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Heading off risks in the fast lane.

Heading Off Risks In the Fast Lane

Risk management means--or should mean--different things for different types of organizations: nonprofit versus for-profit, small versus large and fast-growth versus mature. All organizations are different, but in my experience, fast-growth organizations, from a risk management perspective, are more than different. They are unique.

Typically, fast-growing companies are more interested in the development of markets, manufacturing of new products, establishment of effective distribution systems, research and development efforts and the like. They are less concerned with so-called overhead items such as risk management. Because the rapid growth itself covers many inefficiencies, these overhead items are less subject to scrutiny.

In such fast-growth companies, overhead costs are less visible and, indeed, often less important. However, it is a mistake to view risk management as merely a cost. Poor risk management creates the opportunity for crippling damage, or even destruction of a fast-growth company in ways in which mature companies are not susceptible. Fast-growth companies are especially vulnerable to unanticipated, unplanned or unfunded losses. Such losses in a fast-growth company can mean the difference between success and failure. Even the small but debilitating losses which rob the organization of funds and people to use for growth can be crippling. Fast-growth companies are also unique because they often cannot afford to "solve" risk management problems by simply throwing money at insurance companies.

All risk management professionals would wholeheartedly agree that the proper application of risk management procedures to a company is critical to its successes and, sometimes, its survival. However, what role does it play in the dynamic, fast-growth company? What is principles to the fast-growth company and other types of firms, such as mature or even declining organizations? Further, how does the process and structure of risk management change as the fast-growth company expands from one location to many locations domestically and, ultimately, internationally?

This article explores the transition from the loose, informal and dynamic characteristics of a start-up company into a more structured, specialized and complex firm. How risk management can and should be applied to protect the firm, its employees and key officers and directors against not only infrequent catastrophic loss, but also smaller, more frequent and debilitating losses, are explored.

What characterizes a fast-growth firm? Generally, the fast-growing firm is not characterized by a smooth and continuous process. Rather, it is marked by abrupt and sometimes substantial changes in organizational strategy and structure as the firm attempts to define and then exploit its market niche. To maintain growth, its management must monitor resource allocation very carefully. Adjustments in this allocation process must be made as opportunities and risks present themselves.

Unlike slowly developing firms, the fast-growth firm has a high degree of risk involved. Poor risk management practices can kill a company as fast as poor business decision-making--faster in some cases. The fast-growth firm is in a more precarious position. One significant mistake can bankrupt it swiftly.

Most mature companies have sufficient capital and/or borrowing power to post-fund significant, otherwise catastrophic losses. Fast-growth companies typically have neither; they need every dollar they can acquire. What would be an unpleasant, perhaps even crippling, blow to a mature company could be death to a fast-growth company.

The adroit risk management professional's overall strategy should be the protection of these resources as they are utilized in the growth and the development of the firm. The specific steps taken are dictated by the nature of the firm's business objectives, its inherent fortuitous risks and especially the degree to which communication between senior management and risk management staff is handled.

Unfortunately, many firms on the fast-growth track may not have a trained and experienced risk management professional monitoring the changing risks and exposures. Essential information for senior management, such as unsafe working conditions which have led to several employee injuries, may go unnoticed or receive low priority. Because of a lack of insurance sophistication, senior management may not realize that rising numbers of incidents are not only bad for business in terms of lost productivity, but also result in being targeted by the insurance company as a bad risk. This is a difficult stigma, once perceived, to overcome. Worse, it is difficult to change the attitudes of supervisory personnel if management has never placed a priority on risk management.

As we will see in our analysis of the fast-growth firm, communication is the primary conduit of effective risk management. Unless dangerous situations and conditions are accurately described, assessed and communicated to the appropriate decision-making personnel, dangerous conditions will continue. Unfortunately, once the stigma of a nonexistent or weak risk management effort is perceived, insurance companies are quite reluctant to change their attitude. High premiums and restrictive coverage are sure to continue until the firm has demonstrated a clear turnaround.

My model study examines five successive stages of the fast-growth company: start-up; initial product development and prototype manufacturing; product development, marketing and distribution; domestic expansion; and international expansion. Although I evaluate a product-oriented firm, the principles are similar for a service-oriented company.


During the first few years, the new firm's organizational structure is simple. Survival, rather than profits, is the main issue as the firm seeks to identify and occupy a viable market niche.

In a fictitious medical products company, there are few levels of management and few departments. The founders/owners separate the financial, marketing and personnel responsibilities among themselves, delegating production, inventory control, product distribution and purchasing to hired employees. A staff of 30 occupies leased facilities. Because the team running the company is so small, there is direct personal contact among all of the "departments," since those running the company wear so many hats.

