Meshing Distinct Viewpoints
Marilyn Rivers, director of risk and safety, City of Saratoga Springs
Several years ago, Whirlpool decided it could save 75 cents per unit if it outsourced the production of dishwasher water seals to a Chinese supplier. The annual savings were projected at more than $2 million.
But soon after the arrangement was made, the Chinese manufacturer changed to a different rubber supplier, causing a failure rate of nearly 10 percent, according to “Managing Risk in the Global Supply Chain,” a study by the Supply Chain Management faculty at the University of Tennessee.
By the time Whirlpool discovered the problem, more than 2 million dishwashers had been produced with the leaky seals and about two months’ worth of supply was in transit. The oversight cost the company millions — destroying the realization of projected savings for more than three years.
The study listed the example as one of the multitude of risks that can occur in supply chain management. And it’s an example of how risk management could have helped avoid the problem altogether.
In the most effective companies, risk management and procurement work together to ensure both the cost and quality of supplies and vendors, as well as proper risk transfer.
When those functions do not align, the organization suffers. That suffering may take the form of safety violations, product recalls and reputational loss, among other exposures.
But it’s not possible for procurement and risk management — organizational functions with two distinct viewpoints — to always agree. In some organizations, they rarely even communicate. It is possible, however, to build a relationship that allows the organization to prosper without undue risk.
Underlying the relationship should be a common mission of focusing on the organization’s goals as a whole, experts said.
“Risk management and procurement are partners in helping to grow the business and at the same time, growing the balance sheet,” said Brian Merkley, global director of corporate risk management at Huntsman Corp., a Salt Lake City-based global chemical manufacturer.
When he first joined Huntsman about 10 years ago, he worked with procurement and legal to develop a contractual risk transfer strategy document, which was “my first introduction to the procurement team and the processes they used. I found a good working relationship with them and it continues today.
“Cultivating a strong relationship with procurement is critical,” he said, noting that there is a constant challenge to make smart risk/reward decisions — balancing price against the potential exposure.
“Risk management and procurement are partners in helping to grow the business and at the same time, growing the balance sheet.” — Brian Merkley, global director of corporate risk management, Huntsman Corp.
Over the years, his department has provided important guidance to refine standards and strategies for procurement that include performance expectations of contractors, indemnity language, and insurance requirements, among others. It also has helped to develop a process to qualify various contractors that meet risk management and procurement’s standards so operations can run smoothly.
Contracts and insurance provisions can’t be reviewed in a vacuum, Merkley said, but have to include scope of work, indemnity, and relationships or prior experience with the parties. “We are going to insist on certain levels of protection based on the type of work,” he said.
In many organizations, risk managers are not in a position to influence procurement or supply chain decisions. They either don’t have the buy-in of the senior leaders of the organization, don’t have effective channels to collaborate on such decisions, or they don’t have sufficient understanding of the organization’s strategies and goals to provide effective input into procurement activities.
Gary Lynch, CEO and founder, The Risk Project, and a former global practice leader for Marsh, said that over the years he has been “shocked at how little the risk management community knew about the operations of their business. They knew how they made money, but they didn’t know who contributed to bringing value to the market.
“The majority of risk managers that I have worked with don’t have the opportunity, don’t have the capability and don’t have the value to really support [procurement or supply chain decisions]. Those are the three stumbling blocks,” he said.
The same can also be said for many supply chain professionals. According to the University of Tennessee study, most of them have little expertise in insurance products. Nor do they understand many of the potential claims issues — or the insurance programs that are available to protect them.
In the study, insurance ranked dead last in a list of 10 risk mitigation strategies to protect supply chains — ranking 4.5 out of 10. The top strategy was “strong suppliers,” ranking 7.5 out of 10.
“I think there is a lot of disconnect with folks between procuring and supply chain, and the risk management function,” said Mark Robinson, vice president of global operations at UPS Capital, which offers supply chain finance and insurance services. “In my mind, they don’t talk very much.”
There are some risk managers, however, who are able to add value to the procurement process. The words that keep coming up in conversations with them are “relationship” and “partnership.” Risk management and procurement work best together, they said, when both functions keep the organization’s strategic goals top of mind.
Robinson said the visibility of catastrophic events, targeted thefts and the larger size of container ships has heightened awareness of cargo, trade disruption and cyber risk insurance. From 2011 to 2013, the global cargo insurance market increased from $17.2 billion to $18.2 billion, about a 6 percent increase. And the U.S. market is increasing faster than the global market, he said.
