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Corporate Risk and General Insurance: Prof.

Sojung Park Aaron Tal

Honeywell, Inc. and Integrated Risk Management (Harvard Case)


The Case deals with Honeywell's considerations in the process of changing its risk management program from a practice which manages each risk separately, to an enterprise risk management system. The integration of such a system seemed to promise a decrease in total risk and lower cost of capital, benefiting from the portfolio effect. The treasury team of Honeywell began an extensive evaluation of current program design, examining whether Honeywells existing strategy was consistent with its risk management objectives. After examining the firms existing financial practices Honeywells managers determined that Honeywell lacked a set of strategies that identified what their actual objectives are. The current risk management within Honeywells Treasury group encompassed a dispersed group of risk management units, all being responsible for different kind of risks with different loss characteristics. Honeywells risk management had active hedging or insuring of risk only occurring for financial and traditionally-insured risks. Furthermore, every risk management unit were managed using different risk management methods and instruments. The managers concluded that change was needed in order to support the firms operational goals.They figured out that applying the concept of enterprise risk management they would be able to benefit from the portfolio effeet by reducing the total risk exposure and thereby a cheaper cost of capital. However, organizational barriers involved in developing such a program were daunting. First, in the traditional risk management approach that Honeywell currently operated the management risk units used different instruments and methods to assess risks, which made it hard to combine them. Second, the insurance-based risk management area historically had little to do with the derivatives-based currency risk management team. The third challenge Honeywells managers faced, was to find the optimal risk management structure, in terms of the appropriate retention and insurance coverage levels, and adapting the insurance program to incorporate foreign-currency translation risk. The Integrated Risk Management Program was a multiyear insurance-based strategy that covered all traditionally insured global risks and currency translation risk in a single master insurance policy. The integrated risk management plan had the tentative support of Honeywells CEO, conditional on the Finance Committees in-depth evaluation of the Treasury teams proposal. However, due to the novelty of such an integrated risk management concept several questions, regarding the effectiveness and efficiency, needed to be addressed in order to decide whether or not to fully apply the new complex
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Corporate Risk and General Insurance: Prof. Sojung Park Aaron Tal
program.

Appendix:
Honeywells Treasury Risk Management Units: 1. Capital markets unit a. Capital structure risks (liquidity risk) 2. Cash management unit 3. Financial risk management unit a. Currency risk, interest rate risk, credit risk 4. Insurance risk management unit a. Risks traditionally covered by insurance (pure risks) b. General liability, property, product liability, automobile liability, employer liability, ocean marine transit and workers compensation risk Honeywells' Insurance Policies: Honeywell used separated annually renewable insurance policies for each type of insurable risk. Each policy had specified deductibles in an amount that ranged between zero and $6 million. Honeywell would absorb any losses up to the retention level before it received any insurance payments for a loss (attaching). Each loss was subject to a separate retention. Transaction risk: (contractual risk): is the specific exposure faced by a firm when it enter into a contract with a future payoff. In the context of foreign operations the future payment can be subject to exchange-rate risk. To mitigate this risk, a firm can can take a long position in the currency of the contract. Honeywell used such a strategy to manage transaction risk. Translation risk: It refers to the difference in reported earnings that can occur when a domestic firm translates its earnings denominated in foreign currency back into its domestic currency. It might to do for reporting purposes ( international financial statements ). The reporting-based translation from foreign currency into domestic currency may or may not represent repatriation or actual exchanges. In order to hedge such exchange-rate exposures Honeywell used at-the-money options as well as basket-options consisting of 20 currencies, representing 85% of Honeywells foreign profits.

By Aaron Tal

Corporate Risk and General Insurance: Prof. Sojung Park Aaron Tal