By Ryan Pratt and Allen Melton
It has long been espoused that companies must go global in order to expand meaningfully. And these days, the globalization of business is fueling the fires of growth in many companies.
But for many U.S.-based companies, expansion outside of the U.S. brings new and heightened risks. The 2012 Ernst & Young and Risk & Insurance Catastrophic Claims Survey looks at how and why companies are expanding globally, and ultimately how this expansion has affected their operational and financial responses when catastrophic loss occurs.
U.S. companies are frequently said to be expanding overseas to take advantage of lower costs in foreign markets. In some cases, companies are demonized for allegedly abandoning the U.S. labor force by opening operations abroad.
But the survey results point to quite a different reason for global expansion by U.S.-based companies. The survey questions explored the genesis of this globalization and the results indicated that only 20 percent of the respondents said their companies expanded due to cost considerations.
Figure 1 on Page 28 demonstrates that, more often, U.S. companies seek expansion to either access new markets or generate the type of growth that can only be achieved through developing markets with large populations, i.e. gaining new customers.
Beyond the question of why companies are expanding internationally is the question of how businesses are expanding. This is an important question, as it points to the level of risk that U.S. corporations are willing to take in foreign markets and how they weigh that risk against the opportunity of gaining access to those markets.
For example, in some countries, it may be possible to work with the local government to build manufacturing facilities, sales offices and corporate offices to effectively set up shop. In others, the only way to feasibly access the market may be to pursue a joint venture relationship, either due to regulatory and political limitations or simply to leverage an existing company's position in any given country.
Each of these courses of action can result in a very different risk exposure that a company must gauge against its risk appetite. Setting up physical operations and operating a wholly-owned subsidiary means risk of physical loss or damage, local labor and management risks, and greater go-to-market risk which may be somewhat mitigated by working with a partner that has an established in-country presence.
While it is possible to mitigate some of the above risk through a joint venture, an organization then opens itself to more contingent risks and less control of how the foreign business operates, depending on the level of control that the company has in the partnership.
Figure 2 on Page 28 shows how the respondents' companies achieved global expansion.
While 73 percent of those surveyed indicated that their companies have experienced some international expansion in the last 10 years, 74 percent of U.S.-based companies in the survey still generate more revenue from domestic sales versus international sales.
global expansion alters risks
As businesses reach across the globe for new customers and markets, their risk profile will undoubtedly change. New suppliers, business partners and vendors bring on a host of heightened risk scenarios that often result in companies thinking differently about how to mitigate and address those risks on an ongoing basis. In fact, over half of the survey respondents indicated that their companies have changed their approach to risk management as a result of the globalization of their business.
The question then becomes -- what effects will this have on a company's risk management department? Regardless of whether there is a more intense influence from corporate compliance or whether companies buy more or different insurance, in the end the assessment and mitigation of global risks will still fall on risk management departments.
The survey asked respondents to identify the greatest risks their companies face when expanding internationally and found that the greatest risk that companies face is their relationship with customers and suppliers. These results are illustrated in Figure 3.
Catastrophic loss and risks related to physical operations can be more easily addressed by simply expanding the global scope of a company's property policy to include new operations and geographies or increase the limits of insurance afforded to certain perils.
For example, a company with operations primarily located in the Southeast United States is keenly aware of the risks related to potential hurricanes and flooding. When that same company decides to expand by investing in physical operations in Asia, it not only has to potentially increase the limits of its insurance, it also faces much greater earthquake risk than it did prior to expansion.
Global expansion brings a new cast of vendors, suppliers and customers into play, and often it is decidedly more complex to assess and manage those relationships and the attendant risk of doing business in a foreign market. Uncertainties about the integrity and reliability of foreign suppliers can often lead companies to increase the corporate control over those relationships to try and mitigate risk and identify potentially problematic business partners. Through business continuity planning, companies will often identify and partner with multiple redundant resources dispersed geographically to guard against the supply chain damages that could result from catastrophe that affects a sizable geographic area.
The ultimate backstop in this situation is insurance coverage to address these indirect or contingent risks. There are a number of options to address supply chain risk via insurance.
The most common may be through a policyholder's property and time element coverage via an endorsement called Contingent Business Interruption and Contingent Extra Expense coverage. This coverage is more generally known and more common than it was even 10 years ago. In fact, nearly 60 percent of survey respondents were aware that their insurance program included some combination of contingent coverage. Where things tends to get murky is in the breadth of the coverage and whether or not it effectively and fully addresses a company's operational and supply chain risks.
Many insurance policies and endorsements are currently being tested to their limits given the number of major catastrophic events that have occurred in the last 18 months.
These incidents have not been limited to natural disasters but have included other risks such as political instability and corporate liability downfalls.
In fact, more than one-third of the survey respondents indicated that their non-U.S. operations had experienced a catastrophic event or loss in the last 10 years. These events ranged from natural and man-made disasters to global fraud and political events.
Response to Catastrophe
The survey further explored how companies respond to global catastrophes -- both operationally and financially -- to offer better insight into their risk management processes.
Operationally, it is apparent that U.S.-based companies are responding to foreign crises by utilizing local country resources led by U.S. management.
According to the survey, 64 percent of respondents indicated that their response to an international event was handled by a combination of U.S. and local company resources, while less than 25 percent of the companies allowed local partners or resources to address an issue on their own.
This oversight provides U.S. businesses with greater control and ultimately more confidence that the local business is acting in a timely manner to address issues and restore the business. In fact, those respondents that used both U.S. and local resources indicated that the incident was handled "effectively" or "very effectively" nearly 90 percent of the time.
From a financial perspective, the survey responses were strikingly similar. Approximately two-thirds of the catastrophic events discussed above resulted in a covered loss and a claim being pursued by the respondent companies.
For an idea of the type of claims that were filed, see Figure 4 on Page 28.
As the events varied in scope and intensity, so did the types of claims that were made -- with property and business interruption claims being the dominant outcome. While it is not surprising that property and business interruption claims make up the lion's share of the international claims, it is useful to note the other categories of coverage that may be available to policyholders as they assess and address their respective risks.
The primary theme from the 2012 survey is that while companies are striving to achieve significant growth through global expansion, they are keenly aware of the risks associated with new ventures, new operations and global relationships.
While it may be difficult to "touch and feel" those global enterprises, it does not mean that U.S. companies are ready and willing to completely turn over the reins to their international counterparts.
This played out in the results of this year's survey when respondents were asked to comment on the level of control afforded to foreign operations with respect to global claims.
More than 60 percent of the international claims were led by U.S. management with the assistance of in-country resources.
This demonstrates that while global expansion continues to be a priority for U.S. corporations, those same companies have not lost sight of the need for effective corporate oversight and governance in assessing, managing and mitigating risk on a global basis.
ALLEN MELTON is a partner with Ernst & Young. RYAN PRATT is a principal with the company.
July 24, 2012
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