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FDE - FERMA report

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In these times of financial distress and economic uncertainty, the Finance Director is a key board member for the risk manager to collaborate with. Finance Director Europe (FDE) magazine has ...

In these times of financial distress and economic uncertainty, the Finance Director is a key board member for the risk manager to collaborate with. Finance Director Europe (FDE) magazine has therefore teamed up with FERMA to produce a special report that explores the risk manager - finance director dynamic and tackles key risks of mutual concern.

Within the report, FERMA board members and close affiliates Paul Taylor, Terry Mikes, Julia Graham and Sabrina Hartusch are interviewed alongside their Finance Directors Kevin Dangerfield, Paul Edwards and Javier van Engelen. Philip Broadley, Group Finance Director of Old Mutual Group and chairman of the pensions committee of the influential 100 group of finance directors in the UK also makes a special appearance to tackle pension related risks - so please click here to read a complimentary copy.

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    FDE - FERMA report FDE - FERMA report Document Transcript

    • In association with: Special report Connecting the dots The importance of risk management cannot be underestimated. The emerging roles oftoday’s risk manager demand a much wider set of competencies, as well as a board presence to enable frictionless communication and decisive action. From regulatory and legislative changes to cashflow and liquidity, risk in all its forms ignites the motivation for growth.
    • Risk management > Connecting the dotsA FERMA commitmentto the futureA s the new president of the more recently the earthquake and Jorge Luzzi Federation of European Risk tsunami in Japan – have reinforced President, Management Associations the importance of an effective risk FERMA(FERMA), I am pleased to collaborate mitigation strategy to the board.with FDE and support a unique report The role of the modern risk manager is fuelling ever greater pensionthat explores the role risk management was one of the items on the agenda deficits, and CFOs, as pension planplays in corporate strategy. This topic during the recent FERMA biannual forum sponsors and often as trustees, needis particularly relevant to our federation in Stockholm, which attracted over to be aware of the various optionsas we have recently submitted 1,500 delegates and featured Joseph for de-risking.answers to the green paper by EU Ackermann, CEO of Deutsche Bank, as On page 60, Philip Broadley, groupCommission staff on a corporate keynote speaker. Highlights of the forum finance director of Old Mutual Groupgovernance framework, and later this are featured in the first part of this report. and chairman of the 100 Group’syear we will provide further guidance This is followed by a series of pension committee, provides anon the risk management provisions of exclusive interviews with prominent interesting perspective on the variousthe eighth EU Company Law Directive risk and insurance managers (who are challenges presented by the proposedin collaboration with the European either board members or close risk-based supervision of IORPS toConfederation of Institutes of Internal affiliates of FERMA) interviewed regulate pan-European pension funds.Auditing (ECIIA). alongside their finance directors. Broadley touches on the challenges of What is of most relevance to the These interviews are complemented Solvency II, which is also a concernreaders of Finance Director Europe with insight from two leading D&O for FERMA and its members.concerning these measures is that liability insurance underwriters, who As well as being the president ofthere is clear responsibility given to look at the importance of robust FERMA, I manage risk at the globalboards of directors and their audit global D&O liability insurance in a tyre company Pirelli, collaboratingcommittees. Senior management is climate of bribery legislation and closely with the Pirelli board as wellexpected to be involved in risk greater personal risks posed by as the group finance director, Michelemanagement and risk-taking. Directors increasingly litigious stakeholders. Lerici – I therefore hope that, as ahave to give direction depending on The second part of this report finance director or CFO, you find thisthe risk appetite of shareholders. revolves around the topic of defined report of value. Key ‘black swan’ events and benefit pension risk management. Look out for an interview withdisasters – the financial meltdown in An aging population coupled Michele and me in a forthcoming2008, the BP Oil disaster in 2010 and with considerable market volatility edition of Finance Director Europe. FERMA Since 1974, the Federation of European Risk Management Associations (FERMA) has been the leading organisation for risk management in Europe, providing the means of coordinating risk management and optimising the impact of national risk management associations outside of their national boundaries. FERMA promotes communication among its members and also within IFRIMA (International Federation of Risk and Insurance Management Associations), of which FERMA is a member. FERMA is frequently invited to participate in meetings and discussion groups with other trade and business organisations. Through these professional networks FERMA presents the risk management methodology and its benefits to business and the community. Every two years, it holds its Risk Management Forum, featuring specific seminars and surveys. FERMA works with educational bodies in Europe and welcomes collaboration from academics and professionals involved in risk management. As part of its continuing influence, it is in ongoing discussion with risk management organisations in other countries to expand the membership. Source: www.ferma.eu 46 Finance Director Europe | www.the-financedirector.com
    • Risk management > Connecting the dots The role of the modern risk managerT he role of today’s risk manager According to Taylor, a diverse set of what risk management does is was a central talking point at the skills and competencies are now connect the dots, so that strategy annual forum of the Federation required by today’s risk manager to impacts the risk environment, and theof European Risk Management operate effectively in today’s most significant risks require theAssociation (FERMA) that took place in challenging global economic landscape. strategy team to deal with that. SoStockholm in October. During a plenary This view was echoed by Julia Graham, you link the two in discussions. I ampanel discussion, Paul Taylor, chairman chief risk officer of DLA Piper, who also not a strategist and I am notof the UK risk management association spoke at the forum, stressing the responsible for that.” ■Airmic and director of risk assurance at importance of risk managers talkingMorgan Crucible, asserted that the role the language of the board.of the risk manager has evolved into a “To skill-up, risk managers need to Top ten risks for 2011key support function for a board. improve their own financial awareness “The role of insurable risk and ability to perform because if they 1. Economic slowdownmanagement hasn’t changed, what has are talking at a board level, [then] these 2. Regulatory/legislative changeschanged is the broader scope of risks are the kinds of issues that boards 3. Increasing competitionthat many risk managers are involved understand and deal with,” she said. 4. Damage to reputation/brandwith,” he said. “The role of a broader One FERMA board member was 5. Business interruptionstrategic enterprise risk management keen to distinguish between risk 6. Failure to innovate/meethas evolved over the last ten years management and strategy setting, customer needsbecause boards of companies, senior stating that a risk manager should not 7. Failure to attract top talentexecutives, have reaIised that they need be a board member or an architect of 8. Commodity price riskto manage the downside risk of their corporate strategy but instead be there 9. Technology failure orbusiness in a better way and they need to help support strategy development. system failureto have clear contingencies in place “Risk management is not 10. Cashflow/liquidity riskwhen things go do wrong, as sometimes responsible for setting strategy. That Source: Aon’s 2011 global risk management surveythings will go wrong.” is for the boards,” he said. “Instead, Finance Director Europe | www.the-financedirector.com 47
    • Risk management > Connecting the dotsAligning governance, risk andcomplianceThe recent ‘Roads to Ruin’ report by UK association Airmic suggested poor riskmanagement and corporate governance were behind companies’ failure to respondeffectively to crisis. Paul Taylor, Kevin Dangerfield and Terry Miles of MorganCrucible explain to Jim Banks why bringing together corporate governance and riskmanagement, including insurance, under one umbrella can bring significant rewards.R isk has been foremost in Kevin Dangerfield everyone’s mind since the Kevin Dangerfield is chief financial officer of Morgan Crucible. He joined the global economy took a turn for firm in 2000 as deputy group controller and was promoted to group financial controller. He then joined the board and was appointed CFO in 2006. Previously,the worse in 2008, and many companies he worked for London International Group and Virgin Retail Europe.have taken a long, hard look at howthey identify, quantify and manage risk.In the boardroom, questions will often beraised about how risk affects corporate Paul Taylor Paul Taylor is director of risk assurance at Morgan Crucible with responsibilitystrategy, how it drives a business for creating and implementing risk management strategy, upgradingforward and what dangers it poses to corporate governance, and managing and developing the internal audit function. He is chairman of Airmic, the UK risk managers’ association.profitability and long-term success. The UK is leading the way inenterprise risk management andcorporate governance, with many Terry Milesorganisations looking at a broad Terry Miles is head of insurance procurement for Morgan Crucible. He is responsible for the placing of global insurance policies and liaison withspectrum of risk and controls, often brokers. Prior to joining the firm in 2006, he worked for Aon, specialisingimplementing a risk framework that in global insurance programmes for major multinational corporations.permeates the organisation from top tobottom. One such company is MorganCrucible, which has a senior executive A FTSE 250 company, Morgan disciplined manner, and the same isfocused on risk – not only to develop a Crucible is one of the UK’s largest true of many corporations,” saysclearer picture of the company’s risk manufacturers of carbon and ceramic Dangerfield. “Paul has come in to giveexposure and manage it more effectively products for industrial use. Taylor has us a level of risk analysis that goes– but also to ensure that its attitude to been at the company for three years, from the operational side right up torisk is not too conservative. After all, risk and along with the treasury team and the boardroom. It gives us clarity ofgoes hand in hand with opportunity. the head of insurance procurement, risk for the group, enabling “Why do this? Well, there are specific Terry Miles, he reports to the management to think more clearlybenefits, like improved decision-making company’s CFO Kevin Dangerfield, who about risk in a disciplined way as partthroughout the organisation, and there also chairs its risk committee. of a comprehensive governance, riskare fewer unwanted surprises, which “I came in to evolve what was in and compliance plan.”has happened recently in UBS and BP,” place, moving towards a new direction, So far, the new approach to risksays Paul Taylor, director of risk a new strategy,” says Taylor. “There were management has proven effective, notassurance at the Morgan Crucible discussions about what had been done only in identifying risk within theCompany and current chairman of well and what could be improved and organisation, but also external issues.Airmic, the UK risk managers’ we put together a three-year strategy on “We can’t control all of the externalassociation. “It also improves governance, risk and compliance, including risks, like the trends in the globalcompliance, which is important for a internal audits and control of policies. Now, economy or disasters such as thequoted company. The changes we have we are in the third year of the roll-out.” earthquakes in Japan,” continuesmade to hearts, minds and culture are “In the past, the company had not Dangerfield. “But we have weatheredalready bearing fruit.” looked at risk in a comprehensive and the economic storm well through 2009 48 Finance Director Europe | www.the-financedirector.com
