For Your Consideration

It is being reported that what is being billed as “Wall Street Reform” is likely to be passed in Senate and will be sent to the President’s desk for signature. Tucked in this 1600 page bill is Title V, relating to the federal regulation of insurance, constituting pages 384-421.

Today I share a review of Title V, Subtitle A, “Office of National Insurance” with very little in the way of personal commentary, except to say that I am ashamed of how little coverage of the substance of this law has received in the press/media, including no real critical analysis in the insurance and risk management journals. This review is not by any means comprehensive, but a general guide to the law’s provisions. If time permits, I will review the other subtitle/sections of Title V.

Initially, this law creates the “Office of National Insurance”, which, as part of the Department of Treasury, shall have the authority to “monitor all aspects of insurance… that could contribute to as systemic crisis in the insurance industry or the United States financial system”. This is essentially a “blank check”, as many aspects of the insurance industry could conceivably “contribute” to a systemic crises, as evidenced by what occurred at AIG.

The ONI will be tasked with coordinating “Federal efforts and develop Federal policy on…international insurance matters”, determining “whether State insurance measures are preempted by International Insurance Agreements”, and consulting “with the States… regarding insurance matters of national importance”.

ONI’s scope of authority extends “to all lines of insurance” except health and crop insurance and specifically authorizes reception and collection of “data and information on and from the insurance industry and insurers”, but does not specify what specific data shall be collected. For those interested in the notion of privacy, this is a huge unknown.

It grants the federal government the right to preempt state insurance measures if it determines (in its sole capacity) if the measure “results in less favorable treatment of a non-United States insurer domiciled in a foreign jurisdiction that is subject to an international insurance agreement… and… is inconsistent with an International Insurance Agreement on Prudential Measures”.

According to attorneys Francine L. Semaya and William K. Broudy from the law firm Nelson Levine de Luca & Horst, the main purpose of this provision is to “give the federal government, acting through agreements with other nations, the sole authority to regulate international insurance matters.”

But what is an “International Insurance Agreement on Prudential Measures” exactly? According to law’s text, this is “a written bilateral or multilateral agreement entered into between the United States and a foreign government, authority or regulatory entity regarding prudential measures applicable to the business of insurance or reinsurance”. This begs the question: what constitutes “prudential measures”? That is currently unknown and undefined. It further strictly forbids a state from enforcing “a State insurance measure to the extent that such measure has been preempted…”

But this is only the proverbial tip of the iceberg as the law specifically requires a study on “how to modernize and improve the system of insurance regulation” shall be submitted to Congress for review within 18 months of enactment. This report must specifically address “the degree of national uniformity of state insurance regulation”, the “regulation of insurance companies and affiliates on a consolidated basis”, the “international coordination of insurance regulation” and shall examine the feasibility of regulating “certain lines of insurance at the Federal level” and the “potential consequences of subjecting insurance companies to a Federal resolution authority”.

Despite apparent insurance industry approval, what should be abundantly clear is that the door to federal and international oversight of the domestic insurance industry has been opened. Insurers and state regulators should be so advised and not surprised when their autonomy is eventually usurped.

Some time back, I was hopeful  that we could see an inadvertent renaissance in self-employment, as firms were reluctant to bring on full-time employees in the the current business environment we now call the “new normal“. Well, as hopeful as that post was, it may not come to pass if certain members of Congress have their way.

In January, Financial Advisor Magazine warned that “Rep. Jim McDermott (D-Wash) introduced legislation that would eliminate Section 530 of the Revenue Act of 1978, the so-called safe harbor provision that lets employers classify workers as independent contractors rather than employees as long as they meet specific criteria” and that Sen. John Kerry (D-Mass) introduced his version that “aims to kill Section 530, or at least make it more difficult and costly for businesses to incorrectly classify employees as independent contractors.”

More recently, Daniel J. Aguilar of Morrison & Foerster commented that the President’s proposed 2011 fiscal year federal budget includes a $25 million “Misclassification Initiative” for the U.S. Department of Labor, intended to target employers who (intentionally or unintentionally) misclassify workers. To accomplish this, the DOL plans to hire more than 350 new employees, including 177 investigators and other enforcement staff.

