Listening to the signals: the decibels that ring loudest in the ears of risk executives in the electronics industries have to do with privacy and business interruption

John Williams

If you ask risk managers in most any industry what their significant risks are, the majority will be able to rattle off half a dozen or more in rapid succession.

However, ask risk managers in the electronics industry and, due to the nature of the business, many will focus on the growing challenges they face with unique exposures, such as privacy.

Business interruption is their major risk, hands down, either what happens between the "four walls," or, perhaps more significantly, throughout their supply chains. The other primary risk lies simply with the ups and downs of the insurance market and the importance of educating carriers to the uniqueness of the electronics industry.

A few other issues do come up, such as intellectual property, product recall, D&O liability, and privacy. Of these, privacy is growing into an interesting and challenging exposure, given the patchwork of worldwide regulations.

"Electronics companies must deal with privacy issues more than other companies because of the technology they use, which can impact privacy either positively or negatively," points out Mark Carey, CEO and founder of DelCreo Inc. of Alpine, Utah, a risk consulting firm that specializes in the electronics industry. "One problem is that privacy regulations differ from country to country."

For example, in some European countries serial numbers on electronic equipment are considered private. In addition, when you send your data across borders, you create additional risk. "You may be in compliance with regulations in India, but not in Canada," he says. "As such, if you are a U.S. company with tech support operations in India and customers in Canada, the privacy issues can become very complex," Carey adds.

"Electronics is a specialized industry, and we have a lot of unique exposures," says Paul Miles, director of risk management for Analog Devices Inc. in Norwood, Mass. "Even a small incident can cause extensive damage and property losses. It can also interrupt the production cycle and lead to downtime."

Patrick O'Brien, Sr., director, global tax, treasury and risk for Molex Inc., the Lisle, Ill.-based maker of electronic, electrical and fiber optic connection systems, agrees. "Our biggest concern is business interruption." In this, he includes business continuity planning, disaster recovery planning, and supply chain security. "We can't prevent disasters, but we can be poised to react so that a disaster has the least impact on our ability to get products to our customers."

David T. Torpey, a partner and practice leader of the insurance claims service practice of Ernst & Young in Dallas, also stresses the importance of paying attention to business interruption risk.

"If you end up being shut down due to a flood, hurricane, fire or other event, you need to make sure you have excess capacity in other plants or the ability to utilize temporary facilities to continue manufacturing," says Torpey.

Another useful strategy, says Carey, is to consider implementing an enterprise risk management initiative. "This is variously called supply continuity, business resiliency, and crisis management," he explains. "Regardless of what you call it, though, the key is to make sure all parts of your organization are involved in risk management to some degree and are coordinating and communicating with each other."

ACHILLES HEEL: THE SUPPLY CHAIN

While Torpey admits that internal business interruption is a significant concern, an even greater risk for electronics companies is supply chain risk, especially in terms of the relationships manufacturers have with their suppliers.

"This is especially true since many electronics companies simply assemble the parts that they receive from subcontractors," he says. "What if one of these subcontractors in Asia is hit by a typhoon? What if there is political risk in that country? You need to make sure that you have alternate suppliers."

Tom Henderson, corporate risk manager for Texas Instruments in Dallas, agrees with Torpey's assessment. "The biggest challenge with supply chain risk management is that you have little control over how your suppliers and customers manage their risks, so your insurable interests are limited," he says. "However, you still have to try to manage these risks."

In the past decade the semiconductor industry has intensified that challenge by using more outsourcing, fabricating foundries and subcontractors. "We continue to look at supply chain risk issues, especially in our semiconductor business, which has become more global in recent years," says Henderson. We address the issues of potential loss of customers and potential loss of suppliers."

Whenever possible, Henderson works with risk managers in supplier and customer organizations. "It can be very useful when two risk managers, particularly when there is a contract issue, can sit down and resolve differences," he explains.

Molex's O'Brien also focuses on managing supply chain risk issues. "We make sure our suppliers have the ability to second-source from one of their other facilities, or we are poised to go to an alternate source ourselves," he says. "We also work with [freight company] carriers to make sure they have business continuity plans in place." These are the freight companies that deliver shipments from suppliers to Molex's facilities, from Molex to its customers, and even between its own facilities. "A substantial part of our business model is intercompany," says O'Brien.

