Risk Management Strategies for Small-Medium Enterprises and Micro Companies - Case Study Example

Risk Management and Insurance Student’s Name Institutional Affiliation Date Part One: Critical Analysis James Nolan’s article New Insurance Coverages for the Small Businessman heightens the essence of purchasing insurance under an association on the part of small business enterprises (SMEs). As opposed to taking insurance covers on an individual basis, the author emphasizes on the need for small businesspersons to purchase insurance covers under an association because of the several changes that have occurred in the risk management and insurance aspects of SMEs. The changes have resulted in improved and better insurance packages that favor SMEs. Considering the high cost of indemnity rates in the current business world, it would be proper for individual businesses to insure their businesses under associations. According to Terungwa (2012), risk demotivates investors from investing into SMEs. In the event that SMEs can find a proper way of dealing with the potential risks associated with their businesses, investors would consider them potential investment opportunities. Terungwa’s argument is consistent with Nolan’s argument that the insurance of SMEs is detrimental towards making SMEs potential investment opportunities for investors. In the article, Nolan notes the tendency of insurers to shift a substantial proportion of the premium income to high-yield investments rather than small and medium business ventures. Apparently, the move has had an adverse impact on the running of SMEs because of the significant risks of business interruption that may arise in the course of running the business. Gathering under an association of similar small and medium enterprises has the effect of transforming them into a single high-yield investment thereby making them attractive to investors. It is evident that group purchases of insurance covers for businesses have turned out to be the latest trend for SMEs. Having understood the significance of the trend, commercial line underwriters have resorted to the option in the quest to remain competitive in the industry. On the part of insurance companies, “association insurance” has turned out to be the latest trend in the SMEs insurance business. As a way of emphasizing the significance of association insurance for SMEs, Nolan cites the testimony of Guy, R. Migliaccio, a director of an insurance broker, Marsh & McLennan that testified that SMEs find it difficult to offer health insurance policies to their employees. According to the managing director, the soaring problems and rates associated with workers compensation have presented numerous problems to SMEs due to their limited scope of business. Furthermore, SMEs are encountering additional overhead expenses associated with the price problems and availability of social insurance when they have to deal with the task of paying premiums for such insurance covers for their workers. According to Migliaccio, purchasing association insurance enables practicing professionals and small firms to put a lid on the increasing costs of running the business. Association insurance also enables leveraged buying besides enabling the firm to access risk financing options that would have been unavailable if the firm had opted for a single purchase of insurance cover. Collective risk management advocated in the article is consistent with the findings of Falkner and Hiebl (2015) that considered risk management as a significant option in ensuring the survival of small and medium-sized businesses. From the article, it is also evident that association insurance enables small and medium firms to pay reduced premiums for insurance protection. Besides being beneficial to the firms by enabling them to survive the turbulent business environment due to their limited economies of scale, association insurance also helps attract new memberships besides retaining the old members. The article also mentions the difficulty faced by SMEs in spreading the cost of liabilities premiums for its products. In the event that the firm incurs very high costs, the business faces the risk of collapsing. However, the situation is different for a firm that opts for association insurance. This is because of the high buying power of association insurance that enables members of the association to offset such liabilities. Just like the case of large buyers versus small-scale buyers of products, it is evident that large buyers of insurance products also get wholesale products as opposed to taking individual insurance covers where the firm ends up incurring higher premium costs. As a result, purchasing an insurance product under the umbrella of an association maximizes the purchasing power of the association thereby reducing the costs incurred by other firms in paying premiums. The article also states that association insurance extends beyond the mere provision of coverage, as is the normal case with insurance products. Sanborn cites the example of a nail manufacturer that may be sued for having manufactured the product in the event that a nail hits and injures a worker in the workplace. Even though the suit would be meritless, the business would have to incur costs associated with defending the case. As a result, taking an insurance cover under the umbrella of an association would transfer costs associated with defending the suit from the business to the insurance company thereby reducing additional expenses that the firm would have incurred in settling the case. Sanborn’s example reiterates the crucial role played by association insurance in ensuring the smooth running of small and medium-sized firms. From the example above, the author opines that the ability of association insurance to deal with product liability claims at reduced premiums on the part of the individual business reiterates the rising need for small and medium-sized businesses to take insurance covers under the umbrella of an association. Purchasing insurance cover under an association is an effective way of managing the risks of an enterprise such as strategic, financial, technological, human, operational, and market