on web-based freight exchanges, online cargo tracking facilities and embezzlement claims. • Armed with knowledge of the local loss development patterns, a loss prevention team can engineer economically viable solutions, including propose alternative transportation providers; recommend the implementation of dedicated routing; utilize pre-planned and secure rest stops. • An increase in claims in some geographical regions, due to delocalization of production and economic growth in countries with poor infrastructures. • An increase in natural hazard claims, especially hail – a major risk in the automotive sector. • An increase in large scale claims for damage to temperature controlled goods. The reasons for this are varied and include the use of out-dated marine fleets and missing controls and standards (i.e non-compliance with Cool Chain Quality Indicators (CCQI). ‘‘ insights 10 » Third party logistics providers Transportation is often entirely delegated to third parties and it can sometimes be difficult to control this segment of the supply chain. In a recent case, a manufacturer of fibre-optic cables was reporting frequent and, in some cases, heavy losses when transporting their products on drums weighing from eight to 25 tonnes. Upon review of the nature and history of the claims it was noted that the causes of these damages were almost entirely attributable to improper handling and securing by ship and onshore personnel, coupled with poor or inadequate design of supports and saddles. A large part of the problem was that for these shipments, general cargo vessels were used where the crew was not always familiar with the difficulties of transporting and lashing heavy cargoes on deck. A loss control strategy could have been prepared, the objective of which is to mitigate the risk of damages along the supply chain. This can be achieved by loss prevention manuals/guidelines for handling, storage and transportation, cascading best practices along the supply chain to influence behavior of third party logistics providers, working on packaging design and diagrams for lashing and securing of deck cargoes. I cannot stress enough the importance of ensuring that third parties entrusted with the cargo maintain the expected standards of care during transportation and are made accountable for how they do it. I very often hear repeatedly from shippers that they are reluctant in questioning transport companies or freight forwarders as supposedly ‘they know what they do’, until the damage happens. I would also recommend trying to understand the safety culture of the partners you entrust your goods with. ” Luca Bussani – Senior Marine Risk Engineer, Zurich Risk Engineering. 14 » 15 Previous Home Next Driving out marine risk Cargo security Cargo theft in the logistics chain has become one of the most prevalent and costly forms of loss for shippers of retail products and raw materials today. The highly organized criminal element in virtually all markets means that now no product in transit is safe. Criminals are able to prey on all but the most watchful companies and transportation providers. The theft of entire truckloads of merchandise has replaced pilferage. The claims usually occur in the inland transit phase of transportation during rest stops, on off-hours (evenings, weekends and holidays) and are often perpetrated on shipments where the inland transportation has been sub-contracted to a ‘less interested’ carrier. Interaction between claims and risk engineering is essential. Previous claims data can show potential types of damages, helping risk engineering to better assist in packaging design, handling guidelines and package markings to help minimize the possibility of damage. Risk engineering can also assist in producing guidelines and standard of care for carriers and freight forwarders in order to help drive third parties toward best practices. Claims data can provide valuable information to help with the review, and in some cases revision, of freight contracts with logistics providers in order to help develop a higher standard of care for your goods in transit and enhance recoveries when those standards are not met. insights 10 » Through our claims experiences, we’ve seen that a watchful customer, who proactively manages all legs of the transportation chain with their logistics provider and/or ocean carriers responsible for intermodal transit, suffers the fewest losses and has the greatest percentage of recovery after theft. By being vigilant, these organizations and their transportation partners, in conjunction with Risk Engineers, can define the safest routes and service providers, minimizing the possibility of loss. By maintaining a close reign on the movement of their goods, such customers also increase their chance of recovery after theft because they become aware of the theft quickly after it occurs and have reactive plans that can be implemented immediately to track down any shipment that is stolen. The most sophisticated technologies may prove ineffective if any attempted theft is not adequately flagged and a response deployed in a timely way. There are many approaches to help minimize the possibility of theft in transit including transportation provider screening, GPS positioning / tracking equipment, dedicated transportation routes and armed security escorts just to name a few. “Something I’ve often encountered in my experience when meeting shippers and transport companies is that even expensive security solutions are purchased without a clear view of how the various elements of the security chain integrate with each other; the most sophisticated technologies may prove ineffective if any attempted theft is not adequately flagged and a response deployed in a timely way.” Oliver Lopez, Senior Marine Risk Engineer, Zurich Risk