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Steve Yahn

Steve Yahn is a freelance writer based in Croton-on-Hudson, NY. He has more than 40 years of financial reporting and editing experience. He can be reached at riskletters@lrp.com.

Industry Risk Report

Hurdles Remain for Retailers

The economy, both domestically and globally, is one of the five top sources of risk for U.S. retailers.
By: | October 1, 2014 • 10 min read
10012014_03_risk_report_home_depot

Like other forward-thinking U.S. retailers, Wal-Mart is actively trying to find new ways to reach out to current and prospective customers.

“Wal-Mart is trying to bridge physical and digital, and help our customers get what they want, when they want it and how they want it,” Brian Monahan, vice president of marketing for Walmart.com, said at a recent e-commerce trade conference.

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Facing heightened competition as never before, retailers face major risks (as outlined in their Form 10-K filings with the U.S. Securities and Exchange Commission) as well as new opportunities.

Using that SEC data as well as surveys, reports and observations from experts, Risk & Insurance® has identified five top risks facing U.S. retailers in 2014.

1) The overall economy remains lackluster

Worries about general economic conditions rank as the No. 1 retailer concern, according to risk factors listed in the most recent 10-K filings of the 100 largest public U.S. retailers, compiled by BDO USA, a professional services firm. The economy was the top risk for the second straight year.

There appears to be light at the end of the tunnel, though.

Jan Hatzius, chief economist of global investment research at Goldman Sachs, observed: “We don’t think weakness in the first quarter was really representative of what’s going on economically. We actually are seeing clear acceleration in underlying growth both in the United States and Europe.”

BDO found that interest rates (80 percent) overtook fuel prices (74 percent) and unemployment (70 percent) as the most frequently cited general economic concern, for the first time in the study’s eight annual analyses.

While the slowly improving job market bodes well for retailers, it is heightening concerns that the Federal Reserve may move to increase interest rates after five years of historic lows.

“In addition to the potential impact on consumer spending and sales, retailers also express concern that changes in interest rates could impact their debt financing and pension plan assets,” the BDO report noted.

Al Ferrara, national director, retail and consumer products practice, BDO

Al Ferrara, national director, retail and consumer products practice, BDO

Al Ferrara, New York-based national director of the retail and consumer products practice at BDO, emphasized that he believed that the top general economic concern is $5 or more for a gallon of gas.

“If there’s anything that’s going to have an impact on Middle America, it’s the price of gas,” said Ferrara. “That just sucks money right out of the economy.”

Uncertainty about currency rate fluctuations is also a concern for global retailers.

According to Apple, demand for its products “could differ considerably as a result of currency fluctuations because the company generally raises prices on goods and services sold outside the United States to correspond with a strengthening of the U.S. dollar.”

Wal-Mart, the world’s largest retailer, noted that currency rate fluctuations negatively impacted its first-quarter financial results. The company said its net sales would have increased by 2.1 percent without currency rate fluctuations. With fluctuations, net sales were $1.6 billion lower.

The Kroger Co. grocery chain, one of the world’s largest retail chains, said volatility in the global economy has been due to uncertainties related to “energy prices, availability of credit, difficulties in the banking and financial services sectors, and the decline in the housing market, diminished market liquidity, low consumer confidence and high unemployment rates.”

As a result, consumers have become more cautious and have reduced spending and switched to less expensive mixes of products, it said.

“They also have been patronizing discounters and dollar stores to a greater extent, all of which has affected and could continue to affect our sales growth and earnings,” according to Kroger.

2) Inability to penetrate emerging markets

“Especially for Western companies, understanding emerging markets is an undeniable (but blatantly obvious) opportunity,” one retail panelist noted in an Ernst & Young LLP survey of top 10 risks facing the retail sector.

“The size of the global middle class is expected to triple between now and 2030,” said EY.

“Yet 29 percent of retail sector respondents to our global survey reported that their efforts to enter these markets had yet to produce any positive results,” according to EY.

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That may be compounded by the risks involved in such expansion, according to BDO’s survey.

Eight in 10 retailers cite international risks, including managing a dispersed workforce and complying with international laws and regulations such as the Foreign Corrupt Practices Act, the report noted.

Nonetheless, it noted that “many companies are also looking abroad for opportunities to introduce or expand their brand,” including the Gap and several teen apparel retailers, the report noted.

Big Box retailers are looking at smaller footprints in some markets to gain that crucial edge.