While risk managers can do a lot to mitigate supply chain risk by working closely with suppliers and transportation companies, they also need to pay attention to the insurance aspect of supply chain risk management, experts say.

"In terms of insurance, you need to have contingent business interruption coverage if there were to be a loss in the supply chain," says Ernst & Young's Torpey. He emphasizes the importance of paying careful attention to the wording of such coverage. "Some policies require you to identify each and every supplier when renewing each year," he says. "Some also require you to identify your suppliers' suppliers."

He also recommends talking with risk managers in companies that have suffered supply chain-related losses and have filed claims, to see what they went through and where some of their gaps were.

Another important step in assessing coverage is to make sure you are being charged fairly. "Pay close attention to how property and business interruption premiums are being valued," he says. It may be done based on the old method used in traditional manufacturing, which assumes that most manufacturing is done on-site. However, according to Torpey, if most of your manufacturing is done off-site, the insurance company may be "double-dipping."

In other words, the insurance company could be charging you for your suppliers' manufacturing, otherwise known as your contingent business interruption coverage, as well as for manufacturing on your own site via the business interruption worksheet, which may be virtually nonexistent. "In sum, make sure that your insurance company isn't using an archaic method for valuing your business interruption risk," he warns.

EDUCATING CARRIERS

When insurance rates were relatively inexpensive, buyers didn't pay much attention to whether they were charged more in premiums than their competitors. However, with rates exploding in the last three years, it has become very important for buyers to separate their companies from the rest of the pack.

"A lot of insurance carriers went crazy after Sept. 11, putting everyone in the same buckets as far as risk levels, increasing everyone's premiums often for no good reason," explains Molex's O'Brien. "It is important that insurance carriers focus individually on the companies they're underwriting to get a better understanding of them. As risk managers, we have to properly market our companies to insurance carriers." Molex, for one, is very open with carriers, allowing them to assess the company's strengths and weaknesses on a global basis.

For example, if the company introduces a new product with a different risk profile, Molex will notify its broker and carrier. "In this way, we don't wait for something to happen and then have to argue whether or not it was really covered in the policy," says O'Brien.

Analog Devices' Miles agrees. "It is important that clients and insurers understand where their exposures are and work together to evaluate and address them," he says. The challenge, he has found, is to continue to educate the underwriters about how some companies are better than others at protecting their risks, and evaluating and protecting their exposures.

"This is why we work with carriers who are equipped to deal with companies like ours, rather than carriers who aren't very sophisticated in determining the difference between semiconductors and other industries," he says.

Analog Devices makes an effort to educate its primary underwriters, on the property and the liability sides, about the nature of its business. The company has relationships with its primary D&O carrier and its general liability carrier. "We are relatively new with our current property carrier, because our previous carrier left the business," notes Miles. "We are now with Factory Mutual and are already creating a very good cross-educational effort with them. For example, they are very good about working with us when it comes to different ways to consider implementing their recommendations."

As a manufacturer, Intel Corp.'s property risk is significant. The company invests a lot of money in its Santa Clara, Calif. facilities. "The value, when fully operational, can be as much as $3 billion," says Kenneth Kwidzinski, the company's risk manager. In the past, the insurance industry has been cautious about covering these types of technical investments, although the situation has improved in recent years.

"One reason is that, as our technology has advanced in terms of our manufacturing capabilities and outputs, so have the hazard controls, which we build into the manufacturing design and systems," he says. To this end, Intel educates insurers on how its facilities operate.

"We can offer a lot of 'science' on how our operations work, the details of our loss control programs, and so on," says Kwidzinski.

Overall, Intel's risk department spends a great deal of time learning everything about the company so they can relay this information to the insurance market. "We want to make sure we are heard correctly and make sure we differentiate ourselves to insurance carriers, so they realize that we are better than the norm," he says.

INDUSTRY RISK REPORT ELECTRONICS

Here's the challenge for managers in the electronics manufacturing business: The plant is in Asia, customer service is in India, clients are in Canada, and company headquarters are in a suburban office park in the United States. And all of this, just to produce a $700 kitchen appliance. Under these circumstances, it's not unusual for small incidents to degenerate into major headaches as the corporation's disparate divisions fail to work in unison. Because managers have little or no control over how suppliers manage their risks, insurable interests are limited. Is it any wonder, then, that supply chain and business interruption issues are most likely to keep ringing in managers' ears?

