After Hurricane Maria battered Puerto Rico, a large medical device manufacturer worried about sourcing backup manufacturing facilities should a similar event occur: "We may be unable to manufacture the relevant products at the previous levels—or at all," the company stated in a 10-K filing.
This predicament exemplifies how natural disasters such as hurricanes, flooding, wildfires and earthquakes can harm businesses in ways, and for durations, that extend beyond the scope of any insurance policy.
Following record hurricane and wildfire seasons the past couple of years, it's evident that a prolonged business interruption can negatively affect a company's market share, free cash flow, investor confidence, share price, reputation and potential growth opportunities—none of which are covered by insurance.
Prepare for the hot seat
While the senior financial executives’ role is all about having controls in place, the one thing that can’t be controlled is Mother Nature. And when that risk isn’t properly managed, financial executives often need to answer for the destruction when challenged by board members, CEOs and investors to prove capital has been properly allocated to protect the business.
In many cases, the allocation is questionable. My colleagues examined 10-K regulatory filings from nearly 100 major publicly traded companies that suffered property damage and business disruption from Hurricanes Harvey, Irma or Maria. The review suggests that many financial executives should be allocating more capital to reduce the financial risk related to potential natural disaster. Otherwise, they risk facing volatile balance sheets and other potential consequences of their inaction. (Volatility is anathema to the insurance industry. No insurer or client wants it in their financial results, and no investor wants it in portfolios. In fact, insurance’s raison d'être is absorbing volatility.)
Here are just a few examples of major losses identified in the 10-K reviews:
- A large power company in the southeastern United States reported US$333 million in storm-related damage from Hurricanes Irma and Maria, as well as other storms.
- A large bank holding company reported US$53 million in hurricane-related losses during the third quarter of 2017, primarily affecting its retail automotive loan portfolio.
- A Fortune 500 health care company reported a US$32 million third-quarter 2017 charge related to the impact of Hurricane Maria in Puerto Rico, and a negative impact on fourth-quarter sales of approximately US$70 million.
- A large global pharmaceutical company reported US$43.4 million in costs associated with the temporary shutdown of its Puerto Rico-based facilities following Hurricane Maria.
- A major multinational information technology company reported US$93 million in disaster charges as a result of Hurricane Harvey.
- A large U.S. department store chain reported US$16 million in losses related to the costs of property damage from Hurricanes Harvey, Irma and Maria.
- A major American conglomerate headquartered in New York cited net catastrophe losses of US$256 million from the three hurricanes and California wildfires.
While most companies offset property damage and business disruption losses through insurance, several entities reported disaster-related costs that were uninsured.
Unfortunately, many businesses appear to take the view that unpredictable events like hurricanes, fires and earthquakes will not likely occur in the current earnings season. Or, they think, if such events do occur, the resulting loss wouldn’t be preventable or that insurance would cover it. These misconceptions can backfire in the aftermath of a natural disaster.
Be among the prepared minority
When natural-hazard losses do occur, the buck is often passed until it ends up in the lap of the CFO. Board members, investors and analysts increasingly want credible information on the company’s preparedness for the next big one. If they’ve seen repeated losses, they may question the company’s risk management decisions.
Some executives say their companies have come up short in this regard.
We recently surveyed executives at large U.S.-based companies with operations in Texas, Florida or Puerto Rico, two states and a territory enduring the brunt of 2017’s three major hurricanes. Of the many companies suffering adverse impacts, 62 percent admitted their organizations were “not completely prepared” to deal with the hurricanes’ effects, and 68 percent of the adversely affected cited plans to make changes to their risk management strategies going forward. These changes include enhancing their disaster recovery and business continuity plans, investing more in property loss prevention, and reassessing the supply chain risk management strategy.
Such changes tend to produce a significant return on investment: For every US$1 a company spends to protect structures from hurricane, wind and flood damage, estimated property loss and business disruption exposures decrease by an average of US$105.
Use the valuation lens
This growing pressure to be resilient in the face of natural disaster requires financial executives to carefully analyze operations and risk. I recommend using valuation-based models to help determine the total financial impact of a major property loss event after insurance recoveries. The data produced by such models can paint a good picture of a natural disaster’s possible impact on market share, investor confidence and missed growth opportunities.
Armed with this knowledge, financial executives can discuss with risk managers how the company’s resilience strategy is offsetting these threats, thereby revealing loss-prevention gaps where capital is needed. CFOs generally have more latitude than a risk manager to fill these gaps, including the ability to relocate versus simply reinforce a facility in a flood zone or on a fault line.
If CFOs and other financial executives fail to lead the charge in reducing exposure to loss in valuation, they will be the ones that stakeholders likely will hold accountable for not properly addressing the risks. And for good reason. A company’s profitability and survivability are on the line.
Robert Hartwig, director of the Risk and Uncertainty Management Center at the University of South Carolina, put it like this: “Major natural disasters, more than ever, threaten to interrupt tenuous global supply chains, increase cash flow volatility and inflict lasting harm on customer relationships. Severe natural disasters thus have the potential to become capital events, and as such must be addressed by CFOs directly and not merely relegated to risk managers.”
If that was not true before the record hurricane and wildfire seasons, it’s true now: we’re all in the hot seat.As published in FEI Daily