For entrepreneurs and investors, risk management is an important tool for the proper performance of their work.
Surprises exist and not everything can be foreseen, despite planning, unforeseen events arise. Risks are always there and you have to analyze them and try to mitigate them as much as possible.
Many think the control of external risks is out of our hands (weather-related events, financial credit events), but in reality, they can be mathematically managed as much as internal risks.
Investing companies must prioritize their risk management plans and take out appropriate insurance to ensure that their business and their activity does not derail.
A good risk management plan is critical to the sustainable success and long-term preservation of the company.
First of all, let us briefly explain what liability risk is. We will say that it is an operational risk, i.e. the risk that a company, person, enterprise, institution, etc. is liable for an action or omission resulting in direct or indirect financial losses.
In reality, there is no standard definition, since various concepts are used in the field of risk analysis, although they are all, in one way or another, similar.
It is a type of operational risk, also known as op risk, the risk of loss due to inadequate failures or processes of both personnel and internal systems, or due to external events.
It is not a minor issue. Some studies indicate that 70% of UK insurers have recognized that operational risk is as important as other types of risk: credit or market. It is not something we can take lightly.
Globalization and technological advances have increased these risks, including large-scale mergers and acquisitions that always test the viability of implemented or integrated systems.
Companies often encounter many risks in merger and/or acquisition processes, especially risks of an operational nature, which are not properly dealt with by legal and financial advisors due to their specific complexities.
Merger processes are often long and complex. To avoid risks, it is necessary to avoid leaving loose ends and to thoroughly analyze the operational circuits and all the procedures associated with the merger or acquisition.
It is normal at times of major mergers to create working groups and temporary committees to analyze risks in order to mitigate or avoid them if they arise. This is common and essential.
Liability risk insurance
Liability risk insurance works so that individuals, institutions, companies or businesses can develop their activities without the constant fear that their actions may generate losses in their patrimony.
They are insurances that protect against a situation in which damages are caused to third parties, damages that entail losses by way of economic compensation. The insurances also protect in case of aggressive lawsuits and monetary demands that are not true because such lawsuits, which are initiated by law firms, are expensive to defend, which is a cost in itself that is covered by the insurances.
There are different forms of liability risk insurance, but we will enumerate two very important ones:
- Rep and Warranty Insurance, which insures liability from M&A transactions;
- D&O Insurance, which protects individual directors from liability coming from shareholders;
Another form of insurance worth mentioning, which is relevant to banks and lenders and that has a component of liability risk insurance, is Mortgage Impairment Insurance. This insurance protects the bank/lender or mortgage servicer from financial losses due to physical damage to a borrower’s home whether pre or post-default.
Fraud in large companies tends to be a very striking issue for the press, with information about it appearing all the time and generating a great media stir. In fact, Fraud risk is not an unimportant issue for companies and businesses of all sizes.
Most entrepreneurs and investors think that they are “vaccinated” against fraud. But fraud is the order of the day and can happen anywhere and at any time. No company is truly safe unless they have a proper Fidelity Bond in place, which protects against employee and third party fraud.
Every year companies lose gigantic amounts of money as a result of the large number of minor frauds that are committed. Research on the magnitude of the costs of fraud to business and society does not give a complete picture of the scale of the problem, but it does indicate that fraud is a frequent, serious and costly problem.
Globalization, the presence of an increasingly competitive marketplace, the introduction of new technologies and recurring periods of economic crisis can increase the risks of fraud. Estimates suggest that the global economy loses $1.5 trillion each year to corruption and fraud. Companies typically recover only a small percentage of these losses, which can amount to as much as 7% of annual turnover.
Research also indicates that most perpetrators of fraud tend to work in the financial sector, and are not limited to specific sectors or countries. They are everywhere.
Despite the complex context, many companies and organizations do not pay due attention to the problem of fraud, its prevention, detection and response. This is a mistake.
Tips for investors and entrepreneurs
Entrepreneurs and investors should be very aware of liability and fraud risks to avoid unnecessary losses, which in turn increases their returns over the long run.
Liability risks are important to be aware of, as they include potential negligence claims, shareholder lawsuits against a company’s board of directors, customer lawsuits against a manufacturer of an allegedly defective and/or harmful product, etc.
Claims may also include claims for management and investment errors, poor quality of services and claims for damages.
It is a mistake not to pay attention to danger signals. Investors and business owners should pay attention to the recommendations of risk management professionals and make sure that such professionals are independent of any insurance broker or company so that they get unbiased advice. It is imperative to analyze which risks are most likely to occur and which could generate the greatest losses.