CFO Magazine

Fear Factor

(continued)

A dollar number was ascribed to most risks, representing probability, frequency, and severity. All the risks were then assembled on a matrix. The final part of the process — a determination of risk-mitigation options and a process for monitoring risk-management compliance — is still under way. "For fuel price volatility, the option is a fuel hedging program; for the loss of power lines, the option is insurance; for the risk of terrorism, the option is elevating our security officer to senior staff level," notes Geeraerts.

Agricor's Granular Approach
Agricore United could tell both Peabody and Seminole a thing or two about ERM. The Winnipeg, Canada-based company initially went through the risk-identification phase in 1997, only to learn its risk-management focus was misplaced on more-transferable risks like a fire to a facility, rather than on the one major operational risk that could doom it, a reduction in grain volume.

Agricore's first step was to form a steering committee to identify and evaluate the major threats to earnings. More than 30 employees from all levels gathered in 1997 in one room at headquarters to identify the risks facing the company. This meeting was repeated earlier this year. "The world is a dynamic place and risks are constantly changing," says Peter Cox, CFO of Agricore, with $422 million (Canadian) in 2002 revenues. "It's much of the same thing with markets to transfer or mitigate risks. Nothing is static."

At the last outing, more than 30 areas of exposure were tabulated. In both years, the number-one risk was grain volume. "When a drought causes less grain to grow, we handle less grain volume, which depresses revenues accordingly," explains Cox. "Last year our revenues plunged almost 50 percent due to drought."

But Agricore went further than Peabody and Seminole to find a risk-mitigation solution to its primary risk problem. At first, the steering committee examined a weather-based financial instrument to hedge the grain-volume risk. But wide geographic regions in which grain is grown in Canada, and divergent weather patterns affecting each region, made such an instrument impossible to structure.

With help from its broker, Willis Group Solutions, Agricore assembled a unique risk-transfer program, combining nearly all its risks, including the grain-volume exposure, in a portfolio for transfer as a single block of risk to insurer The Citadel, which was reinsured by Swiss Reinsurance Co. of Canada. The losses from different risks would aggregate into an annual loss total that, if exceeding a prearranged dollar threshold, would result in an insurance payout.

A trigger for the grain-volume risk was built into the multiline insurance program, based on volumes reported by the Canadian Grain Commission, an independent body. The innovation was the fact that Agricore was able to transfer an operational risk to the insurance market that had never been transferred to insurers before.

When the novel three-year program expired at the end of 2002, Agricore sought to reinstate it. But back-to-back droughts and tightening terms, conditions, and premiums in the insurance market dissuaded Swiss Re, not to mention other reinsurers, from a similar deal. Yet Agricore again scored a unique contract, an insurance policy covering grain volume solely. The policy, bought from European International, a Swiss Re company based in Barbados, runs through July 2006, offering up to $25 million in coverage each year — minus an undisclosed deductible — and three-year coverage limits of $52.8 million. The payout is based on a simple formula that takes into account a five-year rolling average of industry grain volumes, Agricore's market share, and average profit margin per ton of grain handled.

Adding It Up
ERM has many proponents, but companies aren't exactly racing to install it. A survey of clients with at least $500 million in revenues conducted by KPMG found that only 28 percent had formal ERM programs, even though most of the same companies rated risk identification as their most important risk-management issue. Almost half the respondents (47 percent) without an ERM strategy stated they did not see the value proposition in ERM.

Readers' Comments

Comment on this article...