Historically, risk management has mainly focused on protecting assets and maintaining business viability and the “bottom line” - tangible issues that could fairly readily be understood and quantified. Management of liability risk has, on the other hand, been rather ad hoc. It is only in recent years - with the increased profile of pollution exposure and the development of a more sophisticated approach to health and safety and protecting the employee “asset” - that the subject has received increased attention.
The liability exposures of the manager of any operation, whether it is an established production unit or a new project, are extensive. It is becoming ever more apparent that the potential impact of a substantial legal settlement on the bottom line of an operation can be significant. Public liability claims (for negligent acts or omissions and for environmental events) can reach millions of dollars, while high profile product liability claims in the United States have, not infrequently, been measured in hundreds of millions of dollars. It is a rare organisation that can take hits of this magnitude against its bottom line.
In the European Community (EC), harmonisation of legislation has helped to rationalise the situation. However, many member states have substantially different legal codes, the populace has different attitudes towards litigation and the countries are at different stages of legislative development.
The basic principles of risk management still apply to liability risks – identification, quantification, reduction and retention/transfer, as appropriate. The major difference from asset risks is that liability risks are much more difficult to quantify. Well-established procedures and routines exist for the objective valuation of property assets and the assessment of the impact on a business of asset destruction. The fact that the size of any liability settlement is closely linked to legal precedent in the jurisdiction in which action is brought makes similar assessment of liability more difficult and more subjective.
Freedom of movement and trade throughout the EC means that the risk manager must be aware of the legal nuances in member states. Aspects such as health and safety legislation, employment law, public liability, environmental law and the liability of directors and officers are likely to present common exposures, albeit with different approaches, across all member states.
If, however, any part of an operation involves the US, an entirely new dimension opens. Hardly surprisingly, the US does not recognise European law on US territory and expects anyone who operates in, or exports products to, the US to abide by US law. Contrary to popular belief, the US is a protectionist environment and foreign operators should not expect to be treated on a par with an equivalent domestic US operation. Who said life was fair, anyway?
The protection and insurance of cargo transportation across country boundaries is a truly European project which, apart from being very challenging, can be one of the most regulated. Different customs and insurance regulations, social and cultural attitudes to service, varying levels of crime and differing infrastructures present the risk manager with a complex task in arranging the most appropriate coverage to protect the cargo and his own insurance arrangements. As always, the safe arrival of the goods reflects upon the company, both its image and its future order book.
Risk managers dealing with cargo transits have a number of options:
If goods are to be shipped out of the European Union to eastern Europe and beyond, the transfer of ownership, including insurance at the border, may be a route to protect the insurance policy.
In some instances where a company wishes to portray and protect its image, tight control of the transport chain can be essential, including use of vehicles in own livery and handling claims on behalf of its clients. The programme would need to reflect this requirement, especially in the methods of claims settlements.
In developing a European marine cargo programme, the risk manager must be confident that his chosen insurer or claims service provider has a good branch network, experience of local regulations and the ability to issue local policies and settle claims locally, and that he is aware of all the transit risks, so he can keep parts of risk in his programme and pass other risks to his carriers or customers.
Construction and power generation
Whereas EU harmonisation of legislation is assisting risk management of general liability in Europe, the opposite applies in the power industry. In an expanding Europe, momentum for private partnership in the electricity market is gathering pace following the EU Electricity Directive 96/92 of 19 December, 1996.
Article 19 of this directive affords a progressive approach to the deregulation and privatisation of electricity generation and distribution in member states. In some countries, such as the Nordic states and Spain, liberalisation is now well advanced. In others, such as France, Germany, Italy and Greece, progress is protracted due to legal and other issues.
This is not to say that liberalisation has stabilised those power markets already privatised. In the United Kingdom, after approximately ten years of regulation under the electricity regulator (originally Offer, now Ofgem), further restructuring of electricity trading arrangements is taking place to encourage increased competition and make electricity pool trading more akin to the commodity market. The NETA/RETA (New Electricity/Revised Energy Trading Arrangements) are due to come into effect in November this year. Although tailored for the UK, they will be watched and fully analysed by all European generators and distributors as the days of public/state generators are numbered with ED 96/92 affording cross-border ownership and trading.
Needless to say, this new European-wide market for generators and distributors lays waste many previous risk management strategies. New theories and practices are now required to assess on an integrated basis each individual risk (the likelihood of an event taking place), be it market or technical. Typically, a single generator with nil transmission and distribution exposure often follows the risk model below, where the technical risk of plant and equipment remains central to the business risk of the marketplace, be it financial or economic.
However, the simple model of a single generator does not entirely represent the changes and trends in the electricity market. Generating companies are broadening their plant portfolio base across borders, utilising new energy sources, reducing manpower and continually up-dating technology, be it by refitting existing or the construction of new plant. In addition, reinsurers have to come to grips with the more traditional but changing aspects of manufacturers' risk and perceived changes to global climate, not to mention the volatility of electricity prices and generator profits.
Thus, management of risk and strategies developed to minimise the effects on the business has, taken on a new dimension and one that now has to determine what risk or combination of risks can be transferred, to what extent, to whom and at what cost. This integrated approach to the management of risk looks to the combination of insurance (asset protection), finite risk and derivatives (futures for fuel, forwards for currency) to provide the generating company in question with a reduction in risk and/or more resilience to a given level of risk.
Traditionally, the larger and more specialised power generation insurance companies have taken on board asset risk management by way of survey assessment to given standards or best engineering practices. Survey outcomes provide recommendations aimed at reducing risk and are usually qualified to investment cost versus perceived savings, remembering that a power generator will carry a proportion of the risk itself as monetary and time deductibles.
These trends and changes suggest that insurers must not only change with the industry but also take a more leading, proactive and interactive role in the management of risk. Adopting this approach will require working in partnership with generators to afford an understanding of the power industry and offer more accurate predictions of risk profile. The result should be a combination of traditional and advanced risk management strategies to afford complex and industry specific coverages, ie. loss indemnification to match the financial needs of the generating companies in a constantly changing electricity market.
Any manager/operator understands his own business (or should). He probably also understands the impact on that business of the legal, social and political environment of his native country of domicile. The challenge is to expand that knowledge into nine or ten other territories. An approach based upon individual territorial compliance may be valid in certain circumstances, ie. where the number of territories in which a company operates is limited. More often, however, a “best practice” approach, based upon adoption of the most onerous individual territorial requirements applied across all territories may be the safest strategy for the larger, more territorially diverse operations.
Eldred Clark is chief engineer, construction and power generation, Maurice Pullen is liability risk management consultant and Phil Skelton is senior transportation risk manager, ACE Europe.