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MCE: RAISING QUALITY THROUGH RISK MANAGEMENT

Posted On: Nov. 9, 1997 12:00 AM CST

BRUSSELS, Belgium-Risk management should be a key business process that companies can use to enhance quality control, two consultants say.

When integrated with the company's business goals, risk management can play a key role in such deals as buyouts, according to Neil Harrison and Gerry Tollan, both executive directors of Aon Risk Consultants in London.

Messrs. Harrison and Tollan spoke at the 27th International Insurance & Risk Management Conference last month, organized by Management Centre Europe.

To illustrate how risk management can improve quality, Mr. Tollan presented a case study in which risk management saved a recent management buyout.

Managers of a U.K. rail company, an Aon client with revenues of 320 million pounds ($539.1 million), wanted to buy the company. There was substantial competition from other investors, so the management needed "to use every piece of risk management skill to create a competitive advantage," explained Mr. Tollan.

The risk management process of analyzing potential losses and mitigating them had become a key factor in the deal, he said. Risk management continuously enhanced confidence in the buyout and enabled the management buyout team to achieve its goal.

In the clients' own words, the "risk management process added value" to the whole situation, and the skill of the risk manager matching business risks to business goals was proved, ensuring that the investment did not fall apart early on, he said.

The process had four critical aspects, Mr. Tollan said. The first stage was to relate the risks of the buyout to the financial goals of the buyout team. Early in the process, management focused on various business issues, particularly the personal investments to be made by the managers concerned.

The next step was to integrate decision support data with the business planning process to help make the buyout bid more competitive.

Then the buyout team consulted the employees for ideas on how to improve the company's operations.

Compiling all the data and evaluating the risks, management identified the major threats to the buyout's success. Management then was able to create a risk reduction and control strategy.

Insurance, reinsurance and capital markets were brought into the equation to deal with the financial impact of the risks.

In all, about 400 key risks were identified during the process, said Mr. Tollan, which lay in five key areas. These included the threat of labor strikes, poor performance in complying with regulations, pollution liability, the cost of mandatory modifications to rolling stock, and the loss of leased rolling stock.

The buyout team strongly felt that the threat of strikes would lead the team not to make the investment. A strike of more than five days would have bankrupted the individual investors in the buyout. Although various management mechanisms were found to mitigate the impact, extending investors' survival period to 35 days, this still was insufficient for the buyout team.

By turning to the insurance and reinsurance markets, the team put together a risk transfer mechanism to provide 30 million pounds ($50.5 million) in the event of a strike, enough to extend the survival period to 235 days.

As an added bonus, the investors backing the deal were prepared to reduce their rate of return by 0.5% once the mechanism was in place. This meant the deal was back on course "with renewed confidence of the management team willing to drive it forward," said Mr. Tollan.

Aon's Mr. Harrison said risk managers need to become more involved in corporate quality control efforts. He cited five areas where risk management and quality should be linked.

First, risk management is a key business process, not a stand-alone operation, and risk management should be integrated into the entire company's operations.

Second is the definition of quality, a term that can vary from company to company. "The challenge as risk managers is to link the definition of quality with the business objectives of the organization," said Mr. Harrison.

Third is the measurement of quality.

Fourth is linking quality performance with the goals of senior executives, aligning risk management with business management.

Fifth, risk managers need to ensure quality in the risk management function as a key business process.