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Business Risks and Role of General Insurance Featured

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Business Risks and Role of General Insurance


Risk refers to future events that may result in losses or reduction of profits (Mikes, 2010). Risk is an inevitable element in business. Thus, their influence on business cannot be ignored. Running an energy business is not a simple task as these businesses are exposed to a wide variety of risks. Thus, managers of businesses that operate in the energy industry need an in-depth knowledge of the risks that their businesses are likely to encounter. Identifying the risk will enable the business to identify appropriate solutions that will guarantee smooth operations by the business. This report has explored the main risks that Hybrid Energy Ltd is likely to encounter and suggested approaches that the firm should use in addressing these problems.


 Business Risks

  1. Corporate asset risk

The first category of risks is the corporate asset risk. This refers to events that may result in loss of company asset (Mikes, 2010). The energy industry is a capital intensive industry. This implies that Hybrid Energy must invest a lot of capital in acquiring long terms assets such as machines, tools and equipments. These company assets are exposed to diverse risks. Fire is one of the risks that can result in loss of assets. In the energy industry, the risk of a fire outbreak cannot be ignored. Fires can originate from malfunctioning of equipment of from any other cause. Natural calamities such as floods, storms, earth quakes, and winds can also result in loss of assets. The prevalence of the global warming phenomenon has increased the frequency of occurrence of these natural calamities. Thus, this risk cannot be ignored.


             Terrorism is also an integral threat to the Hybrid’s assets (The Energy Information Administration, 2012). Hybrid Energy Ltd provides energy solution to Telecommunication companies. Since telecommunication is an essential infrastructure in any society, it presents a sensible target for terrorists. Thus, this risk cannot also be ignored. Political unrest can also result to loss of the company’s assets. Hybrid Energy Ltd has focused on the developing markets. The firm’s primary markets include South/ Central America, West Africa and the Middle East. These regions are characterized by volatile political environments, and thus the risk of political unrest is real. Theft is also another possible threat to the assets of the organization. The company seeks to provide power to mobile phone towers that are located in remote areas. The remote locations of the facilities make them suitable targets for thieves.   


 Liability Risks

Liability risks refer to losses that result from liabilities for harm that result from the operations of the company (Raanan & Kennet, 2008). The energy industry is full of hazards. Though the firm may implement measures to avoid the occurrence of hazards, it is impossible to have a 100% guarantee that the hazards will not take place. Thus, companies need to prepare for liabilities that may result from the occurrence of hazardous events. One of the significant liability risks that the company is likely to encounter is pollution liability. Modern business environments are characterized by strict laws governing environmental issues. Companies that violate these environmental regulations incur huge liabilities in terms of payments of damages, fines and compensation (Bigliani & Feblowitz, 2011). Though Hybrid Energy Ltd provides renewable energy solutions, its operation may result in one or another forms of pollution. The installation of energy equipments may result in scenic pollution or death of wildlife such as birds. This may give rise to expensive litigation.


 Hybrid Energy may also suffer from equipment liability. Providing energy solutions entail installation of heavy equipments. The installation and maintenance process may result to injuries to employees, thus forcing the company to pay for damages (Bigliani & Feblowitz, 2011). Malfunctioning of equipments may also result in production downtime thus causing losses to the customer. This may also result to expensive legal battles. Hybrid Energy may also encounter automobile liability. The company needs vehicles to cater for the transportation of employees and equipment to the installation point. They also need the vehicle in order to carryout monitoring and maintenance services. These vehicles may get into accidents that cause damages to third parties (Bigliani & Feblowitz, 2011). The company may also need to be covered against damages that may be pursued by employees. Being an energy company that operates in remote locations of developing nations, employees are exposed to numerous hazards. The employees may end up suing the company if the hazardous events take place.  


 Financial Risks

Financial risks refer to events that may result in financial losses for the company. There are different categories of financial risks. The main categories include;

  1. Credit Risks

These are losses that result from failure to honor the payment agreement by the company debtor (Raanan & Kennet, 2008). Hybrid Energy has a payment arrangement that requires the customer to pay a down payment that is equivalent to 30% of the entire service amount. The company stands to incur massive financial losses in the event that the customer fails to pay the remaining installment after the installation process is complete. Thus, the management of Hybrid Energy cannot ignore the credit risks.


  Liquidity Risk

These are losses associated with insufficient liquidity within the company (Raanan & Kennet, 2008). Hybrid Energy requires sufficient liquidity in order to funds its operations. The firm needs money to cater for transportation of equipment, payment of employees, provision of maintenance services and catering for other overhead expenditures. Liquidity risks can occur when the company is unable to trade its assets quickly in order to generate cash. Liquidity risks may also be as a result of failure by the company to secure funding.


 Currency risk

These are losses that result from fluctuation in the value of currency (Raanan & Kennet, 2008). Hybrid Energy operates on an international scale. This implies that the company will be dealing with different currencies. The company may receive payment in pounds, but has to pay the local employees using the local currencies. This means that Hybrid Energy may end up paying additional pounds to the employees in case the value of the local currency appreciates (Raanan & Kennet, 2008). The company’s assets within the different geographical location are also valued using the local currencies. This means that the firm may incur losses in case the value of the local currency declines. The management of Hybrid needs to ensure that the company is protected from losses arising from the currency risk.