EMERSON ELECTRIC

St. Louis, Mo.

Emerson was incorporated in Missouri in 1890. Originally engaged in the manufacture and sale of electric motors and fans, Emerson subsequently expanded its product lines through internal growth and acquisitions. Emerson is now engaged principally in the worldwide design, manufacture and sale of a broad range of electrical, electromechanical and electronic products, systems and services.

CHIEF RISK EXECUTIVE Paul Morrison, Director, Risk Management

CEO David N Farr

CFO Walter J Galvin

BOARD AUDIT CHAIR August A. Busch III,

NET REVENUE $13,958 million

NET INCOME $1,089 million

NUMBER OF EMPLOYEES 106,700

PRIMARY BROKER Withheld

CAPTIVE No

RISK EXPOSURES current and future business environment, including interest rates and capital and consumer spending; volatility of the end markets served, as demonstrated by the recent decline in the electronics and telecommunications market; availability of raw materials and purchased components; government laws and regulations, including taxes; outcome of pending and future litigation, including environmental compliance.

RISK STRATEGIES The company selectively uses derivative financial instruments, including forwards, swaps and purchased options.

WHIRLPOOL

Benton Harbor, Mich.

Whirlpool is the world's leading manufacturer and marketer of major home appliances. It manufactures in 13 countries and markets products in more than 170 countries under major brand names such as Whirlpool and KltchenAid. The company has approximately 68,000 employees worldwide.

CHIEF RISK EXECUTIVE Gary Kilburg, Director, Risk Management

CEO Jeff M Fettig

CFO R Stephen Barrett, Jr.

BOARD AUDIT CHAIR Allan D Gilmour

NET REVENUE $12,176 million

NET INCOME $414 million

NUMBER OF EMPLOYEES 68,000

PRIMARY BROKER Becher and Carlson Management

CAPTIVE Whirlpool Insurance Co., Ltd. (Vermont)

RISK EXPOSURES The company is exposed to market risk from changes in foreign currency exchange rates, domestic and foreign interest rates, and commodity prices; competitive pressure to reduce prices; ability to gain/maintain market share; success of Latin American businesses operating in volatile environments; effectiveness of a series of reconstruction measures taken by the company beginning in 2003; threat of terrorist activities and war;

RISK STRATEGIES Whirlpool uses foreign currency forward contracts and currency swaps to hedge price associated with risk.

EATON

Cleveland, Ohio

Eaton Corp. is a global diversified industrial manufacturer with 2003 sales of $8.1 billion. The company is a leader in the design and manufacture of fluid power systems, electrical power quality, distribution and control, automotive engine air management and power train controls for fuel economy.

CHIEF RISK EXECUTIVE David Johnson, Manager, Corporate Insurance

CEO Alexander M Cutler

CFO Richard H Fearon

BOARD AUDIT CHAIR Victor A. Pelson

NET REVENUE $8,061 million

NET INCOME $386 million

NUMBER OF EMPLOYEES 51,000

PRIMARY BROKER Aon

CAPTIVE Aeroquip-Vickers Assurance, Ltd. (Barbados); Saturn Insurance Co., Ltd. (Bermuda)

RISK EXPOSURES unanticipated changes in the markets for Eaton's business segments; unanticipated downturns in business relationships with customers or their purchases from the company; competitive pressures on sales and pricing; increases in the cost of material and other production costs; the introduction of competing technologies; unexpected technical or marketing difficulties; unexpected claims, charges, litigation or dispute resolutions; acquisitions and divestitures; new laws and governmental regulations.

RISK STRATEGIES On an ongoing, regular basis, certain processes continue to be modified in order to reduce the impact on the environment, including the reduction or elimination of certain chemicals used in, and wastes generated from, operations. The company is exposed to various changes in financial market conditions, including fluctuations in interest rates, foreign currency exchange rates, and commodity prices. Eaton manages exposure to such risks through normal operating and financing activities.

SPX

Charlotte, N.C.