The City of Saratoga Springs, N.Y., operates under regimented bidding processes. But even as the city is required to take the lowest bidder, it must ensure that it hires the lowest “responsible” bidder.
“Sometimes, folks give outlandishly low-priced bids,” said Marilyn Rivers, Saratoga’s director of risk and safety. “We structure it so that when we send out a request for quotes or a request for proposal, we place in the language that anyone chosen has to meet all of the requirements and has to be qualified.”
That means vendors or suppliers have to submit a certificate of insurance, execute the city’s “risk and safety agreement” and a “vendor code of conduct” as well as have sufficient prior experience and the ability to complete a project within the set time frame, among other requirements.
“We are always cognizant of the cost, but we must ask, ‘What is the benefit to the public versus the cost, because tax dollars are being used for those projects,’ ” she said.
Plus, Rivers said, the city must “look at the totality of how it impacts the community. … We can’t just slice up a roadway.”
At Sodexo Inc., which has 8,000 food suppliers and 25,000 non-food suppliers, Peter Rosiere, vice president, risk management, created a new position — supply risk analyst — to more fully bring the risk perspective to the supply chain team.
“One primary reason we created the new position was to develop that communication, linkage and a balance point between the two groups,” he said. “The groups tend to spin in different orbits. What we are trying to do is build a bridge. We have a good bridge. We want to make it even better.”
Evelyn Joe, who holds that new position, said her primary goals are communication, education and collaboration, trying to find the “best working relationship that meets the needs of the company and each team.”
It’s necessary, she said, to understand the other group’s needs and goals while sharing with them the needs of risk management “so we are not talking apples and oranges, so we understand the foundation. … We have worked extremely hard to become part of the supply management process.”
Sometimes, she said, procurement will seek approval of a supplier that does not comply with the department’s insurance requirements or standards. In such cases, procurement and risk management work together, along with legal, to research the organization and find a solution.
“That’s when I’ve been pleasantly surprised because of the constant relationship-building and education with supply management that they completely understand,” Joe said. “The supply manager understood why we couldn’t change our risk management requirements. It’s our job to help our client understand why we have the high standards we do, for both brand and customer protection.”
Opening the channels of communication is, obviously, the first step to creating or enhancing that relationship.
For Dwayne Eastwood, risk manager, McCoy’s Building Supply, it can mean walking around the office with a cup of coffee and asking, “What’s up? What’s the latest? Are you thinking about safety and risk management and contractual arrangements?
“It’s just getting in front of people for a couple of minutes and talking it up. You have to be involved early on. It’s critical.”
But it’s not just asking, he said. It’s also about following up on what is heard by “pointing out and illustrating what the risks are. …Credibility is paramount.”
Credibility matters because the ultimate decision is not within risk management’s control, he said.
“When you step into their world and you point out and illustrate what the risks are, they make the decision for the company that this risk is or is not acceptable. It’s everybody else who makes those decisions,” Eastwood said.
When he explains why a proposed plan “is not really a good idea, most of the time, they will go along with us. They don’t necessarily want to go against the grain. They take our advice most seriously,” he said. “That’s good, and I think credibility is where you get that from, and a proven track record.
“In the beginning, there were a lot of ‘a ha’ moments. It was really up to me and others to educate them that we needed to be involved on the front end. They didn’t ignore it; they just didn’t consider it. When they realized the risks and possible loss of life or big dollar amount lawsuits and what that could look like it was, ‘oh OK.’ ”
Using claims data in such conversations “speaks volumes,” he said. “I’m a huge fan of using loss history to evaluate the risk, frequency and severity, both.”
Eastwood’s colleague, Kevin Shute, director of merchandising-hardlines and merchandising operations, said that the partnership between his function and risk management has over the years “moved from a reactive to a proactive situation. … We like to think that the key to our interconnectedness or connectivity is we know each other personally.”
Shute said that when his team finds a new product from one of its 1,400 vendors, such as virgin sulfuric acid, which is “powerful, powerful stuff,” his team will work with risk management to review all of the processes, packaging, paperwork and safety training and product handling issues.
In another situation, when McCoy’s recently launched a propane tank exchange, the two teams “worked from cradle to implementation” through the contracts, insurance, permitting, vendor and store compliance, employee training, and all other aspects to eliminate any potential liability issues, Shute said.
“We typically don’t look at [risk mitigation efforts] as a problem,” he said. “We look at it as that’s what we have to do to protect our assets.”