    • Risk management > Connecting the dots We want to quantify risk as a number. That focuses the attention whendeciding whether a risk is acceptable. Our holistic approach gives us better,quicker decisions across risk, corporate governance and insurance.and this year with resilient earnings prevents risk managers from addressing regulations in different jurisdictions.and cashflow. That shows the change issues in a company’s top echelons. “We run local programmes under athat has been made in the company, Improving the structures, processes, global umbrella and no one has thehow management looked at risk and and even the language used for answer to compliance on a globalthe value of its sensitivity analysis. managing risk can encompass all of basis,” continues Miles. “A lot dependsWe saw some issues from the crisis these issues. on interpretation of the law, but youin Japan, but we also saw the “Corporate governance and risk are have to take a sensible approach. Weopportunities to supply to our dealt with as one thing across the no longer have a captive insurancecustomers when our competitors could group,” says Dangerfield. “It is company, which many companiesnot. So, our approach to risk means we are important to set the tone from the top. would think was a natural thing tobetter at responding to outside events.” For instance, robust controls are have, because there has been a shift in important in light of the UK Bribery Act, the insurance market and deductiblesA holistic approach so we have run global training sessions are low, so there are not sufficientWithin this framework, corporate as part of a rolling programme of business drivers for a captive.”governance is an important strand. corporate governance measures on a The structure for procuring insurance,A recent report prepared by CASS worldwide basis.” establishing risk controls and instillingBusiness School on behalf of Airmic A similarly broad approach is taken corporate governance priorities shouldshowed that the main reasons to insurance as a powerful tool in focus on giving everyone in ancompanies fail to respond well to crises managing risk. organisation a better understanding ofare tied to both risk management and “It is mandatory for all countries in how risk affects a business.corporate governance policies. our group to be part of a global “It’s all about clarity of thought and The ‘Roads to Ruin’ report suggested insurance programme, though auto and the ability to see what the top risks arethat risks arise from inadequate employee liability insurance are handled in the organisation in a qualitative andboardroom skills and the inability of locally,” says Miles, head of insurance quantitative way,” says Dangerfield.non-executive directors to exercise procurement. “We have a strong team “What gets quantified gets managed,control; blindness to inherent risks that ethos here, so there is no resistance to and we want to quantify risk as amight threaten a company’s business having a global programme.” number,” adds Taylor. “That focusesmodel or reputation; inadequate Inevitably, there are challenges to the attention when deciding whetherleadership on corporate culture; implementing an insurance strategy a risk is acceptable. Our holisticdefective internal communication; across more than 50 countries, as approach gives us better, quickerorganisational complexity; inappropriate Morgan Crucible does, not least of decisions across risk, corporateincentives; and the ‘glass ceiling’ that which is the complexity of the governance and insurance.” ■ Finance Director Europe | www.the-financedirector.com 49
    • Risk management > Connecting the dotsHeld to accountIn the wake of the global financial crisis, legal action is on the rise and isincreasingly being targeted not just at companies, but also at individualexecutives. Géraud Verhille of Chartis discusses the legislative changesthat have facilitated this, the implications they have for executives andboards of directors, and what they can do to protect themselves.T he global financial crisis of 2008 set off a wave of media, which gives people the ability to drum up support litigation activity that is gathering pace with each and frame an issue in a certain way,” Verhille says. passing year. Grievances related to the ethical conduct There has been a rise in the number of cases related toof directors, alleged anti-competitive behaviour (anti-trust or corporate bankruptcy proceedings, impropriety in thecorruption) and bankruptcy proceedings are being pursued to context of mergers and acquisitions, including instances ofthe fullest degree. Such cases are not only a cause of concern aiding and abetting or simple breach of fiduciary duty. Thisfor corporations; they increasingly target individual executives. is observed in many countries, including Spain where the The number of claims brought against company directors burst of the real estate bubble – a sector rife within Europe is running at 20% above 2009 and 2010 levels, acquisitions – has had far-reaching consequences includingwhich were already considered ‘peak years’, and this bankruptcy proceedings and shareholder litigation.pattern looks set to continue. The introduction of legislation “On the litigious side, where there have been financialsuch as the Dodd-Frank Act in the US and the Anti-Bribery losses, shareholders are quite simply trying to bring directorsAct in the UK is likely to underpin this pattern in the future, to account,” Verhille says. “Allegations based around the wayas it further empowers regulatory bodies and criminal organisations make representations to the market are alsocourts to place past and future actions of corporate board very common at the moment. CFOs have personal liabilitymembers under intense scrutiny. for this, which is why regulators and shareholders are going “There is a greater push for transparency in what after the individual, not just the company.”corporations do, especially in the financial markets, and a Another noteworthy change is the increase in collectivedrive for a more ethical business conduct across the globe,” action suits in European courts. The US has long been seensays Géraud Verhille, vice-president, Financial Lines Europe as the most favourable forum for such disputes, leadingat the insurer Chartis. “This is aided by legislation such as many foreign investors to join US actions even if their casethe Dodd-Frank or Bribery Acts but also by the allocation of did not directly relate to that jurisdiction. The US Supremegovernment resources, the existence of bodies such as the Court decision in the Morrison case has strengthened theEnterprise Chamber in the Netherlands, or quite simply by hand of judges to push such cases back into morehistorically active regulators like the Corte dei Conti in Italy geographically relevant arenas.or the AMF in France. In a way this has been an existing trend “They may not be full-blown class action suits like we seefor a number of years but the crisis has provided a renewed in the US yet, but multiple party actions involving groupspolitical drive that has accelerated the process.” that have suffered common losses or share common problems are emerging in Europe,” Verhille explains. “What also contributes to this is US courts telling holders of foreign The number of claims brought shares ‘there is an alternative forum for your class – you didagainst company directors in not purchase your shares on the US stock exchange’ andEurope is running at 20% above redirecting the case to an indigenous forum. As a consequence we see the foreign component of existing US2009 and 2010 levels. actions being pushed back into Europe and litigated here.”Shareholder power A class actThis increased power to hold individuals to account This must also be seen in the context of the increasedmanifests itself in a number of ways. Many direct or strength of regulatory and legal authorities in a number ofderivative shareholder actions are being launched out of different countries. In the UK, for example, the recentlyanger and disillusionment with recent events. In certain introduced Bribery Act has given the Serious Fraud Officeinstances this is for financial recovery, but in many others it potential access to a much greater number of companies andis about governance. For example, new ‘say on pay’ rules individuals. The terms of the legislation mean that the onushave given shareholders greater powers of governance and a of guilt has shifted, placing greater pressure on the executivehigher volume of motions are being tabled at company boards of companies to prove that no wrongdoing has takengeneral meetings. “This is at times even supported by social place. Recent years have also seen a noted increase in 50 Finance Director Europe | www.the-financedirector.com
