The Upside of Risk
In 2012, the LEGO Group considered increasing its investment in the fast-growing Chinese market.
A year later, it began weighing whether to build a sales and distribution presence in China. The company had existing sales hubs in Connecticut, London and Singapore. That required the Danish toy company to consider the potential opportunities of such a move as well as the potential risks.
“There is a tendency for people to look on the negative side of risk, but the objective from my point of view is mainly the positive,” said Rico Ferrarese, who was with LEGO Group’s strategic risk management department until recently moving into an operational role.
Hans Læssøe, senior director of strategic risk management at LEGO, created the department in 2007. It focuses on company strategy. It doesn’t handle insurance, safety, claims or other traditional risk management responsibilities.
“Insurance has value but it doesn’t help you develop your business,” he said.
“How do we help management make better decisions — decisions that are better informed about the uncertainties? … To me, that’s much more proactive,” he said.
“I think a lot of risk managers right now are hampered by the fact that they are coming from an auditing or insurance business,” Læssøe said. “They want to make sure everything is covered. They have not been trained or asked to look at opportunities. They have not been asked to support decision quality.”
Focusing on the positive side of risk is unnatural for many risk managers. There’s a reason many executive and operational leaders dub such departments, the “department of no.”
By the same token, it also is uncommon for the C-suite or operational leaders to rely on their risk managers when they are contemplating strategic moves. They often fail to recognize the tools that risk managers can bring to the table to help assess potential opportunities and challenges.
Generally, it is only when a strategy moves forward that the organization informs the risk manager as a prelude to securing insurance protection.
“All too often, risk managers get called in after the decision has been made,” said Elizabeth Carmichael, director of compliance and risk management for Five Colleges Inc., which includes Amherst, Hampshire, Mount Holyoke, Smith College and University of Massachusetts-Amherst.
Risk managers who successfully integrate themselves in C-level discussions often must take the initiative themselves. They ask questions and develop relationships throughout the organization. They make sure they understand the entire business and its operations.
They ask key leaders what would help them do their jobs better, and then follow through with ways to help.
When LEGO considered going into China, it used a scenario process known as “Prepare for Uncertainty.”
“There are a lot of things we don’t know about China and especially China five years from now when we would be up and running,” Læssøe said.
“We have a set of uncertainties.”
Among them: What is the retail distribution structure like? Is it like the United States, with a few very large toy distributors, or like Germany, with “a gazillion and one small stores?” Or is it a combination of the two?
What are the consumers like? Will they want the same products as the American market, or will LEGO need to create different colors, heroes and concepts geared to the Chinese culture?
“How do we help management make better decisions — decisions that are better informed about the uncertainties?” — Hans Læssøe, senior director of strategic risk management, LEGO
Læssøe facilitated a structured discussion with the leadership team responsible for deciding whether to enter the Chinese market. Using Post-it notes, each team member team individually listed their “two most important uncertainties” about the potential move.
It was done that way to prevent group-think.
“We don’t even consider whether things are a risk at this time,” Læssøe said.
For three hours, the team talked through the ideas as they placed the notes two-by-two across on the table.
The leadership team then used the “Park Adapt Prepare Act” (PAPA) model.
“We prioritized them, not based on impact. The impact is inherently high. We look at the likelihood, low or high. Do we believe it will happen or not, the speed it might happen and our agility to respond,” Læssøe said.
If an issue was not likely to happen or offered sufficient time for the company to respond if it did, the uncertainty was “parked” on the side. Eventually, the only issues left on the table were those with a high likelihood and a short amount of time to respond.
All of the items had the potential to be both risks and opportunities, he said. “Now, we look at the issues we need to address.
“We want to make sure our strategy is resilient in a world that probably will change in a different way than we expect,” he said.
“What will give you a competitive advantage in the future world is maneuverability or agility.
“Competitiveness to me is like a penicillin for the flu. It can get you nauseous and uncomfortable but it makes sure you are on your toes and don’t get really, really sick,” he said.
LEGO started building its factory in China a couple of years ago.
“It’s just about finished,” Læssøe said.
On the Cutting Edge
LEGO’s strategic risk management process is “probably the leading edge of best practice,” said Andrew Bent, manager, enterprise risk management, Alberta Energy Regulator, in Calgary, Canada.
Bent, who is chair of the RIMS strategic risk management development council, said that more risk managers are recognizing that they must create as well as protect value for their organizations.
“Risk managers shouldn’t be the ones saying, ‘No, no, no. It’s too risky.’ They should be working — and many now are working — to provide the organization with the information needed to make good decisions,” Bent said.
