Managing Risk in Business & Industry

Managing Risk in Business & Industry

David R. Peters, CPA, CFP®, MST, CLU, CPCU

Securities offered through Cetera Advisor Networks LLC, member FINRA/SIPC. Advisory services offered through Carroll Financial Associates, Inc., a Registered Investment Advisor. Carroll Financial and Cetera Advisor Networks are not affiliated.

4201 Congress Street Suite 210 Charlotte, NC 28209

Why risk management?

AICPA: Primary duty of the CPA is to protect the assets of the organization.

Internal Controls are part of risk management

Accountants are often the risk watchdogs of the organization

“statistical relationship between the use of good practices by accountants and lower incidence of dysfunctional behavior”

(Leitch, 2012)

Why risk management?

More businesses are implementing risk management into their strategy

Formal ERM: 25% All Orgs (15% - 2011) & 51% Large Orgs (32% - 2011) (Amato, 2016)

Risk is becoming more complex

AICPA Survey: 57% believe that business risks have changed extensively in the past 5 years (Amato, 2016)

Still have gaps though….

Barriers to ERM:

Insufficient Resources: 46%

Competing Priorities: 44%

Lack of Perceived Value: 34% Companies have not yet implemented ERM programs:Risk is managed in other ways besides ERM: 47%No requests to change the org’s risk mgt. approach: 31%

More pressing needs: 31%No one to lead an ERM program: 23%Don’t see benefits exceeding costs: 17%

LOTS

of misperceptions about value of risk

mgt…

(Amato, 2016)

Where are we headed?

Enterprise wide risk management (ERM)

Measuring and Managing Risk

Risk Assessment

Risk Control vs. Risk FinancingCommon Insurance TermsCommon types of commercial policiesNon-Insurance Risk Mgt. IssuesSuccession Planning

Big Question: How can we improve risk mgt. functions of our organizations and make them more valuable?

Let’s get some basics down…

Losses can be incurred through:

Assets; or

Activities

Loss Exposure – Any condition that presents the possibility of a loss, regardless of whether or not it actually happens

Let’s get some basics down…

Every Loss Exposure has 3 Elements:

Asset/Activity exposed to loss

A potential cause of loss (aka - peril)

A potential for financial consequences of a loss

Removal of any element eliminates the loss exposure

Let’s get some basics down…

Risk can be positive or negative

Pure Risks vs. Speculative Risks

4 General Risk Types:

Hazard Risks

Operational RisksFinancial Risks

Strategic Risks

Traditional Risk

Mgt

vs ERM

Traditional Risk Management

Pure Risk  No upside

Focused on Operational Risks

Siloed within the companyPrevent or Reduce Losses

Traditional Risk Management = How can I lessen or get rid of risk?

Traditional Risk

Mgt

vs ERM

Enterprise-Wide Risk Mgt.

Pure & Speculative RisksAll Risk Types (including Strategic)

Integrated throughout CompanyOptimize Risks

ERM = How can I use risk to the company’s advantage?

ERM is about Approach & Process

ERM is about Approach & Process

Most Difficult!

Developing the Risk Mgt. Process

Questions to Ask:

How are risk events identified?

Do employees know what constitutes a risk?

How often are they reviewed?

Who reviews them?How are risk events followed up on?

What areas do we look to identify risks?

AICPA Examples:

Accounting Practices

Audits

– Is sufficient attention paid to potential “red flags” in accounting records, such as high sales volume at period end?Record RetentionPolicy Reviews – How often are procedures updated?

Variable Compensation Programs – Are they lined up with the best interests of the organization?Pension Calculation AssumptionsCapital Projects – Risk and return calculations

Employee TrainingTravel policiesSecurity and response plansContingency Plans

Finding Risks

Checklists can be a good way to get you started:

Risk Management Society (RIMS)

Industry

 the US Dept. of Agriculture has one!

Financial Statements/Legal RecordsCollaborative ApproachKey departments beyond Accounting and Legal

Front Line Employees

Elements of a Good Risk Register

12 Key Elements:

Risk Category

Risk Description

Risk ID

Potential ImpactLikelihoodConsequence

Risk RankRisk TriggerPrevention PlanContingency Plan

Risk OwnerResidual RiskUpdated FrequentlyRecommended: QuarterlyScoring should allow for comparison & consistency

COSO favors a 5 pt. scaleScoring: Frequency & Severity

(Deloitte &

Touche

LLP, 2012)

Example: Measuring Frequency

(Deloitte &

Touche

LLP, 2012)

Example: Measuring Severity

(Deloitte &

Touche

LLP, 2012)

Example: Measuring Severity

(Deloitte &

Touche

LLP, 2012)

Example: Risk Scoring

Risk Control vs. Risk Financing

Risks are typically dealt with using Risk Control and/or Risk Financing

Risk Control – Avoid/Minimize Losses

Risk Financing – Pay for the Loss

Most situations will require a combination of techniques….