    • Risk management > Connecting the dotscross-border cooperation between regulators, anacknowledgement of the global impact of how modern Know your ABCbusiness is conducted. There are three kinds of directors and officers (D&O) liability “Before the Bribery Act the criminal prosecution had to insurance, which offer varying degrees of coverage:prove that there was a ‘directing mind’ within a company nn n idenAndirectly covers directors and officers for Sthat led to an act of bribery,” Verhille explains. “Now, once an losses resulting from claims made against them foract of bribery has been discovered, a company can be liable wrongful acts committed in their capacity as an executive for which no indemnification by theirunless it can demonstrate that all possible measures had company is possible.been put in place to prevent it. It makes it so much more nn SidenB coverage reimburses a company for the costdifficult for company directors and so much easier for the of indemnifying its directors or officers as a result ofauthorities to enforce and fine.” claims made against them. “The increase in the budget allocation to ensure n SidenC provides coverage for a company’s losses forenforcement in the US and a review of plans to consolidate claims in relation to the violation of securities laws,regulatory bodies in the UK for fear of losing effective typically brought by shareholders.enforcement are strong political signs,” Verhille explains. “Thechanges in the legal landscape regarding whistle-blowingand self-reporting are also helping to allocate enforcement Private vs publicresources more efficiently. As a result, we are now seeing that In this environment, steps need to be taken not just by largewhen regulators and subsequently investors decide to litigate, public firms, but by private companies as well. In Verhille’s viewthe action tends to go further. It’s an issue that sticks.” there has been a misconception that directors of private In addition, some of the key deterrents to civil action are companies have a much higher immunity to claims. The realityeroding in Europe. The ‘loser pays’ rule made many possible is that cases lodged against executives of private companiesclaimants think twice about launching action, wary of the now outnumber those brought against their public counterparts.need for a watertight case if steep costs were to be avoided. “Of course, most private companies don’t have to worryThe rise in the amount of litigation funding available in about cases related to misrepresentation to financial markets,”certain European countries mitigates this and the local he explains. “But they are at the mercy of a whole range ofimplantation of law firms used to US-style class actions, as claims, not least brought about by state attorneys. For example,well as the relaxing of contingency fee limitation (e.g. in the with respect to health and safety, anti-trust issues, or casesNetherlands) has provided extra impetus to pursue claims. related to the environment, executives of private companies are just as accountable. On the civil side they face cases broughtEnsuring transparency by their stake-holders related to breach of fiduciary duty whichThere are things that finance officers can do to mitigate may have led to financial losses. All of these are on the rise.”two of the largest risks they might face; one with respect torepresentations to markets and the other to bankruptcies. Defence industryIf companies are to ensure the correct representation of For all the doom and gloom, strong defence of directors andinformation to the markets, systems must be put in place officers against litigation often proves successful. Even ifthat allow for real-time, cross-company visibility of both initial decisions prove unfavourable, recent history suggestsoperational performance and liquidity levels. This includes that many appeals lead to the dismissal of a case or thesubsidiaries and sub-groups, which are being targeted more reduction of an award or fine. Comprehensive, road-testedand more. directors and officers (D&O) insurance combined with strong “Most CFOs are clearly aware of these risks and their claims-handling experience and a global footprint can go aconsequences, which is the first major step,” says Verhille. long way to mitigating risk. Court action is always costly and“In terms of mitigation, many have been moving in the right stressful, but strong defences can make it much less so.direction for years, changing the way organisations are run “There just needs to be that risk awareness,” Verhille says.to make more accurate representations to the market. There “When it comes to criminal or regulatory investigations andis also a lot of risk associated with providing guidance, as prosecution, a powerful defence is expensive but paramount.altering it tends to affect your share price. Should we provide Whether you are big or small, strong defence is criticalit? How should we do it? These questions need to be because the ultimate consequences to a practice, or as aassessed rigorously. director or officer, be it fines, imprisonment or disqualification, “When it comes to liquidity and solvency, CFOs must could be considerable.” ■monitor all parts of the group. Bankruptcies of subsidiaries oraffiliated companies can lead to tough litigation againstindividuals – allegations of late notification or asset-stripping Further informationare typical. You have to try to stay abreast of these situations Chartisto build up as strong a defence as possible should anything www.chartisinsurance.comhappen,” he adds. Finance Director Europe | www.the-financedirector.com 51
    • Risk management > Connecting the dotsA triumph of riskmanagementInsuring the right risks at the right price while mitigating all other hazards and exposuresfor which cover is not available is often a complex and dynamic process. Javier vanEngelen and Sabrina Hartusch of international lingerie and shapewear manufacturerTriumph International Spiesshofer & Braun KG explain why it helps to integrate insuranceand risk management within the finance and administration function.B ased in Switzerland but founded management, that all risks should be alignment among all stakeholders, not in Germany 125 years ago this reviewed at least annually, along with to mention the great strides that have year, family-owned Triumph was the strategies to mitigate them. been made in terms of Triumph’sfor a long time a decentralised Insurable hazards such as trade credits, organisational structure.organisation that grew to become a any type of liability and trade or valuecompany with a turnover of CHF2.2 chain disruption were clear and defined. Uninsurable risksbillion and 36,500 employees. Today, it However, as Sabrina Hartusch, Triumph’s Among the uninsurable risks that weremanufactures in ten out of the 46 global head of insurance, points out, it is thrown up by the risk map, van Engelencountries in which it has an established still important to promote competition singles out three key areas. Being firstpresence, and operates in a total of 120 among insurers and to diligently select to market with quality, innovative anddifferent markets. your provider. The company insists that consumer-focused products is a constant Triumph specialises in high-quality, policies are tailored to Triumph’s specific challenge he says can only be met bymid-segment-priced underwear, where requirements rather than simply the firm’s commitment to workmanshipfit and comfort are of crucial importance. supplying off-the-shelf products. and its 125 years of experience.Renowned brand names such as Hartusch has conducted a stringent A second risk concerns Triumph’s globalTriumph, Sloggi, Valisère and HOM analysis of Triumph’s insurance world. scale. Its main competitor, Victoria’s Secret,belong to the group. As CFO Javier van As a result, the company does not pay may be bigger but it is US-focused.Engelen explains, Triumph has recently for risks it no longer considers important. Triumph is the only truly internationalmade two major strategic changes. The Moreover, competition has reduced player; it therefore must leverage thatcompany began to centralise its premium cost and delivered a better reach to stay ahead of competitors who,functions, not least risk management service. What is also clear is that global says van Engelen, will challenge it withand insurance in its global headquarters insurance is ultimately responsible for all lower cost and lower-quality products inin Bad Zurzach. It also decided to company policies, from legal entity to an industry where margins are shrinkingestablish its own retail stores alongside personnel insurances. because of commodity price rises.its wholesale trade. Van Engelen and Hartusch have The third challenge is to remain best done much to promote effective in class, not just in commercial termsRisk mapping communication within the Finance and by bringing new products to market,“Two years ago we started with global Administration function and emphasise but also in the way Triumph managesrisk mapping,” says van Engelen. “We the importance of cross-departmental itself internally.asked everyone within the company to doa risk map, a heat map of the biggestrisks that we have from their individual Javier van Engelenfunctions.” Up until this point, there had Javier van Engelen is the global CFO and a member of the global managementbeen a disjointed view of the totality of board of Triumph International. Previously, he worked in multiple countries for Procter & Gamble and AstraZeneca Pharmaceuticals. He holds a masters degreerisk. Creating the map produced a picture in Economics/Econometrics from the Antwerp Business School.of the compounded risks and openedexecutives’ eyes to the reality that whileindividual risks could be managed, therewas considerable complexity when they Sabrina Hartusch Sabrina Hartusch is global head of insurance at Triumph, responsible for thewere taken together. group’s global and the local subsidiaries’ insurances. She holds an MSc in It was also clear to the Triumph global insurance and risk management from Cass Business School, London, and is on the board of the Swiss Association of Insurance and Risk Managers.management board, which oversees risk 52 Finance Director Europe | www.the-financedirector.com
    • Risk management > Connecting the dots “This comes back “For me, the biggestto insurance, finance differentiator is notand risk,” van Engelen necessarily being private orexplains. “What we’re public,” he says. “It is aboutdoing here in terms of how you manage yourour finance structure cash. There is one bigand the overall risk difference between privatemanagement has to be and public companies,a top-quality approach.” which has implications, The mitigating and that’s the quarterlyadvantage that reporting. The advantageTriumph enjoys is its that we have is that we dofamily ownership. not have to worry aboutShort lines of fluctuating results, quartercommunication by quarter. So we have amean that problems bit more flexibility. We docan be spotted and not have to cover for allfixed quickly, and potential risks and tovan Engelen notes hedge them over time sothat five generations that we avoid significantof owners have disruption. We save money.”pursued the same “The translation hasfundamental nothing to do with themandate: to reinvest operational health of thein the business. company,” van Engelen He also says that continues. “It doesn’tit’s not possible to impact my profit margin.have a global It is purely translatingmandate for credit operating results from allrisk. Instead he my subsidiaries into a Swissdrives home to local franc consolidation report.”subsidiaries the need The current strengthto assess credit risk Triumph has been creating lingerie and shapewear for 125 years. of the Swiss franc hasand insure where only impacted the 2% ofappropriate. These local subsidiaries any insurance against that. We thought sales the company makes in Switzerland.are held accountable for bad debts, but there was absolutely no risk. We got it There is one ‘risk’ that van Engelendespite Triumph having many thousands wrong. However, in the total scheme of cheerfully admits he would never haveof customers, the recession has not things, it was a very small pimple on a suspected when he came to Triumphproduced any significant increase. smooth surface.” three years ago. Apparently, when a new However, he admits: “Life is not The solvency of Triumph’s insurers and colour is introduced to an underwearalways rosy. We have been hit by one their three renowned banks is always on range, it can affect the all-important fitbad debt. A major German retailer with the risk radar. There is, however, one risk of a garment. It seems there are somea triple-A credit rating and they still area van Engelen doesn’t have to worry scenarios even an experienced CFOwent into insolvency and we didn’t have about: foreign exchange risk. cannot plan for. ■ Company profile: Triumph International Triumph International, one of the world’s leading manufacturers of lingerie and underwear, is a family-owned company with 36,500 employees worldwide and an annual turnover of CHF2.2 billion in 2010. It develops, produces and markets underwear, sleepwear and swimwear both wholesale and through its own stores for its Triumph, Sloggi, Valisère, and HOM brands. Triumph began life as a corset manufacturing business in southern Germany in 1886. Founders Michael Braun and Johann Gottfried Spiesshofer laid the foundations for an innovative product policy, coupled with the highest standards of material and workmanship. Triumph rapidly became a pioneer in the transformation of the shaping corset into luxury lingerie. Having extended its name to Triumph International in 1953, the company subsequently opened subsidiaries on all continents. Today, it has a presence in over 120 countries. Finance Director Europe | www.the-financedirector.com 53