risks. The article also considers the ability of the business to evade possible interruption as an incentive for purchasing insurance under the umbrella of an association. Li and Wang (2015) also heightened the need for business interruption (BI) insurance for the guaranteed success of the business. In the article, association insurance plays a pivotal role in covering businesses against possible interruptions. Small businesses may encounter possible shutdown due to fire that may disrupt normal operations. The case is different with large companies that may experience shutdowns when its raw materials undergo a shut-off or the shutting down of a components supplier. Business interruption has devastating effects on the operation of the business when the cause such as fire destroys computers that are central in the production of the firm’s products. In essence, the destruction of computers yields devastating business interruption losses to the business. Out of ten companies that suffer business interruption losses after encountering a major loss of their computers, only one is able to survive the devastating business interruption losses. Nolan’s article considers business interruption (BI) insurance to be pertinent towards guaranteeing the recovery of the business from losses caused by business interruption. In the event that the risk insured against occurs, say fire, the insurer would compensate the company regardless of its size if the company had purchased the insurance cover for the specific risk. However, large firms, due to economies of scale, can purchase BI insurance comfortably. The situation is different for small and medium-sized firms that find it exceedingly difficult to cover themselves against such risks on an individual basis. This leaves SMEs with the sole option of purchasing insurance cover against BI risks under an umbrella of an association to take advantage of the cover offered at significantly lower premiums. Before purchasing insurance protection under an association, it is imperative for small or medium-sized business to identify an inventory of the potential risks that may interrupt its business. In dealing with new insurance cover for the small businessperson, Nolan’s article also includes a detailed analysis of qualifying for the coverage. On the part of large firms, analyzing the BI risk would entail gathering resources from insurance buyers, risk managers, planning and marketing professionals, accountants, operating managers and engineers, lawyers, and transportation experts. An insurance broker would then orchestrate the entire process. However, the process is different in the case of association insurance. Purchasing association insurance starts with the decision of the insurance committee to engage outside experts that would be responsible for establishing compliance standards as well as conducting risk study. According to Marsh & McLennan, the processes include developing flow diagrams for materials within the firm, identifying production bottlenecks, identifying worst-case loss scenarios based on sabotage, breakdown of machinery, natural hazards, explosion, and fire among others. The other processes include determining the lead-time required to replace or repair critical equipment, analyze other operating plans that minimize financial loss, determine costs associated with property replacement, and calculate the income contribution reduction to fixed costs and profits. Nolan’s article also discusses the spin-off dilemma where some SMEs do not receive full benefits from the mass buying power of associations following their decision to take insurance cover under the umbrella of an association. The article cites the example of the computer manufacturing industry that contains many small owner-operators. At the onset, the small owners were either scientists or highly sophisticated engineers with major firms. The article reveals that small operators in the industry present new exposures that ought to be covered by insurance companies. As a result, the difficulty associated with insuring small operators under association insurance emanated from the fact that it was difficult to determine the real liability exposures and the available coverages. The difficulty associated with the identification of liability exposures for small operators in the computer manufacturing industry emanated from the fact that the analysts attempted to tread the traditional path in the electronics sector that requires the adoption of a non-traditional option. One of the challenges associated with insuring small operators in the computer-manufacturing sector is the lack of information on social insurance and wage arrangements (ILO, 2014). Such information is mandatory in providing association insurance for such operators. Besides the challenges noted in the ILO report, Nolan’s article identifies other challenges that impeded the provision of insurance coverage to small operators in the electronics sector. These include addressing issues associated with taxes, identifying measures to protect intellectual property rights in databases and software programs, the management of suppliers’ liability exposures, and the identification of ways to finance the development of software programs. The lack of substantial amounts of pertinent information for lawyers and underwriters about the electronics sector has made it difficult for insurers to insure small operators in the industry under association insurance. In the article, Meltzer notes the essence of introducing the legal aspects associated with the computer-manufacturing sector to the insurance sector to enable underwriters to fashion proper insurance packages that suit the industry. In essence, the legal sector should create awareness about the legal liabilities associated with the industry to the operators as well as insurers to enable the effective tailoring of insurance packages. In essence, the article advises the businessperson to seek insurance programs that cover insureds that make an effort of preventing losses from occurring before their actual occurrence. In the quest to prevent the occurrence of risks in the workplace, SMEs should devise means that