risk management in the boardroom - foley & lardner · 7. use of sophisticated quantification...

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Risk Management in the Boardroom

February 10, 2010


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Today’s PresentersModerators

John Landis PartnerFoley & Lardner LLPAnn GaritiManaging Director of SalesAon Risk Services

PanelistsCorina MonaghanVice President, Political Risk PracticeAon Risk ServicesSteve ShappellManaging Director and National D&O Product LeaderAon Financial Services GroupLaura TaylorManaging Director, Enterprise Risk Management Global Practice LeaderAon Global Risk ConsultingRick FunstonPrincipalDeloitte & Touche LLP


Agenda

Enterprise Risk Management UpdateInternational D&O Insurance TrendsPolitical Risk


Enterprise Risk Management Update


Current ERM Landscape

Risk “bar” is getting higher and higher for Board members, executives and other stakeholdersMultiple recent examples of risk issues: Toyota and the FI sector meltdownExternal stakeholders expect more integrated risk managementERM maturity levels are increasingNew SEC disclosure rules and S&P focus on ERM for non-FIs driving discussions with CEOs, CFO’s and Treasurers


Examples of Enterprise RisksBrand / Reputation

PartnershipsSocial / Ethical

Corporate Social ResponsibilitySocial / Demographic Change

Public HealthCompetitors

Mergers and AcquisitionsTrends/Fashion

Research/Development

ManufacturingSupply ChainProduct RecallWeatherEnergyWater AvailabilityShipping / TransportIndustrial ActionProduction CapacityExplosion / DisasterPandemic

Confusion Over Regulatory ProtectionsCopyright InfringementRegulatory ChangeLegal ComplianceCorruptionLicensingNon-Admitted InsuranceIntellectual Property

Debt ManagementForeign Exchange

CreditContractual Liabilities

LawsuitsProduct Recall

TaxationMarket Volatility

Operational

Regulatory

Strategic

Financial


ERM Programs are Maturing

Source: Aon’s 2010 Global Enterprise Risk Management Survey


Prime Drivers of ERM Implementation



Success in Driving Value



What Gets in the Way?



Hallmarks of Advanced ERM ApproachERM Hallmarks

1. Board-level commitment to ERM as a critical framework for successful decision making and for driving value

2. A dedicated risk executive in a senior level position who drives and facilitates the ERM process

3. An ERM culture that encourages full engagement and accountability at all levels of the organization

4. Engagement of all stakeholders in risk management strategy development and policy setting

5. Transparency of risk communication

6. Integration of financial and operational risk information into decision making

7. Use of sophisticated quantification methods to understand risk and demonstrate added value through risk management

8. Identification of new and emerging risks using internal data as well as information from external providers

9. A move from focusing on risk avoidance and mitigation to leveraging risk and risk management options to extract value



Directors and Executives Are Asking For HelpHelp us:– Find the unexpected before it finds us– Become more proactive– Change the way we think about risk and reward– Develop the necessary skills, processes and tools that are targeted,

practical, simple and non-bureaucratic– Build a repeatable & sustainable process into the way we do business– Leverage our strengths and culture– Take it one step at a time - don’t boil the ocean– Improve the transparency of risk management for the board and key

stakeholders (e.g., shareholders, regulators, rating agencies)


10 Enterprise Risk Intelligence Skills1. Check your assumptions at the door2. Maintain constant vigilance3. Factor in velocity and momentum4. Make the key connections 5. Anticipate potential causes of failure6. Verify sources and corroborate information7. Maintain an acceptable margin of safety8. Set your enterprise time horizons9. Dare to take enough of the right risks10. Sustain operational discipline


International D&O Coverage Trends and Risks to Directors and Officers


2009 Non-U.S. Claims Brought Against Directors and OfficersOne important factor to consider when deciding whether to purchase D&O insurance abroad is the frequency of D&O claims outside the United States. In order to assist clients with their purchasing decisions, Aon has been tracking D&O claims outside the United States since 2007. The claims information gathered comes from both publicly known sources and from Aon brokers around the globe.

In 2009 there were a total of 283 civil, criminal or regulatory actions against directors & officers. This is a significant factor when you consider that this number has more than doubled since 2007.

2009 D&O Actions Outside the U.S.

01020304050607080

Argentina

Australia

Austria

Azerbijan

Bangledesh

Belgium

Brazil

Canada

Chile

China

Cyprus

EgyptFinlandFranceG

ermany

Hong K

ongH

ungaryIcelandIndiaIndonesiaIrelandIsraelItalyJapanK

azakstanLuxem

bourM

alaysiaM

exicoM

oldovaN

. IrelandN

etherlandsN

ewN

igeriaPakistanPolandR

ussiaS. A

fricaS. K

oreaSaudiScotlandSingaporeSlovakiaSpainSri LankaSw

itzerlandTaiw

anTurks &U

gandaU

kraineU

AE

United

Venezuala


2009 Non-U.S. Claims Brought Against Directors and Officers, cont’d.In 2007, Aon counted a total of 134 actions against D&Os in 30 countries as compared to 2009 where there were 283 actions in 50+ countries.