“Risk managers are now asking, ‘How do we actually create value for the organization? How do we support the business strategy?’ ”
It’s about ensuring decision-makers have solid information about both the upside and downside of a potential strategy, he said. When that happens, the leadership takes accountability for the decision and is able to explain to their shareholders or board the reasons behind decisions and what controls were put in place.
“Over the last few years, we have seen much more emphasis on the C-suite and boards to be actively engaged with risk management, to really understand what is going on,” Bent said.
“Risk managers shouldn’t be the ones saying, ‘No, no, no. It’s too risky.’ ” — Andrew Bent, manager, enterprise risk management, Alberta Energy Regulator
“The implication for the risk manager is that we must be prepared to answer their questions. Most risk managers I talk to see this as the opportunity they have been looking for and waiting for.
“The organizational culture has to be ready to receive and ask for information about risk, and risk managers must be better prepared to not only give the information they are asked for, but also the information the organization needs to hear,” Bent said.
Adding value to the organization takes many forms. It is as individual and specific as each organization’s operations.
When Bent was working in risk management at a law enforcement agency, the city he worked for had the highest murder rate in Canada.
“In addressing this serious community problem, we needed to think beyond the very obvious downside. We had to ask, ‘What is the value that risk managers can add to our organization?’ ”
The downside, or traditional approach, he said, would have been a push to ban knives and increase police patrols.
Instead, the agency focused on the potential opportunities. It began to coordinate activities with social service organizations, such as homeless shelters; employment, training and housing agencies; mental health and addiction centers; and others; to bring more organized support to residents, he said.
“They were doing great things without a lot of coordination,” Bent said.
“Is this our job as a police agency to coordinate? Perhaps not in a traditional model. But we manage the downside of the risk, so we thought it was more useful to manage to upside first so we don’t get to that point.
“It was about bringing together all of those pieces and putting the right people at the table to have those conversations and make sure they are risk informed and understand the good, the bad and the ugly,” Bent said.
In another situation Bent is aware of, a construction company facing a range of safety issues decided to focus on the upside economic advantages of creating a strong safety culture to prevent further injuries.<
Leaders who had higher rates of injuries on their sites were also the ones who tended to have more re-work on their jobs, and the sites used more materials. By addressing the safety culture, those sites became more profitable.
Supervisors and foremen were trained, performance indicators were created, unions were consulted, and if workers refused to transition to the new safety climate, “they were no longer welcome on the company’s worksites,” he said. “It was costing money and hurting people.”
“By addressing the safety culture, the company was able to control downside risk and also improve profitability.”
A New Way of Thinking
It’s challenging for many risk managers to think about the positive side of risk, said Joanna Makomaski, president of Baldwin Global Risk Solutions Inc., and a columnist for Risk & Insurance®.
The Institute of Risk Management in London recently honored Makomaski as Risk Management Professional of the Year for her work on the Toronto 2015 Organizing Committee of the Pan/Parapan American Games.
Too many risk managers equate risk management with the company’s insurance portfolio, Makomaski said.
“When you rely only on insurance, in essence, you are waiting for something negative to happen and you can only mitigate the consequences.
“I am an advocate of identifying what your opportunity risks are, but you also have to look at the possible collateral damage of that risk,” she said.
For example, utility companies have a great opportunity for increased revenue during long, cold winters. At the same time, however, those companies may find that more people can’t pay their bigger bills. That can result in default risk on bill payment and a social responsibility risk.
“When you rely only on insurance, in essence, you are waiting for something negative to happen and you can only mitigate the consequences.” — Joanna Makomaski, president of Baldwin Global Risk Solutions Inc.
“That’s the challenge: Should the utility cut off their heat in the middle of a frigid winter? All of a sudden, even though this really good thing is happening, there are other risks to consider.”
In exploring opportunities, risk managers must consider their organization’s risk appetite, its tolerance for periodic excess risk, and the possibility that the failure to take a risk can have a negative impact. An example would be the way the manufacturers of the BlackBerry phone overlooked the risk posed to it by the iPhone.
“Given that risk is integral to the pursuit of value, strategic-minded enterprises do not strive to eliminate risk or even to minimize it,” according to “Risk Management in Practice” by Deloitte.
“Rather, these enterprises seek to manage risk exposures across all parts of their organizations so that, at any given time, they incur just enough of the right kinds of risk — no more, no less — to effectively pursue strategic goals. This is the ‘sweet spot,’ or optimal risk-taking zone.”
