1. United Grain Growers Enterprise Risk Management: A Case Study
More about ERM
CAS ERM website:
SOA CERA Credential:
RIMS ERM Center:
Wikipedia:

2. Enterprise Risk Management
Traditional approach:
Manage each type of risk separately (silo approach)
Enterprise risk management approach:
Manage all risks in a unified framework
Focus more on overall firm risk
Some firms have established a new position: chief risk officer

3. Enterprise Risk Management
Arguments for ERM:
Process provides managers with a better understanding of the firm’s risks
Many of the reasons for managing risk suggest looking at an aggregate performance measure (e.g., cash flows)
Arguments against ERM
Too costly to implement

4. United Grain Growers Case
UGG was one of the first to use ERM
Background on UGG:
Operates in western Canada
Provides services to farmers
Governance structure: Members and Shareholders
Main business: grain handling
Capital expenditure program: replace old grain silos
Recently increased financial leverage

5. UGG’s Business Segments
Operates in western Canada
Grain
Handling
Livestock Services
- Feed Mills
Crop
Production
Services
-Fertilizer
-herbicides
-Seed
A Farm
-Marketing
-Production
-Planning
Country
Elevator
Terminal
Elevator
End
Users
Communications

6. EBIT for UGG’s Business Segments (Fig.4)
Grain Handling proceeds
Highly volatile, Why?

7. The ERM Process Formed a RM Committee Brainstorming session
CEO, RM, CFO, Treasurer, Manager of Audit Services
Brainstorming session
Willis analysts, RM committee, other employees
Identified 47 main risks
Six risks were chosen for further investigation:
Environmental liability
Effects of weather on grain volume
Counter-party risk
Credit risk
Commodity price and basis risk
Inventory risk

8. Example of Analysis of each of the Six Risks: Counterparty Risk

9. Focus on Weather Risk
Ken Risko (statistician) & Michelle Bradley (actuary) from Willis Risk Solutions, found weather was most important source of risk
Weather
Crop yields (Table 5)
UGG’s grain shipments (Table 1)
UGG’s gross profit (Table 3)

10. Weather  Crop Yields (Table 5) Results of Regression Analysis of Crop Yields (bushel per acre) and Weather Conditions in Three Canadian Provinces using data from ; Temperature is measured in degrees Fahrenheit and precipitation in inches. The time trend variable equals (year-1960); thus, for the year 2000 the time trend equals 40.

11. Crop Yields  UGG’s Grain Shipment (Table 1)

12. Grain Shipment  Gross Profit (Table 3)

13. Why UGG has to cope with Weather Risk?
Attain stable profits and cashflow
More capable to carry out strategic plan
Capital Expenditures
Lowered Cost of Debt Capital
UGG’s Grain Volume
Weather
Crop Yields
Beta=0.881
Beta=0.82
UGG’s Profit

14. Removing Effects of Weather (Figure 6)

15. Choices and their Disadvantages
Retention
Weather derivatives
Insurance contract
Planned capital expenditures;
Increased leverage;
Protect reputation
Basis risk (weather index crop yields shipments UGG profitability;
Thin market  low liquidity & high costs
Moral hazard  use industry volume
Basis risk (industry shipments UGG profitability);
Thin market  low liquidity & high costs
Should UGG integrate with other coverages?

16. What did UGG Do? Purchased multi-year insurance contract
bundled P&C coverages with grain volume
grain volume coverage based on industry shipments

17. Grain Volume Coverage
AvgShpmnts = Average industry shipments in past five years (in tons)
Shpmntst = industry shipments in year t
If Shpmntst < AvgShpmnts, then a loss occurs
Magnitude of loss = $25 * (15%) * ( AvgShpmnts – Shpmntst )
Coverage depends on loss subject to retentions and limits

18. Bundling of Coverages
Illustration of how coverage was bundled

19. Bundled insurance policy
Contract 1
One
Contract
Contract 2
Bundled Insurance
Policy
Advantage
- risk diversification
- administrative cost reduced
Problem
Moral hazard
Contract 3

20. Accomplishments UGG Lowered Their Cost of Risk
Insurance Premiums remained about the same
Better Coverage
Better able to carryout strategic plan
Capital Expenditures
Lowered Cost of Debt Capital
Better Understanding of their risks

21. Lessons from UGG’s Experience
Cooperation from many individuals
Buy-in from top managers was important
Technical expertise – Willis
Patience – ERM takes time & it is on-going

22. Conclusion Insurers have a new way to manage risk.
It has evolved into a basic requirement for lasting survival in the competitive environment.
A new way for insurers to offer additional services to industrial enterprises.

23. Questions before Final Decision
(5) Given that any method of reducing the weather risk exposure will be costly, what are the benefits to the UGG’s diversified owners from reducing the weather risk?
(6) Should UGG’s rather unique ownership structure influence the decision to reduce the weather risk exposure?
(7) How could they structure a weather derivative to cover the exposure? More specifically, what would be the underlying index? Would they need a separate contract for each crop and each province?

24. Questions before Final Decision
(1) How could they structure an insurance contract to cover the grain volume exposure? More specifically, how would a loss be defined? And, what would be the payment to UGG conditional on a loss?
(2) What are the advantages and disadvantages of integrating the grain volume coverage with the firm’s other insurance coverages? That is, instead of having separate policies with separate deductibles and limits for the various exposures (including the grain volume exposure), what are the advantages and disadvantages of bundling all of the firm’s exposures in one policy with one deductible and one limit?
(3) Ignoring cost differences, are there any advantages of the insurance contract approach versus the use of weather derivatives?
(4) Are there any loss control measures that could be used to manage UGG’s weather risk?