2009 Regions - D&O Actions Outside the U.S.

5% 5%

31%

22%

12%

25%

LATINAMERICAAFRICA

ASIA

EUROPE

N.AMERICA

OCEANIA

0

5 0

1 0 0

1 5 0

2 0 0

2 5 0

3 0 0

2 0 0 72 0 0 8

2 0 0 9


2009 Non-U.S. Claims Brought Against Directors and Officers, cont’d.

In narrowing D&O actions by industry, it is not surprising that the Financial sector experiences the greatest degree of activity. However, as in the past, there is a significant percentage of the D&O actions coming from the Oil and Gas industry. The obvious connection between these two sectors is that they are both highly regulated.

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2009 D&O Actions Outside the U.S. by Sector


Why May Local Country Policies Be Appropriate?1. Non-admitted insurance is problematic in many countries (137 as researched by Aon,

partial listing below).

2. Claim activity is growing against directors and officers outside of the U.S. Aon tracked over 283 non-U.S. claims in 2009 in all regions of the world.

3. Increased personal risk despite lesser claim activity: A larger percentage of claims are non-indemnifiable outside the U.S. since indemnification protections are more limited or non-existent. Therefore, if a loss were to occur in a jurisdiction where legal or regulatory requirements prohibit the insurer from paying a claim, and corporate indemnification is not permitted, or limited, the directors, officers, managers or employees could find their personal assets at risk.

Puerto RicoRussiaSouth AfricaSpainSwitzerlandTaiwanTurkeyUruguayVenezuela

GuatemalaHungaryIndiaIrelandItalyJapanKoreaMexicoPanama

ArgentinaBrazilChileChinaCzech RepublicEcuadorFranceGermanyGreece

So, while the overall risk of claim is far less than for the parent company directors and officers (where the subsidiary is wholly owned and not publicly traded), and applicable claim examples are few, the actual risk of Loss from such (less frequent) claim being non-indemnifiable is, or may be, far higher.


International Indemnification LawLack of Legal Clarity:

– The law in many countries is unclear regarding indemnification of directors and officers. Of the 100+ countries researched by Aon, approximately 1/3 of those countries do not have laws that address indemnification.

– In the countries that do have indemnification laws, the protections are typically much narrower than those in the U.S.

– Some countries allow for exemption of liability rather than indemnification.

No law on indemnification

Law permits exemption from liability

Indemnification narrower than permitted in the U.S.8%

39%53%


How to Respond to an Indemnifiable International Loss*

Scenario 1 – Indemnifiable Loss

Company indemnifies the

Insured Persons; Company funds loss from company balance sheet

Company (HQ: USA)

Ireland(Non-admitted insurance

not permissible; Limited corporate indemnification)

*Assumes the Captive is for Side A D&O claim only


How to Respond to a Non-Indemnifiable International Loss*

Scenario 2 – Non-Indemnifiable LossNeither Parent Company nor the Subsidiary Company may

indemnify the Insured Persons…

Company may not pay the Loss to or on

behalf of the Insured Person

Note: Where the Subsidiary Insured Person is a U.S. citizen residing in the U.S. or having a U.S. bank account, we believe that the insurer could (or must endeavor) to pay the Loss in the U.S. (or other country of residence/citizenship where non-admitted insurance is permissible.)

Company (HQ: USA)

*Assumes the Captive is for Side A D&O claim only

Ireland(Non-admitted insurance

not permissible; Limited corporate indemnification)

Captive program


FactsSignificant D&O exposures no longer limited to the U.S.Recent legislative and regulatory developments, in addition to large settlements outside the U.S., require companies with foreign operations to re-assess D&O exposures and related insurance coverage issuesA growing number of companies have enacted legislation allowing shareholders to file unified claims seeking damages from investment lossesMulti-national companies more aware of exposures and the need for D&O programs that meet the local regulations of foreign jurisdictionsThe local and financial responsibility laws and qualifications of many countries may require a locally admitted policy thereby increasing the potential exposure for multinationals choosing not to purchase admitted insuranceCorporate governance rules and SOX type regulations in foreign jurisdictions have become tougher


TerminologyMaster Policy (or program where multiple layers exist)– A policy issued to the parent company inclusive of coverage for its subsidiaries (as defined).

Generally coverage is intended to be global—meaning the policy addresses claims brought anywhere in the world relative to the company's operations and defined insureds wherever located in the world—where such coverage is permissible. In the U.S. marketplace, this is generally thought of as a U.S. headquartered parent company. In reality, the issue of non-admitted insurance applicability has relevance to all multi-national companies, regardless of where their headquarters are located.