    • Risk management > Connecting the dotsCalculated riskRisk management is a complex task for any multinational and DLA Piper, the world’slargest law firm, knows only too well the many challenges posed by different regulationsand insurance requirements. Chief risk officer Julia Graham and CFO Paul Edwardsexplain to Jim Banks why the company’s decision to appoint a CRO to coordinate anenterprise-wide risk management strategy has been its trump card.I n early 2011, DLA Piper became the world’s biggest law firm with Julia Graham Julia Graham is chief risk officer for global law firm DLA Piper. Her more than 4,000 lawyers in 76 responsibilities include the design and procurement of internationaloffices in 30 countries. For such a programmes for all classes of insurance. Graham is a past chair of Airmic and a board member and vice-president of FERMA.globally distributed organisation riskmanagement and insurance provisionpose many challenges, not only interms of divergent regulations in Paul Edwards Paul Edwards was appointed chief financial officer of DLA Piperdifferent jurisdictions, but also from a International LLP in 2004. Prior to that he was finance director for eightcost perspective. years at Simmons & Simmons. Edwards has also worked as a chartered accountant with Arthur Andersen in both London and Brisbane, Australia. To ensure that the right insuranceand risk mitigation strategies are inplace, and that they are cost-effective,the organisation places great The CFO and CRO Edwards, who is responsible for allemphasis on the relationship between financial matters outside the US, ischief risk officer (CRO) Julia Graham may have a natural part of the firm’s international boardand the firm’s top management, conflict, the former and its management executive. Anincluding CFO Paul Edwards. Graham, immediate past president driving growth and the ACA, he qualified with Arthur Andersen and has since worked in theof Airmic and currently VP of FERMA, latter controlling risk, finance teams of leading law firms.is in charge of the firm’s handling of but that tension can “The key thing is the very existencelegal and regulatory risk, operational of a CRO, as we need a specialist torisk – including HSE and business be very important in advise us when we make commercialcontinuity – and client intake issues creating solutions. decisions,” he remarks. “We absolutelysuch as conflicts of interest and need insurance, but it adds red tapemoney-laundering countermeasures. risk committee, which includes the and can constrain the business.Her brief also covers compliance, the chairman, managing directors and “Julia runs the risk committee andpurchase of insurance and claims some senior partners, but my focus is it is her job to show all the risks andmanagement for all classes of cover. on insurance. exposures the firm faces. Usually, theHer previous experience in the financial “Paul looks at financial management CFO and CRO may have a naturalservices industry gives her a unique and control, so he wants to see that conflict, the former driving growthinsight into how different things are in I spend our money wisely. My role is and the latter controlling risk, but thata professional services firm. to agree the insurance programme tension can be very important in “Our business model drives many with the partners who run the creating solutions,” he adds.things, including the relationship business, while part of the CFO’s brief Graham agrees but says that she isbetween CRO and CFO,” says Graham. is to address challenges like tax and not always pushing in the opposite“It is not like financial services, where transfer pricing as part of the global direction to Edwards.often the CRO is the CFO and the role insurance programme. He needs to “Risk management is not just aboutfocuses on the market, credit and know that it is compliant and prevention; it is about convertingliquidity risk. In a law firm the agenda appropriate for the territories in which opportunity,” she explains. “It is partlyis different. Both Paul and I are on the we work.” about comforting non-executive directors 54 Finance Director Europe | www.the-financedirector.com
    • Risk management > Connecting the dots Compliance can be a challenge, especially in emerging markets. Youhave to navigate a very complex landscape in which markets are at verydifferent levels of maturity, and regimes are changing all the time.so that they are less risk-averse. Risk core team of centralised expertise confirms Graham. “D&O insurancehas negative connotations, so the under Graham makes managing covers management liability for thechallenge is to play the upside.” compliance simpler. actions of external directors and “The management team doesn’t see “Compliance can be a challenge, the management of the firm, butthe CRO role as a negative thing,” especially in emerging markets, where professional indemnity, or malpractice,stresses Edwards. “We must have a local tax and regulatory regimes is our largest kind of cover by far andmore enlightened view. Professional differ,” comments Graham. “You have takes priority over D&O.”indemnity, which is a very specific to navigate a very complex landscape Important work by the likes ofarea of expertise for Julia, is very in which markets are at very different FERMA and Airmic is bringing theimportant. Sure, the CFO might get levels of maturity, and regimes are industry together to improve the optionsfrustrated by the many regulations changing all the time. There is no from brokers and make choices lessaround the world, but Julia must guide blueprint for an insurance programme. disparate, but there is still much to do.us through that to help the board You can’t just get an off-the-shelf “The complexity of a globalunderstand them.” solution from a broker.” insurance programme means that as The core team handles many kinds of CRO I have to be very inquisitive andGlobal policy, local cover insurance, but the most significant is constantly vigilant,” says Graham.DLA Piper operates a global insurance cover for malpractice; broadly speaking, “My team must stay informed andprogramme to ensure consistency and this is the equivalent of D&O insurance. educated, which helps relationshipseconomies of scale, but the most “Malpractice insurance is the with brokers. We develop a partnershipimportant driver is central control. The biggest professional risk for us,” with them and work closely together Finance Director Europe | www.the-financedirector.com 55
    • Risk management > Connecting the dots nThenproblemsnatnNewsnCorporationnemphasisenissuesnlikenreputationalnrisk,nandnraisenquestionsnaboutnthenworkabilitynofnD&Oncovernwhennmanagementnschismsnpitndirectorsn–nandntheirninsurersn–nagainstneachnother.nto design programmes. For instance, compliance are managed verywe may need local cover to get a closely together.” Company profile:business running in a particular “I want a CRO who brings up and DLA Pipermarket, as well as the umbrella of the addresses issues by working with nn DLAnPipernwasncreatedninn2005nglobal programme. It is a complex the CFO and senior management,” bynthenmergernofnDLA,nPipernstructure, which is why we need a says Edwards. “We want to know if RudnicknandnGraynCary.ndedicated professional to manage it.” we have suitable plans for disaster recovery to react to things like nn Thencompanynemploysn4,200n lawyersninnnearlyn76nofficesninnTopical risks outbreaks of swine flu or the Asia-Pacific,nEurope,nthenMiddlenTo control this complexity, DLA Piper earthquakes that Japan had this year. EastnandnthenUS.nhas a risk register which is constantly We need Julia to put a good systemupdated to track topical risks. These in place that is cost-effective.” nn Withnandirectnpresenceninn30n countries,nDLAnPiper’snclientsncomprise: the economic environment; Events constantly inform the firm’s includenmorenthannhalfnofnthenthe rising tide of tougher regulation; risk profile. The ongoing problems at Fortunen250nandnnearlynhalfnofnthensecurity of information; the fight for News Corporation emphasise issues FTSEn350norntheirnsubsidiaries.ntop talent; perennial risks; and the risk like reputational risk, and also raise nn Thencompanynoffersnservicesninnof catastrophes, whether they be questions about the workability of multiplenbusinessnsectorsnincludingnnatural disasters or the social unrest D&O cover when management banking;nhealthcare,ninsurancenseen in markets like Egypt. schisms pit directors – and their andnreinsurance,nandntechnology.n “We have to look at very specific insurers – against each other. nn DLAnPipernadoptsnannenterprisentypes of risk and mitigate any risk In short, a big professional services approachntonriskndeliverednbynannthat might affect the way we deliver firm needs not only a risk specialist integrated,ninternationalnrisknon our strategy,” says Graham. “We like Graham, but a coherent, global, managementnandncompliancenteam.n nare specific about risks so that people enterprise-wide strategy for risk nn Inn2011nDLAnPipernbecamenthencan embed them in how they manage management to ensure compliance world’snlargestnlawnfirm.nthe business. Governance and risk and cost-effective cover. ■ 56 Finance Director Europe | www.the-financedirector.com