Engineering. Criminality becoming more sophisticated We have seen quite a number of cases where criminals displayed a remarkable level of skills in exploiting the opportunities offered by online freight exchange websites and ability in gaining a high level of knowledge of the operating procedures of the company they were targeting. The ease of access and user-friendliness of the cargo tracking services offered by large forwarders and transport providers represent a potential security threat to shippers of valuable or attractive goods. All too often these well-intentioned services display this information automatically, without reference to the shipper, and while password protected, it takes a relatively low level of hacking skill to by-pass this. We strongly recommend shippers of target goods to review the protection given to their freight shipment information. New developments in risk engineering There is a rising awareness of the potential disruption and long term commercial impact that missed deliveries of critical shipments can generate. The logistics chain has become more complex and granular in terms of numbers of interfaces, partners, quantity and quality of information, while at the same time the interfaces between risk transfer (mostly but not only to insurance) and loss control has become even more a quality insight. The multi-dimensionality of the supply chains will continue. It is therefore necessary for the logistics providers as well as the customer to review their risk exposure situation in order to avoid claims instead of getting them paid. We realize that the level of risk engineering support must keep up with these developments, which means not only helping mitigate losses and reducing potential disruptions to operations, but also providing the correct risk analysis methods in order to provide customers with a clear picture of the nature of the risks their organizations can be exposed to and the level of controls required to manage them. This workshop was presented by: Howard Kingston, Chief Underwriting Officer – Marine, Zurich Global Corporate. Luca Bussani, Senior Marine Risk Engineer, Zurich Risk Engineering. Juergen Deters, Head of Marine, Zurich Global Corporate Germany. Steve Gillen, Global Head of Marine Claims, Zurich. Oliver Lopez, Senior Marine Risk Engineer, Zurich Risk Engineering. Alexander Barwinna, Managing Director, Aschaffenburger Versicherungsmakler GmbH (Inhouse broker of Logwin). 16 17 Previous Home Next insights 10 “A number of supply chain teams have started to analyze the risks they face, but few have moved into ‘proactive’ risk management on more than a selective risk basis.” Nick Wildgoose, Global Supply Chain Proposition Manager, Zurich. Protecting your profitability if the supply chain breaks Recent volcanic activity in Iceland has acted as a timely reminder of the fragility of our global supply chains. The relatively minor six-day disruption directly impacted one form of logistics, in one area of the world. Yet it still led to a significant number of supply chain issues within many international organizations. Could your company be modelling itself on the Titanic? In other words, do you fully understand your exposure to supply chain risks? Have you seen the tip of the supply chain iceberg that threatens your organization’s profitability? Are you forcing cost cuts on your suppliers, reducing buffer stocks and lengthening payment terms without looking at the impact these might have on your overall risk profile? If you are pursuing these actions, you could be heading for an inevitable supply chain iceberg, which could damage your reputation and sink your profits and potentially share price as well. Interestingly, it is believed one of the reasons the Titanic sank so fast could have been due to cost cutting and availability actions of the sourcing team. Using lower quality rivets to hold the boat together resulted in disaster. Risk teams have a significant opportunity to work with their supply chain experts to improve the performance of their business operations in the area of supply chain risk. A number of supply chain teams have started to analyze the risks that they face, but few have moved into ‘proactive’ risk management on more than a selective risk basis. We still see many depending on ‘reactive’ approaches and only a few use supply chain risk management as a cross-functional/value-added activity to gain competitive advantage. Risk teams have great opportunity to add value in this increasingly important risk area. If the opportunity is not grasped, you are potentially in danger of becoming less and less relevant to your organization’s risk management requirements. Supply chain teams are also likely to be very open to different insights that you will be able to provide them. The impact of a disruption Over the past year, Zurich has been working with the Manchester Business School and Dow Jones, analyzing over 2,000 supply chain disruptions which have occurred over the last 10 years. The work has generated some very interesting findings. We discovered, for example, that nearly 20% of supply chain disruptions had an impact that went beyond nine months. » 18 19 Previous Home Next insights 10 » The impact of a supply chain disruption Rather than try to predict the next incident or unforeseen event that could disrupt operations, you can examine whether your suppliers at various levels are at risk from a number of broader perils: Number of disruptions 600 500 400 • Supplier’s property – could an incident such as a flood or earthquake damage the supplier’s premises? 300 200 • Supplier’s financial strength – is the supplier likely to go insolvent? 100 ng oi ng Yr s O – Yr s 2 >5 Yr s 5 Yr s 2 1 – Yr – 1 s th 9 M – s th 6 M Yr s th 9 M M th s 6 – s 3 M th th 1 M W k – – 3 1 M M th th k W