Non-admitted Insurance– A non-admitted policy is issued by an insurance company in a country in which it is not

licensed and/or a country outside of the risk's domicile. (Advantages of this include absolute control over coverage terms and insurance buying decisions, lower costs, and accelerated implementation.) The challenges associated with these programs are the inverse of those experienced with admitted insurance, namely: non-compliance with local laws and possible country penalties (i.e. fines) as a result; no access to government pools; tax liability for non-compliance and for repatriating claims payments; no local premium allocations; no certificates of insurance; and the insurers' position on non-admitted coverages in countries where it is not permissible varies.


Terminology, cont’d.Local Policy(ies)– A policy issued to an organization domiciled in one country that is a subsidiary of a

parent company domiciled in another country. The policy is issued by an insurer admitted in the subsidiary's country of domicile. (In some cases the admitted insurer is a "fronting company" and is wholly reinsured by a non-admitted insurer.)

EU and EEA– EU refers to the 27 European Union countries. Those countries include: Austria,

Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and the United Kingdom. EEA refers to the European Economic Area and includes Iceland, Norway, and Liechtenstein.

Freedom of Services Policy ("FoS")– A single policy to address multiple EU or EEA countries in accordance with the Freedom

of Services Directive, which includes the freedom to provide insurance services, such as the provision of coverage by an insurer established in one Member State to a risk situated in another Member State, regardless of where the policyholder is resident or established.


Generalities for All CountriesApplicable legal/regulatory authority– Relative to the business of insurance

Is non-admitted insurance problematic?– Potential responses are Yes or No. A “Yes” response (where

problematic due to law or considerable insurer penalty or Tax implication), suggests that a local/admitted policy may be beneficial toward securing a loss payment.

Insurers capable of providing a D&O management liability policy in the local country – The listing is (currently) limited to potential Master policy

insurers for U.S.-based parent companies for consideration of purchasing local/admitted coverage on a tied-in Limit basis.


Generalities for All Countries, cont’d.Indemnifiability ratings– None

Assigned when the law does not reference indemnification

– Not permittedAssigned where the law does not permit indemnification

– Generally not permittedAssigned when there are only limited circumstances in which indemnification is permissible

– LimitedAssigned when indemnification is permitted, but materially more limited than that typical in the U.S.

– UndeterminedAssigned when the research has not been conducted, typically due to ongoing research or because there is no version of the applicable law in English

– Full (most favorable)Assigned when indemnification is permitted to a degree materially the same as in the U.S.


Generalities for All Countries, cont’d.Penalties – Potential ratings imposed upon insureds purchasing non-admitted

insurance (subjective and based solely upon impact for client, not insurer or broker). Where the liable party is not clearly stated (i.e., "any person"), it is presumed the client may be so liable.

None (most favorable)– When research has been conduct and no penalty is identifiable. Subjective rating

based solely upon impact for the client and not the insurer or brokerSevere– If there is a financial penalty only

Moderate– If the potential penalty includes imprisonment, or a very substantial financial

penalty or cancellation of the policyUndetermined– When research is not conducted (typically because it is ongoing or because there

is no version of the applicable law in English)


Generalities for All Countries, cont’d.Penalties (continued)– Potential ratings imposed on the insurer and/or broker for placing or

transacting non-admitted insurance (subjective and based solely upon impact for the insurer or broker)

Severe– If the potential penalty includes imprisonment, thus explaining an

insurer's unwillingness to pay a claim into these countries where an admitted policy is required

Moderate– If there is a financial penalty only

Undetermined– When research is not conducted (typically because it is ongoing or

because there is no version of the applicable law in English)


Generalities for All Countries, cont’d.Risk of D&O Claim – Potential ratings (subjective and based on tracking of

publicly known D&O claims globally relative to other non-U.S. countries):

Low (most favorable)– Few or no claims

Medium– Sporadic claim activity

High– Consistent multiple claims

NOTE: In many countries, such claims are not publicly disclosed and they may even be treated as confidential. Generally, if rated relative to U.S. claim activity, most countries would be rated Low or None.


Doing Business In Emerging Markets -“Short” Guide to Political Risks and

Insurance


Aon Political & Economic Risk Map 2010Movements on the 2010 Map

Nine countries have been upgraded to a lower risk level: Albania, Myanmar/Burma, Hong Kong, Colombia, South Africa, Sri Lanka, East Timor, Vanuatu and Vietnam

Eighteen countries have seen conditions worsen leading to a downgrade: Algeria, Argentina, El Salvador, Equatorial Guinea, Ghana, Honduras, Kazakhstan, Latvia, Madagascar, Mauritania, Philippines, Puerto Rico, Seychelles, Sudan, United Arab Emirates, Ukraine, Venezuela and Yemen

Sudan, Venezuela and Yemen have been added to the Very High category, joining Afghanistan, Congo DRC, Iran, Iraq, North Korea, Somalia and Zimbabwe


Change is Good

“Without risk-taking there is no change; without change there is no growth; and without growth, we don’t create wealth.”