improve workplace safety. Part Two: Risk Management for SMEs in the UAE Risks Affecting SMEs in the UAE As mentioned in the first section, SMEs should manage risks affecting their business to reduce their chance of occurring before convincing insurers to protect them against such risks. Five major risks affect small and medium-sized firms in the UAE. High competition suffices to be one of the risks. Approximately 33% of SMEs in the UAE consider high competition as a threat to their continued survival in the marketplace. Poor consumer demand is the other main risk that affects 20% of SMEs in the country. Thirdly, 16% of small and medium-sized firms in the UAE consider legal and fiscal problems to pose significant risks to their businesses. The health and safety of the employee and customer suffice to be the other risk that affects 14% of SMEs in the UAE. Placing a lid on the first five major risks that affect small and medium-sized businesses in the UAE is reputation damage that affects 13% of SMEs in the country (Emirates 24/7, 2014). Having identified the major risks that pose a substantial threat to the guaranteed survival of SMEs in the country, there is a need for firms to implement effective risk management strategies to classify them as “insurable”. Apparently, insurers tend to refrain from insuring firms against risks that present a high probability of occurring in the workplace. The fact that a significant proportion of SMEs in the UAE tend to overlook key risks that threaten the continued existence of their business implies the need for the adoption of risk mitigation strategies by the small business operators in the quest to purchase insurance cover under the umbrella of association insurance. Supply chain disruptions and other risks such as fire that may interrupt the normal operations of the business are some of the risks that firms in the UAE overlook thereby rendering themselves uninsurable. Risk Management in SMEs The fact that a small work environment characterizes SMEs implies that each activity has a direct influence on all other activities in the workplace. As a result, managing an issue should go hand in hand with the other operational issues within the business (Duong, 2013). Rather than being an individual program as it is the case in large organizations, risk management in a small and medium-sized firm should be an integrated program. Most importantly, firms in the UAE should integrate risk management with the entire management processes of the firm such as human resource management, customer relationship management, financial management, and business strategy planning. The operators or owners of SMEs in the UAE should be responsible for the risk-related decisions in the workplace. The scope of the business and the complexity of the operational processes of the firm should determine the extent of risk management efforts implemented in the workplace. On the part of non-employing businesses, the human resources risk encountered by such businesses is not comparable to the human resources risk encountered by small and medium-sized businesses having more than five employees. Regardless of the scope of the business, all SMEs should consider risk management as a pertinent aspect of their businesses. Towards achieving the same, firms should commence with risk planning as the first step associated with risk management. Risk planning entails measuring the efforts required to implement the risk management project in the business (Duong, 2013). The planning phase also includes an assessment plan of the schedule and control activities in advance. Since risk planning is one of the stages in general risk management, it enables the operators of the business to discern whether the risk management benefits exceed the input. Risk Identification Risk identification succeeds the risk planning stage. Operators of small and medium-sized firms in the UAE should consider risk identification as an ultimate stage because of its prime contribution towards determining the outcome of the project. The effective implementation of the risk identification phase requires the operators and entrepreneurs of SMEs in the UAE to have an open vision and mindset towards reviewing the possible scenarios that could have an impact on the objectives of the business. Screening the project life cycle phases is a proper way of listing the potential risks that could affect the operational activities of the business (Duong, 2013). The operators should understand the how, when, where, and why aspects of the risks that could occur. The operators should also list the specific risks that have an association with each of the priorities of the business. Moreover, the entrepreneurs should also identify the specific risks that are impediments to the achievement of the priorities of their businesses (Verbano & Venturini, 2013). Finally, the operators should identify all stakeholders such as contractors and suppliers in the business operations. It is evident that the risk identification process yields potential accidental events that could happen in the workplace. The correlation of different damage classes and risks to local areas necessitates the use of a risk register. The other tools include the Failure Mode and Effect Analysis (FMEA), event-tree logic diagrams, and Hazard and Operability (HAZOP) studies (Duong, 2013). Risk Analysis Risk analysis succeeds the risk identification process. It entails considering the risk’s source and the likelihood and consequence to estimate the unprotected risk without the necessary controls. Rather than identifying the controls, risk analysis also entails estimating the effectiveness of the identified controls and the level of risk that occurs with the controls in place (Berg, 2010). Concerning the specific risk in question, business operators can use quantitative, semi-quantitative, or qualitative techniques in analyzing the risks. Risk screening necessitates the use of semi-quantitative and qualitative techniques. On the other hand, business operators can use quantitative techniques to screen higher risks. Examples of the tools that business operators could use to analyze risks include risk matrices, risk