When risk managers understand a company’s potential exposures and the company’s risk tolerance, they can be in a position to tell the organization it can take on even more risk than they think, said Læssøe of LEGO.
Makomaski said she sometimes uses a “global heat map” to illustrate possible risks and returns of potential business strategies.
A heat map plots the likelihood and impact (ranging from very low to very high) of a strategy, including such potential risks, for example, as supply chain disruption, economic downturn, customer preference, new or increased competition, etc.
It’s important to note that such risk assessments are only as good as the data.
“Assessments are vulnerable to the garbage in, garbage out rule,” Makomaski said.
Marti Dickman, vice president, risk management, Advanced Disposal, said her risk management department is designed to “be the instrument that enables senior management to contemplate all of the risk factors and make good sound decisions about how to manage risk on the front end, recognizing we will still have a downside of risk.”
One way her department looks to add value is when the sales and marketing department negotiates with customers.
“They engage us right away and we offer suggestions for [contract] language, coverages that perhaps the customer has missed that we can provide,” she said.
“We can offer recommendations on how a component of the contract could be changed to create a value add and allow us to win the business. It gives us a competitive edge,” Dickman said.
“I work with my team so that my folks are not seen as the ‘no people.’ We want to be the ‘go-to people.’ The direction my team is charged with is to explain the challenges we see and the opportunities to make something even better.
“Instead of looking to avoid risk, we help them understand the risk on the front end so decision-makers can use that to make informed decisions. Ultimately, it will depend on the risk appetite of your company,” she said.
Carmichael, of Five Colleges, said most of her risk management colleagues “are pretty skilled at understanding the upside of risk.”
“We get requests for all kinds of interesting projects within higher education,” she said.
“Our students and faculty are very creative and the administration is often looking to do things that are innovative.
“When asked to do a risk assessment, it may be wise to ask the administrator, ‘Are you looking to say yes or no,’ because that way you have a better sense of what direction they are working toward.
“If they are looking to say no, the task is fairly easy because you can probably come up with many things that can help the school say no,” Carmichael said.
“But don’t leave off the upside of the activity, as other administrators are likely to want to weigh in at some point.”
In one instance, an honors student with a circus project wanted to bring a trapeze event to campus. Participants would have the chance to learn how to swing on and transfer from one trapeze to another.
“The upside of the risk was great. It would be an on-campus activity that would engage a large number of people in the community, both staff and faculty. It would bring the campus together and give people an experience they might not otherwise have in a relatively low-risk environment.
“The obvious downside [to the event] was that someone could have been hurt or there could have been some other snafu, for lack of a better term, with the project,” she said.
“As the risk manager, in collaboration with other administrators, we were able to ensure that our facilities staff and public safety officers were on board.
“We also worked through a very well-reasoned and balanced contract with the trapeze company and used waivers to help spread the risk to the participants. We had an extremely successful event.”
Supporting the Business Plan
“When you invest in something,” said Ferrarese of LEGO, “it must have a positive outcome. You may not be able to put a financial outcome on it, but there is a positive reason we are doing it.”
“The key challenge,” said Dickman of Advanced Disposal, “is to overcome the traditional view that many people have of risk management.”
While that may be slowly changing among senior leadership, the onus is on risk managers to “reach out and take that initiative if the culture sees risk management in that more traditional role. Push forward,” Dickman said.
“Don’t be discouraged. Make inroads so people see you as a resource and benefit so they will want to bring you in at the beginning.”
At the same time, some risk managers need to change their own mindset.
“Instead of being risk averse, we need to understand there is a benefit to taking on more risk — when we do so in a controlled way,” she said.
Carmichael suggested risk managers “look for ways to engage in conversations about getting to ‘yes’ rather than starting at ‘no’ … and getting carried grudgingly along.”
They also need to educate senior leadership. “The more aware your senior officers are about risk and risk management, the more likely risk management will be called in before a decision is made,” she said.
Makomaski said one way to gain traction and engagement is to “dance to the rhythm of the business.”
“I like to attach myself to an agenda or internal system that is working and risk adjust that,” she said.
“Make yourself an enabler to the strategy. My job is to enable the risk to happen within the bounding risk position of the organization.” &
Court Sinks Subrogation
On March 17, 2012, the commander, a vessel owned by Nature’s Way Marine, ran aground in the mouth of a narrow channel of the Mississippi River near Crown Point, La., owned and operated by Crown Point Holdings LLC.
As it maneuvered to free itself, the movements created “extreme wave wash” that broke the mooring lines of two of Crown Point’s vessels, the Port Gibson and the Buccaneer, grounding them on a mud bank.
