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Funding difficult risks.

You must take the position that there is an uninsured loss somewhere in your company, said Roy T. Johnson, senior vice president of Johnson & Higgins of Pennsylvania Inc. "This creates the mindset to seek out a potential surprise."

According to Mr. Johnson, uninsured exposures develop through societal change. "Global changes are bound to cause added exposures to risks in the 1990s," he said. These risks, he said, stem from pollution, substance abuse, AIDS, political restructuring, financial stability of the insurance industry and tort reform.

Carl B. Seaholm, corporate risk manager for J.C. Penney Co. Inc., differentiates between intentional and unintentional uninsurable risks. Companies often assume intentionally uninsurable risks because the frequency and/or severity of their losses are usually within their ability to absorb. In other cases, the cost of losses can be charged to the facilities that incurred them or reporting losses would necessitate exposing confidential information. With the exception of catastrophic losses, he explained, "swapping dollars" with an insurance company will ultimately result in more cost than self-insuring. According to Mr. Seaholm, to plan for these intentionally uninsurable losses, the risk manager must conduct a policy review to ascertain what is and what is not covered, keep current with policy language, new markets and underwriting philosophies, address identified exposures as to whether the risk is acceptable and develop a self-insurance plan.

Unintentionally uninsured risks stem from pollution, nuclear accidents, errors and omissions, risk manager ignorance, unclear or inconsistent policy language, missing layers in coverage, deficient loss prevention and insurance company insolvency, according to Mr. Seaholm. To plan for these losses, he said, risk managers must develop a loss response manual that includes loss reporting procedures, alternate sites for conducting the impinged activity, personnel responsibilities, guidelines for reducing operations to salvage some production and instructions for reviewing contracts.

Once losses have been minimized, the risk manager must devise a recovery plan, said Mr. Seaholm. Ask yourself, he suggested, if the loss can be absorbed out of current earnings or if a special loss fund, loan agreement or line of credit is needed. Should assets or subsidiaries be sold? Should post-loss insurance be purchased? Should the company consider structured settlements? In addition, he said, recommend to management changes in or cessation of "troublesome" operations based on pre-loss planning observations and/or post-loss experience. "This is not a popular position to take with senior management," he said, "but if your recommendations are constructive, it can help the bottom line."

Uninsurable losses often arise from managing an overseas property/casualty insurance program, according to Edward M. Fitzgerald, foreign manager for the corporate insurance operation for General Electric Co. "You shouldn't approach the handling of international property and casualty insurance coverages with a U.S. risk analysis cookbook mentality," he said. "There are definite differences, which reflect the multiplicity of economic, cultural and legal systems found around the world." Special coverages include political risk insurance; kidnap and ransom; "gap" policies; war, revolution and insurrection; expropriation; and inconvertibility of currency.

Mr. Fitzgerald warned of locally placed property insurance that covers imported goods such as machinery, equipment or inventory from hard currency countries. "Unless frequent currency exchange monitoring is undertaken, major currency exchange movements could cause a serious uninsured loss because there is a tendency toward 100 percent co-insurance clauses overseas," he said. The solution, he said, is purchasing a U.S. dollar policy locally.

Regarding local goods such as buildings and other contents, he said, keep track of local inflation, particularly if situated in countries such as Brazil and Argentina. Consequently, he added, explore the availability of "inflation guard-type property endorsements" that automatically tie the insurable value of local goods to changes in inflation. While it is important to understand international property/casualty insurance coverages, Mr. Fitzgerald said it is equally important to "have convenient access to a U.S. broker with a geographical network of foreign branches." These brokers' local branches should provide risk analysis reports, knowledge of local laws, coverages and rates, claims handling, property loss control and the ability to coordinate the parent company's risk management philosophy with local management's coverage needs. In addition, he said, the U.S. broker is expected to monitor the performance of each local branch. According to Donald E. Freudenheim, vice president, AIG Risk Management Inc., there are three ways to pay for uninsurable risks: alternative, pre- and post-funding.

"A stabilization program is the state-of-the-art solution to pre-funding needs," according to Mr. Freudenheim. The purpose of the program, he said, is to build a fund that over several years grows to an amount equivalent to the aggregate limit of liability provided for the catastrophe exposure.

Alternative mechanisms, such as captives, supply handy containers for holding cash reserves, he explained. "Opportunities exist in some industries to take advantage of pools and association groups to gain access to these alternatives," he said.

"Unless you are a company like Exxon," said Mr. Freudenheim, "you probably do not have the cash flow to absorb a loss without time-shifting or spreading loss funding chronologically." The real opportunities, he said, exist in the post-funding approach. "Build them in advance," he said, "and have them on standby."

Post-funding mechanisms include credit facilities, such as commercial paper programs. Commercial paper is low-cost funding, he said, and generally requires backup bank-type facilities which can be combinations of contractual revolving credit lines and unsecured credit lines. In addition, he noted, many companies have cash buried in assets that can quickly be liquidated.

"Many companies do not feel this kind of preparation is necessary," said Mr. Freudenheim. "But, believe me, it is difficult to arrange financial watersheds quickly and almost impossible after a catastrophic event."
COPYRIGHT 1990 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
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Title Annotation:companies' uninsurable risks
Author:McCabe, Monica
Publication:Risk Management
Date:Jun 1, 1990
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