    • Risk management > Connecting the dotsReduce complexitywith global D&O coverMore than ever, company directors working in unfamiliar countriesand jurisdictions need robust D&O coverage. Michael Rieger-Goroncyof Beazley explains why working with his firm – a Lloyd’s of Londoninsurer licensed to operate in 79 countries – can save businessesvaluable time and money.I n 2009, the title for the FERMA conference was ‘Global defence. In the absence of dedicated Side A cover that village: the future of risk management’. Two years later, complies with local requirements to cover such costs, they will life in the village is far from harmonious. Political unrest be completely on their own.in the Middle East and North Africa, and extreme economicvolatility in the eurozone and North America have contributed A flexible policyto the world becoming a much more unstable place, with So how can insurers help to resolve this? Some are nowthe risk of nationalist and protectionist reactions from offering local policies provided by their regional subsidiary orgovernments increasing daily. As a result, company directors a local partner fronting the policy. However, this can proveworking in unfamiliar countries and jurisdictions require both costly and complicated – especially if the local insurer isreliable, far-reaching directors and officers liability insurance not an expert in writing D&O insurance. Experience shows(D&O) coverage. that getting local policies fulfilled is, at best, a difficult and In the past, directors have taken comfort in the fact that their time-consuming task. Problems often arise when dealing withglobal D&O policy purported to afford them cover all around local laws and regulations, negotiating different terms andthe world. However, many governments are now requiring conditions for each jurisdiction, and, finally, consolidating alldirectors and companies to use policies that comply with local of this coverage in the global policy.legislation. The penalties for failing to do so are significant; Of course, everybody dreams of buying a genuinely globaleither a sanction against companies and their insurers or – policy that offers compliant coverage in each jurisdictionmore ominously from the director’s perspective – a prohibition without having to resort to local policies. While there is no panacea, the problem can be significantly eased by working Many governments are now with an insurer licensed to write direct business in a wide range of countries.requiring directors and companies Beazley, like other Lloyd’s of London insurers, is licensed into use policies that comply with 79 countries and can offer immediate coverage in manylocal legislation. The penalties for territories. This prevents the need for complicated, time consuming and costly local polices in these countries.failing to do so are significant. Furthermore, Beazley is able to offer this solution even when it is not the primary insurer on a programme, but on an on the payment of D&O claims under a excess layer only. The risk manager can elect to buy an global policy. additional Beazley Side A excess endorsement with an The problem is particularly ‘international drop down’ provision. While this may not serious for directors when always prevent the company from having to buy local they are operating in policies (for example, in Brazil, where Lloyd’s is not currently overseas jurisdictions licensed), it will often help to make the placement of an that forbid companies international programme much easier, faster and less indemnifying directors, expensive than if the primary insurer needed to issue local meaning they cannot be policies for all territories. ■ protected by so-called Side B D&O cover. In these cases, the director Further information will be personally liable for Beazley Group costs arising for local legal www.beazley.com representation to conduct their Finance Director Europe | www.the-financedirector.com 57
    • Risk management > Connecting the dotssoapClean without US Foreign Corrupt Practices Act (FCPA) v UK Bribery Act Who is being bribed? FCPA: Limited to the bribing of ‘foreign officials’. Bribery Act: Prohibits bribes paid to any person to induce them to act ‘improperly’. Nature of advantage obtainedWhen Siemens agreed to pay a record $1.34 billion fine for FCPA: Payment must be ‘to obtainbribery and corruption in 2008, a wide-scale compliance or retain business’.transformation programme was already in full swing within Bribery Act: Not limited to business advantage – extends tothe company. Finance Director Europe looks back at how any improper action.Siemens cleaned up its act and why robust compliance 1 Active offence vs passiveand internal controls are so important for modern offencecompanies in a climate of increased bribery legislation. FCPA: Only the act of payment, rather than the acceptance of payment, is prohibited.T he UK Bribery Act came into culture to make this company a much Bribery Act: Both bribing another (‘active offence’) and being bribed force in July this year. FDE more focused one.”  (‘passive offence’) are prohibited. readers based outside of the Potential penaltiesUK will be interested to know that they Pillars of strength FCPA: Individuals face up to fiveare not necessarily immune, as non-UK The compliance transformation at years in prison and fines of up tosubsidiaries of UK companies – as well Siemens gained momentum when $250,000; Entities face fines of upas other non-UK incorporated companies Andreas Pohlmann was appointed in to $2 million.– can be liable if they carry on a September 2007 as chief compliance Bribery Act: Individuals face  upbusiness or ‘part of a business’ in the officer. In an interview given to the to ten years’ imprisonment andUK. Individuals, no matter what their United Nations Global Compact, potentially unlimited fines; for entities, potentially unlimited fines.nationality, are also liable if an offencewas committed in the UK; so too areBritish nationals working abroad and The crisis gave usdirectors and officers, even if they are that fundamental and appropriate sanctioning acrossonly passively (see table, opposite) push and change in all levels of the business in the eventinvolved in an offence. The UK Bribery Act takes a leaf out of culture to make this of employee misconduct. Peter Solmssen, Siemens’ current generalthe 34-year-old FCPA (Foreign Corrupt company a much council, took over the role of chiefPractices Act) in the US and when more focused one. compliance officer in 2010. In spitecomparing the two, the UK Act appears of the inevitable media storm thattougher. The FCPA has clocked up over surrounded the scandal, Siemens’50 successful prosecutions against Pohlmann outlined Siemens’ three-pillar reputation seems to have remainedcompanies including German “prevent, detect, respond” compliance intact with revenues of €76 billion andconglomerate Siemens, which agreed system, whereby ‘prevent’ focuses on a net income of €4.1 billion in 2010.to pay a massive $1.34 billion fine in information quality, integrity and With ambiguities around theDecember 2008 for operating a S$2.3 reliability, as well as anti-corruption application of the UK Bribery Act inbillion slush fund in Singapore to help training; ‘detect’ focuses on early- specific scenarios such as corporatewin international contracts. Speaking stage detection of misconduct, such hospitality and the sensitivity ofon a Forbes podcast in July 2011, group as a help desk function to encourage specific vertical markets to briberyCFO of Siemens, Joe Kaeser, employees to communicate problems (such as the pharmaceuticalacknowledged that the crisis gave and thus help build a stronger culture sector), ensuring clear guidance andSiemens a much-needed reality check. of integrity; and ‘respond’ focuses on policies for employees, such as those“The compliance crisis gave us that the strict enforcement of policies and adopted by Siemens, could well be afundamental push and change in regulations coupled with consistent good idea for all companies today. ■ 58 Finance Director Europe | www.the-financedirector.com
    • Risk management > Connecting the dotsSeize the dayIn today’s volatile pensions market, more and morecompanies are looking to transfer the risk to insuranceproviders. With a vast array of available options, includingannuity buy-ins and buyouts, Prudential’s Greg Wenzerul(far right) and Andrew Reed explain why many companiescannot afford to wait to transact.T hese are tricky times for defined benefit pension is not possible. They may be quite heavy in equities, and schemes. Faced with the double whammy of equities have dropped down in value quite significantly.” increased longevity risk and extreme market Prudential therefore offers a nuanced range of approachesvolatility, many of them have been plunged into deficit. With suitable for companies’ specific needs. With schemesever more schemes closing to new members, the central increasingly using a combination of solutions as part of theirconcern for sponsors and trustees is finding ways to long-term risk management strategy, Prudential works on wayssafeguard existing members’ interests. of incorporating these into an individually tailored route map. Managing down the risk is therefore seen as essential. An important point of focus has been adding flexibility to“The current climate has really focused trustees’ minds on buy-in contracts. One such area of flexibility is to coverde-risking,” says Greg Wenzerul, corporate deal principal at future retirees within a transaction at an affordable price –Prudential. “For many trustees, the goal of de-risking their a pilot project known as Defined Benefit Vestings. “Definedschemes has become a lot more pressing.” Benefit Vestings allows you take out annuities as people The picture, however, is complex, with no two schemes retire,” says Reed. “That’s particularly attractive when you’veoperating in quite the same way, and no one solution suitable secured your pensioners, and you just want to carry onfor all. While transferring risk to an insurance company may building up the annuitisation.”seem like an attractive prospect, it is important that sponsors Another promising solution is the Future Premium Productand trustees remain alert to what this may mean in practice. (FPP). It is suited to most schemes and avoids the drawbacks of the much touted longevity swaps, which for some If you can find a counterparty schemes may not represent especially good value for money. The main thing, as Reed and Wenzerul see it, is to ensurethat you believe is strong and that you pick an insurance company that will work with youreliable, and they can meet that to provide the optimal solution for your particular scheme.price, then transact. Don’t wait. “With more turbulence expected ahead,” says Wenzerul, “we recommend schemes transact with a counterparty that is financially secure, stable and will be around in the market forBuy-in vs buyout the life of its members.”Two widely discussed options are annuity buy-in and It is an area of the market in which Prudential holds greatbuy-out solutions. Buyouts transfer the pension liabilities sway. With an instantly familiar brand and a long history infrom the sponsor company to the insurer, whereas buy-ins life insurance, the company benefits from a potententail purchasing an insurance policy that fully matches combination of solid administration and financial strength.those liabilities. Since 1997, it has secured pension scheme liabilities in “At Prudential, we have been in the annuity buyout market excess of £5.4 billion, and has successfully completed oversince the mid-90s, with the annuity buy-in market taking off 430 buy-out/buy-in transactions. Such transactions look setaround 2006,” explains Wenzerul. “The key difference is that to continue for many years.a buy-in is an asset of the scheme. It’s similar in many ways “My view would be, understand what your criteria are forto a corporate bond, but instead of coupon payments it pays transacting,” says Reed. “If you can find a counterparty thatthe actual benefits of the underlying members.” you believe is strong and reliable, and they can meet that While buy-ins represent the ultimate de-risking solution price, then transact. Don’t wait. You often miss the boat.” ■for many companies, they require the support of thescheme’s sponsors and affordability remains a consideration. “It’s difficult to say, ‘now’s a good time to enter into a buy-in Further informationor a buy-out’,” says Andrew Reed, Prudential’s director of defined Prudentialbenefit solutions, “because although it is very much a good DBSolutions@prudential.co.uktime if a company has the right assets, for some companies it Finance Director Europe | www.the-financedirector.com 59