It can sometimes be difficult to clearly understand what protection is needed when a catastrophic exposure hasn’t yet occurred, said UPS Capital’s Robinson.
For example, he said, he knows one pharmaceutical company that used to ship $20 million worth of inventory from its location in one truck to an airport 30 miles away every day. From there, it would be divvied up to be transported by plane to various locations.
While the company had claims after the inventory had been brought to the airport and transported, it never had a catastrophic loss related to the 30-mile truck journey. “Can you envision the scenarios? An accident? Being hijacked? Some problem where you lose the whole load?” he asked.
The company had $1 million in coverage for that $20 million load, he said, noting that a conversation ensued with the company about the plausibility of such a loss and how it could protect itself.
A good time for risk managers to begin expanding their partnership with procurement is when contracts are annually reviewed and renewed.
Requiring suppliers or service providers to carry insurance may not adequately protect a company from substantial losses, Robinson said. A major incident could push a supplier into bankruptcy, or a policy’s terms and conditions may not be conducive to compensating the company for its loss -— at least not without a lengthy court battle.
“The groups tend to spin in different orbits. What we are trying to do is build a bridge. We have a good bridge. We want to make it even better.” — Peter Rosiere, vice president, risk management, Sodexo Inc.
It’s not just whether insurance coverage will adequately protect the company. Much of the work risk management must do deals with business continuity planning. Is there resilience in the supply chain for all tiers of suppliers, inventory, labor and transportation? Is there a worrisome geographic concentration? Is there the potential for natural disaster or political upheaval? Is there an acceptable tradeoff between risk and reward?
“The reality,” Sodexo’s Rosiere said, “is that an organization cannot operate without supplies, be it for raw materials or services. But a company cannot operate without good risk transfer. This is not the case with Sodexo, as strict supplier insurance/risk transfer requirements are in place. There has to be an understanding of where the functions rest within the priorities of the organization.
“Sodexo’s awareness of the risk and the partnership with our supply management teams is a key aspect of our growth and culture.”
A lot of it comes down to how decisions affect the company’s margins, said The Risk Project’s Lynch.
When risk managers seek to manage compliance issues or ensure additional capabilities, they are introducing cost into the equation, he said.
“It’s clear to me that these folks have to navigate risk, and not manage it. … You have to manage to the margins,” he said. “Risk management has to be done within the context of the operation’s margin.”
“It’s looking at the totality of the risk,” Saratoga Springs’ Rivers said. “It’s looking at the total risk the project entails and how that project impacts the community, the business or employees, and what an entity, whether public or private, needs to do so it can mitigate risk so it can be successful and the entity doesn’t lose money on it. … The procurement standard should be dovetailed to the project.
“The goal of all risk management is empowering people. It’s a partnership that allows that empowerment but gives the opportunity to know when to ask more questions. … It’s achieving goals cost-effectively but not endangering the health and welfare of employees or the community in the process.”
Regular education and training are crucial, Huntsman’s Merkley said.
“We are all trying to grow the business in an appropriate way and safeguard the balance sheet from making bad bets, and it’s crucial we partner together in doing that.
“The best starting place is to develop personal relationships with the procurement management team, and secondly, you have got to do a lot of work to prove yourself as a reliable subject matter expert. When they come to risk management and look for guidance around insurance language, you have got to back it up.”
Insurer Need Not Cover Investigation Costs
On Feb. 28, 2012, the Department of Justice issued subpoenas to Braden Partners LP, doing business as Pacific Pulmonary Services (Braden), related to its sales practices and claims for payment from federally funded health care programs.
On March 9, Braden notified Twin City Fire Insurance Co., which had issued a general partners’ liability policy, effective Aug. 15, 2011 to June 1, 2012. The insurer denied coverage for defense costs for the subpoenas, saying they did not constitute a claim under the policy.
Subsequently, on Aug. 21, 2013, Braden notified Twin City of a pending lawsuit by the Department of Justice alleging violations of the U.S. and California False Claims Acts. Although it continued to deny coverage based on policy exclusions, Twin City initially conceded the complaint constituted a claim.
It later reversed that decision, and even had agreed to advance defense costs, before changing its position again — this time to deny the notice was a claim under the policy and to assert that it was not “first made” because the DOJ complaint remained sealed and unserved.
In an April 3 decision, the U.S. District Court for the Northern District of California said that a claim had been made against the policy. It cited policy language that required “a judicial or other proceeding against a General Partner for a Wrongful Act in which such General Partners could be subject to a binding adjudication of liability for compensatory money damages or other civil
relief … .”