Big Box retailers are looking at smaller footprints in some markets to gain that crucial edge.

Amazon, the world’s largest online retailer, said that while it is rapidly and significantly expanding its global operations, including its product and service operations, the expansion increases the complexity of its business and places significant strain on its management, personnel, operational systems, technological performance, financial resources and internal financial control and reporting functions.

Amazon noted, “We may not be able to manage growth effectively, which could damage our reputation, limit our growth and negatively affect our operating results.”

However, Amazon added, “Our international activities are significant to our revenues and profits, and we plan to further expand internationally.”

3) Regulation and labor challenges

In its annual report, BDO noted that federal regulation remains top of mind for retailers, especially as the government considers data privacy and minimum wage legislation.

“At the same time, public retailers are also seeing regulators place increased scrutiny on internal controls,” the report said, with 87 percent of retailers noting concerns related to accounting standards and regulations, a significant increase from 2013 (69 percent) and the most in the report’s history.

Much of this pressure can be attributed to a renewed focus by companies, auditors and regulators on internal controls, including the new Committee of Sponsoring Organizations (COSO) internal control framework published in 2013

“The increasing costs and other effects of compliance with U.S. and overseas regulations affecting our workforce and our labor practices … ” are major concerns. — McDonald’s

McDonald’s also cited compliance as a concern, and noted it faced often conflicting standards imposed by local, state and federal authorities in the United States. Unsuccessfully complying with such regulations, it said, can adversely affect popular perceptions of its business and expose it to litigation or government investigations or proceedings.

“The increasing costs and other effects of compliance with U.S. and overseas regulations affecting our workforce and our labor practices, including regulations relating to wage and hour practices, workplace conditions, healthcare, immigration, retirement and other employee benefits and unlawful workplace discrimination” are major concerns, the company said.

At Kroger, a majority of the company’s 343,000 full- and part-time employees are covered by collective bargaining agreements negotiated with local unions affiliated with one of several different international unions. There are approximately 300 such agreements.

“These negotiations are challenging as the company seeks competitive cost structures in each market while meeting our associates’ needs for good wages and affordable healthcare,” the company said.

Prices of certain commodity products also affect government regulation and taxes, Costco noted.

“If there’s anything that’s going to have an impact on Middle America, it’s the price of gas. That just sucks money right out of the economy.” — Al Ferrara, national director, retail and consumer products practice, BDO

“They are subject to fluctuations arising from changes in domestic and international supply and demand, labor costs, competition, market fluctuation, government regulations, taxes and periodic delays in delivery,” the company said.

“Rapid and significant changes in commodity prices may affect our sales and profit margins,” it said.

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BDO’s Ferrara noted that as long as the borders are open, and U.S. retailers are free to sell as well to buy, retailers are generally satisfied.

“Some of this is a big concern because retailers want to get the message out to regulators that their business could be hurt if the government ever starts to constrain imports — there could be some real issues on the supply chain,” Ferrara said.

4) Supply chain failure

EY noted that the supply chain presents a significant opportunity for retailers to reduce inefficiencies and compete on cost, which is increasingly crucial as companies in low-growth consumer markets battle for market share.

However, EY’s survey noted that recent unprecedented events have highlighted the vulnerability to supply disruptions of companies in both the developed world and emerging markets.

“Some companies may elect to reverse some cost saving procedures to attain more supply chain control and flexibility,” EY said.

Supply chain is a dual-edged tool, according to Jefferies, a New York-based retail brokerage.

The firm noted that in contrast to investors’ fears, the supply chain may be accelerating Apple’s innovation “with more than the usual number of prototypes floating around.”

In contrast, Jefferies said, Costco faces deceleration in top-line growth due to tough comparisons, weak hardline sales, margin weakness on price investment and increased store cannibalization overseas.

Also, there are significant benefits to local sourcing of products, according to EY. “They are often healthier, fresher and more environmentally friendly.”

The Retail Industry Leaders Association (RILA) and other business organizations plan to focus on the growing role of global value chains in increasing the ability of American companies to compete in the global economy, while benefitting workers and consumers in the domestic market.

“Retailers are well aware of the critical role imports play in the American economy,” said Stephanie Lester, vice president of international trade at RILA. “For the sake of American competitiveness, U.S. trade policy should also acknowledge the value of imports and work with the global economy instead of against it,” she said.