On March 21, the Port Gibson began to take on water and sank, pulling the Buccaneer down with it. After raising the ships, it was discovered Port Gibson’s hull was punctured by a bolt-studded piece of timber.
Osprey Underwriting Agency Ltd., which issued Crown Point marine hull insurance on the Port Gibson and the Buccaneer, paid for salvage and damage expenses and then, as subrogee, it sued Nature’s Way for reimbursement, arguing the Commander’s maneuvers caused the sinking of Crown Point’s vessels.
A district court in Louisiana ruled against Osprey. It said Osprey failed to prove the Commander’s actions caused the sinking, and even if the causation could be determined, Crown Point’s failure to warn anyone of the timber impaled in the hull was a superseding cause of the sinking.
On March 25, the U.S. 5th Circuit Court of Appeals upheld that decision. It concluded that experts from both sides “vehemently” disagreed with how the hull impalement occurred, and that marine law required negligence to be a “substantial factor” in the damage.
Scorecard: Osprey will not be reimbursed for its costs to salvage and repair the vessels.
Takeaway: Under general maritime law, “negligence must be a ‘substantial factor’ in the injury.”
Legal Fees Contested
On Dec. 29, 2011, William R. Kowalski and Hawaii International Seafood filed suit against Anova Food LLC, claiming patent infringement and false advertising. The lawsuit accused Anova of using Kowalski’s “tasteless smoke” process to treat tuna, although Anova advertised the fish were treated by a “clearsmoke” process.
Anova retained Gary Grimmer as local counsel in Hawaii to represent it.
On Oct. 12, 2012, Anova requested a defense from the Hanover Insurance Co. and its subsidiary, Massachusetts Bay Insurance Co. (“Hanover”). Defense was granted under a reservation of rights, and the insurer agreed to pay Grimmer in accordance with its litigation guidelines and fees.
Hanover’s claim that it only agreed to hire Grimmer and not Zobrist conflicted with its payment of some of Zobrist’s legal fees, the court ruled.
Hanover stated it would not pay, however, for any fees paid by Anova prior to the claim being made.
The insurer said it would not apply the exclusion for injuries “arising out of” infringement of intellectual property, but would not indemnify Anova for any punitive damages.
On Dec. 11, 2012, the Zobrist law firm, which had a history with Anova’s intellectual property issues, filed its appearance as counsel of record for Anova, and was subsequently paid $284,624 by Hanover.
A year later, Hanover informed Anova it was transferring defense in the case from Grimmer to two other attorneys. At that time, it said that any continued involvement by Zobrist “will need to be funded directly” by Anova.
On June 19, 2014, Hanover asked for a court determination that it need not defend nor indemnify Anova. The insured filed a counterclaim for breach of contract and bad faith, arguing Hanover owed it a defense, and the unpaid balance to Zobrist of $385,153.
Anova reached a settlement with Kowalski in April 2015.
The U.S. District Court for the District of Hawaii ruled on March 24, 2016 that Hanover did have a duty to defend Anova but did not have to pay for legal services prior to Anova’s request for a defense.
Because factual questions remained about the legal fees paid to Zobrist, the court denied Anova’s motion for summary judgment on its claim that Hanover breached its contract.
Scorecard: Additional court proceedings will determine whether Hanover must pay $385,153 for Zobrist’s legal fees.
Takeaway: Hanover’s claim that it only agreed to hire Grimmer and not Zobrist conflicted with its payment of some of Zobrist’s legal fees, the court ruled.
Request for Defense Denied
In 2009, Larry Naquin was using a land crane owned by Elevating Boats LLC (EBI) to move a “test block” when the welding holding the crane to its base failed.
Naquin jumped from the crane house, breaking both feet and sustaining a lower abdominal hernia. He was never able to return to physical work.
In May 2012, a federal jury in Louisiana awarded Naquin $2.4 million for physical and emotional pain and lost wages. EBI appealed and the negligence verdict was upheld.
Subsequently, EBI sued State National Insurance Co. and London insurers, accusing them of breaching their contracts by denying EBI’s request for defense and indemnification.
On March 22, the U.S. 5th Circuit Court of Appeals agreed with a lower court in dismissing EBI’s lawsuit.
Scorecard: The insurers are not responsible for indemnifying EBI.
