Halloween season always puts us in a dark frame of mind here at WillisWire, reflecting not on ghosts and goblins but on all the scary risks we help our clients prepare for. This year, 18 of our bloggers submitted the scariest risks their industries faced this year. Which one keeps you up at night? Take our poll at the end and let us know.
D&O – Reservation of Rights Leaving You Exposed
Imagine you have just been shipwrecked. You’re in the water. The waves are threatening to push you under. You spot two lifeboats. One is virtually empty and seems completely sea worthy. The other is overcrowded, listing badly and taking on water. You make it across to the first one and are just about to climb on board when a man leans over the side and says you’re not allowed on board and that you’ll have to swim for the other one. That’s what it might feel like in a large D and O claim when you realise that insurers’ reservation of rights with respect to coverage apply to you as an innocent director as much as to your colleagues accused of fraud or dishonesty. Could it happen? Certainly. The language of the severability and nonrescission clauses in your policy really does matter.
Life Science – Hidden Risks of Outsourcing R&D
The life science industry has evolved away from centralized research, development, and commercialization. Now, many companies look like Frankenstein’s monster with many critical business operations bolted on via outsourcing contracts with:
- Clinical research organizations (CRO’s)
- Contract manufacturing
- Component parts and API providers
- Contract sales forces
- Contract fill/finish companies
- Distribution centers
- A litany of other consultants and service providers
In some cases large pharmaceutical companies have outsourced their entire discovery and research process to CRO’s who, in turn, subcontract the tasks they don’t have as core competencies. To make matters worse, many of these activities are performed by foreign entities. The complex supply chain that results hides many risk hobgoblins. Like ghosts, many of these risks are invisible until one of them decides to manifest with disastrous results. A comprehensive global supply chain risk review will help identify these hidden risks. It doesn’t have to be a scary life science world out there when outsourcing R&D.
Health Care – Jumbo Malpractice Verdicts
The scariest risk in health care in 2013 is the potential for a jumbo medical malpractice verdict ($50 million or more). Outsized verdicts have been an issue since 2010 even though claim counts are at historically low levels. In many of these jumbo verdicts the patient suffered profound neurological impairment requiring a lifetime of expensive care. Many of the cases arose in the obstetrical setting, especially the classic claim of failure to diagnose and/or timely respond to fetal distress during labor. However, there are also cases involving nursing home patients, which exceed $100 million. Fortunately, these cases are a fraction of a percent of all malpractice cases. But they do happen even in favorable jurisdictions. They are reason to bear in mind the old adage: “An ounce of prevention is worth a pound of cure.” This is especially true in obstetrics and pediatrics.
Financial Institutions – Runaway Computer Trading
This year financial institutions learned in a most visceral way that the markets have the potential to destroy an institution with blinding speed. We’ve seen some scary close calls, with large firms affected by errant programs or unable to respond swiftly to DDOS attacks. Call it the “rise of the machines” or “the fall of man” – the truth is that Adam Smith’s Invisible Hand of the Market is too slow. Human hands can no longer keep pace with today’s silicon-driven marketplace. With the introduction of algorithmic trading and other computer-executed transactions, it is becoming more difficult for humans to act as “circuit-breakers” when the programs go awry. Financial firms and regulators are years behind in learning how to manage the risks associated with the blinding speed of today’s computer trading. In the early ‘60s automobile deaths were rising rapidly because the speed of cars was increasing faster than their safety was. It has taken decades for regulators and manufacturers to develop safer cars. We cannot go back to the days of order slips and handwritten passbooks, and we do not have decades to address the issue of market risk caused by computerized transactions. The only viable solution is ironclad controls that mandate systems with adequate procedures in place to deal with any possible errors. Remember it’s not actually the speed that’s the problem—it’s hitting the wall that hurts.
