What your company can learn from the Gulf oil spill Featured

8:00pm EDT October 26, 2010

The Gulf oil spill disaster has been a catalyst for companies to think about their exposure to catastrophic risk. How would you react if a disaster of that scale befell your company?

“Nassim Nicholas Taleb’s book ‘The Black Swan: the Impact of the Highly Improbable,’ states that we all waste a lot of time managing for the predictable risks, but the only ones that really matter are the ones we cannot, or at least do not, imagine,” says Bruce Jefferis, CEO of Aon Energy.

Smart Business spoke with Jefferis and Leo G. Walter III, executive vice president, Aon Risk Solutions East Central Inc., about the issues raised by the Gulf oil spill and about what companies can learn from this disaster.

What lessons can companies learn from the Gulf oil spill?

No firm should underestimate the worst-case situation. Often, when you talk about insurance planning, people assume they will have losses, and they look back at previous losses, but they don’t often look at the worst possible thing that could happen. How would your insurance and risk management programs function in that kind of environment? It seems like an obvious question. But too often, people say, ‘Well, that’s unlikely. So I’ll buy something centered around a more likely loss.’ Frankly, it’s not the ‘more likely’ losses that impact the firm. It’s the completely unpredictable events — like the Gulf spill.

Most companies have already got that message. It doesn’t mean they can completely protect themselves from that worst-case scenario, but at least they have considered it and looked at all of their options.

How can companies prepare for that worst-case situation?

Don’t wait for that event to happen before you look at all your policies. How will you respond to that kind of event?

Many people look at a policy only thinking about a single event, a single line of coverage. But in a really bad catastrophe, almost every policy you have gets involved in some fashion. Property, casualty, fiduciary liability, pollution — it can easily spill over into directors’ and officers’ — a really bad event can cross over into almost every policy you have, so you need to think about it from that standpoint. You need to see how they all work together and figure out if they are going to do what you want them to do.

Say you have a large property claim, but you didn’t buy enough limits. The firm goes into bankruptcy, and you then have a spin-off D&O claim, because someone claims the directors and officers weren’t properly protecting the company. So you have D&O issues, the company stock is tanked because of the bankruptcy and you have some fiduciary claims coming out of that. That can get quite expensive. When an event like this happens, you need to map out how it hits everything — how the policies react, where the issues are — and find out if there is a better way to do it.

What can companies do about safety?

One lesson learned very clearly through all this is that safety should be of the highest priority. It’s fairly easy in the aftermath of an accident to say, ‘If we just did something a little differently, perhaps we could have kept this whole thing from happening.’ Inevitably, the extra cost of doing that thing is minute in comparison to the consequences of not doing it. There’s no question that every industrial company is focused on making sure it has done everything it can do to make sure a disaster doesn’t happen. From a safety standpoint, here are some issues we saw in the Gulf spill: How do you establish controls about who has the authority to stop unsafe operations? How do you manage that within your company so that if there is something unsafe going on, you can communicate properly on how to stop it immediately?

How can companies determine if their insurance is sufficient?

I’ve never heard of a company that had a big claim and said, ‘I wish I had bought less insurance.’ Almost always, the first question asked is, ‘Did I buy enough?’

When a claim happens, you want all you can get. Most of the time, buying additional limits is quite inexpensive.

After a disaster, most firms wish they had purchased more limits, and if they were concerned about their budget, they would have reduced costs in another area. They could take bigger deductibles or remove unimportant coverages.

I’m not saying you have to spend more money, but that most firms, in the aftermath of a disaster, would have spent their dollars in a different way than they did.

To help companies make that decision, they can use our Risk Financing Decision Platform. It helps companies by doing dynamic financial modeling of how they spend their insurance dollars. It can measure the impact of different program options against a company’s specific financial criteria used to drive its business. It is a sophisticated way of aggregating a lot of insurance options by using historical loss data and other loss forecasting methods to stress-test the different options.

How does the platform work?

You can put simulated losses through different insurance programs, then measure the results. Whatever metric is important in their business, it can measure the impact of different loss scenarios against those metrics under a variety of different programs.

It can help a company try different limits on for size, so to speak. Set them, run them through the model, look at the results, then decide if you are more comfortable with this spending versus this outcome. It’s a very flexible process that allows companies to home in on the program that is optimal for them.

Bruce Jefferis is CEO of Aon Energy. Reach him at bruce.jefferis@aon.com. Leo G. Walter III is executive vice president, Aon Risk Solutions East Central Inc. Reach him at (330) 734-6101 or Leo.Walter@aon.com. The Aon Energy Risk Symposium is scheduled on Jan. 19, 2011, in Houston, Texas. Aon will present a one-day conference to address the latest risk management issues facing companies in the upstream, midstream, downstream and service sectors. Contact Jefferis for more information.