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Executive Summary:
Honeywell was a multibillion-dollar, International Corporation employing 53000 people and managing operations in 95 countries. It was the largest producer of control systems and products used to regulate heating and air conditioning in commercial buildings and of systems in avionics systems. Carrying out business in 95 countries firm faced a number of risks. Honeywells risk management activities were dispersed throughout the firm as shown in the table. Other risks were managed operationally.
The committee voting for this new program depends on whether the anticipated savings of the program would be realized, and whether the coverage provided by the new contract would be adequate. The proposed plan is a first step in a firm wide integrated risk management program that would extend to cover all of Honeywells financial and operational risks, the finance committees decision would establish Honeywells risk management strategy for some years to come.
Honeywells existing strategy was consistent with its risk management objective of minimizing earnings volatility and its cost of risk. The team wondered about the applicability of the relatively new concept of enterprise risk management, which is grouping many risks together into a portfolio of risks, rather than managing each risk separately. The team thought that the new enterprise management concept could be implemented through an innovative insurance contract. Though the idea seems promising the organizational barriers involved in developing such a program were daunting. A significant challenge for the Honeywell team members designing the new integrated program was finding out the optimal risk management structure in terms of appropriate retention and insurance coverage levels and adapting the insurance program to incorporate foreign-currency translation risk. The integrated risk management program was a multiyear insurance based strategy that covered all traditionally insured risk and currency translation risk in a single master insurance policy. The proposed program had one time annual aggregate retention of $30 million, rather than a separate retention for each individual risk. The program subject to a maximum payout of $100 million over the two one-half year term of the policy and also have an excess coverage subjected to a maximum pay out of an additional $200 million. While traditional insurance was viewed as a business necessity, the integrated risk management concept had not yet reached such a degree of acceptance by the broader business community.
Problem Statement:
Honeywell was the first to introduce an integrated risk management program that combined traditionally insured risks with other risks in an insurance contract. This case identifies the benefits of integrating risks and shows how such an approach might be valuable. Honeywell has diverse variety and variant degree of risks. Given this, how should its risk be managed?
Type of Risk Traditionally Insured (i.e. Hazard) Risks Currency Risks Other Financial (interest rate, credit and liquidity) Risks Pension Fund Risk Operational Risk Credit Risk Environmental Risks Department Handling Risk Treasury - Insurance Risk Mgmt. Unit Treasury - Financial Risk Mgmt. Unit Treasury - Financial Risk Mgmt. & Capital Markets Unit Financial Dept. Operating Units Operating Units Health, Safety and Environment Dept.
Currently, various units managed under Treasury managed their risks in the following way:
i. Capital market unit which managed the Capital structure and Liquidity risk ii. Cash management unit managing the cash requirements. iii. Financial risk management unit which managed the Currency ,Interest rate r and
Credit risk Currency hedging operations were independent of any other hedging or insuring carried out in other parts of the firm Used at-the-money options Used basket-option of 20 currencies that matured quarterly These 20 currencies represented 85% of HWs foreign profits Provided protection when UD$ strengthened against the currency basket
iv. Insurance risk management unit which managed risk generally covered by insurance. Used separate annually-renewable insurance policies for each type of insurable risks Each policy had specified deductible (retention) in an amount ranged between 0 and $6 million HW would absorb losses up-to retention level before calling insurance company for any claim Each loss was subject to separate retention HW paid a new deductible for each loss that occurred
Features included: Traditionally insured risks should be consistent with currency risk management program
Monthly cross-functional meeting to interact with two groups to understand the others tasks Multi-specialty team: insurance unit + currency risk management team All members were named as member treasury management team
Challenges to the program include: New program to provide.., Equal or greater level of earnings protection Total cost is less than existing program costs Flexibility to incorporate additional risks in the future Comply with all accounting standards Finding optimal risk management structure
Std
Value
of
Insurance
Dev. Of under different probability of cost of risk risk 14% 50% 84% -0.3 4.1
General Liabilities Property Worker Compensation Auto D&O, Side B Currency Risk Individual Risk Management value
12.2
8.5
12.5
4.1
-4.7
1.1 11.2
5.5 2.5
4.5 11.2
4.5 2.1
0 -0.4
-3.4 0
-2.4 0.4
4.3 0.3 4
5 0.4 5
4.1 0.8 0
of
Higher risk coverage as it has higher limits for different risks whose total is much larger than new options $ 100 million Disadvantages Higher cost of risk as probability of risk approach to mean Pays higher premium
Conclusion
The proposal of integrated insurance policy gives better benefits than individual risk management. It minimizes cost of risk and stabilizes earnings while forcing consistency in risk management in different segments of risks and addressing specific needs of different risks. So, Honeywell should go for new policy of risk management.