Integrated Risk Management. T.A.W. Geyer and M.I. Morris, Four Elements Limited, 8 Cavendish Square, London, UK
INTRODUCTION
Accidents like the Exxon Valdez oil spill in Alaska, the toxic
release at Bhopal, India, and loss of the Piper Alpha oil platform
in the UK North Sea do not happen very often. However, when such
accidents do occur, their impact can critically impair a company's
financial health. When combined with negative publicity and increased
levels of regulatory scrutiny, even the management of major corporations
become defensive. In addition, with the increasing trend towards
"right sizing" organisations, many operators do not
have the management resources to carefully monitor and
control their total liability or financial exposure. Decentralisation
of responsibilities for environment risk management, insurance,
and legal counsel often precludes corporations from getting a
composite view of accidents which could severely cripple their
business. Plant managers face many of the same concerns when
assessing their liabilities and insurance needs.
To reduce the likelihood of being faced with unanticipated, unrecoverable
losses of any magnitude, many companies in industries ranging
from petroleum to finance are taking a proactive approach to managing
their liabilities, utilising integrated (financial) risk assessment.
Integrated Financial Risk Assessment creates a complete picture
of a company's total liability by translating the impact of accidents
into financial terms. This basis facilitates the comparison of
various consequences, and incorporates the total costs of incidents
to obtain a true financial liability of the undesired event.
A financial basis naturally lends itself to the cost-benefit analysis
of alternative approaches and/or potential mitigation options.
The approach devises cost effective strategies to eliminate and
reduce risks and, Ultimately, to protect companies from liability.
The oral presentation of this paper will describe the technique
of integrated risk management, and give case study examples of
its application.
DIEFFERENT TYPES OF RISKS
Fatalities and Injuries. A number of accidents have occurred
in recent years which have resulted in large numbers of casualties.
These are vivid reminders that material failure, human error
and management shortcomings can affect even the most developed
of technologies. The most significant example is probably the
toxic release at Bhopal noted in the introduction where many thousands
of Fatalities resulted from the accidental release of methyl-iso-cyanate.
Environmental damage, regulatory fines, and clean-up costs.
Adverse events can occur which result in no casualties, but
nonetheless have significant financial impact. The most well
known example here is probably the Exxon Valdez oil spill. This
event has cost Exxon billions of dollars, primarily due to the
clean up cost and regulatory fines.
Lost Production. The Piper Alpha platform was a key platform
through which a number of other platforms pumped hydrocarbons
to shore, and thus m addition to the loss of life and assets,
there was a significant production loss (or deferred production)
due to the loss of this platform.
Asset Loss (replacement costs). An example in this class
of risk is Statoil's Sleipner concrete gravity based offshore
platform The base of this platform sank to the bottom of the fjord
during the final stages of the commissioning tests.
Property damage. An ethylene explosion at a Philips plant
in the US required the complete redesign and rebuilding of the
plant at a cost in excess of $1 billion.
Loss of market share. ARCO Chemical Company in the US
were one of a limited number of producers of MTBE, a petrol additive.
An explosion at one of their plants led to a period during which
they could not produce, and by the time production had resumed,
significant market share had been lost to other manufacturers
and importers.
Product boycott. The Brent Spar incident, particularly
the response of consumers in Germany, demonstrates the potential
financial impact of product boycott.
All the above risks can be evaluated in terms of an adverse financial
impact on the operator. Not only do accidents require financial
resources, they can also result in increased insurance premiums,
make raising capital more difficult, and decrease share values.
THE IMPORTANCE OF RISK MANAGEMENT
It is widely accepted that there is no such thing as zero risk.
In a wide variety of industries, many years of design evolution
and operational experience have failed to eliminate all risks,
and there remains a residue which must be consciously managed
and controlled.
Integrated risk management refers to the assessment of a wide
variety of risks on a common basis. It involves the bringing
together of a range of disciplines (e.g., major hazard assessment,
environmental impact, site remediation, economic appraisal), and
also the consideration the whole spectrum (life cycle) of an operator's
operations (e.g., from R&D, through raw material delivery,
processing/manufacture to product delivery and use).
THE APPROACH
Integrated Financial Risk Assessment comprises three main stages:
developing a risk profile, evaluating risk control alternatives,
and reviewing risk finance options.