    • Risk management > Connecting the dotsThe riskrenaissanceThe effects of volatile investment markets on pension funds could be compounded bythe proposed EU risk mitigation regulations. Philip Broadley, group finance directorof Old Mutual and chairman of the pension committee of the UK’s highly influentialHundred Group of Finance Directors, talks to Nigel Ash.E arlier this year, Philip Broadley, Philip Broadley CFO of Old Mutual and past Philip Broadley is group finance director at Old Mutual. He held the same position chairman of the Hundred Group at Prudential and was a partner in Arthur Andersen. Broadley is chairman of the Hundred Group of Finance Directors’ pension committee and a foundingof finance directors visited an exhibition member of the CFO Forum of European Insurance Company Finance Directors.in Florence on the activity of the city’sRenaissance bankers. “Florentine banks suffered from many nature of a pension scheme and in the states such as the UK that hadof the same concerns we have today,” end the importance and value that widespread systems of funded definedobserves Broadley, “about whether the attaches to the sponsor’s covenant.” benefit provision.bankers were facilitating trade or merely While UK pension provision had taken Broadley accepts that pan-Europeanextracting an economic rent from doing a while to develop, Broadley believes schemes might of themselves beso. There were many questions relating that the current system, with the relevant in the longer term. However,to risk-taking in Florence during the powers of the trustees and the ultimate he is concerned they would be of less15th-century. That demonstrates that backing of the Pension Protection use to multinational companies thatnone of the arguments is new; they just Fund, works effectively. also had operations outside the EUcome round every once in a while.” and would in any case add The whole issue of risk is currently considerable complexity.dominating regulatory thinking, There were many He argues that, in the UK, membersparticularly in Europe, and in the view of questions relating to of defined benefit schemes generallymany it is skewing thinking on efficientmarkets. The very complexity of some risk-taking in Florence understand their schemes and their benefits. They can “put their armsproposed regulations, such as IORP 2 during the 15th century. around” their pension provisions,(Institutions for Occupational Retirement None of the arguments which would not be the case in aProvision) and Solvency II might even becontributing to the element of risk that is new; they just remote, pan-European fund. He has a further warning. “I wouldthey are supposed to be preventing. come round every think that, increasingly, employers “I suppose my anxiety is that we are once in a while. regard pension provision simply as partliving in an environment at the moment of the overall remuneration that theywhere, for understandable reasons, there offer to their employees. I would putis a desire to take risk out of everything,” Euro vision forward the argument that certainlyexplains Broadley. “I think it is true to In July 2011, the Hundred Group, in very few large employers are nowsay that there can be no reward without its submission to the European particularly thinking in terms of pensionsome risk in any enterprise, and this is Commission’s call for advice on the provision from the point of view of anyalso true of banking. If we want risk-free proposals from the European Insurance welfare obligation.banks, then we will either have to accept and Occupational Pensions Authority, “So with that in mind, there are stillthat our mortgages are repayable at call argued that current pension provision quite significant differences inor that our deposit accounts have a across the EU was diverse. Therefore, remuneration practice in different30-year notice period.” any significant reform of funding markets,” he continues. “Some of A key exception that Broadley and his requirements would not necessarily those are a function of the marketscolleagues take to the thrust of proposed assist those countries with the lowest themselves and people’s expectations.EU legislation is that it conflates pensions levels of provision. It would, however, Some of them are also a consequencefunds with insurers. “This ignores the impact disproportionately member of other regulation.” 60 Finance Director Europe | www.the-financedirector.com
    • Risk management > Connecting the dots Objective of IAS 19 The objective of IAS 19 is to prescribe the accounting and disclosure for employee benefits, or all forms of consideration given by an entity in exchange for service rendered by employees. The principle underlying all of the detailed requirements of the standard is that the cost of providing employee benefits should be recognised in the period in which the benefit is earned by the employee, rather than when it is paid or payable. Source: Deloitte Global Services Limited Cutting the clutter Broadley sees the revision of IAS19 as being of particular value to general portfolio managers who need to have a view across various sectors. “There will be a reduction in profits shown in the financing line from the expected return on assets being changed to the discount rate,” he observes, “and that will affect everyone and there will be a removal of spreading from the small number of schemes currently using it.” Broadley cites the efforts to regulate Though apparently arcane, he The impact will vary between firms,banking pay. Just as the provision of believes that this last element would be and he anticipates there is likely to be asaving products across Europe is still particularly relevant for the UK, more so large number of additional disclosures.very different, so pension provision probably than anywhere else in the EU. “It is interesting that there are quite avaries as a result of custom and practice. “DB schemes will want even less number of initiatives underway in various But he warns that over-regulation will be to invest in equities than they do quarters to ‘cut the clutter’ – the phrasecounterproductive. “It will lead to a further currently,” he explains. “Thus it that is used around financial reporting,” hecontinuation of benefit reduction, the increases the long-term trend, which notes. “Yet here we have something thatclosure of defined benefit (DB) schemes, one can observe in the UK market, is going against that. The removal ofthe switch to defined contribution often which is that pension funds will not spreading will increase volatility for somewith lower contribution rates, buyouts and wish to be long-term holders of equity. but the benefit ultimately for analysts ismore conservative investment strategies If the pension funds are not holders of that there will be greater consistencyfor those DB schemes that do survive.” UK equity, who is?” between companies’ disclosures.” ■ n Introduce enhanced disclosures estimates of mortality rates, tax Overview of changes about defined benefit plans. and administration costs and introduced by IAS 19 risk-sharing and conditional n Modify accounting for termination Employee Benefits, benefits, including distinguishing indexation features. as amended in 2011 benefits provided in exchange for n Incorporate other matters service and benefits provided in submitted to the IFRS The standard requires recognition of exchange for the termination of Interpretations Committee. changes in the net defined benefit liability employment and affect the (asset) including immediate recognition n Applicable on a modified recognition and measurement of of defined benefit cost, disaggregation retrospective basis to annual periods termination benefits. of defined benefit cost into components, beginning on or after 1 January recognition of remeasurements in other n Clarification of miscellaneous 2013, with early adoption permitted. comprehensive income, plan amendments, issues, including the classification curtailments and settlements: of employee benefits, current Source: Deloitte Global Services Limited Finance Director Europe | www.the-financedirector.com 61
    • Risk management > Connecting the dotsRisky businessAs finance directors look for ways of managing down the risk of theirpension schemes, they must select from a complex array of solutions,both within their company and externally. John Smitherman-Cairns ofLucida explains the benefits of transacting with an insurance companyand the importance of an individually tailored approach.O ver the last few years, the pensions market has longevity, and we’re seeing a lot of reports in the market around followed a clear-cut trend. With companies seeking how people are living longer and the burden they’re placing on to protect against volatility, de-risking solutions are corporates. With a longevity swap, the scheme chooses toin greater demand than ever, and the market is evolving to retain all the other risks of the pension scheme, but passes onmeet this demand. the longevity risk to an external party.” While much of the risk can be managed internally, theexternal market is growing fast. Increasingly, finance directors Flexible, strategic solutionsare calling upon insurance companies to take on the liability As an insurance company specialising in annuity and longevityfrom their pension funds, thus transferring the risk and risk business, Lucida offers a full and nuanced range of solutions.administrative burden elsewhere and freeing up resource to Progressive buy-outs, for example, allow clients to purchase afocus on their core business. series of insurance policies over time, each covering a different “We are in a period where more and more UK corporates are portion of the scheme and leading ultimately to a full pensionlooking to take risk off the table,” says John Smitherman-Cairns, de-risking solution. This fits better with some organisations’corporate development director at Lucida. “For many it’s not a funding plans and helps them to selectively de-risk.case of, are they going to de-risk? It’s a case of, when are they Day one risk transfer, meanwhile, removes riskgoing to de-risk and what approach are they going to take?” instantaneously while also giving the insurance company These are pertinent questions for finance directors, who are responsibility for closing the pension scheme.generally the ones tasked with writing the cheque. Of late, they The difficult thing from a client’s perspective is working outhave been making some very significant contributions to what will work best for them specifically. “There has been apension schemes. For example, in 2010, around £10 billion was rapid expansion in the range of products offered, and thatpaid in as deficit funding by FTSE 100 companies alone. creates opportunities for pension funds, but also some confusion,” says Smitherman-Cairns. “So this is a process Writing insurance protection for where clients often turn to expert support. We are very happy to sit down with trustee boards and companies, and talk themdefined benefit pension schemes through what they are trying to achieve and how we canis a capital intensive proposition customise the product to deliver that.”and demand has the prospect of Lucida prides itself on delivering the optimum blend of strategies