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Risk Management for In-House Counsel Risk Management for In-House Counsel By John A. Chamberlain Introduction otherwise be reluctant to bring to manage- ment’s attention. A risk manager who knows Everyone manages risk every day. On a pro- how to read financial statements can glean fessional and personal level, everyone is a important information from standard finan- risk manager. For in-house counsel, risk cial statements, especially if there is a history management is especially crucial because of statements to review. Reviewing balance the risk management and legal processes sheets, income, and cash flow statements for overlap. A legal department that helps its the past five years is an excellent place to business partners determine the most cost- start. Process diagrams (flow-charts) are effective method of managing risk will assist effective for many different types of opera- the business in becoming more competitive, tions. They assist in identifying potential efficient, and profitable. Risk management is bottlenecks in the manufacturing process a process that reduces accidental or business that could put an operation at risk. For losses to an acceptable level and allows a example, if an entire manufacturing opera- business to avoid or survive situations that tion depends on one assembly plant, and might lead to serious problems. What types that plant happens to be one-half mile from of risk are there? Although there are too the San Andreas Fault, it would be a good many to be listed here, a short list would idea to manage the risk of a possible earth- include property, liability, crime, product lia- quake. This may sound simple, but opera- bility, transportation, environmental, finan- tions become very complex very quickly. cial, professional, regulatory, and personnel Once the investigation process is complete, a risks. The risk management process identi- risk manager should have a good idea of the fies risks and determines how to manage types of risk that exist for the organization. them effectively. Techniques that managers The hard part is dealing with risks in a cost- use to handle risk vary; there are as many effective manner. Organizations do this both different ways of handling risk as there are by controlling accidental losses and by figur- risk managers. Some managers are interest- ing out how the organization will pay for ed in long-term stability while others are losses that occur. The balance of how losses interested in improving the bottom line of are controlled and financed will determine the corporation immediately. The important the effectiveness of the risk management factor for senior management of any organi- process. zation is the ability to make informed deci- sions. Controlling Losses Identifying Risk There are several ways to control losses. If a The first step of the risk management particular activity is too risky, an organiza- process is to determine the risks faced by the tion can avoid it, but that is not usually prac- organization. Good risk managers will know tical. Since risk is associated with virtually as much, if not more, about an organization every activity, risk managers determine how than any other employee in the organization. to reduce the frequency and severity of loss- They should know as much as possible es. Risk managers also control risks by main- about the organization’s operations. How taining geographic diversity, by duplicating does a risk manager obtain this knowledge? crucial operations, and by using subcontrac- Some common methods include confidential tors. Subcontracting high-risk portions of an questionnaires, financial statement analysis, operation to another party equipped to han- personal visits to physical locations, and dle the risk (either because of its financial sit- process diagramming. Confidential ques- uation or expertise in a particular area) is tionnaires are effective because they allow very common. employees to identify problems they may One of the easiest methods of controlling 10 RISK MANAGEMENT FOR IN-HOUSE COUNSEL 11 risk is to avoid it. If the risks associated with overall liability an organization may face a particular business operation are too great, because of the spill. Delay and dishonesty by the best method of handling the risks is to management when dealing with a loss may avoid them. Building a manufacturing plant make matters worse and could turn a bad on an earthquake fault, a flood plain, or in situation into one that threatens the exis- close proximity to another high-risk opera- tence of the organization. tion (such as a nuclear facility, a large oil/gas Using contractors to reduce risk may facility, or a manufacturing facility that pro- reduce both the frequency and severity of duces toxic chemicals) may simply not be loss. Contractors may be in a better financial worth the risk, no matter how inexpensive it position or have more expertise to deal with is to construct a facility on that site. If an a particular aspect of an operation. The most organization does not have the requisite common example of this form of loss control knowledge or resources necessary to effec- is leasing property. The risks associated with tively deal with the risks associated with an owning the property are accepted by the activity, it should not become involved (at landlord (at least if the lease is properly least until it has the minimum expertise nec- worded) who is in a better position to accept essary to make informed decisions). this risk because it is the landlord’s business Reducing the frequency of losses is one of to know real estate and manage its risk. the easiest and most cost-effective means of Manufacturers may be unwilling to accept dealing with risk. To know how to reduce risks associated with a certain aspect of their the frequency of losses, an organization manufacturing process because the environ- Risk needs to know what causes them. Perils mental risks are too high. There may be come in different varieties (natural, human, organizations that specialize in handling management and economic). Examples of natural perils these operations that can accept the risk. is a process include wind, lightning, tidal waves, and that reduces earthquakes. Human perils include error, Paying for Losses criminal activity, or espionage. Economic accidental or perils include inflation, market decline, and Once an organization has identified its risks business currency fluctuations. A good example of a and has a plan in place to reduce the fre- method used to reduce the frequency of loss- quency and severity of losses, how will the losses to an es attributable to crime involves security organization pay for the losses that occur? acceptable measures (such as fencing or regular securi- Options include treating the loss as an ty patrols of a plant). To reduce the frequen- expense, creating a reserve (either funded or level and cy of earthquake losses, organizations unfunded), borrowing funds, creating a cap- allows a should minimize their physical locations tive insurer, purchasing insurance, or hedg- near areas prone to earthquakes. Regardless ing via the purchase of certain investment business to of the actions taken to reduce the possibility vehicles. Purchasing insurance is the most avoid or of loss, losses will occur; but even though a common form of paying for losses, but survive loss has already occurred there are ways to insurance is not available or economically reduce the severity of the loss. viable for all risks. The best financing plans situations There are several ways to reduce the combine elements of several risk financing that might severity of losses. Organizations should techniques to create an overall risk plan that diversify operations geographically. A peril allows an organization to achieve its objec- lead to (especially weather-related) affecting an tives in the most efficient manner possible. serious operation in California should not affect Invariably, a plan includes some amount of problems. another operation in Michigan. Sometimes risk retention by the organization. organizations even create an entire duplicate Risk retention is a common technique for operation that remains idle until required. financing losses. Over a long period of time, The government’s use of duplicate com- it is cheaper for an organization to retain risk mand centers is a good example of this tech- because insurance premiums include over- nique. This is an expensive option, but if an head and profit for the insurance company. organization must continue operations, it However, bad timing may place an organiza- may be worth the investment. Diversifying tion at risk if sufficient funds are not avail- operations also has the advantage of making able to pay losses. The different retention losses easier to predict, and that makes techniques include paying losses as an financing the risk easier to accomplish. expense, using an unfunded or funded Taking quick action to control an environ- reserve account, borrowing funds, or using a mental spill is an example of reducing the captive insurer. Expensing losses when they 12 THE MICHIGAN BUSINESS LAW JOURNAL—SPRING 2005 occur is the least expensive and easiest pay for losses. Typically, organizations option, but it is not practical for large losses arrange for lines of credit in advance because that could force an organization into bank- if an organization waits until after a signifi- ruptcy. An organization may also find itself cant loss has occurred, it may have a difficult short of cash because of a business slow- time obtaining the funds. Financial institu- down that affects the cash reserves necessary tions may not have confidence in the organi- to pay the loss. Risk managers should keep zation’s recovery. The arrangement can take in mind that one of the goals of risk manage- the form of a letter of credit, catastrophe ment is to ensure the long-term viability of bond, or promissory notes.
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