CFO Magazine

Fear Factor

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Evidently Peabody's audit committee is pleased. "We've learned through this process not only the scope and breadth of risks inherent in the business, but also the various methods that management is using to effectively manage and balance those risks," says William Rusnack, chairman of the audit committee.

Still a Costly Process
The value of ERM must be balanced against its cost. Several third-party firms approached Peabody to facilitate the ERM process, not one of which quoted less than a $200,000 fee. Instead, Navarre decided to facilitate the process internally.

But even without a consultant, the process and infrastructure costs associated with uncovering material risks are significant. "You have to be more invasive within the organization, meaning that you have to ensure that each of the business units is examining its risks in a rigorous, well-defined, systematic way, as opposed to ad hoc oversight," says Terzuoli. "That costs money, since you have to put in place policies and procedures and then ensure that these are being complied with. Then you have to automate this process with an IT component, building a conduit from back-end legacy systems to capture risk-based data to provide risk transparency in a dynamic environment — a flow of information that typically is daily or at the very least weekly."

Fortunately the software tools to construct a dynamic ERM technology infrastructure already exist in package form, sold by vendors Hyperion, Cognos, and Active Strategy, among others. The tools identify the dozens of data elements that require ongoing monitoring, extract them from legacy systems, and gather them in one place, typically a data warehouse. The tools then create a conduit from the data warehouse to a front-end dashboard that alerts users when risks emerge. "Once tied together, the data may reveal, for example, a cash-flow surprise relative to market expectations," says Terzuoli.

The cost of a good back-end to front-end system, with all the hoopla in between? Another $500,000.

Seminole's Strategy
Cost concerns didn't stop Seminole Electric Cooperative Inc., a not-for-profit Tampa-based electrical generation and transmission cooperative with $714 million in 2002 revenues, from pursuing ERM. Seminole's strategic plan mandated a broad corporate-risk profile. "We needed to create a broad list of risks facing the company, not just the risks that executive staff had cited, but risks perceived by executives across all corporate lines," says Seminole vice president of financial services John Geeraerts.

To create it, Geeraerts and Timothy Rogers, manager of tax risk and property accounting, put together a fully fledged ERM strategy with assistance from London-based global insurance broker Willis Group Holdings. Like Peabody, they assembled a multi-departmental committee that included risk overseers from internal audit, tax, finance, and power-plant operations — roughly 8 people altogether. The committee wrote up a detailed questionnaire that was E-mailed to 110 other people in the organization asking them to identify and list risks in their individual areas of oversight, what Rogers calls "brainstorming across all corporate lines."

The process generated more than 60 defined risks, which the committee then boiled down to the top 25. Two workshops were held without executives, who were questioned separately. The goal was to drill down into each of the risks to determine what actions, if any, were being taken to mitigate them, and who was accountable for ensuring and monitoring these actions. "We wanted to know the probability of each risk causing financial harm, from both a frequency and a severity standpoint. [We also wanted to know] who was watching the store," explains Geeraerts.

Ultimately, the company was able to force-rank the five top risks challenging Seminole. Number one was electrical-generation capacity — the loss of a generating plant due to an unplanned or forced outage. The company evaluated factors such as tornadoes and terrorist incidents that would disrupt power supply or cause a unit to go down. The second-highest risk was loss of market, a concern given Seminole's status as a cooperative. Filling out the top five risks were the need to have an optimum mix of power resources to serve customers, fuel price volatility, and regulatory risks, such as the impact of potentially stricter environmental standards.

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