Magazine article Risk Management

Utilizing Off-Balance Sheet Structures to Increase Shareholder Value

Magazine article Risk Management

Utilizing Off-Balance Sheet Structures to Increase Shareholder Value

Article excerpt

In today's fast-paced business world, success or failure largely hinges on how well the game of risk is played. As the new economy transforms traditional industries such as manufacturing and utilities, increasing global interdependence is creating new complexities. Ironically, though our understanding of risk is increasing, volatility in the financial markets is proliferating and growing in scope, rather than diminishing.

This challenging environment places greater pressure on financial managers to reduce earnings volatility, increase management productivity and enhance shareholder value. One of the most critical components to managing shareholder value is through the evaluation and management of risk. An increasing number of corporations are seeking more efficient risk management models because they understand that risk is risk, no matter the source. Any type of risk--be it exposure to natural disasters, confiscation of assets following political upheaval, strikes, exchange rate fluctuation or a rise in the price of a commodity--can eventually have the same effect on earnings per share. As such, an enterprise risk financing strategy that is cost-effective, flexible and less complex has become a critical component of a comprehensive business strategy.

Research conducted recently by Zurich Corporate Solutions revealed that 12 percent of Fortune 1000 companies are already adopting an integrated approach to evaluating risk, while an additional 50 percent are beginning to ponder the benefits of such an approach.

There are many explanations for this new attitude towards risk management, but the most compelling incentive to switch to an integrated risk management solution is the resulting cost savings that accrue by analyzing the interaction of various risks. Investment theory explains how investors can increase returns without increasing risk by merely diversifying their holdings. Similarly, as multiple non-correlated risks are viewed simultaneously, the volatility associated with those risks decreases.

To achieve these benefits, a company must view risk differently. Senior management must, first, ensure that their company's investments are on the "efficient frontier" through the careful distribution of financial resources. Secondly, management must evaluate its risks on an aggregate, horizontal basis, using the most efficient risk management and financing tools available. These two tenets are the drivers behind the theory of integrated risk financing.

Architecting a solution

While each integrated risk financing structure is unique and designed to address the individual needs of each client, some characteristics are common to most structures:

Single aggregate limit -- The traditional approach to buying insurance is segmented, transactional and focused on limits, retentions and product lines. A single, aggregate limit that applies to a company's entire portfolio of risk is often more effective.

Basket aggregate protection -- Earnings volatility can be minimized by locking in the amount of risk a company retains in a given period.

Fungible capital option -- An integrated structure can be a tax- and accounting- efficient mechanism for funding risks that are not currently being addressed. …

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