SPX is a global multi-industry company that is focused on profitably growing a number of platform businesses that have scale and growth potential. The company is a global provider of technical products and systems, industrial products and services, flow technology, cooling technologies and services and service solutions.

CHIEF RISK EXECUTIVE Carol Brocci, Risk Manager

CEO John B Blystone

CFO Patrick J O'Leary

BOARD AUDIT CHAIR J. Kermit Campbell

NET REVENUE $5,081 million

NET INCOME $236 million

NUMBER OF EMPLOYEES 22,200

PRIMARY BROKER Withheld

CAPTIVE No

RISK EXPOSURES indebtedness may affect business and may restrict operating flexibility; failure to successfully integrate recent acquisitions, as well as any future acquisitions, could have a negative effect on operations; acquisitions could cause unexpected financial difficulties; a portion of revenues is generated through long-term fixed-price contracts, which could expose the company to various risks, including the risks of cost overruns, inflation and credit risks associated with certain customers.

RISK STRATEGIES SPX is primarily self-insured for workers' compensation, automobile, product and general liability costs, and believes that it maintains adequate accruals to cover its retained liability. SPX maintains third party stop-loss insurance policies to cover liability costs in excess of predetermined amounts.

HAYTAG

Newton, Iowa

Maytag is a leading producer of home and commercial appliances. Its products are sold to customers throughout North America and in international markets. Maytag is among the top three major appliance companies in the North American market. The company offers consumers a full line of washers, dryers, dishwashers, refrigerators and ranges. The company distributes its products through large and small retailers across the United States and Canada.

CHIEF RISK EXECUTIVE Steven Bruner, Director, Corporate Risk Management

CEO Ralph F Hake

CFO George C Moore

BOARD AUDIT CHAIR Neele E. Stearns, Jr.

NET REVENUE $4,791 million

NET INCOME $120 million

NUMBER OF EMPLOYEES 20,640

PRIMARY BROKER Withheld

CAPTIVE No

RISK EXPOSURES The operations of the company are subject to various federal, state and local laws and regulations intended to protect the environment. Maytag is exposed to foreign currency exchange risk related to its transactions, assets and liabilities denominated in foreign currencies. Maytag also is exposed to commodity price risk related to its purchase of selected commodities used in the manufacturing of its products.

RISK STRATEGIES The company uses foreign exchange forward contracts to manage the currency exchange risk related to sales denominated in foreign currencies. The company uses commodity swap agreements to manage the risk related to changes in the underlying material prices of component parts used in the manufacture of home and commercial appliances. In addition, the company uses interest rate swap contracts to adjust the proportion of total debt that is subject to variable and fixed interest rates.

ROCK, NELL AUTOMATION

Milwaukee, Wis.

Rockwell Automation Inc., a Delaware corporation, is a leading global provider of industrial automation power, control and information products and services. The company is organized based upon products and services and has three operating segments: control systems, power systems and first point contact. Total company sales in 2003 were $4.1 billion.

CHIEF RISK EXECUTIVE Christopher Johnson, Director, Insurance and Risk Management

CEO Keith D Nosbusch

CFO James V Gelly

BOARD AUDIT CHAIR J. Michael Cook

NET REVENUE $4,104 million

NET INCOME $286 million

NUMBER OF EMPLOYEES 21,500

PRIMARY BROKER Withheld

CAPTIVE No

RISK EXPOSURES economic and political changes in international markets where the company competes, such as currency exchange rates, inflation rates, recession, foreign ownership restrictions and other external factors over which the company has no control; demand for and market acceptance of new and existing products, including levels of capital spending in industrial markets; successful development of advanced technologies; competitive product and pricing pressures; future terrorist attacks.

RISK STRATEGIES The company's self-insurance programs include primarily product liability risks and workers' compensation risks. For product liability and workers' compensation, the company self-insures from the first dollar of loss up to specified retention levels. Eligible losses in excess of self-insurance retention levels and up to stated limits of liability are covered by policies the company purchases from third-party insurers.

HARMAN INTERNATIONAL INDUSTRIES

Washington, D.C.

Harman International Industries Inc. is a Delaware corporation, incorporated in 1980. Harman is a worldwide leader in the manufacture of high-quality, high fidelity audio and electronic products for consumer and professional use.