Developing the Risk Profile
The first stage of the risk management process is the identification
of how things can go wrong. This is the hazard identification
stage of the risk assessment. In industries involved in the manufacture,
handling or transport of hazardous materials, the risk arises
mainly as a result of loss of containment accidents. For transport
operations, events of interest are derailment and collisions of
trains, groundings and collision of ships, extreme weather conditions,
road traffic accidents, etc.
The next stage of the process is to establish how often such events
can be expected to occur. This involves estimating the frequency
of the hazardous incidents and requires data such as the failure
rates of valves, pipes and vessels, transport accident frequencies,
etc. This stage involves assessment of not only the frequency
of the initial incident, such as the release of a flammable material,
or the derailment of a train but also establishing the frequency
of the ultimate outcome. This will be determined by the success
or failure of the various mitigation systems and emergency response
actions. For example, in the event of a loss of containment accident,
the consequences will be influenced by whether the release ignites,
whether the spill is on land or water, whether isolation valves
act to limit the duration of the release etc. In the case of
a derailed train, the consequences will be increased in the event
of a secondary collision, or whether there is a subsequent fire.
This stage of the analysis develops a variety of different scenarios
(each associated with a particular level of damage, severity of
explosion, size of material spills, etc.).
The final stage is then to quantify the total cost of the accident
scenarios. This involves estimating the environmental damage,
and the likely clean-up costs, scrutinising legal case precedents
as regards the level of regulatory fines associated with accidents,
estimating the loss of production costs and asset replacement
costs, etc.
Finally, the frequency and financial consequence information is
combined to produce overall measures of risk to support the decision
making process. This may be frequency loss curves, mean recurrence
frequency data, annual average liability, maximum liability, etc.
One advantage of this kind of approach is that the risk profile
can be easily understood by both technical and financial managers.
Risk Control Evaluation
The next step involves identifying potential risk control measures.
The previous stages win have identified the dominant contributors
and these become the focus of management attention they are the
areas where potentially most benefit will be gained. Risk control
options may include improvements in the areas of:
The risk model allows the impact of such control options to be
assessed and a measure of the risk reduction to be obtained.
Together with the cost of implementing the risk control measures,
their cost effectiveness can be established.
Risk Finance Options
Given a detailed knowledge of the risks, and having implemented
cost effective risk control measures, a number of options are
available to finance the residual risk. Firstly a company can
decide to accept the risk and do nothing further. Alternatively,
self insurance may be decided upon, taking advantage of the tax
benefits, or transference of the risk either through insurance
with a third party or, for example, by purchasing a material rather
than manufacturing it. The risk profile will show where insurance
is most needed.
Risk Management Guidelines - Criteria
It is also possible to define risk guidelines or criteria, primarily
determining the maximum level of risk which the company is prepared
to tolerate. Risk criteria provide the anchor points in a decision
making framework, which ensure that risk related decision making
is both consistent and repeatable. Criteria can be set in terms
of the absolute losses, or in terms of the asset value of the
company, or in terms of loss of annual profits, etc.
BENEFITS OF INTEGRATED RISK MANAGEMENT
Quantification of risks in itself beings a number of benefits,
including identifying the dominant contributors to the risk upon
which management attention can be focused, providing a basis for
evaluating remedial measures which reduce the frequency and/or
consequences and for evaluating the cost effectiveness of such
measures, and allowing judgements to be made as to the acceptability
of the risk.
However, the benefit of the integrated risk management approach
is that it measures all liabilities on a common financial basis.
This is important as rarely will a risk control measure only
address one risk, and one may draw incorrect conclusions about
the cost effectiveness of a measure if its total effect is not
studied.
For example, consider a railway operator who is evaluating a measure
which reduces the frequency of derailment. A safety only assessment
may conclude that the measure is not worth implementing, as very
few derailments result in fatalities. However, if the same measure
reduces the likelihood of freight train derailment, and the potential
spillage of hazardous cargoes (with the associated environmental
damage and clean-up costs), and account is also taken of the asset
replacement cost of damaged rolling stock and the lost revenue
due to the time for which the lines cannot be used are taken into
account, the measure may well be judged cost effective.
Summary
Integrated Financial Risk Management addresses the following questions:
Application areas include:
Ultimately this type of approach should lead to increase profits
through optimisation of resource usage. It should also lead to
increased financial stability through reducing the frequency of
unexpected losses, and devising appropriate insurance strategies.