The process of risk management is not performed. Rather, the responsibility for handling the known exposures of the firm, including products liability, premises & operations liability, property, workers' compensation, is given to a local insurance broker to handle through placement of traditional insurance.

The person at the firm generally responsible for the insurance program, such as it is, is the owner/chief financial officer. Unfortunately, at this early stage, the financial officer of the firm does not perceive insurance or risk management to be high priorities when compared with other urgent issues. Although he or she may be right, the pattern that develops is that risk management is not a key concern. As the company grows, and especially in a fast-growth situation, this inaccurate thinking process can lead to significant problems.

However, during the start-up stage, the total cost of risk for this firm, defined as net insurance cost plus unreimbursed losses, is minimal. The bulk of the cost is the insurance portion. There is very little immediate exposure arising out of losses for the small firm. Liabilities arising out of medical products, although significant, have a long tail. Workers' compensation and property exposures are minimal at this point. The number of vehicles used would also be minimal.

The administrative burden for the financial person in the company is almost nonexistent. He or she would be delegating that responsibility totally to the broker, paying bills as they become due. From a risk financing perspective, the control over the insurance cost, as an item within the risk management program, would not be price-sensitive due to the very small scale of the insurance purchased.

This approach is not necessarily wrong; after all, design and sales are vital. The best small, fast-growth companies have CFOs who are aware of risk management techniques and applies them in small doses to existing operations. It is the manager who does not know or does not care about risk management techniques that breeds trouble.

At this stage, the CFO can become knowledgeable about risk management reading some basic magazine articles or chapters in general management books.

Initial Product Development

The next stage occurs much more quickly--perhaps one to two years before a normal-paced growth company. Despite the rapid pace of a new firm, the organization is becoming more formal. Lines of communication from senior management to the functional department are taking shape. There is still only one location, but there is more capital being invested to develop the machines and the physical plant necessary to design and build the product.

Specific risks facing the firm at this juncture are the unnecessary assumption of liability through contract, worker safety, product quality control, product security, raw material (or component parts back-up sources), limited channels of distribution and adequate and proper space allocation. In a fast-growth company, management will be giving these issues attention in an almost haphazard fashion with a "squeaky-wheel" principle being applied. Whatever requires immediate attention and screams for it, gets it. Unfortunately, the firm is at definite risk because it is probable that inadequate thought and attention are being paid to plant and people safety, security and finding adequate back-up sources for raw materials, products and distribution channels.

Actual risk management efforts during this stage are still a minor concern. The financial officer still has responsibility for the purchase of insurance, but has delegated that to the broker. He or she would tend to react to problems, rather than plan to avoid them. Because the financial officer lacks knowledge and experience in risk management and feels that insurance provides adequate protection, a dangerous situation is created. The perceived unimportance of risk and insurance management issues means that the well-meaning broker does not have the accurate underwriting information needed to convince increasingly skeptical insurance companies to provide reasonably broad coverage at reasonable prices. The high degree of uncertainty, fueled by the lack of precise underwriting information, will result in poorer coverage from the insurance company.

It will take a catastrophic claim, a series of claims or the absence of essential insurance coverage, such as products liability, to bring the importance of risk management to life. Ironically, while the firm may be proactive in its management style in identifying potential markets to sustain its growth, it is reactive in the crucial area of risk management.

In this critical stage of the fast-growth company's life, informed senior management should recognize the significance of risk management and hold it in equal esteem with the other critical areas, such as market share, product development and profitability. It is during the first two stages of company development that proper planning for risk management should take place. The perceptive senior manager responsible for insurance should take immediate steps to either educate himself or herself in risk management practices or acquire the services outside. Because the former is too time-consuming, it is better to obtain outside help. That help can be obtained either in the form of a hired risk manager or by engaging the services of a risk management consultant on a retainer basis.

In either case, the senior official should spend minimum but consistent time in learning about risk management: identifying risks, examining the feasibility of alternate risk management techniques (risk control or risk financing), the selection of the best techniques, the implementation and the monitoring/improvement of the risk management program over time. He or she does not need to be an instant expert but ought to familiarize himself with the process. It will pay great dividends in the future, as the company grows, especially when difficult insurance cycles or catastrophic events occur.

During the first two stages of the fast-growth company's life, it is likely that a full-time risk manager will not be necessary in the short term. Until one becomes necessary, the options are to designate a person in the organization to either learn risk management or acquire somebody who can perform risk management responsibilities in concern with other activities such as purchasing, accounting, or other related financial activities. Such multiskilled staffers are available and can be a great asset to the emerging company.

Second, much more care should be given to the selection of the broker who will continue to be the vital point man for risk financing activities. The education process on exactly what are the risks and exposures of the fast-growth firm must also include the broker so that these risks can be tangibly explained in the best fashion to suspicious underwriters.