CHIEF RISK EXECUTIVE Bill Prescott, Insurance Manager

CEO Bernard A Girod

CFO Frank Meredith

NET REVENUE $2,228 million

NET INCOME $108 million

NUMBER OF EMPLOYEES 10,776

PRIMARY BROKER Withheld

CAPTIVE No

RISK EXPOSURES Changes in consumer confidence and spending; automobile industry sales and production rates and the willingness of automobile purchasers to pay for the option of a premium branded audio system and/or a multifunctional infotainment system; model-year changeovers in the automotive industry; the outcome of pending or future litigation and administrative claims, including patent and environmental matters.

RISK STRATEGIES The company uses interest rate swaps to convert the interest rate on a majority of its borrowings from fixed rates to variable rates. To assess exposure to interest rate changes, it has performed a sensitivity analysis assuming a hypothetical 100 basis point increase or decrease in interest rates across all maturities.

DIEBOLD

North Canton, Ohio

Diebold Inc. is a global leader in providing integrated self-service delivery systems and services. Founded in 1859, the company employs more than 13,000 associates with representation in more than 88 countries worldwide. The company maintains its headquarters in Canton, Ohio.

CHIEF RISK EXECUTIVE Mark Tucker, Corporate Risk Manager

CEO Walden W O'Dell

CFO Gregory T Geswein

BOARD AUDIT CHAIR William F. Massy

NET REVENUE $2,109 million

NET INCOME $174 million

NUMBER OF EMPLOYEES 13,401

PRIMARY BROKER Withheld

CAPTIVE No

RISK EXPOSURES changes in the company's relationship with customers, suppliers, distributors and/or partners in business ventures; political, economic or other factors such as currency exchange rates, inflation rates and laws affecting the worldwide business in each of company's operations, especially Brazil; unanticipated litigation, claims or assessments; potential security violations to the company's information technology systems.

RISK STRATEGIES Diebold uses derivative financial instruments such as forwards to hedge certain foreign currency exposures. The company also manages interest rate risk with the use of variable rate borrowings under its committed and uncommitted interest rate swaps.

ACUITY BRANDS

Atlanta, Ga.

Acuity Brands Inc., with fiscal year 2005 net sales of over $2.0 billion, is comprised of two divisions. They are Acuity Brands Lighting and Acuity Specialty Products. Acuity Brands Lighting is a world leader in lighting fixtures.

CHIEF RISK EXECUTIVE Mary Bruce Edmunds, Director, Risk Management

CEO James S Balloun

CFO Vernon J Nagel

BOARD AUDIT CHAIR John L. Clendenin

NET REVENUE $2,049 million

NET INCOME $47.8 million

NUMBER OF EMPLOYEES 11,400

PRIMARY BROKER Withheld

CAPTIVE No

RISK EXPOSURES Risks relating to distribution; the potential loss of any main supplier of outsourced product; planned spending on new equipment and plants in 2004-2005; interest rate fluctuation and foreign exchange rate currency risk.

RISK STRATEGIES It is the policy of the company to self-insure for certain insurable property and casualty risks (consisting primarily of physical loss of property, business interruptions as a result of property losses and workers' compensation). Insurance coverage is obtained for catastrophic property and casualty exposures. The company is also insured for the majority of its medical benefits plans.

MOLEX

Lisle, Ill.

Molex is the world's second-largest manufacturer of electronic, electrical and fiber optic interconnection products and systems. The company is also involved in the manufacture and production of a variety of switches and application tooling.

CHIEF RISK EXECUTIVE Patrick O'Brien Sr, Director, Global Tax Treasury and Risk

CEO J Joseph King

CFO Robert B Mahoney

BOARD AUDIT CHAIR Douglass K Carnahan

NET REVENUE $1,843 million

NET INCOME $84.9 million

NUMBER OF EMPLOYEES 17,275

PRIMARY BROKER Withheld

CAPTIVE No

RISK EXPOSURES The company is subject to market risk associated with changes in foreign currency exchange rates, changes in interest rates and changes in certain commodity prices.

RISK STRATEGIES The company has implemented a formalized treasury risk management policy that describes the procedures and controls over derivative financial and commodity instruments. It has also implemented an environmental program to reduce the generation of potentially hazardous materials during its manufacturing process.

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