Security – The Relentless Wave of Violence
Undoubtedly those of you who are tasked with the management of risk within your organizations are aware of the numerous and horrific incidents of violence that have occurred during the past year and their impact on our communities, our country, and our world. 20-30 years ago these acts of violence would be considered unimaginable, today they have become almost commonplace and it seems as if no place within our society is off-limits. From a small classroom in Sandy Hook to a shopping mall in Kenya, from the athletes of the Boston Marathon to the workers of the D.C. Navy Yard, one thing remains clear: Today, perhaps more than ever before, risk leaders must take steps to prepare for the worst. Domestically or internationally, those who fail to take steps now to mitigate its crushing effects could find themselves or their organizations overwhelmed and lost in the wake of its destruction. Instead, transform this wave of senseless loss into a wave of action, an opportunity to address or re-address issues of workplace violence, campus violence, facility protection, and crisis management planning. Plan now rather than after an event has already struck. Pay attention to what you’ve seen around you, today’s tragedy could become your nightmare tomorrow ….
Personal Insurance – Being Caught Without a Disaster Plan
“Everyone has a plan until they get punched in the mouth.” ~Mike Tyson
Lots of Americans got punched this year, with wildfire in Yosemite, flooding in Colorado, tornadoes in Oklahoma, Missouri, Mississippi, a fertilizer plant explosion in Texas and record-breaking snow in the Mid-West and New England. Natural and not-so-natural disasters are rare for most of us, but they are frightening for all of us. Surviving them can depend on having a plan in place. Can you actually plan for disaster? I think we must plan. No plan is perfect, and plans are useless unless you execute. (That includes following the direction of local authorities. If they say evacuate – do it.) But being prepared means you’ll have fewer panic moments, because you’ve already taken care of many important tasks during your planning process. While we hope none of our clients will face these scary, unexpected types of disasters, we urge them to plan ahead. Many of our insurers provide disaster planning tools. You can also find tools through the American Red Cross and through various government sites, such as Ready.gov. Don’t be scared, be ready!
Environment – M&A “Clean Exits” Getting Dirty
For private equity companies—as well as real estate owners, funders, lenders, developers and tenants—achieving a “clean exit” when winding down investments in property assets or portfolio is a quest with many obstacles. Many contractual techniques exist to reach this objective:
- Not offering buyers any warranties
- Arranging small escrows when protection is required
- Agree on diminishing the sale’s price in exchange of liability waivers
But when it comes to environmental liabilities, the cleanest exit on paper can get dirty if historic pollution happens to be found by the buyer or the neighbors of the property after the sale. Environmental due diligence audits may have missed something, an acceptable residual pollution situation could become unacceptable because of a change in law or if its extent had been underestimated. Due to the “polluter pays” principle applicable in many jurisdictions or the burden of maintaining an escrow large enough for a long time, a seller can be caught up and need to financially “re-enter” in a settlement. Hopefully, they can turn to environmental insurance to help their exits to stay “clean” in the long run.
Energy – Arctic Disaster
From an energy industry perspective, Arctic deep-water drilling and sub-sea completion production systems stands out as the scariest in 2013. Relatively high oil prices, together with advances in technology, have meant that hitherto unattainable hydrocarbons under the Arctic ice shelf are now able to be extracted and produced profitably. However, the shadow of Macondo continues to haunt the exploration and production industry, as a major pollution incident in the Arctic on the scale of that disaster could prove to be catastrophic for all concerned—not only would the cost of clean-up be exorbitant, but the political ramifications could well mean a total suspension of Arctic E&P activity. The energy industry needs to learn how to manage these risks more effectively, primarily from a risk mitigation rather than risk transfer perspective.
Executive Risk – The Wrath of the Whistleblower
Every firm has an employee (or two) who seems to be a chronic complainer. Something is always amiss, they are always being overlooked or ill-done by… but it could be that for once they get it right. In today’s age of the whistleblower—with state, local, and possible federal protection, including Sarbanes-Oxley and Dodd-Frank—the global challenge is to treat seriously each and every report of possible organizational misconduct rather than focus on a witch hunt into the possible motivation of the tipster. Failing to do so (perhaps the one time that the blind squirrel finds the nut), may have serious implications for organizations and executives. The least of which could include fines, penalties; the most serious of which could be the loss of reputation.