Takeaway: EBI’s policy offered indemnity for the company “as owner of the Vessel,” and it was not triggered because the accident occurred on land. &
Insurers Must Pay $58 Million
On sept. 12, 2008, a power plant unit owned by TransCanada Energy USA’s subsidiary TC Ravenswood in New York was taken out of service due to excessive vibrations. On Sept. 16, a crack in the unit’s rotor was discovered. The unit was out of action until May 18, 2009.
TransCanada filed a claim for $7 million in property damage and $50.8 million for loss of gross earnings from Factory Mutual Insurance Co., National Union Fire Insurance Co., ACE INA Insurance and Arch Insurance Co.
The insurers denied the claim.
In legal proceedings, the insurers argued the crack that damaged the unit formed before the policy went into effect on Aug. 26, 2008, and that the plant’s loss of sales were not covered because they were incurred after the period of liability ended.
National Union later settled.
TransCanada countered that the all risks policy covered the breakdown because the unit was operating properly when the policy began.
The New York Supreme Court ruled on March 2 that “it is irrelevant here whether the crack existed or could have been discovered before the policy commenced.” It also ruled for TransCanada on the loss of capacity revenue.
The losses, the court ruled, “were neither speculative nor incapable of being linked directly to the period of liability at issue.” &
Scorecard: The insurance companies must pay TransCanada $58 million to cover its property damage and business interruption costs.
Takeaway: It was immaterial when the cause of the damage began as long as the property damage was sustained during the policy period.
Sophisticated Buyers of Coverage
Templo Fuente De Vida Corp. formed Fuente Properties in 2002 to acquire a property for a church and daycare centers.
Templo and Fuente (collectively Templo) received a funding commitment from Merl Financial Group Inc. (which later restructured and renamed itself First Independent Financial Group).
However, Templo had to terminate its purchase agreement when the funding did not materialize on the closing date. It filed suit against First Independent in February 2006.
On Aug. 28, 2006, First Independent gave notice of the claim to National Union, which had issued the company a $1 million directors, officers and private company liability policy.
Templo and several defendants, including First Independent, reached a settlement exceeding $3 million. First Independent assigned its rights under the National Union policy to Templo.
National Union denied coverage because of the delay in notifying them of the claim. On Feb. 11, the Supreme Court of New Jersey agreed with both a lower court and an appeals court, upholding the insurance company’s decision.
At issue was whether the insurance company had to establish it suffered prejudice by the late notice in a claims-made policy. For occurrence policies, the state has ruled that insurers must show they are prejudiced by late notice because many insureds are unsophisticated consumers.
For insureds under a claims-made policy, such as D&O, however, the court ruled insureds are sophisticated buyers of insurance. &
Scorecard: National Union will not have to contribute a share of a $3 million-plus settlement agreement.
Takeaway: New Jersey insureds with claims-made policies are treated as sophisticated consumers who are expected to comply with policy terms.
Ingredients for Dismissal
In July 2008, Wisconsin Pharmacal Co. placed an order with Nutritional Manufacturing to manufacture its Daily Probiotic Feminine Supplement chewable tablet, sold at a major retailer. The tablet was to contain Lactobacillus rhamnosus (LRA), a probiotic ingredient.
Nutritional Manufacturing ordered a supply of LRA from Nebraska Cultures of California Inc., which in turn ordered the LRA from Jeneil Biotech Inc.
After the tablets were manufactured and sold by Pharmacal, the retailer notified the company in April 2009 that the tablets contained Lactobillus acidophilus (LA) instead of LRA.
Nutritional Manufacturing assigned its causes of action against Nebraska Cultures and Jeneil to Pharmacal, which filed suit against those companies on Jan. 14, 2011, along with their respective general liability insurers, Evanston Insurance Co. and The Netherlands Insurance Co.
In October 2011, a Wisconsin circuit court dismissed some of the allegations and held others in abeyance while it decided whether the insurers must defend and indemnify its insureds. The court ultimately granted the insurers’ request for summary judgment.
That decision was reversed by the court of appeals, which ruled the defective ingredient physically injured the other tablet ingredients, and that the claim was covered by the policies.
On March 1, the Supreme Court of Wisconsin reversed that decision, in a 3-2 ruling.
It ruled there was no property damage because the policies covered only products that caused damage to “property other than the product or completed work itself.” Because the LA ingredient was integrated into the tablet, it did not cause damage to “other property,” it ruled.
In addition, it ruled, there was no “loss of use of tangible property” because a “reduction in value” of the tablets is not the same as “loss of use.” &
Scorecard: The insurance companies do not have to defend or indemnify Nebraska Cultures or Jeneil.
Takeaway: Blending all of the ingredients together into one tablet created one product.