to meet each company’s requirements. The aim is tooutstripping capacity. engage clients in open discussion at the earliest possible stage. Its individual focus extends right through to the payment “They don’t want that payment to just go into what they schedule. In this regard, Lucida is immensely flexible, asmight see as the black hole of the defined benefit pension Smitherman-Cairns explains: “We offer deferred premiums,scheme,” says Smitherman-Cairns. “That’s what’s driving a lot where a corporate can secure an insurance policy immediatelyof the de-risking activity we’re seeing in the market.” with part of the premium deferred and paid to the insurer at a For those that transact with external providers, the product later date, say five years. This enables the pension scheme tooffering is extensive. In recent times, there has been much retain a degree of investment freedom or fund the premiumdiscussion of buy-outs, where the liabilities are transferred through future agreed contributions.directly to the insurance company, and buy-ins, where the “Rather than crystallise recent losses, deferred premiumsinsurance policy fully matches the scheme liabilities. The provide the pension scheme with the opportunity to benefit fromparticularly striking thing, however, is the number of ways future increases in the value of the retained assets before payingthese products can be adapted. them to the insurer,” he continues. “This opens up possibilities to “Some companies want full risk transfer solutions, whereas clients that have seen deficits emerge or widen and concludedothers want, or can only afford, solutions that just address a that they cannot, at present, afford to transact. Therefore, there areslice of the risk,” says Smitherman-Cairns. “Within defined answers if your asset values have fallen. Solutions just need to bebenefit pension schemes there are obviously risks around a bit more sophisticated to deal with the current market volatility.” 62 Finance Director Europe | www.the-financedirector.com
    • Risk management > Connecting the dots Ultimately, the advisability of transacting will depend upon a deals have been performed since 2006, with roughly £7 billioncorporate’s investment profile and objectives. Although the last of those deals originating with FTSE 100 companies.few years have not been kind to many funds, this does not Nor do present market trends show any sign of abating.apply across the board. If a company’s scheme, for example, “I think we’re in a time where the product offering has becomeholds a portfolio of gilts, transacting may not be as expensive as increasingly sophisticated to appeal to a wide range of clientthe true cost of holding on to the risk. needs,” says Smitherman-Cairns. “But if we look forward and take account of the growing demand for de-risking solutions, IInformed decisions believe capacity could become a key issue.The cost of de-risking will also depend on whether the client “Writing insurance protection for defined benefit pensionis coming from an accounting or a funding perspective. Most schemes is a capital intensive proposition and demand has thetrustee boards are focused on their funding liability, but prospect of outstripping capacity, unless significant new capitalcompanies will also be focused on the P&L and balance comes into the market.”sheet impact. Clear communication between the parties willbe imperative. As pension costs continue to Corporates that do not wish to transact tend to focuson modifying benefits and restructuring their schemes rise, and the market remainsto dampen down some of the liability. Solutions include early unpredictable, defined benefitretirement programmes, enhanced transfer value exercises and pension schemes are starting topension increase exchanges. However,many businesses are running what is in essence a seem untenable.quasi-insurance company on the side with limited control overthe way the risks are managed. For now, the onus is on trustees and sponsors to manage “We monitor what’s happening in the markets almost on an risk intelligently – a tricky process made simpler throughhour-by-hour basis,” says Smitherman-Cairns. “We make sure harnessing all available expertise. “This is where trusteesthat we’re selectively trading our assets to take advantage of and corporate sponsors could benefit from a detailedmarket opportunities, and that is quite an intensive approach to conversation, either with their advisors or with insurancemanaging our exposure. A pension scheme has quite a different companies, just to talk through their options,” saysgovernance structure, and is not always in a position to be able Smitherman-Cairns. “And there always will be options withto react the same way.” so many innovations on the product front.” ■ The crucial thing is to stay savvy in the face of a rapidlychanging picture. As pension costs continue to rise, and themarket remains unpredictable, defined benefit pension schemes Further informationare starting to seem untenable. Lucida Corporates are jumping onto the de-risking bandwagon in www.lucidaplc.comtheir droves. In the UK, around £30 billion of insurance-based Finance Director Europe | www.the-financedirector.com 63
    • Risk management > Connecting the dotsA grown-upapproach to pensionsWith more and more defined benefit pension schemes looking to de-risk,the market for risk management solutions is starting to mature. Aviva’sNick Johnson explains why this is less about offering new products,and increasingly about adopting a more collaborative approach.O f late, the risk management landscape for defined benefit among them – it can be worthwhile implementing several pension schemes has become vastly more sophisticated. different solutions. With many new solutions on the table, ranging from For example, Johnson believes that longevity swaps canbulk buyouts and buy-ins to longevity swaps – and even the represent a useful step on a de-risking journey, but that theymethod of auction used to choose a provider – scheme trustees should be viewed in a similar way to synthetic investmentsare being asked to choose from an ever-evolving set of options. within your scheme rather than a comprehensive answer. Bulk annuities, for instance, have changed almost beyond “Longer term, you need to ask what is the real worth to you,recognition. Whereas five years ago, a bulk annuity was little how marketable is it, and are you going to get realisable valuemore than a bundle of individual annuities, it has since for that asset?” he says.developed into a complex and customisable product. “The amount of bespoking, along with the scheme-specific Working relationshipselements that shape what the bulk annuity looks like, has Concurrent with the diversified product offering is a changegrown exponentially,” explains Nick Johnson, head of in the relationship between sponsor, trustees and insurancedefined benefit pension risk at Aviva. “This is not merely an provider. “There has been a shift of opinion,” says Johnson.off-the-shelf product, which you can choose to buy or not, it’s “It used to be the case that companies would do the difficult bitsomething for which we ask, ‘What could we do extra to help themselves, and treat the insurance company simply as theyou purchase this?’” provider of a product. History has shown that this process For an insurance provider like Aviva, the task is to assist isn’t particularly efficient – many schemes would get to the finalschemes manage down their risk. If there is something specific transaction before companies realised they couldn’t actuallythat has previously prevented that scheme from transacting, afford it. They didn’t have perfect information from the outset.”Aviva will sit down with the trustees and discuss their These days, rather than looking at insurance providers as anperceived obstacles to success. opponent to win against, trustees and sponsors are embracing a new spirit of collaboration. With the shared goal of a The critical thing is to pick the transaction, the focus is on working together and openly sharing information to ensure that this contract will take place.right provider. You need to have full The critical thing is to pick the right provider. You need toconfidence in whoever you choose, have full confidence in whoever you choose, selecting aselecting a partner you believe will be partner you believe will be around for the life of the scheme. Aviva is a major player in this market. The sixth-largestaround for the life of the scheme. insurance company in the world and the biggest in the UK, it benefits from a long track record, and continues to develop in Key to the company’s mission is an understanding that no accordance with new demands.two pension schemes look alike. A scheme may have grown “Over the last five years, insurance companies have been on aup over a number of decades, taking in numerous changes to steep learning curve,” points out Johnson. “Initially, the markettrustees and administrators in that time and as many changes was almost embryonic – it was a question of ‘can we do a deal,in legislation. who will give us the cheapest price?’. Now it’s got to the stage “The history behind each scheme is different,” says Johnson. of, ‘how do we work together to transfer pension risk to the“When you throw its funding levels and investment strategies insurer?’. That requires a grown-up, joined-up approach.” ■into the mix, you see that every pension scheme is in a uniqueposition. All these issues determine whether you can do a dealand what risks you’re willing to accept as part of that.” Further information Generally, schemes benefit from having a range of tools in Avivatheir armoury. Because liabilities manifest themselves in www.aviva.comvarious forms – interest rates, inflation and longevity risks 64 Finance Director Europe | www.the-financedirector.com
