Fundamentals of Risk Management for CFOs--Unlocking Hidden Value

Background—Furniture Industry

• Furniture Manufacturers are facing grueling, unrelenting economic pressure to survive. In the process, the industry continues to contract resulting in the loss of thousands of jobs

• To survive, furniture manufacturing companies are actively trying to discover new efficiencies in their business processes

• Aggressively managing Total Cost of Risk can potentially provide currently unrecognized operational and economic benefits to participating companies

Background—Insurance Marketplace

• The insurance market continues to act in a somewhat irrational manner. Eventually there will be a shift towards a harder market– Higher premiums– Higher deductibles

• Insurance carriers impacted by:– Poor underwriting performance in 2008– Lack of investment income to offset underwriting results– Lack of available capital from outside investors to bolster balance sheets

Risk Management Techniques

• Risk Identification– Examples of types of risk: first party, third party, property,

management liability, financial, human resources• Risk Analysis

– Frequency of risk, severity of risk, impact on business continuity

• Risk Treatment– Avoid it (discontinue the practice)– Control it (engineering, administrative, operating practices)– Transfer it (contractual risk transfer, financial risk transfer)

Total Cost of Risk

InternalCosts

Risk Transfer Costs(Insurance Premiums,

Agent/Broker Commissions)

Losses(Direct costs, Indirect costs—whether

retained or transferred)

Total Cost of Risk

• Direct losses– Losses of any type (workers compensation, third party liability, property, etc…)

that are borne by the company or transferred to an insurance carrier• Indirect losses

– “soft losses” that are due to loss of productivity, overtime, delay in delivery, loss of customers, etc…

• Financial Risk Transfer Costs– Insurance premiums paid to insurance carriers to transfer risk

• Broker/Agent Fees and Commissions– Sales commissions or fees paid to brokers/agents for the placement of insurance

and delivery of risk management services• Internal Administration Costs

– Internal expenses associated with safety/claims/risk functions

Today’s Focus—Basic Operational Property/Casualty Risks

• Employee Injury/Workers Compensation

• Third Party Injury or Property Damage/General Liability

• Third Party Injury or Property Damage/Auto Liability

Risk Identification

• Risk Identification– What types of accidents/incidents are we experiencing or

have we historically experienced?– What types of accidents have occurred most frequently?– What types of accidents have created the greatest expense?– Can I pinpoint these losses to specific operations or types of

jobs?Key reference points:1. Internal Accident/Incident Investigations2. OSHA Injury Reporting Logs3. Insurance Carrier Loss Runs (all lines)4. Insurance Carrier Safety/Loss Inspection Reports (all lines)

Risk Analysis

• Risk Analysis (Financial)—Basic Questions

– What is my workers compensation “loss rate” per $100 of payroll?– What is my workers compensation experience modification rate? Is it

correct?– What is my company’s loss ratio (losses compared to premium?)– What is the cost of a day away from work or a “light duty” day?– How does my risk management program’s performance compare to my

peers?– What is the financial impact of losses on our business’ financial

performance? How much do we have to sell to offset our annual Total Cost of Risk?

Risk Analysis

• Risk Analysis (Financial) – Some Basic Examples

Calculation = # of claims (or lost workdays) X 200,000 divided by actual hours worked for the period

This measurement allows you to compare to your peer group in these categories

General Classification

BLS Total Case Frequency per 100 Employees

BLS Lost Workday Frequency per 100 Employees

Case Goods 7.1 3.6

Upholstery 7.2 4.0

Risk Analysis

• Risk Analysis (Financial)—Basic Examples Workers Compensation Carrier Book of Business Statistics

Top 5 Loss Areas # Cases % Total Incurred Average % TotalMATERIALS HANDLING-. .. 887 25.34% $4,609,879 $5,197 28.28%SLIPS AND FALLS-SAM... 361 10.31% $2,665,610 $7,384 16.35%REPEATED TRAUMA-UPP .. . 290 8.28% $2,164,979 $7,465 13.28%STRUCK BY/AGAINST 818 23.36% $1,738,407 $2,125 10.66%HAND TOOL-MANUAL AN . .. 401 11.45% $1,339,745 $3,341 8.22%

Statistics from a national workers compensation carrier based on 3,501 claims over a three year period

This measurement allows you to compare the types and average costs of claims to your peer group. It also may help you focus prevention efforts

Risk Analysis

• Risk Analysis (Financial)—Basic ExamplesProfitability Analysis based on Annual Sales of $24MM

At 5% Profit Margin1. Total Incurred Workers Compensation Expense = $100,0002. Total Incurred Expense x Loss Development Factor = $200,0003. Indirect Cost of Accidents = 2X TI Cost of Accidents = $200,0004. Total Accident Costs = $400,000 (Developed Costs + Indirect Costs)5. Annual Sales = $24MM6. Total Sales Required @ 5% margin to Offset Lost Profit Due to Accident Costs =

$8MM7. Months of Production Required to Offset Accident Costs = 4months

This measurement allows you determine the “breakeven” period for your annual loss costs and how the affect profitability

Risk Analysis

• Risk Analysis (Operational)– How does Risk Management “happen” around here? Is it intentional or

passive? Are our results a matter of discipline or luck?