Mr. Aguilar also advises that the IRS is launching its National Research Project (“NRP”), which requires the audit of approximately 6,000 employers over the next three years. It’s goal is to “examine and compile trending information” in five categories (worker classification, fringe benefits, payroll taxes, expense reimbursements, and other related payroll issues) and “will require comprehensive audits” in an effort to close an estimated $15 billion employment tax gap.

Folks, this issue is a prime example of where regulatory, employment and legal risks intersect and one that is of prime importance to small business.

Due to the uncertainty this new proposal (amongst many other new government proposals) adds to the equation, businesses will continue to “hunker down“, depressing employment and economic activity in the process, as they attempt to ride out the storm. And while there will always be pockets of the economy where the sky is clear, structural debt stresses in the U.S. and global economies not only remain, but intensify.

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In the end, however, I don’t think the heavy-handed approach will ultimately prevail, despite the best effort.

For every law that is created or “reform” enacted, there are hundreds of millions of people (some with very smart and talented attorneys) that will utilize their God-given talents to “game” the new system. And the more bone-headed and misguided the law, the more genius the response tends to be.

And it’s only a matter of time before we witness the miracle that is American ingenuity again.

…to the show that never ends. As many of you have noted, I took a serious hiatus from posting. During my time away, I did a lot of writing, but was thoroughly unhappy with the results.  I’ve missed you, though and so, I am compelled to return to share a few more nuggets of joy while I still can.

Instead of taking this opportunity to discuss the ever-apparent “employer’s revolt” where “less bad” is not better or that cheap money is sowing the seeds of the next economic crisis or discussing the increasing (yes, increasing) global meltdown risk (irrespective of the results of the upcoming so-called “Wall Street reform” vote),

or even the new health care responsibilities “entrusted” to the I.R.S.,I really just wanted to share with you a quote from Abraham Lincoln from his address at Sanitary Fair, Baltimore, Maryland on April 18, 1864:

“We can not fail to note that the world moves… We all declare for liberty; but in using the same word we do not all mean the same thing. With some the word liberty may mean for each man to do as he pleases with himself, and the product of his labor; while with others, the same word may mean for some men to do as they please with other men, and the product of other men’s labor. Here are two, not only different, but incompatible things, called by the same name - liberty. And it follows that each of the things is, by the respective parties, called by two different and incompatible names - liberty and tyranny.”

It is sad state of affairs that many feel the only winning move is not to play and that “going Galt” (where one refuses to lend one’s genius to the world) is logically perceived as the most rational course of action. And while Publilius Syrus’ (a first century B.C. Syrian slave) maxim “Bonis nocet quisquis malis pepercit- Whoever spares the bad, injures the good” is currently out of vogue, its return will very likely be at once stunning, vicious and unexpected.

We can only be kept in cages we cannot see.

Once the bad are no longer spared, and a rational risk/reward equilibrium restored, Publilius Syrus will smile and we will all come to know (or remember) who John Galt really is.

Should national health care be a reality soon, we will see the most important (R)evolution in a generation rapidly unfold before our very eyes: the EXTINCTION of the corporate employee and the EMERGENCE of the independent contractor. I’m sure this is not what the President and Congress have in mind of course, but while a free-market exists for human capital, it is this end that strikes me as most plausible.

Which ever version of health care scenarios wins out in the end is not at all relevant. In the end, they all rely upon workers to be classified as “employees” in order for this thing to “work”. Whether the new national health care “premium” comes in the form of new taxes, surcharges, fees or penalties, no business will stand blithely by and be gutted by legislation. Accordingly, an interesting question comes to light: what happens when the business employs a relatively few number of “employees” and contracts their work out to independent contractors?

Everyone (including the IRS) has a slightly different definition of what makes a person an independent contractor versus an employee. They all converge around the same issue, that one being the issue of control. Who controls the work product? Who controls where the work will be performed? Who control when the work will be performed? Who provides the tools in order to process the work?  Does the “independent contractor” have their own telephone number? Their own insurance? Do they invoice regularly or are they paid weekly? Is there an “arms-length” business transaction between the parties?