However, the court also ruled that the claim was not “first made” because the lawsuit had not yet been served, and that Twin City had no obligation to advance defense costs. The court ruled Braden could refile its complaint when the claim was “first made” due to service of a summons or similar document.
Scorecard: Twin City Fire Insurance Co. does not have to cover a company’s defense costs related to potential violations of the False Claims Act.
Takeaway: Insureds should clarify whether their liability policies cover the costs during the investigatory phase of potential violations.
Pollution Exclusion Bars Coverage
In 2010, Energy Wise Inc. sprayed foam insulation into the Shrewsbury Mountain School in Vermont, which caused a school employee, Shirley Uhler, to suffer respiratory problems and other issues, according to court documents.
She and her husband filed suit against Energy Wise, alleging negligence and other issues, and Cincinnati Specialty Underwriters Insurance Co. agreed to defend Energy Wise under a reservation of rights.
The insurer, which had issued a commercial general liability policy to the company, then filed a court action seeking a judgment that it did not need to defend or indemnify Energy Wise due to the policy’s “Total Pollution Exclusion Endorsement.”
The Uhlers contended the exclusion was intended to protect against liability for “traditional environmental hazards” and that the insurer’s “interpretation was so overbroad as to make the policy meaningless.”
On appeal from a lower court decision that refused to dismiss the insurer’s responsibility for defense and indemnification, the Vermont Supreme Court noted that courts have been split on the question of how to interpret the exclusion — whether it related only to injuries caused by traditional environmental hazards or caused by other potential toxins.
“We recognize that the ‘broad nature of the pollution exclusion may cause a commercial client to question the value of portions of its commercial general liability policy,’ ” the court ruled on April 3. “Our role on review, however, is not to rewrite the policy. … [It] must be enforced as written.”
It ruled that the “reasonable expectations” of Energy Wise that it would be covered for its typical work under the commercial general liability policy “cannot trump ‘unambiguous policy language.’ ”
Scorecard: Cincinnati Specialty Underwriters Co. did not have to cover the bodily injury claims resulting from the spraying of foam insulation.
Takeaway: There remains no set standard for interpreting pollution exclusions. As the court noted, “to say there is a lack of unanimity as to how the clause should be interpreted is an understatement.”
Dam Collapse Litigation Must Be Defended
On March 14, 2006, part of the Kaloko Dam in Kilauea, Kauai, Hawaii, collapsed, releasing more than three million gallons of water, causing extensive property damage and killing seven people.
James Pflueger, owner of the dam, sought damages and indemnification from the dam’s previous owner, C. Brewer and Co. Ltd., whose subsidiary Kaloko Sugar Co. constructed the dam and an irrigation system in the late 1800s to irrigate sugar cane fields.
After Kaloko exited the industry, the dam fell into disrepair and it was eventually sold in 1987 to Pflueger. Before that, however, Brewer and its subsidiary, Kilauea Irrigation Co., accepted responsibility to operate, inspect, maintain and repair the dam and irrigation system.
Brewer sought a court ruling regarding obligations owed the company for lawsuits after the dam collapse from 17 insurance companies that had issued various policies. The March 27 ruling by the Supreme Court of the State of Hawaii applied only to the commercial general liability policy issued by James River Insurance Co., which had refused to defend Brewer for the Pflueger complaint.
After a lower court dismissed an obligation to defend or indemnify, an intermediate court reversed, saying the policy was ambiguous as to whether the dam was a premise covered by the policy. It remanded the case for more hearings. On appeal again, the state’s high court ruled the dam was covered, even though it was not specifically listed on the Designated Premises Endorsement (DPE).
It ruled that the policy provided coverage “if the injury or damage arises out of the ownership, maintenance or use of a designated property.”
Because one of the designated properties was the headquarters of Brewer, the damage and injury “relate to C. Brewer’s ‘use’ of its corporate headquarters to make negligent business decisions.”
It also noted that the DPE was “not sufficiently ‘clear and unequivocal’ to limit coverage” to a premises liability policy, which would have limited coverage to certain premises, because coverage included advertising injury, which would not occur on the designated premises.
Scorecard: James River must defend Brewer in the litigation claiming negligence resulting from the dam’s structural integrity.
Takeaway: Business decisions made at a corporate headquarters may extend coverage to other locations, even if not specifically listed in the policy.
Duty of Defense Rejected
In 2011, Bryan Brettin, an orthodontist in Hudson, Wis., used a neighbor’s computer to pose as an unhappy patient of a competing dental practice.