• Examples of some key questions to ask:– How are risk and safety issues managed on a daily or routine basis?– Are roles clearly defined for each area/level of management?– Are those responsible trained and able to perform their roles?– How is performance measured?– How is performance rewarded?

Contractual Risk Transfer

• Concept– Allows companies to contractually transfer certain types of risks to third

parties

• Key Issues– Companies may unknowingly or passively accept risk through

contractual indemnification/hold harmless provisions with subcontractors, dealers, vendors, or suppliers

– Companies may miss opportunities to contractually transfer risk to subcontractors, dealers, vendors, or suppliers through appropriate indemnification provisions

Contractual Risk Transfer

• Analysis– Develop list of subcontractors, vendors, suppliers, and dealers– Review copies of subcontractor, vendor, supplier, and dealer

agreements for appropriate indemnity/hold harmless provisions

• Potential Corrective Actions– Contractually establish third party insurance requirements to ensure

each third party’s ability to respond to indemnity and hold harmless agreements

– Establish a Certificate of Insurance program to ensure each third party has appropriate insurance policies and limits in place

Financial Risk Transfer

• Concept – Allows companies to transfer certain financial risks to third

parties designed to bear risk (insurance carriers)– A general rule of risk transfer is to retain frequency and

insure against severity

• Key Issues– Companies may be over or under insured depending on

their ability and appetite to retain risk– Companies may not have the benefit of performance based

insurance programs– Companies may be exposed to unidentified coverage gaps

Risk Retention/Risk Transfer Decision Grid

IDENTIFYBOUNDARY

SHOULDTRANSFER

CANTRANSFER

MUST RETAIN

Markets won’tInsure or

will charge excessivepremium

Earnings & Equity Capitalare sensitive to losses in

this range

Earnings & working capital

can sustainlosses in this

range

Equity holdersmay be willingto chance a loss in this

range

Insurable RiskTolerance Level

Insurable RiskConf idence Level

Risk Retention Strategy Risk Transfer Strategy

About Praxiom

• Praxiom is a professional outsourced risk management firm that provides:

– Risk assessment– Risk control– Claims management– Review of contractual risk transfer– Assistance in the design and placement of financial risk transfer

• Praxiom’s risk managers have a deep understanding of the furniture manufacturing industry having served as internal risk managers for some of the industry’s leading companies

About Praxiom

• Praxiom is well known to AHFA and several of its member companies through the collaborative development of AHFA’s ISP program

• Praxiom is proud to be an AHFA Supplier Member

Managing the Total Cost of RiskThe Praxiom Service ModelStep One:

• Risk Management Baseline

– Risk Assessment Report• Site visit(s)• Management and Employee Interviews• Review of Processes /Procedures/Documentation• Analysis of Prior Losses to Determine Loss Trends

– Risk Map of Current Risk Transfer Program Structure and Coverages• Policy review by line of coverage

Managing the Total Cost of RiskThe Praxiom Service ModelStep One Deliverables (from Praxiom)

• Written Risk Assessment Report– Performance Metrics (including certain financial metrics)– Identification/Quantification of loss frequency/severity drivers– Identification of management opportunities

• Summary of Key Findings (Issues, Implications, Interventions Format)

Managing the Total Cost of RiskThe Praxiom Service Model• Ongoing Risk Identification

• Ongoing Claims Management

• Ongoing Contractual Risk Transfer – Non-Insurance Risk Transfer to and from Third Parties

• Ongoing Financial Risk Transfer– Assistance in the design and placement of insurance programs

Participating AHFA Member Benefits

• Clear identification/reduction/mitigation of actual and potential risk exposures through the use of professional outsourced risk managers to assist in management Total Cost of Risk

– Professional baseline assessment– Comparison to norms and best practices– Agreed upon risk management action plan with 360 degree

performance accountability– Quantitative performance measures/results

• Ability to customize service platform based on individual company need

Participating Member Benefits

• Ability to make quantitative, informed decisions regarding risk retention and risk transfer

• Structured fee compensation– Complete neutrality during financial transactions– Fees based on each company’s individual platform utilization

• Potential to improve operating efficiencies and profit margins through improving Total Cost of Risk (TCOR)

Interested in a Complimentary Baseline Risk Assessment?• Basic Qualifications:

– Must be an AHFA Member in good standing– Must be serious about committing to improve your

Company’s Total Cost of Risk– Must be willing to consider new/different risk management

strategies and tactics

• Contact Bill Perdue at AHFA to arrange an individual conference with Praxiom’s Team