I think you get the point.

Ultimately, if the business assumes too much control over the worker, the worker shall be determined to be an employee…. Which is exactly why those companies that can structure their business processes to take advantage of true independent contractors in many aspects of their operation shall have a competitive advantage in the coming years. Now this may sound all horrible for the prior “employee”, now newly-minted “independent contractor” but it really isn’t: not when you stop and consider that EVERY business is in essence an independent contractor to its own customers. And surprisingly but naturally, it is this “Employee Extinction (R)evolution” © which may save our economy in the coming years, as people become their own “brands” and compete against each other in the economy for work.

Think of what this kind of (R)evolution could do to all levels of local, state and federal government! And what it could quite easily do to unions…

The progressive fascination with tinkering with 17% of our national economy will have its consequences. Some can be foreseen and some cannot. Here’s one possible consequence which future generations may hail as our President’s greatest unintended accomplishment.

The stack of stuff I want to share seems to be growing by the day… too much stuff and not enough time! So instead of writing fewer/longer pieces, here are a few succinct words of advice/counsel on each subject in one “omnibus” post. Hopefully, you’ll find a “nugget of joy” that’s of use to you and I can start to cut through my growing stack of stuff. So, let’s get to it…

1. Putting money in bank CD’s may seem like the safest choice today, but it might not be. You’ll be told that these things are “riskless”. They’re not. The one primary risk they don’t tell you about and that you retain (and it’s a biggie!) is inflation risk. Very simply. when the inflation rate is higher than the CD’s APR, you’re losing money. Historically, the one asset class which has a real return ABOVE inflation is equities. With stocks “on sale” at about 40% off, you might consider “buying low” today if you have the time to wait until the market recovers. I suspect that 10 years from now, you’ll wish you put every dollar you had in now.

2. Every personal insurance policy should be reviewed annually to make sure it still meets your needs. Take some time to do it. You might find that coverages can be eliminated, deductibles can be increased, insurers can be changed, etc. to reduce your insurance cost.

3. Every small-business owner should review their insurance program annually as well. If your business operates on a 10% operating margin and you save $10,000 in premium, the savings was not just $10,000- The real savings is $100,000 in gross sales you didn’t have to make just to pay the insurance premium.

4. The “annuity vultures” are out in full force. They usually take the form of “investment advisors” working for insurance agencies and especially prevalent in poor economic times, such as today. They prey on your fears that you’ll run out of money before you die which they cryptically call “longevity risk”. There’s 3 main reasons you should shun: 1. These are extremely complex insurance contracts. Most come with a 200-300 page prospectus. Unless you read and understand all those terms and conditions, be ready to get hurt. 2. Annuities are guaranteed by the issuing insurer- want to make any bets on which insurer(s) are going to survive? 3. COSTS. Depending on the insurer and the particular product being promoted du jour, the underlying costs of the annuity are outrageously high. Remember, the agent needs to be compensated for selling you this complex contract. You’re the one paying the freight.

5. If you have a private disability (DI) policy, look to increase your “elimination period” (which is a essentially a deductible measured in time, not dollars) to decrease your cost. I recently changed the elimination period on one of my DI policies from 30 days to 90 days. When the policy was originally written, I could barely afford to be without an income for 30 days. Blessedly today things are a little bit different. I saved over 25% in making this one change.

6. Our preconcieved notions and the media shape perceptions of risk. Do you really think that Congress knows how to “fix” the economy? Do you really have faith in their stewardship? Should we allow government to grow or would you prefer that industrious, entreprenurial Americans be tasked with our economic recovery?

7. Turn off CNBC. Stock market-timers have to be right not only once, but twice. Even Warren Buffett can’t do it. The stock market-timers “Hall of Fame” is an empty room.

8. Remember, it’s all relative. All assets are being repriced. Globally. There’s no place to hide. Forget U.S. Treasuries with their 0.01% interest rate. Invest in your own education. You want security? Look in the mirror. It’s the only place in this world that you’ll find it.

9. Worry only about the things you can DIRECTLY control. Everything else will take care of itself and you’ll save yourself a lot of heartache.

