How can risk managers persuade their boards to invest in risk engineering when money is tight? asks Tony Dowding

It’s not easy for risk managers to make the case for investing in risk engineering at the best of times. But in a downturn, when budgets are tight, cashflow is restricted, and belts everywhere are being tightened, it can become a major struggle. Risk management departments are being asked to make cost savings, and far too often, risk management is seen as an easy cost to cut.

However, there is also an opportunity for risk management at such a time. Controlling and mitigating risk can assume much greater importance during a downturn. The impact of losses on a company can be much greater when revenue and profits are down. Arguably, the case for action is stronger during difficult times.

A recent research report, “Risky Business - how to manage risk in the wake of the financial crisis” by recruitment consultants Whitehead Mann, surveyed more than 50 senior risk management professionals at FTSE 100 companies. The survey found that nearly 80% of risk professionals agreed that they have noticed a changed attitude in the past year in terms of how their organisation approaches the management of risk, and this was seen by the majority as a response to the tougher trading conditions and the credit crunch.

Nick Hedley, head of Whitehead Mann’s legal, governance and risk practice, commented: “The financial crisis and the subsequent sharp economic slowdown have raised profound questions about the way that companies assess and manage risk. Companies seeking to navigate through the current recession must put a premium on effective risk management.”

Making the case

So how do the professionals make the case for investment in risk engineering? Ian Canham, partner, corporate risk solutions, Lockton International, says, “The case for risk engineering in companies is really tied to the sustainability agenda and the fair expectation of shareholders and other stakeholders that the company will protect its value-producing assets, be they people, hardware or intellectual property. The simple case for risk engineering is, therefore, that it is the right thing to do, and management would be failing in their duties not to undertake such a process.”

He adds, “While the case for risk engineering is clear, the arguments around how to manage its cost, such as no insurance, self insurance, third party insurance with retentions or wholesale risk transfer to the insurance market, are less clear-cut. In any one year or cycle, market pricing will have a far greater impact on this decision than the risk engineering process itself. The binary nature of insurance placement, ie price beneficial one year and not the next, should not be confused with the risk exposure of a company over many years, where risk engineering plays its real role is in improving the exposure.”

Bob Randall, property consultant, Health Lambert Risk Management, says that there are very good reasons for investing in risk engineering. “There are, of course, long term insurance premium savings – the business becomes more marketable so that the more insurers you have interested in the risk, then the better the terms you can get,” he says. “Also, prevention is clearly better than cure, and there is a history of companies not actually recovering from a major loss despite having adequate insurance cover.”

Paul Hopkin, executive director, AIRMIC, says that he takes risk engineering quite specifically in the context of property protection, such as sprinklers, fire separation of buildings, and intruder alarms. “In that context, the benefit is more robust business continuity arrangements - that is why you should invest in risk engineering.”

Investing in the downturn

Any investment is likely to be more difficult in a downturn, and risk engineering is no exception, but it will depend on how the downturn has affected the particular company. If the downturn has resulted in the company experiencing cashflow difficulties, then any investment inevitably becomes more difficult.

“Downturns tend to produce a situation where an organisation may have excess capacity in which case they may have mothballed facilities or be running things on reduced capacity,” says Hopkin. “And in those circumstances, your continuity planning may be somewhat easier because if you lose one factory, you have capacity elsewhere that can pick it up.”

He adds, “The argument for risk engineering is just as strong, but whether organisations are willing to invest in it will depend on how robust they feel their continuity plans are, or indeed how robust they feel they need them to be if they have got overcapacity. The situation is very variable, depending on the industry, the mentality of the management of the company, how strapped it is for cash, how much its marketplace has fallen away. It is individual plans for individual circumstances.”

Graham Field, a director of elciem limited, an independent risk engineering consultancy, says that in a downturn many companies may not have the money to do the physical risk improvements that risk engineering has identified, but they often have the time: “Where production perhaps is not as full, factories are not as fully loaded, it is easier to get in to areas and perhaps do physical risk improvements, such as protection systems and the like.