- Fred Steingraber, CEO of A.T. Kearney, in a speech to the Indiana Graduate School of Business


Globalization

Over the next 10 - 20 years, economic power will shift from developed to developing nations– GDP of developing nations represents 40% of World’s

GDP; this will grow to 65% in 10 years– By 2020, China’s GDP will surpass that of the U.S.

GDP from Foreign Trade (including Foreign Direct Investment) represents 48% of World GDP


Balance Sheet – Political RisksHost Government expropriates company assets to benefit the "people"Host Government nationalizes industryHost Government freezes Investor’s bank accountBuyer/borrower cannot pay under contract terms because of political risks causing a loss to balance sheet or non-performing loanThe concession agreement is handed to local competitor by host governmentInvestor is prohibited from exporting because an export license is not issuedInvestor is required by the US Government to leave host countryThe host Government imposes regulation which selectively restricts the operation of the investor causing a permanent inability to do business


Balance Sheet – Political RisksChanges its constitution in regards to how foreign investors’ revenue is treated in the host countryGovernment actions that are popular during tough economic times include arbitrary changes in contracts Local civil unrest may cause significant property damage, terrorist groups such as FARC attacks mining equipmentVenezuela and Colombia engage in war Rebellion occurs as poverty increases in Host Country. Population feels that its only outlet for frustration is to destroy mining assetsHost Country has an economic crisis that shrinks its hard currency reserves and local bank is not able to convert local currency into U.S. dollars. Or local bank is not able to wire US dollars back to U.S.Host Country declares a moratorium on debtGovernment and/or other state entity takes a quasi-commercial action and investor suffers a partial loss due to contractual breach


Balance Sheet – Political Risk Insurance -Features

Non-Cancellable Insurance Policy for up three, five, ten yearsRate is fixed at the inception of the policy, does not change no matter how much the situation deterioratesBetter to purchase insurance when the country is considered a moderate riskOnce the country is ‘high risk’ it is difficult to purchase insurance. Companies that purchased PRI prior to expropriations in Venezuela benefited from the insurance policy.Policy can cover equity and debtLender may require that insurance is purchased when the borrowing entity is in an emerging market


P & L: Greater Interdependence – Supply Chain

To succeed in this new more intensely competitive environment, companies are operating as a single process from original source to consumer, sharing information to speed the flow of goodsThis integrated supply chain creates greater interdependency and ‘new’ exposures such as political risk


P & L - Trade Disruption - Political RisksCovers loss of gross profit for up to 12 Months which consists of:– Business interruption losses– Extra costs & expenses

Loss of profit/Extra Expense would be calculated on a pre-agreed formula or limit to cover– Costs to relocate the project including:

Additional cost to hire equivalent staff in the US or another countryAdditional technology costs for purchase of relevant equipmentAll other ancillary costs and extra expenses

– Covering losses from political & economic exposures such asConfiscation, Expropriation, and Nationalization (CEN) of the local providerActs of Political Violence, including War/Civil War, InsurrectionStrikes, Riots, Terrorism, and Civil Commotion (Physical loss is not required as the Proximate Cause of Loss)


Who Buys PRI?

CorporatesManufacturersLenders (ie Commercial Banks)Private Equity FundsHedge FundsTraders


Who Underwrites PRI?

Multilateral Agencies (MIGA)Export Credit Agencies (ECA’s)Private Insurers…..


Why Buy Political Risk Insurance ?Balance sheet protection– Protect Income stream and shareholder value, assets overseas and protect

against losses that are unpredictable, typically low frequency / high severity, and potentially disruptive to company earnings

Corporate governance – Sarbanes Oxley, Protecting shareholder value

Hedge against emerging market volatility

P & L protection – Protect against loss of profit and extra expense

Facilitate (and potentially increase) lending in emerging markets– Reduce country / borrower exposures by shifting risk

Reduce D&O premiums

Improve transaction ratings (Capital Market Bonds - Rule 144a)


Program Options

Single situation – investment / countryMulti-countryFirst LossExcess of LossPre-agreed selection of countriesReinstatementsCaptive structures available


Questions & Answers


Save the date for upcoming NDI Web Conference Series programs:

February 24, 2010Investor Relations Issues

March 10, 2010The Evolving Role of the Chief Legal Officer

March 24, 2010Nonprofit Corporate Governance

April 7, 2010Global Climate: Heating Up the Boardroom

April 21, 2010Trends in the Recruitment and Selection of Directors

May 5, 2010SEC Enforcement Update

May 19, 2010M&A in the Boardroom

Visit Foley.com/ndi to register and for more details.


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