"This Is a Mega-Event."

The aftershocks of Japan's earthquake continue to ripple through the insurance market. An interview with Jeff Burchill, CFO of FM Global.

In a year that has thus far seen an earthquake in New Zealand; flooding in Brisbane, Australia; and a stunning combination of earthquakes, a tsunami, and nuclear-radiation leakage in Japan, insurance-industry CFOs have even more cause than usual to alert their clients to risk-management strategies. For his part, FM Global CFO Jeff Burchill has been traveling around the United States meeting with clients to preach the company’s particular risk-management gospel. The motto? All loss is preventable. As the finance chief at the 175-year-old commercial-property insurer, which last year had $4.7 billion in revenue, Burchill worries even more about risk management than most of his fellow CFOs. Right now, he says he’s focusing on three things: Japan, Japan, and Japan.

How has FM Global been affected by the crisis in Japan?

It is the event of the moment, and it appears it’s going to have some legs to it. It’s affecting us not only because we’re in the insurance industry, but also because we have an office in Japan, so we have employees there. We’re obviously concerned about their safety and well-being. We’ve long prided ourselves on the fact that we have our claims personnel and engineers on the ground as soon as the Red Cross shows up, and this is the first event that I’m aware of where we weren’t able to do that. We’re actually holding people back in Hong Kong because of concerns about radiation exposure.

What will the impact be on your clients?

That’s hard to say at this point; things are still developing [Editor's note: this interview was conducted on March 30]. I think there’s going to be some significant property damage. There will be some business-interruption claims, of course. There will also be dependent time-element claims. Those occur if XYZ company in New York gets a component made in Japan, and that component is a critical part of the company’s manufacturing process and it’s going to run out of that part in, say, December. That type of gap has some coverage under our policy.

How frequently does that kind of coverage get triggered?

This is going to be the first event where we have a lot of contingent time-element aggregation from one event. That’s because Japan is the third-largest economy in the world and this is a mega-event within that economy.

What are the biggest lessons that CFOs can take away from this catastrophe, regardless of whether they are doing business in Japan or have suppliers there?

The issue is, how well do you know the risk to your supply chain? I think a lot of CFOs are reactive to that issue. And some need to get proactive and think about how to prevent such risks from happening again.

What would have been an appropriate way to hedge that supply-chain risk?

That’s a very interesting question because, especially since 2008 with the weak economy, a lot of companies have made their profitability targets by reducing costs. That means they’ve gone to the lowest-cost supplier in many instances without knowing the risk of making one supplier a sole source of product.

A lot depends on the strength of their enterprise-risk-management process. Did they inquire about the risk to that supplier, not only from a physical risk perspective but also about their downstream suppliers, like the company that supplies the steel to make that bearing that they need to put in their manufacturing process?

We’ve been very proactive in advising clients about the possibility of physical damage to suppliers not only from a fire standpoint but also because of natural disasters. I think a lot of companies will react to the situation in Japan, but they have similar risk with other suppliers throughout the world. You have to balance your desire for low cost with the risk that’s associated with that in the continuing production of your product.

China would be a much bigger concern than Japan as far as supply-chain risk, wouldn’t it?

Huge. We are probably more concerned about China than we are about Japan because not only do you have the earth-movement exposure in China, you also have typhoon risk. You have the Pearl River Delta. A major typhoon in that area would be comparable to putting a typhoon in some of the largest industrial areas in the southeast United States. And they don’t have the same codes and standards to prevent the damage that we do in the United States.

What’s your approach to entering emerging markets?

We tend to follow our clients: as they expand into new markets we go there, too, usually to address the needs of our [current] global customers, versus pursuing new business with indigenous companies.

Why not target local companies?

It all goes back to the risk-management philosophy. In emerging markets, does a company have the appetite and desire to protect its risks? Most often they lack the codes and standards that [support] good risk-management practices, and it’s not fair to our other clients to take on a subpar client where we know our loss costs long-term will probably be higher.

Are companies considering any new factors in their risk-management processes? Are they broadening their view of risk or including new things in their risk models?

After Japan, I think they’ll now be putting a lot of new things into their risk-management models. Before Japan, the risk-management function was being downsized a lot as part of companies’ cost-containment efforts. So a lot of risk managers were asked to do more with less. They had more responsibilities with fewer resources. In light of Japan, there might be another look at that. A lot of companies have to ask themselves, “What could we have done better in identifying risk to suppliers?”

Do you think that companies and CFOs think of risk management as an investment that they make in the business, or simply as a cost?

Historically, they’ve viewed it as a transactional function. In other words, insurance is a commodity that has to be purchased to protect the financial resources of the enterprise. They’ve probably tried to operate the risk-management department at the lowest possible cost. Now, I think they might look at not just the cost of the department, but also at the risk to the enterprise.

What do you think is the biggest mistake that companies make in thinking about risk and insurance?

In general, I think a lot of CFOs think of insurance as a commodity that they buy, and that all insurance is created equal. It’s not until you have an event that you find out that it is not created equal. Some coverages, capacities, and third-party counter-risks are better than others. That’s what I would say is probably the most common mistake: thinking that once you’ve transferred the risk you don’t have to manage it. That’s not true at all.

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