In 2012, Brettin, his employer Daniel Sletten, and Sletten & Brettin Orthodontics (S&B) were sued by Douglas Wolf, a dentist at St. Croix, for defamation and libel, civil conspiracy and unfair competition.
Brettin, Sletten and S&B requested a defense from Continental Casualty Co., from which they had purchased general liability and personal liability coverage. They later added Wells Fargo Insurance Services to the case, as S&B was never added to the policy as a named insured.
The U.S. District Court for the District of Minnesota dismissed the case, ruling that the policy excluded coverage for acts done with the intent to injure. It declined to address the issue of whether S&B should have been a named insured, since there was no duty to defend.
On March 19, the U.S. 8th Circuit Court of Appeals upheld that ruling, dismissing the dentists’ argument that the coverage was ambiguous because it provided coverage for defamation but also precluded it by defining an occurrence as an accident, and including an intent-to-injure exclusion.
The court ruled, however, that the two provisions “are opposite sides of the same coin,” and noted that it was possible to defame someone without intent to injure.
Scorecard: Continental Casualty did not need to provide a defense for the dentists or their dental practice.
Takeaway: Excluding coverage for intentional acts is designed to eliminate an “insured’s ability to cause harm intentionally with impunity.”
Hurricane Damage Partially Covered
In September 2005, Hurricane Rita struck along the Louisiana coast, bending the H-2 offshore well owned by Prime Natural Resources about 7 feet above the mud line, toppling the adjacent H-platform away from the well, and damaging the pipeline that attached the well and platform to a nearby facility.
Prime sought coverage from policies issued by a group of Lloyd’s of London syndicates and Navigators Insurance Co. UK, asking for all costs to restore the well and getting it back into production.
The underwriters declared the H-platform “to be a constructive total loss,” and paid Prime $900,000 for its 50 percent interest in the platform’s replacement cost value, according to legal documents.
The insurers also paid Prime $225,000 (25 percent of the replacement cost value) for debris removal from the platform and $2.88 million for claims related to pipeline damage and debris removal, and well-redrill operations. That was the maximum amount recoverable, they said.
Arguing that its total expenses were “unambiguously covered” by its policy, Prime sued the insurers in Texas District Court for breach of contract. The court dismissed the case.
On appeal to the Court of Appeals for the First District of Texas, the underwriters again prevailed, as the court ruled on March 26 that the contested portions of the policy covered wells and costs to regain control of wells “which get out of control,” but not to restore the wells.
It also ruled that the policy conditions related to physical damage to the platform included removal of debris and not restoring it to its pre-damage state, disagreeing with Prime’s argument that restoration of the platform was necessary to restore the well to production.
Scorecard: The insurers did not have to pay $4.7 million for breach of contract, lost business opportunities, lost profits or attorneys’ fees.
Takeaway: Prime’s costs to refurbish the platform were not accepted as “proactive” efforts to prevent the well from getting out of control.
Insurer on Hook for Cargo Damage
On Dec. 22, 2006, a train derailment near Newberry Springs, Calif., damaged cargo that was being shipped from Ohio and Indiana to Australia.
A.P. MollerMaersk, which had agreed to transport the goods on a single shipping contract that covered the entire journey, had subcontracted with BNSF Railway Co. to transport the cargo by rail from Illinois to California, where it was to be loaded on a Maersk ship for the ocean voyage to Australia.
American Home Assurance Co. sued Maersk seeking to recover damages to the cargo, and Maersk sought indemnification from BNSF.
In 2011, a U.S. District Court ruled the Carmack Amendment, which covers liability of carriers under bills of lading, was the governing rule affecting the inland leg of the shipment, and in 2014, a court granted Maersk’s motion for a summary judgment.
American Home appealed. It argued that Maersk “assumed entire responsibility for the transportation of the cargo, and thus placed itself in the position that BNSF would have been had BNSF contracted directly” with the insurer.
The U.S. 2nd Circuit Court of Appeals ruled on March 25 that the lower court had properly interpreted the Carmack Amendment to determine that Maersk “is neither a rail carrier nor a freight forwarder and that Maersk did not agree to liability” under that amendment.
It also ruled that American Home could not argue the case on a contract claim, while on appeal, when previously it argued based on the Carmack Amendment.
Scorecard: The insurer could not recover damages from the ocean line.
Takeaway: Because American Home previously argued that the Carmack Amendment was the governing rule of the case, it had waived its right to later change to a contract-based argument.