For example, let us assume that this fast-growth firm produces a vital part to be used in the final assembly of a nuclear magnetic resonance imager. Product liability underwriters, in a difficult insurance crisis such as we have recently experienced, would be nervous about insuring a medical product. They would be unlikely to offer coverage at all if they had little or no information on this firm, the type of product being manufactured, the quality controls used to ensure product integrity and the ultimate use of the product. A carefully prepared, well-researched market submission for products liability by the risk manager and broker, demonstrating quality control procedures, historical claims experience on similar products and similar research, will go a long way to satisfy the fear of the underwriter and may result in a reasonable quote.

Therefore, during this stage, the risk manager and broker (with insurance company loss prevention experts) should begin laying the foundation for loss prevention and loss control activities in terms of plant safety, fire protection, disaster recovery plan, identification of alternative raw material sources, best method of product distribution with adequate back-up and the like. The emphasis here is on proactive risk management. It is not expected that a full-blown plan will be in place during this stage, but the beginnings should be evident. This would not only hold true for the normally evolving company, but especially for the fast-growth company which will probably experience violent increases in product demand, placing enormous strain on production facilities, distribution channels and work force.

Marketing and Distribution

Organizationally, this firm continues to take on more rigidity and structure. Capital expenditure on manufacturing equipment and inventory continues to expand at a rapid pace. Space has now become a critical issue. There is now a full-time personnel department and over 100 employees.

From a risk perspective, the products liability exposure continues to expand as more and more products have been marketed, developed and distributed. Workers' compensation exposures increase with the larger work force. Property exposures rise as well due to more property, plant, equipment and the lease/purchase of alternate production and storage facilities. The transit exposure in distributing final product, as well as receiving raw materials, has risen dramatically. The exposure arising out of business interruption and contingent business interruption has taken on significant proportion, not only in the source of materials, but also to the end user.

The rapid increase in the growth of the firm, from revenue, sales and employee-population perspectives, will create a greater diversity in the operations of the firm. This diversity manifests itself in the form of greater products liability as well as contractual, professional and motor vehicle liability. The larger the firm, the more it will use agreements with vendors and subcontractors. In addition, it will increase its sales force, thus creating a greater auto exposure.

Also, as the company becomes more defined and established, its officers (and if they exist, outside directors) begin to be faced with the directors & officers liability exposure. The corporate bylaws should be clearly reviewed for their wording on the indemnity agreement to directors, officers and employees. The structure of these bylaws must coincide with the type of coverage offered by a directors & officers policy. Many directors are reluctant to serve on boards if they are personally exposed to liability. While the corporate bylaws regarding indemnification may protect the directors, it is only to the extent of the company's assets which in this stage are necessary to fund the growth of the company.

During this stage, the cost of risk will increase dramatically. Insurance costs have increased due to the increase in exposure base (acquisition of more machinery and equipment, office equipment and purchase of higher limits of liability) in addition to the purchase of new coverages, such as directors & officers liability, transit insurance, business interruption and contingent business interruption coverage. Compounding the increased insurance costs will be the increased size and frequency of unreimbursed losses.

Without proper risk management attention, the dramatic company growth may not be matched by a growth in expertise by the current insurance agent and insurance company. However, the current insurer may be well able to handle the firm if they continue to get good information; but even insurance companies have their own ideal target client. The growing firm may have outgrown that intended target market of the company.

Simultaneously, the responsible party to handle risk and insurance for the company will start to feel a greater strain due to the increase in insurance responsibilities during this stage. His understanding of risk management at this stage is crucial because it will set the groundwork for future corrections or disasters. It is unlikely, at this stage, that the hiring of a full-time risk management professional can be justified, but serious thought by senior management ought to be considered. After all, this company has been defined as one focusing on the future and its goals. Risk management should be one of those issues targeted for future growth and expansion. Further delay forces the future addition of the risk and insurance professional to be more reactive than proactive.

Regretfully, due to the lack of a defined methodology, as well as comprehensive and accurate information, the costs associated with risk and insurance management are not clearly perceived by senior management. As a result, the increasing cost of risk usually ends up getting dispersed within the various departments and functions of the firm. In other words, the cost of risk is "swept under the rug," and management is never able to fully address these issues within its own decision-making process. Either they do not recognize the importance of cost of risk because they have not yet sustained a dramatic uninsured claim, or they do not care. The sad part is that they will care once it is too late.

A new series of risk and insurance issues have surfaced. For example, transit issues are complicated due to their handling by two separate entities (field office to field office or corporate to field office). Property insurance issues are raised in the sense of theft of materials, and contingent business interruption exposures are created. Workers' compensation exposures have grown, especially now that the company is in different states, some of which are monopolistic; others have varying state laws of different severity. Also, field operations themselves require various insurance support, such as certificates of insurance, bid bonds, performance bonds, contracts, lease reviews, etc.