Lester said numerous economic studies have shown that exports and imports are closely related, and that American workers can add substantial value to imported products through the use of improved global value chains.

One study, “Analyzing the Value Chain for Apparel Designed in the United States and Manufactured Overseas,” found that U.S. workers add more than two-thirds of the actual retail sales value of apparel manufactured overseas.

The study also found that the U.S. value-add translates directly into well-paying American jobs in areas such as research, design, logistics, compliance, distribution and customer service.

5) The e-commerce challenge

Home Depot acknowledges that it faces growing competition for consumers and installers of home improvement products from online building supply outlets and, to a lesser extent, other retailers.

“The success of our business depends in part on our ability to identify and respond promptly to evolving trends in the business,” the company added.

Stores magazine noted that of the top 100 retailers it surveyed “the biggest losers were those that didn’t offer much in the way of exciting merchandise or have much e-commerce to speak of, such as Target.”

E-commerce has saved the day for Best Buy over the past year. Online sales exploded for the electronics retailer during its fourth quarter, rising by 25 percent year-over-year. A big part of that acceleration came from the company’s ship-from-store program, a significant departure from past practice for the company.

Ditto for Wal-Mart. A significant differentiator for Wal-Mart’s in-store pickup for e-commerce orders is the pay-with-cash option, in which customers do not need a credit card or debit card to complete the transaction.

The popularity of tablets will also make an impact on the retail market, as more retailers from furniture shops to airlines equip their sales forces with such tools.

Retailers are also increasingly using tablets to transform the in-store experience, giving consumers access to products not on display and managing long lines by allowing customers to designate purchases for home delivery, according to Deloitte.

“Some retailers are even making their own tablets, thereby increasing the number of touch-points that consumers have with the brand,” Deloitte said.

“As the tablet market fragments, consumer businesses will be required to analyze the data on their customers who shop via tablet in more detail,” according to Deloitte.

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Mary Brett Whitfield, senior vice president at Kantar research firm, said that technology’s spread — specifically web and social media usage — has completely changed the availability of almost every type of information.

“The resulting changes in shopping behavior have intensified efforts to understand how shoppers have incorporated digital tools and technologies into shopping routines, and now, as smart phones and tablets permeate the environment, the horizon of retail opportunity has just moved again,” Whitfield observed.

Steve Yahn is a freelance writer based in Croton-on-Hudson, NY. He has more than 40 years of financial reporting and editing experience. He can be reached at riskletters@lrp.com.
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Insurance Industry

M&A Activity Moving Offshore

The historic domination by the U.S. for M&A activity in the insurance industry has slipped.
By: | September 30, 2014 • 5 min read
Mergers

As with many other aspects of economic activity, mergers and acquisitions are moving offshore.

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The historic domination of the United States in terms of the overall share of M&A activity in the insurance industry has slipped, as Europe moved into the front-runner position in the volume of transactions completed, according to the latest report from international law firm Clyde & Co.

The United States’ dominion in M&As is “an entirely natural consequence given the size and maturity of the world’s largest re/insurance market,” the report noted.

However, in the last 12 months, there has been a reversal. From July 2013 to June 2014, there were 139 transactions in Europe, up from 123, while in the U.S., there was a drop from 113 to 97.

Mergers_DougMaagDoug Maag, a New York-based partner of the firm, said: “Contributing factors to this downward trend in the U.S. appear to include differing buyer/seller perceptions of company value, ongoing regulatory uncertainty, the uncertain economic outlook, and some company’s preference to reinvest excess capital into the business or to satisfy shareholders with stock buybacks and dividends”

The reversal may not be a long-term trend, Maag said.

“It remains to be seen whether Europe will retain that lead, of course, particularly given regional challenges posed by unrest in Ukraine and sanctions against Russia,” he said.

Regulatory Concerns

The U.S. has its own set of challenges, Maag said.

“Questions continue about the durability of the global economic recovery,” he said. “Private-sector uncertainty is a natural byproduct of the political logjam in Washington, which has now persisted for a very long time.”

Also, some insurers have to worry about the prospect of being designated as a Systematically Important Financial Institution (SIFI), he said.

“Large insurance companies that do not qualify for SIFI designation now may, by virtue of an acquisition, change their profile in a way that causes them to become so designated,” Maag said. “If that happens, the insurer becomes subject to heightened levels of supervision and regulation, and possibly to enhanced capital requirements.”