10. Continue to fund your 401k. If enough people opt-out, these tax deferred programs will go away and that’s not a good thing.

11. If you’re in business (or work for one), don’t forget to advertise and market the goods and services you provide. Your competitors aren’t and it’s a great time to steal market-share from them.

12. You may have noticed the increase in advertising by gold sellers, I know I have. Before buying, understand that gold has a ZERO expected rate of return, as it produces NOTHING. Gold has no intrinsic value, only the value we ascribe to it. You’re also going to need to buy A LOT of it to make it “worthwhile”. Where you gonna put it all?

13. Taking medications (legal ones, that is)? Want to try to save some dough? Live in NJ? Try www.njdrugprices.nj.gov for an online prescription drug registry. Prices for a one month supply can vary widely, even within the same zip code. It works surprisingly well.

14. According to John Montgomery, Founder and Portfolio Manager of Bridgeway Funds, there have been nine bear markets since 1940. The average time for the stock market to “recover” to its previous high is 13 months (excluding this current bear market). 13 Months- a little over 1 year. Of course, this time may be different but know that historically speaking, if you can keep your head when everyone has lost their’s, you’ll be well-rewarded.

15. THIS IS NOT THE GREAT DEPRESSION, PART TWO. We do not have 25% unemployment and the only thing we stand on lines for are HDTVs, not bread! Don’t “buy” the doom and gloom the media is “selling”. It’s all meant to manipulate.

Go live your life. Smile and be grateful.

OK, as of today, the Fed has said to Lehman, “NO SOUP FOR YOU!“, and they are now at the mercy of a bankruptcy court. Merrill Lynch ceases to exist as an independent investment bank and will be swallowed up by Bank of America.

Now, we are witnessing the potential of the bankruptcy of AIG, American International Group. This potential collapse is so breathtakingly overwhelming it is difficult to find the words to express its impact.

As of the moment of this writing, the Fed is trying to help orchestrate a $100 BILLION DOLLAR “bridge” loan package to give AIG time to sell assets to stave off bankruptcy and it is EXACTLY this moment that we come to understand the magnitude and utter failure of AIG management who should not have allowed things to escalate to this point. I think in the future there will be entire business management classes and curricula devoted to the study of events surrounding this epic failure.

But the talking heads are missing the point. It doesn’t matter if/how financing for AIG gets arranged today or tomorrow, the damage is done. Credit analysts in the bond markets have marked AIG’s bonds to junk status and the rating agencies have put AIG on “credit watch negative”, which is a precursor to severe ratings downgrades. In essence, perception is reality and many smart people do not expect AIG to survive as it exists today.

But the biggest problem doesn’t rear its ugly head until January 1, 2009 when AIG’s reinsurance treaties expire. Reinsurance is essentially insurance for insurance companies. If the company cannot negotiate renewal of its reinsurance treaties, it  cannot survive as an insurer and will be forced to terminate all in-force policies, citing loss of reinsurance. This is the insurmountable issue as I see it today.  The question of the day is: What reinsurance companies will be willing to “belly up to the bar” for AIG?

Prudence dictates that individuals AND businesses review their exposure to AIG. This is not just an academic exercise. I would urge a review of insurance policies in force as soon as practicable. For individuals that may mean annuities provided by American General, life insurance policies and/or auto policies with 21st Century or AIGDirect. These matters and questions should be reviewed and discussed with your agent. For corporate risk managers or financial controllers: I would direct your insurance broker(s) to provide an assessment of exposure and immediately begin the remarketing of coverage in the event the unthinkable occurs.

That being said, there probably is only ONE person alive who has the gravitas with regulators, capital markets, and reinsurers to “right” the AIG ship: the deposed ex-Chairman of AIG, Maurice “Hank” Greenberg. I believe that only his direct stewardship will assuage these parties. Let’s see if the AIG board has the brass b@lls to bring him back.  Of course, that exposes another long term personnel risk management issue for AIG: life after Hank. But that is an issue for another day. Today is the day AIG needs its Chairman back.

These are truly momentous times. I, for one, will keep my eyes on January 1, 2009 and hope for best (but plan for the worst).