“The wise organisations keep their risk engineering spend as level as possible so that where the opportunity arises, you have the time and the cash to do it. It then prepares you for the upturn, you have all the systems in place to protect your business and that gives you a business differentiator as well. Because when everyone is running at 100%, you are less likely to have the loss which means you are less likely to have to say to your customers that we can’t supply you.”

Canham agrees, pointing out that the need to protect key assets and people will become more important and will be tied directly to the company’s plans both for surviving the recession and benefiting from the upturn. “So once other cost saving initiatives have been taken, such as plant closures and headcount cuts, the investment in the risk engineering effort will become more, not less, important. Management should see it as part of the future growth of the business, not a cost of perpetuating the good times.”

Frazer Argyros-Farrell, senior consultant, Marsh, says it is a mixed picture and depends on the status of the company. “Larger companies seem to be pushing more and trying to get risk sorted out, whereas smaller and medium sized enterprises are less interested because it is a very quick and easy cut: ‘don’t bring someone in to find faults because it will cost you money’, so it is easier to leave it and put it on the back burner,” he says.

He points out that, unfortunately, there are a lot of companies out there that are just looking for a tick in the box for the risk assessment. “So you will give them the information about their problems, and where their liabilities and issues lie, and then they think they are covered, and they don’t take it that step further and actually deal with it,” he says.

It is clear that many companies are working within fairly restricted budgets, and some quite major risk improvements may have to wait until next year’s budget. The business case may simply be over-ridden by budgetary constraints.

The negative benefit

One of the great problems faced by risk managers and other risk professionals is the difficulty of proving the benefits of risk management investment in a direct, correlated manner. The benefits of risk engineering often show as a negative – in other words, no losses occurred, no claims were made. And it can be tempting for boards and management to think that this lack of claims may have happened anyway, rather than being the result of risk engineering.

As Randall explains, “It is very difficult for us to show what we may have stopped. There are occasionally examples where we have asked for something to be done, and it has prevented a loss, but it is very difficult to measure. For example, on the security side, we may ask a client to improve the locks and bolts, intruder alarms, CCTV and so on, and an attempted break-in may fail due to those additional precautions. This can be held up as a good example of something that we stopped happening. But it is always very difficult to say that we stopped a fire happening, or we stopped an arson attack on premises, just because we asked the client to move some pallets away from the building.”

AIRMIC’s Hopkin points to the growing focus on business continuity planning partly as a result of swine flu, and bad weather events such as flooding, and partly as a result of the British Standard published three years ago. “I believe that risk engineering, and protection of facilities, is something that organisations are more actively looking at. I’m not overly pessimistic that organisations have a much more negative view to risk engineering, I think there is a greater level of interest but it is driven more by business continuity plans rather than thinking that if we do this, we will have fewer claims.”

For some, the negative benefit is not enough – they need to see a return on the investment in risk engineering. Randall says that he believes that low capital expenditure items can be quick wins, particularly when dealing with insurer’s requirements.

But he acknowledges that it can be hard to quantify the savings: “One of the problems with a cost benefit analysis is that when you are asking people to spend a lot on something such as a sprinkler system, whilst you might know what the premium savings will be this year, because of the variability of the market cycles, it is very difficult to say that there will be a total payback within five or ten years. The client wants to know what the payback is and it is very difficult to measure that over a period of time. Sometimes there simply isn’t an answer,” he says.

Canham says that, ultimately, “no risk engineering process will eliminate risk and therefore claims. However, the recession is taking its toll and risk managers should not make the assumption that management know and understand the value of a risk management function. The case for risk engineering is the positive creation of a sustainable business not the negative stopping of losses as unfortunately, some may still occur.”

And risk engineering may quite simply allow companies to get the insurance they need. “In a downturn, insurers will be more selective in certain sectors about those they wish to insure,” says Field, “and the more organisations can demonstrate that they are still committed to risk improvements and risk management, the better they will be positioned to ride out premium increases and weather the insurance cycle better.”