graphs, and hazard matrices. However, the risk matrix is the widely used tool. Using the risk matrix, the business operator should determine the consequence of the occurrence of a particular event with reference to the already provided consequence criteria (Berg, 2010). The risk matrix also contains the likelihood criteria that enable the operator to determine the probability of the risk to occur. Most importantly, the entrepreneurs should undertake the assessment having put into consideration current controls. The risk level in the risk matrix enables the business operators to link the risks to a specific level. Complex risks such as the risk associated with a large procurement require the use of more sophisticated methodologies. Risk Evaluation In the implementation of effective risk management, owners of SMEs should also undertake the risk evaluation phase after conducting the risk analysis. Risk evaluation entails comparing the analyzed risks with the already documented risk criteria. The risk matrix contains an already documented tolerable risk (Berg, 2010). In the event that the business operator detects that the tolerable risk is less than the identified risk, the operator should understand that there exists the need for additional control measures for the risk in question. Additional control measures may require improving the already existing control measures. Under the risk evaluation stage, the manager or entrepreneur of the business should ascertain that all risks fall within the acceptable range (Berg, 2010). The characteristics of acceptable risks include the significant low risk that would render its treatment non cost-effective, a risk that does not have an available treatment such as the change of government, and a risk that attracts a sufficient opportunity that outweighs the anticipated level of threat. In the event that the manager finds out that the level of the risk is acceptable, there would be no need for further treatment or improvement of control measures to mitigate the risk. However, managers should monitor acceptable risks on a continuous basis to ascertain that they maintain the acceptable status. Risk Treatment Having completed the risk evaluation stage, managers should move on to the risk treatment phase. Risk treatment only applies to unacceptable risks (Berg, 2010). While implementing the phase, managers should ensure that they use cost-effective measures. The outcomes of the different risk treatment options include avoiding the risk, mitigating the risk, risk sharing, and risk acceptance. In risk avoidance, managers can decide to ignore activities that could lead to the occurrence of the risk. Risk reduction entails controlling the probability of the risk to occur. Besides controlling the likelihood, risk reduction could also imply regulating the impact of the consequence of the risk following its occurrence. Risk transfer either occurs in part or total. Managers can decide to either share the risk with another party such as a partnership venture or insurance or shift the responsibility to a different party totally. Risk Monitoring Bearing in mind the dynamic risk concept, managers of SMEs in the UAE should conduct formal and periodic reviews on both unacceptable and acceptable risks (Berg, 2010). Managers should also monitor the currency of such risks on a regular basis. This also includes monitoring new risks and their possible effect on the firm. In the phase, managers should describe the measurement of the treatment outcomes. They should also identify the success benchmarks or milestones. Managers should ensure that they conduct a comprehensive review after every five years of operation. The objective of the review is to validate the risk management process and the associated documentation. The review should also take into account the industry practices and the regulatory environment that could have undergone significant changes during the period. Managers should also cover the business, effectiveness, and competencies of the safety management system. The other important aspect entails the need for managers to analyze risk interactions. Communication and Reporting This is the last stage of the risk management process. Managers should communicate the goals, risk management process, and all its associated aspects, including the recommended actions and findings. Insurers capitalize on the risk management-reporting framework to understand whether the firm has implemented necessary measures to mitigate itself against potential risks or not. As a result, managers should prepare a risk management handbook that details the fundamental policy, risk categories, risk management process, and risk organization. Documentation of the risk management elements for reporting purposes communicates to the reader that the risk management process is auditable, conducted correctly, besides having properly identified methods and scope (Berg, 2010). Apparently, SMEs in the UAE should attach increasing significance to the risk management process to render them insurable. References Berg, H. P. (2010). Risk management: procedures, methods and experiences. Risk Management, 1(17), 79-95. Duong, L. (2013). Effective Risk Management Strategies for Small-Medium Enterprises and Micro Companies: A case study for Viope Solutions Ltd. Emirates 24/7. (2014). Majority of UAE SMEs overlook key risks to business. Retrieved from: http://www.emirates247.com/business/economy-finance/majority-of-uae-smes-overlook-key-risks-to-business-2014-11-30-1.571781 Falkner, E. M., & Hiebl, M. R. (2015). Risk management in SMEs: a systematic review of available evidence. The Journal of Risk Finance, 16(2), 122-144. International Labor Organization (ILO). (2014). Ups and downs in the electronics industry: Fluctuating production and the use of temporary and other forms of employment. Terungwa, A. (2012). Risk management and insurance of small and medium scale enterprises (SMEs) in Nigeria. International Journal of Finance and Accounting, 1(1), 8-17. Verbano, C., & Venturini, K. (2013). Managing risks in SMEs: A literature review and research agenda. Journal of technology management & innovation, 8(3), 186-197. Read More