China – Tainted Food Supply
Sometimes it’s the unseen risks that are the most worrying. Although their cuisine is amongst the tastiest in the world, China’s residents are increasingly scared about what is really going into their food. In 2008, melamine-tainted milk powder sickened hundreds of thousands of babies and killed six. Despite two people being executed for their involvement, three years later stockpiles of melamine-tainted milk were finding their way back into the market again. But we’ve also had recycled “gutter” oil, cadmium-tainted rice, hormone-overdosed “instant” chickens, rat-dressed-up-as-lamb and exploding watermelons (hormones again). The list is stomach-churningly long and includes some foreign brand names as well. China actually has some of the toughest food quality regulations in the world and is now finally getting more serious about enforcing them uniformly. Meanwhile, this year’s Mid-Autumn Festival moon cakes taste as delicious as ever – but maybe that’s because some of them have fillings recycled from last year’s unused stocks. Bon appetit!
Fidelity – Disabled Safeguards
A company was doing work on its computer system (timed so that certain functionality was affected only in the wee hours of the night). They happened to be a financial institution and their employees could trade on their own margin accounts up to a maximum limit of a not-very-scary $10,000. It just so happened that while the upgrade was being made to the firm’s system, and certain controls were disabled, an employee trading on his personal account from his home computer realized that he could make trades far in excess of $10,000. By morning, this enterprising individual believed that he had amassed a nine-figure profit. Instead, when the markets opened, the night owl had “earned” his company losses in excess of $100M.
Cyber – Individual Suckers; Corporate Losses
At Halloween, some of us dress up as spider man, or pirates, or princesses—but the “Nigerian princes” are out there every day trying to lure the unwary into wiring them money, and it is not only individuals who fall prey to these scams. A firm recently sent a six-figure sum to Russia, by mistake. In at least one instance, the firm was the victim of a phishing scam in which hackers gained access to the firm’s computers. It began with a round of emails ostensibly from an industry group saying that a transaction hadn’t cleared properly. “To resolve the problem, just click on the link below…” Doing so enabled the hackers to install a key logger—a program that tracks a user’s activity—on at least one of the firm’s computers. After figuring out the firm’s online banking passwords, the hackers sent over a quarter of a million dollars to Moscow. When confirmation of the transaction came through, the firm tried to stop it, but it was too late. Wire fund transfer fraud is pretty scary stuff—easy to do and scary across all industries.
Industry & Agriculture – Water Scarcity
One seriously scary risk is the risk of interruption, from whatever cause, to our ability to access water. No longer solely a concern for the areas of the world where there is little rainfall, water scarcity is a global concern affecting both rural and urban communities, businesses and households. Access to clean water is a recognised concern in many parts of the developing world, but it is a resource that most of us in the developed world take for granted. We turn the tap on and it’s there: clean, fresh, consumable water. What if the tap was turned off? Our access to water denied! This might be due to contamination of drinking water on a national scale, a failure in the supply infrastructure or a consequence of drought. Whatever the cause, the potential impacts are varied and far-reaching:
- Impact on agriculture and knock-on consequences for food production
- Impact on industry, causing interruption to manufacturing processes and supply chain breakdown
- Impact on households needing water for everyday living
How would you manage this risk? Redirection and redistribution of water from areas of surplus? Desalination plants to enable sea-water usage? A supply of bottled water at the back of the cupboard? Do you have a survival plan?
Fiduciary – Suspicious Returns
Be afraid—be very afraid—of investments that promise high returns with low risk. This is especially good advice if you are a pension plan fiduciary. Faced with several years of poor investment results and perhaps the reluctance or inability of the plan sponsor to contribute additional funds, today’s search for higher returns can be a perilous one and not for the faint of heart. Several pension plans learned this the hard way after investing about $100 million in a fund promising steady high returns with, you guessed it: low risk. To lure them to their doom, the fiduciaries had been promised (double pinky swear!) that if the investments returned less than a set return, an unnamed financial backer would make up the difference. Ah, the mysterious masked man! Instead of the guaranteed 12% return (spooky), the fund yielded sub-par returns—and law suits on behalf of plan participants.