Quick Update as of 4:45PM EST: It appears that Mr. Greenberg has been rebuffed by AIG management (video in link). In this interview today, Mr. Greenberg (who was ousted from AIG over 3 years ago) was asked what “went wrong” and from his perspective, “what happened?”

Mr. Greenberg replied, “I think several things. I think risk management controls either disappeared or were weakened. There wasn’t attention being paid to the accumulation of risk. I felt there was a determination to grow without the right controls in the financial sector of the business. Many things went wrong.”

Today, the New York Post ran a story that simply mystified me. It was entitled, “Samaritan Trucker Fired” and tells the story of a man named John Acheson who was fired from his job at Sid Wainer and Son  a Massachusetts based specialty food purveyor, for essentially being a good samaritan.

According to the news report:

1. On August 4, Mr. Acheson witnessed a fatal shooting and was delayed after assisting the NYPD in tracking down four suspects in the shooting; and

2. On August 19, Mr. Acheson witnessed a woman strike a livery driver with a hammer and flee. He called 911, chased the woman into an alley and assisted police in arresting her.

3. On August 20, Mr. Acheson was fired from Sid Wainer and Son. His boss (who is unidentified in the story) is quoted as saying, “John, I gotta let you go. You don’t know how to mind your own business”

Simply astonishing.

I’m not sure the founder, Sid Wainer, would’ve approved of Mr. Acheson’s firing. According to the company website, Sid Wainer’s “code of ethics, his strength of character and his resolve to be a positive influence on all those around him” were ideas and concepts Sid Wainer taught his son and current President, Dr. Henry Wainer.

I’m not beating up on Sid Wainer and Son the company, I just think they missed a heck of a marketing and publicity opportunity by not parading the courage of one of their own in the media. They also missed a great human resources potentiality. In an industry where it is difficult to find quality help (truck drivers), Mr. Acheson could’ve become a symbol of “the type of quality employees the company hires”, and used that good-will to attract more and new employees.

Listen, any company that has it’s roots in the depression-era (it opened in 1914) that survives today has my awe and well-wishes, but unless there’s something to Mr. Acheson’s story as reported that we don’t know, they blew it on this one.

That being said, I believe Mr. Acheson has the opportunity to parlay this unfortunate situation into something better for himself. It is obvious that he is special in some way. Perhaps these incidents were cosmic tests of some sort. Perhaps he should consider driving for a paramedical organization or a hospital. This would fulfill his obvious need to assist others in distress and plays to his vocational skillset. Perhaps in doing so, if he has the smarts for it, it will lead him to a career in medicine, or as an EMT.

It is obvious to me that Mr. Acheson is meant for something more. I hope he realizes it too.

To borrow from Nancy Sinatra (of “These boots were made for walking” fame), “These times were made for new business startups!” It’s absolutely true: Ironically, times of economic slowdown are some of the best times for starting up a new business. I know it sounds counter-intuitive, but let me make my case with the following “big-picture” points:

• 1. Competitors are generally weakened
• 2. Employee supply pool is large (and scared)
• 3. Vendor payment terms are much more flexible
• 4. Office lease/rental costs far lower than average
• 5. Many initial startup expenses can be had on the cheap

If we accept the premise that business and economies have predictable cycles, then the above should be “obvious”. Right now, our economy and businesses in general are in “contraction mode” and we are struggling through a very difficult time of burning off the excesses that were “built up” over the last 6-7 years. Despite what you hear in the media, it’s not only normal, but a good thing for us all. This process thins out weakened competitors and strengthens those companies that are and have been managed well. It positions our economy for the next cycle of expansion, which brings us the goods and services we want and need at competitive price points.

Which brings me to point number one above. New businesses can take advantage of weaker competitors and those that are ill positioned for growth going forward in the near-term. They do not suffer from excess “weight”, baggage or balance sheet deterioration. They are nimble and can act fast and react smartly to the current economic reality. They do not fear losing market share.

Point number two: Wow, are people scared about their future, their jobs, etc. I think it would be more fascinating to explore what people *weren’t* afraid of! This mindset can be advantageously by the new business owner. Those owners that can foster a sense of security for their employees will have fruits of their efforts returned several fold over time. Right now, not only is talent easier to find, but it costs less. A win/win for the business owner.