 Interest Rate Risk

These are losses that originate from changes in the interest rates. Hybrid Energy may need to fund its operations or projects using debt. This arrangement requires the company to repay the debt with a given rate of interest. Changes in the interest rates may result in the company paying extra cash in order to finance its debt. Changes in interest rates may thus affect Hybrid Energy’s profitability, financial position and liquidity.


 Market Risks

These are losses that originate from changes in the prices of inputs or final products. Energy risks are pronounced in the energy sector because energy prices are prone to fluctuation (Energy Information Administration, 2010).  Changes in the prices of energy will result in financial losses. Hybrid Energy has already determined it prices. However, the company has to decrease its rates in response to a plunge in the prices of substitute and competing goods (Raanan & Kennet, 2008).  One of the most significant sources of energy is fossil fuel. Fossil fuels are, therefore, the main competitors to Hybrid’s renewable energy. This means that Hybrid Energy will have to drop its selling prices in response to a drop in the prices of fossil fuels. Financial losses can also originate from changes in the prices of inputs. Hybrid energy requires a wide variety of inputs including; direct labor, machinery, raw materials, information infrastructure, and other services (Raanan & Kennet, 2008). Changes in the prices of these inputs will reduce Hybrid Energy’s profit margin thus resulting in reduced profitability.


 Role of General Insurance Solution in Tackling Risks

There are numerous strategies for managing business risks. Insurance is one of these strategies. Insurance is a concept that enables organizations to transfer risk to another entity in exchange of a given fee (Anderson & Brown, 2005). It is an arrangement where a company (the insured) pays a stipulated amount of money, known as a premium to another organization (the insurer), with the later organization promising to pay the former a given amount, known as the benefits or claim upon the occurrence of a given loss. The amount paid as benefit may be fixed or may be equal to the losses incurred by the insured organization.Insurance works on the concept of spreading of risks. Risks can paralyze the operations of a given organization. Insurance enable different organization to unite and help a member to overcome losses that arise from risk by sharing this loss (Anderson & Brown, 2005). Each organization contributes into a pool of fund, which is used to compensate an organization that incurs losses incurred in the occurrence of the stipulated risk. Since risks cannot occur on all organizations that make up the pool of fund, risks incidents have minimal impact on the funds. The insurer is the organization that is responsible for bringing the other organizations together and managing the pool of funds. The insurer restricts the types of risks that are covered by the fund in order to make the arrangement sustainable.


 Steps in Seeking Insurance Solutions

  1. Identifying Risks

Identifying risks is the first step in seeking insurance solution. Hybrid Energy company should identify the risks that the firm is likely to encounter. The company should make a list of risks

  1. Quantifying Risks

The second step in seeking for insurance is to quantify the identified risks. Companies face hundreds of risks at any given time. It is impossible for companies to plan for all the risks (Raymond, 1999). Thus, company must arrange the risks in order of priority and address the risks that have the highest priority. Quantifying the risks is one of the approaches used to arrange the risk in terms of their priority. The process of quantifying risks follows two major steps;


  Determining the magnitude of the risks

The first step entails determining the magnitude of the risk. The magnitude of the risk is determined by the amount of damage or loss that the company would incur when the risk occurs (Ezell, et al 2010). For instance, if the risk in question is fire, then the magnitude of the risks will be quantified in terms of the financial value of the property lost, lost business, cost of repairs and cost of acquiring new equipments. Risks that are of high magnitude should be given priority.

  1. The Probability of the risk occurring

The second step in quantifying risk is to determine the probability of the risk occurring. There are numerous statistical approaches that Hybrid Energy can use to determine the probability of risks (Ezell et al, 2010). Risks that have a high probability of occurring should be given the first priority.


             Once the company has determined the magnitude and the probability of the risks, the management should use these statistics to construct a weighted figure for each risk. The risk with the highest weight should be given the highest priority.

  1. Identifying the best option for managing the risk

The third step entails identifying the best option to manage the risk. Once Hybrid Energy’s management team has identified and prioritized the risks, they need to identify the most suitable option for managing the risk. The company may consider certain choices in order to make this decision.


 Choices that Hybrid needs to Consider

  1. Gain versus Risk Tradeoffs

Insurance entails trading a given amount of money in order to take away the possibility of incurring a loss in case the risk being insured against occurs. Thus, the first choice for Hybrid to consider is whether the benefits associated with the acquisition of insurance cover justifies the payment of premiums (Pereira, McCoy & Merrill, 2009). There are different approaches of arriving at this decision. One of the approaches that Hybrid can use is the Value at Risk (VaR) approach. This entails evaluating the value that the customer stands to lose in the occurrence of the stipulated risk. For instance, in an insurance arrangement that cover physical assets, the company should evaluate the amount of money that it stands to lose in the occurrence of risk that cases damages to the asset. Besides considering the value of the asset, the firm should also consider the amount of losses that will be incurred in terms of down time and repair or replacement activities (Pereira, McCoy & Merrill, 2009). For instance, Hybrid may consider insuring its equipment against theft in case the installation is located in a region that is highly insecure. In general, the VAR equates the benefit of the insurance cover with the amount of loss that the company stands to suffer in the occurrence of the risk.The second approach that Hybrid may use to determine the benefit of insurance is the ‘minimizing the maximum regret approach (Pereira, McCoy & Merrill, 2009).