The process of risk management often cannot be met at this stage, by the local broker; nor can the insurance company anticipate and meet all the needs of this growing company. Until this shortage is corrected, many issues will go unresolved. Information the insurer seeks must come from the company. Because of the communication problems described in that fast-growth company, the information is not easily obtained or translated. Yet, a coordinated effort is critical to identify the exposures in the various areas, both property and liability and to key personnel.

The financial person in the organization responsible for insurance during its previous stages is now overburdened. Serious consideration must be given to a specialist to handle the situation. In many cases, the primary skills most in need seem to be insurance administration. Unfortunately, the insurance administration details are only 50 percent or less of the real need. The remainder and by far the most important are risk management techniques, such as risk control and risk financing. The firm is starting to grow, and certain procedures and guidelines must be established. In addition, past mistakes must be eliminated and/or corrected. The risk manager need not be a full-time position at this point. A finance/accounting person or safety person can handle risk management and insurance or a risk management consulting firm could be retained on an as-needed basis.

Risk management must be integrated within the development of all corporate policies and procedures. Thus, the skills of a risk manager should be considered. The growing firm is requiring a great deal of technical skills to manage growth in production, sales marketing and other areas. This area should get no less effective treatment.

One increasing exposure at this stage is the revenue stream itself. Impairment of manufacturing can stop expansion and allow competition to fill the void. A serious interruption in production without a contingency plan may be an irreparable setback to the long-range growth and stability goals of the company. While business interruption insurance will reimburse the company for its lost profits for the time interrupted, it will never retrieve the lost market share when competition fills the void. Therefore, specific plans must be made to avoid downtime as much as possible. Alternate suppliers, extra storage and alternative manufacturing strategies are all methods to attack the problem.

Domestic Expansion

The fast-growth organization is now ready to expand domestically into a number of branch offices, production facilities, warehouses and the like. With expansion comes a significant alteration in the risk pattern, requiring increasing sophistication.

While the home office management structure is becoming more defined, the field operations still contain the mavericks involved in the early stages of company growth and is still operating "by the seat of their pants." In addition to the communication problems between field offices and home office, risk management is left out of the loop. Poor communication channels generally create barriers to understanding the exposures facing the corporation as well as risk control and risk financing solutions.

Other potential pitfalls in this stage are increased assumption of liability and responsibilities of others in leases and contracts. Also, the lack of proper insurance coverage for field equipment, equipment in employees' homes or cars, at exhibitions or temporary locations and others are areas of that must be taken into account by those responsible for the risk management program. Again, the broker/insurance company cannot really be expected to always ask the right questions. This responsibility is that of the person in charge of insurance/risk management of the company. Senior management must understand the importance of this role.

The cost of risk will increase further due to expenses for contingency planning, loss prevention and establishing a risk and insurance administration network. During the domestic expansion stage, risk management must become a larger issue than insurance. Senior management must understand the difference.

International Expansion

To survive to this level, the fast-growth company must have created both well-organized horizontal and vertical management structures. Vertically, appropriate policies in marketing, distribution, sales, and finance must be effectively transmitted to all levels of management, no matter where the branch office. Horizontally, the branch offices in the United States, as well as across the world, must have clearly defined communication channels between other branch offices, as well as the external, vital vendors and services.

Risk management issues have also become more complicated with international expansion. The principles of risk management, like any other management principle, must also be well distributed horizontally and vertically. Good communication is essential. Because each country has its own local insurance requirements and loss prevention standards, the corporate risk management program must be flexible enough to allow for these differences.

The corporate risk manager must delegate some responsibility to overseas experts. Using trustworthy, knowledgeable international insurance brokers may be one method. The full-time risk manager in the United States will still retain overall responsibility. The international broker, with its local offices in those countries, will have access to the legal professionals necessary to enact contracts, handle tariffs, custom requirements and other issues pertaining to that country.

The cost of risk to corporate headquarters will increase only by a small percentage. The international expansion does require the purchase of a great deal of insurance coverage locally. Those costs will be borne by the local subsidiary. The increased cost to corporate headquarters will be in the form of worldwide insurance coverage, such as difference in conditions, property, liability, umbrella, directors & officers and some transit insurance coverages.

Richard S. Betterley is president of Betterley Risk Consultants, Inc., a national risk management consulting firm in Worcester, MA. The article is reprinted from Betterley Risk Management Commentary, Vol. 8, No. 3
COPYRIGHT 1989 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1989 Gale, Cengage Learning. All rights reserved.

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Title Annotation:risk management
Author:Betterley, Richard S.
Publication:Risk Management
Date:Jan 1, 1989
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