In a world with many new and more interrelated risks, companies need to be aware of threats that are currently underrated, such as cyber-security and pension liability risks. Peter Mullen, CEO of AON Captive and Insurance Management, presented a Top 10 list of global business risks and other findings of AON’s biennial Global Risk Management Survey at the Cayman Captive Forum in December.
The economy, regulations and reputation are the key risk areas for the more than 1,400 companies in 70 countries covered by AON’s survey. The cross-regional and cross-industry analysis highlights that many Top 10 risk factors are still linked to the fallout of the financial crisis and the subsequent recession.
The economy tops the 50 main business risks. The fear of an economic slowdown has been in the top spot for the past six years. In 2013 it was the the top risk in three of the five regions covered by the survey. Sixteen of the industries surveyed considered it their number one risk; only natural resources-based industries, utilities and the food industry regarded it slightly less significant as their fifth or sixth most important business risk.
“Generally there is still an uncertainty that pervades in the economy. Companies are still hoarding cash,” Mullen said. The euro crisis, slowing growth rates in emerging markets and U.S. fiscal policy all have contributed to the uncertainty, he added.
In addition, companies are much more aware of the interdependencies of certain risks than they were before the financial crisis, including, for instance, that a real estate bubble could cause a credit crunch.
The complexities and volume of new regulations, from Dodd Frank, Solvency 2 and privacy laws to Obamacare, make regulation the second most cited business risk of the survey. Banks and health-care companies are the most affected, but the penalties for noncompliance are more severe for all businesses and the costs in terms of diverted resources and the potential impact on brand and reputation are increasing.
“It is a little bit of an irony that regulations were put in place to mitigate risk, whereas our clients see them as a big risk that impacts them,” Mullen said.
In line with the increasing regulation, its potential negative effects become more difficult to manage, and fewer businesses are fully prepared. Only 43 percent of businesses said they are prepared to manage regulatory risk, down from 55 percent two years ago. More than half of the respondents (54 percent) said they had lost income as a result of regulatory issues, up 22 percentage points since the last survey.
Closely linked to general economic risks, increasing competition is seen by companies as their number three risk. “The last four years have been pretty tough. Everybody is focused on brand awareness, differentiating themselves, innovation,” Mullen said.
The risk management function can support senior management to increase competitiveness by integrating risk management more tightly in the strategic planning process, by helping boards to define risks appetite and profiling relevant risks from an opportunity and threat perspective.
4. Damage to reputation and brand
Reputational risks and the negative perception of a company’s brand have been consistently named as a Top 10 business risk, moving up the ranks in recent AON surveys. Anything from product recalls, supply chain failures or ethical issues will not only have a negative effect on a company’s image, but will also impact it economically. The number of respondents who stated that they have been losing income because of brand damage has increased from 8 percent to 40 percent in two years.
Seven of 10 companies in the survey that were involved in a reputational issue said they lost one-third of their value immediately after the incident. Two of the 10 lost 90 percent of their value.
Mullen pointed out that social media tend to amplify the impact of an incident. “Social media acts like gasoline when it comes to reputational issues,” he said. Yet social media as a risk is only ranked number 40 in the survey and, as such, is significantly underrated.
5. Failure to attract and retain talent
Failure to attract and retain key staff is becoming more important as it is closely related to the previously cited economic and competitive risks. For Mullen, it is one of the examples that point to the growing interdependency of risks.
“You can have a political risk incident in the Far East, which results in a supply chain failure, which results in you not being able to get your product to market in Europe. You suffer some brand damage as a result. As a result of the brand damage, you fail to attract the talent that you need to grow your business. As a result of not having the talent, you fail to innovate. You could go on, it is all interconnected,” he said.
6. Failure to innovate
Popular examples like Borders, which went out of business in 2012, illustrate the dangers of a lack of innovation in a competitive market space. Even the captive insurance space is not immune.
Captive insurance used to be new, interesting and cutting edge, Mullen said, but it is becoming conventional. “We have got to be careful. We have always been good at innovating in this space, but we are becoming mainstream, run-of-the-mill. We have got to start focusing on innovation a little bit more.”
However, he also noted that by focusing on clients’ needs, there are many opportunities to innovate – for example, around new regulations such as Solvency 2 or the use of data and analytics.
This also applies to the insurance industry generally. Mullen said the majority of the top 50 risks mentioned by large corporations are either not or not fully insurable, which should give the insurance industry a starting point for innovation. At the same time, the gap between economic losses of $85 billion and insured losses of $20 billion, for the first six months of 2013, should give the insurance industry enough incentive and opportunities to innovate.
7. Business interruption
Business interruption is a risk, mainly emphasized by large corporations, that has moved down the ranks and is projected to move out of the Top 10 in the coming years. As a common focus of risk management programs, the decreasing significance might indicate an improvement in preparedness for business interruption type risks, Mullen noted.
8. Commodity price risk
The importance of commodity prices for overall business and production costs put it into the Top 10. However, unlike many of the other economic risks named in the survey, commodity price risk is “insurable” as it can be hedged through futures and options.
9. Cash flow and liquidity
Cash flow and liquidity is another risk area emanating from the economy as all companies are keen to generate free cash flow and have access to capital. Yet the availability of credit is still not certain for all businesses.
10. Political risk
Political risk is a new entry in the Top 10. “It has been steadily moving up the charts and we project that this will continue,” Mullen said.
In addition to the potential negative effect of social media, AON identified several risks in the top 50 which the firm believes are underrated by businesses and could emerge as key concerns if not managed properly.
“We feel that cyber-risks are underrated, as are pension scheme funding plans,” said Mullen.
While businesses in North America recognize computer crime, hacking, viruses and other data security breaches as significant threats and the eighth most important risk, companies in other regions rank the risk much lower – Asia Pacific (37), Europe (19), Latin America (35), and Middle East and Africa (19). However, recent revelations around NSA surveillance and potential industrial espionage might drive cyber-risks higher up the agenda.
Pension scheme funding, listed at 47, also appears to be an understated risk factor. Increasing market volatility since the financial crisis has made the management of pension plans a challenging exercise, leading to underfunding, which in turn can cause substantial liabilities for organizations.
Mullen argues that “The issue is still there; globally pension plans are less than 75 percent funded.”