But on the positive side, it could all change, and quickly, Maag said.

“With a single quarter of particularly bright economic indicators or a meaningful breakthrough in the political logjam, risk appetite could return with a vengeance,” he said. “I do think this will happen but the question is when.”

“GDP growth is particularly critical in stimulating or dampening M&A,” Maag said. “The consistent rise in the U.S. stock markets over the last 12 months may lead firms to conclude that valuations are back at levels at which they would consider sale, and, therefore, increase the number of management teams willing to consider an offer,” he said.

The faster than expected growth in U.S. GDP in the second quarter of 2014 may also signal a return to a macro-economic environment that could stimulate expansion through M&A, he said.

Looking for Returns

Probably the most powerful trigger for M&A activity in the coming year is the excess capital overhanging the sector, said Andrew Holderness, global head of corporate insurance for London-based Clyde & Co.

“In the absence of a catastrophic event causing significant balance sheet damage, and with rates having trended downward steadily over the last couple of years, re/insurers have become even more active in their search for alternative strategies.” — Andrew Holderness, global head of corporate insurance, Clyde & Co.

“Shareholders are looking for decent returns on their investments and, if management cannot deliver this operationally then there will be pressure either to return it or deploy it elsewhere,” said Holderness.

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“The key challenge is for those companies that cannot demonstrate underwriting excellence or are unable to scale up and move into different markets to acquire new business,” he said.

“In the absence of a catastrophic event causing significant balance sheet damage, and with rates having trended downward steadily over the last couple of years, re/insurers have become even more active in their search for alternative strategies.”

In addition, Holderness said, size appears to be becoming increasingly important — with balance sheet strength seen as being critical to clients, he said.

“If this is the case, then strategic mergers and acquisitions will be driven by the desire to reach optimal scale and relevance,” he said.

Regional Highlights

Here are highlights of region-by-region reports, based on data supplied by Thomson Reuters financial services.

­­­• Asia Pacific

In the last few years, in contrast to other regions around the world, the volume of M&A activity in the insurance industry sector in Asia Pacific has remained comparatively steady.

This pattern continued from July 2013 to June 2014, with an uptick in deals in the second six months. Overall, across the 12-month period, the number of transactions reached 60, compared to 66 in the previous year and the region accounted for 18 percent of deals on a global basis.

“Government liberalization moves will drive M&A activity in India,” said Vineet Anjela in Clyde & Co.’s New Delhi office.

“Interest in M&A in Indonesia is set to rise,” said Ian Stewart of the firm’s Singapore office. “This is a stand-out market in a region that offers promising growth.”

Dean Carrigan of the firm’s Sydney office noted: “We expect some consolidation in Australia to take place between small independent broking groups.”

• Middle East and Africa

The Middle East and Africa span a range of markets at different stages of development both economically and in terms of the insurance industry.

Overall, the number of insurance industry M&A transactions has risen to 17 in the period from June 2013 to July 2013, compared to 7 in the prior year.

However, while activity in the Gulf Cooperative Council (GCC) has been limited, emerging economies such as Turkey and Morocco have seen a number of deals, and a significant spike in transactions elsewhere in Africa suggests that the insurance industry could be waking up to the continent’s huge potential.

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“We are seeing a surge of interest from overseas in starting up reinsurance operations in the Dubai International Financial Centre,” said Dubai-based Wayne Jones of Clyde & Co.

• Latin America

The last year has seen a range of economic and political factors impacting a number of countries in Latin America, many of which could have acted as a brake on M&A activity.

Despite this, the region has seen a spate of deals from July 2013 to June 2014. There were 16 transactions in the period across the region, compared to 20 in the previous 12 months.

“We are seeing Latin America playing with the scale, expertise and ambition to look beyond their national borders for opportunities,” said Sao Paulo-based Stirling Leech of Clyde & Co. “A number of U.S.-based insurers, in particular, are looking to establish or strengthen a presence in the region.”

• Bermuda

While the overall volume of deal activity has not increased sharply this year, it is likely the market is reaching a tipping point at which more M&A activity will occur, Clyde & Co. said.

Steve Yahn is a freelance writer based in Croton-on-Hudson, NY. He has more than 40 years of financial reporting and editing experience. He can be reached at riskletters@lrp.com.
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2014 Risk All Star: Richard Pcihoda

Crisis Management Coordination

Hurricane Sandy hit Jersey City, N.J., hard in 2012, but thanks to four days of intensive advanced planning, PREIT Services LLC’s Director of Risk Management Richard Pcihoda and his team were able to get a reconstruction crew deployed at its Hudson Mall the morning after the storm struck.