Risk Control Techniques

Risk Financing Techniques

Insurance is normally a combination of transfer and retention



Deductibles

Common Insurance Terms

Insurable Interest

P&C

 Time of the Claim

Life  Time of Application

Insurance to Value

Why is this important?

Coinsurance

Common Insurance Terms

Deductibles

Small Business Losses

Valuation Methods:

Actual Cash Value

Agreed Value

Functional Value

Replacement Value = ACV less Depreciation

Sections of the Insurance Policy

Declarations

Definitions

Insuring Agreements

Exclusions

Conditions

Miscellaneous Provisions

Sections of the Insurance Policy

Declarations

Nuts & Bolts of the Policy

Definitions

What does stuff mean?

Sections of the Insurance Policy

Insuring Agreements

Insured’s Responsibilities

Insurer’s Responsibilities

Exclusions

What isn’t covered

Sections of the Insurance Policy

Conditions:

Requirements for paying the claim

Ex: Prompt Notice, Protection of Property, Police Reports

Miscellaneous Provisions

Dividends

Insurance Policies: Rules of Thumb

Wear & Tear is never covered

Policies will generally exclude items that are:

Difficult to underwrite

Covered better under another policy

High Severity, Low Frequency Items are best covered by Insurance

Commercial Package Policy (CPP)

Multiline Policy that combines several coverage lines

Common Forms vs. Coverage Part Forms

Often Includes: Commercial Property, Commercial Crime, Equipment Breakdown, Commercial General Liability, Commercial Auto, etc.

Business Owners Policy (BOP)

CPP tends to be for larger companies, while BOP tends to be for small & mid-size companies

Usually include: Building, Personal Property, Business Income, and the equivalent of CGL

Other coverage options

Commercial General Liability

Covers Non-Professional Negligent Acts

Covers liability caused by your services, operations or employees for:

Bodily Injury & Property Damage (Part A)

Ex: Customer slips & falls in your store

Commercial General Liability

Personal and Advertising Injury (Part B)

Libel, Slander, False Arrest, Copyright Infringement, Malicious Prosecution

Medical Payments (Part C)

Reasonable Costs for Medical Treatment, Hospital, Ambulance, Funeral Expenses of Non-Employees

Buildings & Personal Property (BPP)

Covers any combo of:

Building

Insured’s Personal Property

Personal Property of Others

Standard Deductible: $500

Buildings & Personal Property (BPP)

Covered:

Leased Personal Property that you have a responsibility to insure

Tenant’s Interest in Improvements

Most Inventory

Not Covered:Money & Securities (Usually on Inland Marine)Electronic Data & Valuable PapersAirborne or Waterborne Personal Property

Business Income Insurance

aka – Business Interruption

Part of BPP, CPP, or BOP

 Not Stand-Alone

In the event of a disaster, covers:

Increased expenses

Income that would have been earned

Business Income Insurance

Covered (based on prior F/S):

Profits

Temporary Location CostsFixed Costs

Extra ExpensesGovernment Mandated Closures

Commercial Crime Policies

Criminal acts can be covered to some degree in other policies, but since loss exposures can vary significantly

 Need special underwriting

Covers Money, Securities, and Other Business Property against criminal acts

Commercial Crime Policies

Criminal Acts Covered:

Employee Theft

Robbery

Forgery

Extortion

Computer Fraud

Discovery or Loss Sustained basis

Equipment Breakdown Insurance

Aka – Boiler & Machinery Breakdown

Covers almost any type of equipment that:

Operates under pressure

Controls, transmits, transforms, or uses mechanical or electric power

Equipment Breakdown Insurance

Typically Covered for

Accidental

Losses:

Boilers and Pressure Vessels

Electrical Equipment

Mechanical Equipment

Air Conditioning EquipmentRefrigeration EquipmentOffice Equipment & SystemsExpertise Required  small, specialized field

Cyber & Privacy Insurance Policies

Covers Liability & Property Damage claims of consumers of technology services or products:

Internet Selling

Collecting Data

Not Technology E&O Coverage

Website Designers, Computer Software Manufacturers, etc.

Cyber & Privacy Insurance Policies

Covers Liability for Data Breach:

Notification Costs

Credit Monitoring

Costs to Defend Claims by State Regulators

Fines and PenaltiesLoss Resulting from Identity TheftOften underwritten based on amount of data

Specialized Policies

Inland Marine Policies

E&O Insurance Policies

Industry Specific Policies

ISO Farm Program

Financial Institution Bonds

Non-Insurance Risk

Mgt

Issues

Employee Termination

Succession Planning

Employee Termination – Best Practices

What to get from the employee:

All office property (Phones, Laptops, System Access)

If applicable, proof of departure (Resignation Letter)

Exit Interview

Feedback to Company

Documentation in case of future allegations

(Paychex.com, 2014)

Employee Termination – Best Practices

What to give to the employee:

Final Paycheck

 May have to include accrued PTO

COBRA  For eligible employees, the HIPAA Certificate of Coverage (COC) must be provided no later than the COBRA election notice (44 days).