The aim of this method is to minimize the difference between the benefits that the company would enjoy in case there were no risks and the benefits that the firm will enjoy by taking a certain option. Regret is the difference between some choices and the best choice for a particular risk. For instance, regret for Hybrid Energy may be the difference between the maximum profit that the company can get in the absence of risks and the profit that the company stands to get when it makes a given decision (Pereira, McCoy & Merrill, 2009). Thus, if the option of taking insurance cover results in minimal regret, then the company should take this option.   The third approach that Hybrid Energy may use in determining the benefit risk tradeoff is the utility function approach (Pereira, McCoy & Merrill, 2009). This approach equates benefits to the element that maximizes the utility/ interests of the company. Since companies have different interests they will give different priority to various risks. For instance, a company that has a high propensity for taking risks in order to maximize result may have varied view concerning a given risks (Pereira, McCoy & Merrill, 2009). Thus, the choice on whether to acquire an insurance cover is determined by the utilities/ interests of the company.


 Cost of Obtaining Insurance

Hybrid Energy Ltd should also consider the cost of obtaining insurance. The benefits obtain from the insurance arrangement should justify the cost of obtain this arrangement. The company should take up the insurance if the premium is below the fair value of the insurance (Kunreuther & Pauly, 2005). A rational company should not pay premiums that greater that the maximum claim that the company can get in the occurrence of the stipulated risk.


 Negotiation Approach

  1. Conduct a Search

Hybrid Energy management team needs to conduct a search in order to get information concerning the products of the insurance company (Mertz, 2008). Insurance companies come up with new products and new terms with time. Hybrid managers should focus in finding out new products and terms that are better than what was in the previous contract.


 Read the Contract

Hybrid Energy’s management team should go through the contract identifying all the essential details within the contract. They should familiarize themselves with the content that makes up the contract (Mertz, 2008). It is also essential for managers to pay attention to the language used in the contract. Many contracts contain deadlines for sending notice concerning the renegotiation of contracts.  The management needs to consider consulting legal and other experts concerning the content of the insurance contract. The management should identify areas that need clarification and/ or changes.


 Arrange for a meetingThe final step entails arranging a meeting with the insurance company renegotiate the terms of the contract (Mertz, 2008). The managers will arrange for the meeting by sending a notice to the insurance company. The managers should point our areas that they would like the insurance company to change.


 Conclusion

            Risk is an inevitable part of every business. However, they can result in losses that paralyze the business.  Thus, the management of Hybrid Energy Ltd cannot afford ignore this essential part of the business. This report has analyzed the categories of risks that Hybrid Energy is likely to encounter and the role of general insurance in managing these risks. Corporate asset risks, liability risks and financial risks are the main categories of risks that the company is likely to encounter. Insurance is one of the approaches for managing business risks. The concept of insurance enables the organization to transfer risks to other organizations. The management should evaluate the gain/risk trade off and the cost of insurance before making decisions concerning the insurance choice.


 References

Anderson J. & Brown R. (2005). Risk and Insurance. February 20, 2013. http://www.soa.org/files/pdf/P-21-05.pdf

Bigliani R. & Feblowitz J. (2011). Minimize Risk in the Gas and Oil Industry. February 20, 2013. http://www.emc.com/collateral/analyst-reports/minimizing-operational-risk-in-oil-gas-industry.pdf

Ezell B. et al (2010). Probabilistic Risk Analysis. Risk Analysis Journal. 30 (4): 575- 589

Kunreuther H. & Pauly M. (2005). Insurance Decision making and Market Behavior. Foundations and Trends in Microeconomics. 1 (2): 63- 127

Mertz G. (2008). Negotiate Better Payer Contracts. February 20, 2013. http://www.physicianspractice.com/articles/finance-negotiate-better-payer-contracts

Mikes A. (2010) From Counting Risk to Making Risk Count. February 20, 2013. http://www.hbs.edu/faculty/Publication%20Files/11-069.pdf

Pereira M. McCoy M. & Merrill H. (2009). Managing Risk in the New Power Business. February 20, 2013. http://merrillenergy.com/ManagingRisk.pdf

Raanan Y. & Kennet R. (2008). Operational Risk Management. USA. John Wiley and Sons

Raymond (1999). Quantify the Risk to Manage Cost and Schedule. Acquisition Review Quarterly. 147- 156

The Energy Information Administration (2012). Derivatives and Risk Management in the Electricity, Natural Gas and Petroleum Industries. February 20, 2013. http://www.eia.gov/oiaf/servicerpt/derivative/chapter2.html


 

Last modified on Friday, 20 September 2013 11:51
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