Unchecked Risks That Can Lead to Catastrophe

At board level, companies have gone to great lengths to ensure that they comply with the corporate governance codes which apply to their business. They have identified risks, improved controls, implemented mitigation measures and, where possible, insured them.

At operational level, risk management has concentrated on minimising the effect of higher premiums and coverage restrictions during hard parts of the cycle and taking full advantage of reduced premiums and wider cover when they are available.

In the middle ground lie a number of major business risks with the potential to create disaster for a business if the systems for dealing with them are inadequate or not maintained. The three specific areas I would highlight are asset management, planned maintenance and procurement.

Asset management

Most organisations have systems for recording the physical assets they own and operate, but these systems are frequently flawed. At worst, they remain fixed in time, never updated when there are additions, deletions and alterations to the assets, with a knock-on effect on accounting, auditing and insurance programmes.

Any asset register needs to be rigorously maintained, with all alterations to the assets entered into the system as soon as possible.

The system should contain:

1. The relevant description of the assets

2. Their value to the business both in terms of the straight line depreciation for the annual audit and their value in existing and continued use

3. The insurance reinstatement value

4. An appropriate link to the planned maintenance, procurement and accounting systems, if these operations are not on the same software system

The problems that result from an inaccurate system can be:

• From the accounting perspective, understated figures for the physical assets in the accounts leave the organisation open to takeover and asset stripping, or difficulty in raising finance for expansion.

• From the perspective of the insurance programme, understated values and inaccurate asset information mean insurance coverage may not respond appropriately in the event of a loss, leaving the organisation to pay much of the cost.

Here are some examples where a lack of records either did or could have resulted in significant problems.

A petrochemical company’s asset register, bequeathed by the constructors of the plant, was totally unaltered 20 years later, and both the accounting and insurance programmes were based on this ancient information.

A food company failed to record appropriate details and costs of specialist plant worth many millions of dollars, with serious financial consequences following a major fire.

An oil refining company initiated an insurance claim that included facilities that had been dismantled or removed years earlier.

Planned maintenance

Every organisation needs to ensure that all its facilities, buildings, structures, plant, machinery and vehicles, are properly maintained.

The maintenance system should provide as a minimum:

A unified system controlled from the centre should ensure the regular maintenance of all facilities, at all intervals, whether daily, weekly, monthly or after a specified number of running hours.

“Most organisations have systems for recording the physical assets they own and operate, but these systems are frequently flawed

The system should cascade down to everyone involved in maintenance, irrespective of the size of the organisation, and its operational use must be monitored and audited.

Line managers need to forward upwards maintenance issues from the shop floor for systems to be amended throughout the organisation.

Appropriate managers should issue regular bulletins on maintenance issues and circulate relevant information from equipment manufacturers.

All the processes should be audited regularly, down to and including the operational level. If outside contractors are involved, they should be effectively project managed, either from within the business, if the expertise exists, or by an external project manager. One of the oil majors commented, “If the contractors on a project make 0.5% more profit than the company has ‘calculated”, something has been down-spec’d or corners cut. Independent, external project management is essential”.

Some cases where the lack of an appropriate system to implement and track required maintenance has or could have resulted in significant problems include:

?A utility company discovered that a certain type of pump, which was a major component, required more frequent maintenance than the manufacturer specified.

A bulletin had been issued, but an audit found that none of the company’s many locations was servicing the item at the appropriate frequency. This left the company vulnerable to a major machinery breakdown and subsequent business interruption, to which the insurance programme might not have responded.

?A major building belonging to a school chain was suffering serious structural movement even though it was only a few years old. The cracks had been just filled in during the annual maintenance, but an audit uncovered the true nature of the problem, and structural engineers were appointed. The engineers’ report was chilling; a serious collapse could have occurred and killed or injured staff and pupils.

?A company leasing out warehouses discovered on audit of its maintenance programme that a tenant was not, as thought, distributing innocuous chemicals, but, in fact, making fireworks. The in-house maintenance team was aware of the change of occupation, but not sufficiently aware or well trained to report back to the company. The block of warehouses was in a congested port area and an explosion would have been disastrous for both the company and surrounding organisations.

The procurement of facilities, spares and other equipment to the correct specification and within budget guidelines, is at the heart of maintaining the performance of the business’s hard assets. Systems need to include:

• Budget authorisation and purchase orders for external purchases

• Internal requisition and budgetary control

• Goods receivable against purchase order, etc.

• Quality control and certification of goods received

• Returns of faulty, non-specified and over-supplied goods

• Settlement of invoices within agreed terms and conditions

Once these systems are working, it is essential that their efficiency is tested regularly and any shortfall addressed and rectified as soon as possible. If the organisation does not have appropriate staff to audit items like certification, it should use an outside organisation. Never leave it to the contractor!

Here are some examples where the lack of appropriate procurement checking have or could have led to significant losses or problems to the businesses concerned.

?Glass reinforced plastic (GRP) vessels, from a Far East supplier, all came with ‘certification’, but no one checked whether the certification and testing, etc. conformed to the usual international norms for the purpose for which they were to be used. All the vessels failed. Luckily, there were no catastrophic losses, although there were significant insurance claims.

?A gas company suffered a series of explosions, all of which resulted in significant insured losses. It was not until the insurers instigated a detailed engineering investigation that it was discovered that during a maintenance shutdown, a piece of equipment had been replaced with a new unit which was incompatible with the other parts of the process plant.

?A mining company sank a new shaft and installed all the associated equipment. After a few weeks, one of the two fans driving fresh air down the shaft failed. With no back up air supply, the shaft had to be closed for health and safety reasons. On investigation, it turned out the fans were not up to specification. The initial machinery breakdown claim was relatively small, but the business interruption claim ran into hundreds million dollars.

Asset management, planned maintenance and procurement are essential to the operation of a business and can give rise to serious and expensive problems if the systems for managing them are not properly controlled. The case histories will, I am sure, flag up possible problems in other organisations.