Severance

Agmts

.  Relinquishment of Rights(Paychex.com, 2014)

Employee Termination – Best Practices

Down the Road:

If an employee files for unemployment, you may need to supply a separation document, depending on the state.

Should have someone appointed to handle reference requests from former employees.

(Paychex.com, 2014)

A Few Stats on Succession….

From the Financial Services Industry….

78% of accounting practices had identified suitable future business owners, only 53% had offered ownership partner training to them (

Knafo

& Dennis, 2014).

An AICPA survey of 500 multi-owner firms and 400 sole practitioners contained similar results. A majority of senior partners (60%) said that they were training for specific competencies in leadership-targeted staff, but only 15% of practices had identified specific leadership requirements (Amato, 2013)

How Long Does Succession Take?

IP & Jacobs (2006) – 400 academic articles, 3 Steps:

How Long Does Succession Take?

IP & Jacobs (2006) – 400 academic articles, 3 Steps:

Succession Documents

Partner Agreements

Operating Agreements

Key Person Life Insurance

Buy/Sell Agreements

Key Person Life Insurance

Financially covers the company for the period after a key employee leaves

Need to consider:

Duration of Coverage Needed

Age of the Insured

Cash available for funding the policy premiums

Key Person Life Insurance

Advantages of Term:

Cheaper when Insured is young

Unknown/Short Coverage Needs

Advantages of Permanent:

Cheaper, if insured is likely to stay

Cash values may be used to fund retirement benefits of insured

Buy-Sell Agreements

Variation on the Key Person Life Insurance Policy

Using life insurance to protect against the death of an owner

Closely-held Corporation

Partnerships

Buy-Sell Agreements

Entity Agreement:

Individual policy on each business owner

Beneficiary on each policy is the company itself

If a business owner dies, the company receives the policy proceeds and is able to purchase (redeem) the ownership interest from the owner’s estate

Buy-Sell Agreements

Cross-Purchase Agreement:

Each business owner owns a policy on all the other business owners.

Other business owners are able to buy the ownership interest from the deceased owner’s estate using the proceeds they receive.

Buy-Sell Agreements

Cross-Purchase Agreements:

Require more policies

Not ideal for a large number of business owners

Large cash outlays

Need to consider how ownership %’s change under either method

Succession Planning Considerations

Succession Planning is not just about documents, it’s about people

Impact on Vendors/Suppliers

Impact on Customers

Impact on Company Culture

Impact on Firm Valuation

Succession Planning Considerations

Executive Training Programs

What are you looking for in a future leader?

Internal vs. External Succession

Summing It Up….

Risk Management is more than just insurance policies & operations

Risk management is strategic

Risk Management looks at the present and the future

My Contact Information

David R. Peters,

CPA, CFP®, MST, CLU, CPCU

Financial Advisor

704-247-2817

dpeters@carrollfinancial.com

Carroll Financial Associates

4201 Congress Street, Suite 210Charlotte, NC 28209

Works Cited

Amato, N. (2013). Succession Planning: The Challenge of What's Next.

Journal of

Accountancy

, 215(1), 44-47.

Amato, N. (2016, April 13).

The gaps that remain in risk initiatives.

Retrieved from Journal of Accountancy Website: http://www.journalofaccountancy.com/news/2016/apr/risk- management-initiatives-201614225.htmlDeloitte & Touche LLP. (2012). Thought Leadership in ERM: Risk Assessment in Practice. Retrieved from COSO Website: http://www.coso.org/documents/COSOAnncsOnlineSurvy2GainInpt4Up dt2IntrnlCntrlIntgratdFrmwrk%20-%20for%20merge_files/COSO- ERM%20Risk%20Assessment%20inPractice%20Thought%20Paper%20O Ctober%202012.pdf

Works Cited

Ip

, B., & Jacobs, G. (2006). Business Succession Planning: A Review of the Evidence.

Journal of Small Business and Enterprise Development

, 326-350.

Knafo

, J., & Dennis, A. (2014). Succession Challenges for US.

CPA Firms to Tackle. Journal of Accountancy, 218(5), 54-59.Leitch, M. (2012, January). The reality of risk: culture, behaviour and the role of accountants. Retrieved from Association of Chartered

Certified Accountants: http://www.accaglobal.com/content/dam/acca/global/PDF- technical/corporate-governance/tech-afb-rrm_long.pdfPaychex. (2014, April 29). Terminating an Employee: Employee Separation Best Practices. Retrieved from Paychex Website: http://www.paychex.com/articles/human-resources/terminating-an- employee