Environment – Pollution Exclusions
It’s not just the fear of ghosts and goblins that keep people up at night thanks to the total or absolute pollution exclusion found in most casualty insurance products. Companies are scared to death that they could have a claim that’s not covered under their current insurance program. Environmental claims are no exception and are one of those hidden risks that always seem to be lurking in the dark (gradual pollution or historical contamination, indoor air-quality concerns such as vapor intrusion, mold, legionella, toxic tort liability, legal defense costs, natural resource damages, regulatory “reopeners,” crisis management, business interruption, remediation expenses/cleanup costs, etc.). Unfortunately, risk managers can’t look to their standard general liability and/or property policies to respond, as the pollution exclusions function to provide very limited, if any, coverage for a variety pollution exposures and risks that exist. Fortunately, the environmental insurance marketplace is very robust and offers cost-effective insurance and risk transfer solutions. Don’t let visions of environmental claims haunt your nights… sleep well.
Property – Perfect Storms
Last year, two days before Halloween, New York sustained a fright night like no other in recent memory. Not only did storm surge from “Superstorm Sandy” cause extensive damage to numerous buildings housing many financial institutions along Water Street (appropriately named) and other buildings in the financial district but also caused extensive damage to New York’s infrastructure (subways, tunnels, etc.) and power outages throughout lower Manhattan. Notwithstanding the billions of gallons of water that wound up on normally dry land and that the storm came at high tide, the water intrusion occurred in a limited number of areas. Overall financial loss from Sandy is estimated at $60 billion. Next time? Think about Hollywood disaster movie-type flooding in major oceanfront cities and urban areas, then add 120-mile-per-hour winds and you have the makings of a catastrophic event of the magnitude not previously considered.
Employee Benefits – The Self-Insured Scare
Under the Patient Protection and Affordable Care Act (“PPACA”), fully insured plans are subject to new taxes and mandates that will increase the costs of coverage for employers. Self-funded plans are also subject to new taxes and mandates, but not to the extent of fully insured plans. Therefore, many employers who never considered self-funded plans have begun to consider them to avoid potential cost increases. In fact, carriers and other providers are introducing products with much lower attachment points for the stop-loss (needed for all self-insured plans) than had traditionally been the case, permitting much smaller employers to consider self-funding their plans. Historically, a rule of thumb had been that employer plans had to cover 500 or more lives to make them viable for self-funding. With the newer products, employers with 200 and fewer lives have begun to consider self-funding. This shift concerns some state and federal regulators. Several states have begun to take steps to regulate stop-loss coverage the same way they regulate fully insured plans. In addition, the Department of Labor has indicated it will now explore treating self-funded plans as insured plans, requiring the same mandates and expenses that self-funding was intended to avoid. If this occurs, it could eliminate an arrow in the cost management quiver for employers, and is a direct threat to employer flexibility and the protections that ERISA offers to employers who offer medical plans to employers. That attack should scare all employers and their risk managers, as it limits their ability to avoid costs, and make changes to their plans to react to the new reality of PPACA.
Terrorism – TRIA: Trick or treat on Capitol Hill.
Will the insurance industry be treated to an early reauthorization of this important legislation or tricked into major changes or non-renewal of this key legislation by an ineffective Congress? For most U.S. companies the continued availability of sufficient property and casualty terrorism insurance will become a significant issue in the coming months, with the reauthorization of the Terrorism Risk Insurance Program Reauthorization Act of 2007 (formerly known as “TRIA”) in jeopardy. The Act sunsets December 31, 2014 and with TRIA not on the 2013 agenda, it is feared that a disinterested Congress will not take up the issue until late in 2014, causing major market disruption. Come back next week when I discuss this in greater detail.
Did we miss any? Tell us about it in the Comments section. Meanwhile, tell us which of these you worry about most in your business.