“The night before the storm was underway, we had continuous communication with all of our properties in the mall and our service providers,” said Pcihoda. “We also had a command group that stayed here in Philadelphia within the corporate office overnight.”

Richard Pcihoda, director of risk management, PREIT Services LLC

Richard Pcihoda, director of risk management, PREIT Services LLC

Once the storm struck, it was important to have someone in a forward position who could relay information back, Pcihoda said.

“I immediately jumped in my truck and ran up to Jersey City and got there early enough in the day that a lot of people were still hunkered down from the night before,” Pcihoda said. “I was there in advance of formal travel bans.”

By the time community panic grew, about 18 hours later, PREIT had a truckload of fuel on-site, and dumpsters, food and sanitation facilities in place, Pcihoda said. Remediation work began within 72 hours.

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In the end, the mall suffered millions of dollars of damage, but because of the advance planning and swift set-up, PREIT was able to reopen the Hudson Mall 17 days after Hurricane Sandy made landfall.

An enormous amount of construction was completed in that period, via a trusted vendor with whom PREIT, a real estate investment trust specializing in differentiated shopping malls, had extensive prior dealings.

As a result, the mall and its tenants had a successful holiday season.

Michael Tiagwad, president and COO of Conner Strong and Buckelew, PREIT’s insurance broker, said Pcihoda is “very big on preparedness and anticipating issues and problems, and having a game plan and how to deal with a variety of situations.”

“I’d say, in general, Richard is a consummate risk manager. He has experience with all sorts of risks and exposures.

“He also has a very deep background in safety and claims,” Tiagwad added. “So he really is diverse in terms of his skills. He’s a good quarterback and he is a very engaged person, very proactive.”

PREIT’s insurance claim proceeded swiftly and smoothly, with Pcihoda coordinating with the national flood insurance program as well as PREIT’s property carrier, Fireman’s Fund.

Fireman’s provided a senior adjuster with whom Pcihoda had worked with in the past, and the 10-year relationship paid off nicely.

There was also a public adjuster to help catalog the damages, and handle a massive documentation effort, which freed Pcihoda and his team to focus on recovery.

Pamela Hans, managing shareholder in the Philadelphia office of Anderson Kill P.C., and PREIT’s insurance coverage counsel, said the business income loss at the mall was much smaller than anticipated.

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The large upfront investment in reconstruction, facilitated by prompt advances from the insurance company, paid off for all parties in the form of a smaller long-term loss and claim, Hans said.

The claim was completed and paid in full by May 2014, a tight timeframe for a claim of that scale, she said.

Responsibility Leader

Richard is also being recognized as a 2014 Responsibility Leader.

Running to the Fight

Maybe it’s his history in emergency management and current service as a volunteer firefighter that gives Richard Pcihoda the reflexes to run to the fight, because that is what he did as Superstorm Sandy threatened in October of 2012.

Not only did Pcihoda conduct the necessary planning and preparation to reduce his own company’s business interruption, he went out of his way to counsel his company’s Jersey City (N.J.) Hudson Mall tenants on coverage and recovery methods after the mall suffered millions in damage.Pcihoda, the director of risk management for the Pennsylvania Real Estate Investment Trust, based in Philadelphia, wasn’t the only risk manager whose job got a lot tougher when Sandy hit, but it looks like he outperformed many of his contemporaries.

Pcihoda looked at the whole picture and acted on it. The day after the storm struck, Pcihoda jumped in his truck and drove to Jersey City, getting there before formal travel bans were in place to jump start the recovery process.

He had his contractors in place ahead of the storm to get a jump on reconstruction. He had the adjuster relationships to pull it together seamlessly.
Pcihoda is a Risk All Star because he possesses passion, creativity and perseverance. He’s a Responsibility Leader® because through his actions, he shows others how it’s done.

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350px_allstarRisk All Stars stand out from their peers by overcoming challenges through exceptional problem solving, creativity, perseverance and/or passion.

See the complete list of 2014 Risk All Stars.

Responsibility Leaders overcome obstacles by doing the right thing over the easy thing to find  practical solutions that benefit their co-workers and community.

Read more about the 2014 Responsibility Leaders.

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