    • Risk management > Connecting the dotsIt pays to getthe right adviceDefined benefit pension schemes are notoriously complex, with a host oflegal issues to consider when managing down the risks. Catherine McKenna,partner at Squire Sanders Hammonds, explains how schemes canbenefit from the advice of a specialist law firm, especially in light of theupcoming regulations around auto-enrolment.What are the key legal issues in the bulk Firstly, you can delay putting people into the pensionannuity buy-in and buy-out process? plan and paying contributions for them for three months.Catherine McKenna: There are three main issues that Secondly, you can implement a salary sacrifice, whichyou’re going to face legally. Number one, both buy-in and typically saves both employer and employee NI and canbuy-out involve an element of cross-subsidy. The second wipe out 15-20% of your extra costs. Thirdly, you canpoint is collateral – if the insurer you’ve transacted with implement a pay freeze, adjusting other employee benefitsgoes bust, will you be able to strike a deal that puts you in a instead. Finally, you can employ more part-timers, becausemore advantageous position than their normal unsecured unless an employee earns more than £7,500 a year, they willcreditors? The third one would be the different protections not have to be auto-enrolled.that apply before and after a buy-out, which differ a lot interms of their impact. To what extent are pension deficit issues These are complex legal contracts, and your rights and dictating outcomes in mergers and acquisitions?obligations will be governed by them. So they’re not the M&A activity is slower than it has been, but where you getkind of thing you’ll want to enter into without legal or a pension deficit it’s still a major issue. The two main risksactuarial advice. That’s where a specialist law firm comes in. that you face are firstly that you crystallise the shortfall in the pension plan and have to pay it, and secondly that,What other strategies are open to finance because of the way the deal is struck, the pension regulatordirectors looking to manage down the risks expects you to re-open your deal.associated with defined benefit pension plans? The overall message is that if pension deficit issues areAside from buy-ins and buy-outs and other forms of recognised and managed they won’t get in the way of aninvestment hedging, I’d say there are three main options. M&A deal, but otherwise they can trip them up. One of these is an enhanced transfer value exercise,where the corporate approaches its ex-employees and What were the main drivers behind youroffers them an enhancement if they transfer their benefits recognition as the European Pensions Law Teamelsewhere. This will almost certainly cost less than providing of the Year and Global Pensions Law Team ofthose benefits over the fullness of time. the Year at the European Pensions Awards 2011? Another option is to offer a similar deal to the people One driver is the critical mass of the UK team. We havewho are currently in receipt of the pension, reshaping it in about 60 specialist lawyers within our pensions practice,such a way that they can have more cash today, but give up which is about the biggest in the industry. We also nowfuture increases on parts of it. have a global platform as a result of our recent merger And then the third main strategy is to try to find with US firm Squire Sanders, which is represented insomething other than cash to fund the scheme, such as real 17 countries.estate, brands, receivables or trade debts. This gives the fund And then the third one is a recognition that we’re not justassets if the company’s no longer there. reactive lawyers – we’re proactive. We have a role in many of the industry bodies, which gives us advance warning ofHow should finance directors prepare for the extra developments and a chance to lobby for change. ■costs involved in the auto-enrolment regime? When auto-enrolment is ultimately rolled out across theUK, the average cost for a business with 5,000 heads will be Further informationaround £2 million a year. We have a hit list of things that we Squires Sanders Hammondsthink finance directors should be doing in order to minimise www.ssd.comthe impact. Finance Director Europe | www.the-financedirector.com 65
    • Risk management > Connecting the dotsDefinite benefits to de-riskingDonald Fleming (near right), Simon Willes (centre) andPaul Thornton of Gazelle Corporate Finance, which ,advises the trustees of some of the largest UK definedbenefit pension schemes, offer their views on importantquestions facing FDs in this specific industry sector.D efined benefit pension schemes were once a major this background FDs should have a long-term game plan part of a corporate remuneration package, but now for de-risking. they are being seen more as a financial risk liability. Pension trustees can be expected to welcome de-riskingFor a smaller business, the endgame would be to buy out. For measures, if not actively initiate them with the company aslarger schemes, where a buyout might not be feasible, the need part of funding negotiations.to de-risk has come to the fore. Paul Thornton, Donald Flemingand Simon Willes of independent pension advisory group DF: For most smaller and medium schemes, the ultimateGazelle Corporate Finance share their views on the subject. solution will be an insured buyout. This fully removes the financial risk by transferring both liabilities and assets to theHow should FDs see de-risking? Are they too insurance provider at a cost that reflects the strength of thefocused on short-term financial performance? scheme. For schemes that may be too large for the insurancePaul Thornton, chairman, pensions advisory: market to absorb, ‘self-sufficiency’ is a more realistic aim,FDs often look at de-risking in terms of opportunity cost – where liability risks are fully hedged without recourse to the‘If we hadn’t spent money on de-risking, we could have insurance market. The cost of moving to such a positionbought a new factory’. They need to think ‘This is adding should be viewed against the shareholder value created asvalue to our business because we’ve removed this very well as the value for money in actuarial terms.dangerous area of risk’. We are trying to help it along withour own thinking. PT: It makes sense to introduce as many risk reduction measures as possible. The foremost risks to hedge are usually interest rate and inflation risk, and these are Increasingly, pension schemes commonly done through swaps. Equity risk may bewill be seen as ‘legacy’ liabilities, diversified by the use of ‘alternative assets’. Once these risksand for FDs they will be a have been addressed, longevity risk may need consideration. Trustees and FDs need to proceed with caution, as at thissignificant source of financial risk. stage of the market there may be residual counterparty risk and hidden costs arising from a lack of transparency.Donald Fleming, managing director, pensions Simon Willes, executive chairman: De-risking comesadvisory: Today’s finance director is focused heavily on at a price, but FDs need to embrace this by considering thewhat the investor base and equity analysts are saying about value added to the business by removing unnecessary risk.pension risk. But the analysts are often still using marketmeasures of pension risk and relying on fairly basic Are FDs too reliant on equity performance toaccounting measures. This focus is not always helpful in that get them out of deficit repair problems?it may work against the real problem, which is containing PT: Ever since the 1960s there has been an implicit faithand managing overall pension scheme risk rather than just that equities will give a higher return in the long run, if youreducing pension contributions – which may make for a see them through the ups and downs. Particularly in themuch bigger problem later on. We need to move to a more 90’s that paid off handsomely. It’s taken quite a few yearsholistic measurement and management of pension risk. of financial crisis to shake that implicit faith. At the same time, many employers have realised that,What form of de-risking should FDs be looking at? once a scheme got into deficit, if they should get out ofPT: Increasingly, pension schemes will be seen as ‘legacy’ equities and into gilts they would just be sealing their fate.liabilities, and for FDs they will be a significant source of As long as they continued to hold some equities, whichfinancial risk. The issue can hang over a company’s share might bounce back, they could get out of trouble. So thereprice and credit rating, limiting strategic options. Against has been much less de-risking than has been needed. 66 Finance Director Europe | www.the-financedirector.com
    • Risk management > Connecting the dotsDF: Unfortunately, the last several years have shown thatthere is high risk in maintaining an equity strategy. It’s finefor companies whose pension liabilities are relatively small,but smaller companies have been drawn into this and theycan’t really afford the downside. Good governance now isabout hedging risk as much as possible. Not everybody iswhere they should be on that. But as long as FDs takeaccount of the equity risks they are carrying, it’s much lessof an issue.Are FDs right to substitute contingent assetsfor cash contributions or security? pension scheme. In some situations, such as during one of theSW: We are professionally sceptical about contingent three-yearly actuarial valuations, when a funding recoveryassets. These come into play where a company needs to plan is being negotiated, the FD is in a very difficult positionrepair its deficit but hasn’t got the available cash to do so regarding their knowledge of the financing needs of thewithout hurting the business. The trustees are unlikely to company and affordability of the scheme.push the argument too hard because it’s a long-term So what was treated very much as a board linked with therelationship and they are hoping the scheme will be company has developed a great deal of independence. Thisattached to the company in the future. That’s where the means that sometimes the trustee board can lack independenttrustees would benefit from contingent assets to help plug or internal in-depth financial knowledge of the company.the cash gap. Advisors such as ourselves bring trustee boards up to speed. We try to take a more holistic To what extent should FDs value independent covenant assessments?view where the covenant PT: Covenant assessment is a developing area andassessment, investment strategy generally the value is increasing. Assessments themselvesand actuarial funding advice are are becoming better, more forward looking and more integrated with corporate information sharing protocols,linked up much better than they risk management information and forecasting. Equally,have been. trustee boards are learning to use assessments more effectively in the overall assessment of scheme funding risk, affecting levels of prudence adopted for valuation,PT: These arrangements are advice intensive and careful investment strategy and the appetite for de-risking.due diligence is needed. The special purpose vehicles thatare created are structurally complex, difficult to value and DF: This isn’t a threat for the sponsoring employer. In manyoften lack liquidity. They are challenging for trustees to ways the more professional the trustees, and the moreassess and the more complex ones are subject to the law of experienced they are in finance, the easier it is for the FD tounintended consequences. deal with the trustee board. Advisors like us are using the same financial language as the FD and have no axes toWhat value can an independent trustee board bring? grind or emotional involvement.PT: There is an integral long-term dependency betweenscheme and employer both in terms of funding and SW: Having said that, some of the covenant assessmentsmembership. However, the interests of key stakeholders – that have taken place have been rather routine assessmentsshareholders, bankers and scheme – are not naturally of key financial ratios from current statements. Theydestined to coincide. The trustees may not have the depth haven’t really looked deep enough under the bonnet atof expertise when difficult choices have to be made. The underlying factors and how the business is evolving. We trypensions governance and regulatory framework needs to to take a more holistic view where the covenantprovide the necessary checks and balances. But this is assessment, investment strategy and actuarial fundingabout a balance of stakeholder interests and these checks advice are linked up much better than they have been. ■and balances need to be proportionate.DF: They effectively have to deal with another board, which is Further informationindependent of the company. This is an interesting and quite Gazelle Groupchallenging relationship. Since the Pensions Act of 2004 it’s www.gazellegroup.co.ukvery difficult for a finance director to be on the board of a Finance Director Europe | www.the-financedirector.com 67
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