Point number three: Vendors of all types (all other businesses that are not your direct competitors) are weakened by a one-two punch of loss of quality business and bad debt write-downs. Those new businesses that can establish a good working relationship with their vendors quickly will reap the rewards long term. Remember, good “terms” from your vendors are not necessarily just financial, they can (and should) be on the service side as well. A vendor may well pay better attention to a new business relationship where future growth potential lies than a long-standing one that is stagnant.

Point number four: Office space is *cheap* and a properly constructed lease can be written to provide the new business with not only a very low initial rental cost (relative to a few years ago), but can (and should) take into consideration at least a five year rental plan. I personally prefer a one year lease with 4 successive one-year renewal options, for a total of 5 years. This way you are locking in a lease cost lower than market average rates, but not locking yourself into the space should it no longer meet your needs. Oh, and one more thing: no personal guarantees! If the landlord insists on a personal guarantee, find other space.

Point number five: I love a good bargain. I can’t remember a time when so much technology can be purchased for so few dollars. Whether it’s computer equipment, office equipment, office tables, chairs, cabinets, etc., deals can be found as companies liquidate to generate cash. Setting up the infrastructure for your new business will cost you far less today than it would’ve just 2 years ago.

So, anyone got any good ideas on our next new business?

Well, just a flurry of activity today, isn’t it? I’m going to be away on vacation until late April/early May so I wanted to commit a few ideas that I’ve been mulling over lately to the site before I either forget them or get caught up in other things. Some concepts I have “in development” as of today that’ll have to wait for my return:

1. A line item breakdown of variable annuity costs - OUCH!

2. Why stock market timing is a bad (but pervasive) idea;

3. A discussion of “senior” seminars and the art of the “sale” - beware the siren call of the “free” steak dinner!;

4. The allure of fixed index annuities and when they are suitable;

5. Long Term Care Insurance Objections (and rational responses);

6. Within every small business owner lies the soul of risk manager;

7. Moral and ethical obligations of a fiduciary;

8. Legal considerations of the sale of securities by “captive” financial advisors/insurance agents;

9. Exploration of the concept of “Personal” Enterprise Risk Management;

10. How to reduce health insurance premiums through exposure analysis;

11. Matching bond fund durations to meet a 1-5 year financial need;

12. “If investing *isn’t* boring, you’re doing it wrong”; and

13. An exploration of personal risk control techniques.

Just a little “light” reading, huh? Also, if you haven’t already done so, please consider registering your email address (or send me an email at md at marcd.com and I’ll register for you!) so that the site updates will be forwarded automatically to you by email. Consider referring a friend to the site - we need more friends! Thanks again for your support and I’ll see you in about a week.

Small business start-up capital financing is notoriously tricky. Even in the best of economies, banks won’t lend to start-ups without significant collateral. It shouldn’t be surprising then that in the vast majority of cases, a business’ initial capital financing comes from an owner’s personal savings. In fact, I cannot think of one of my businesses that *wasn’t* initially funded primarily by my personal bank account. It’s the ultimate in “putting your money where your mouth is”.

Self-financing of the initial capitalization of a company is a relatively easy (and subsequently dangerous) course. That being said, I find it prudent for a prospective owner to consider self-financing start-up expenses where all other sources are inadequate (either in amount available or in terms offered) or simply unavailable. It forces the owner to carefully consider whether or not to start the business and can save the owner from a financially ruinous affair.

Unfortunately, where I often see “trouble ahead” is when the owner starts using personal assets to cover the on-going monthly operational expenses of the company. Monthly expense items such as payroll, taxes, insurance, rent, etc. need to come from the company’s generated sales and revenues. If there is a consistent monthly shortfall that is being financed by the owner to keep the small business going, warning lights should be flashing!

I know all the rationalizations because I’ve been a victim of them at one time: “Things will get better”. “Next month will be a big month”. “If this business fails, I’m a failure”. Etc.

Here’s what I’ve learned from my own past mistakes: There is something fundamentally “broken” in either the operation or focus of the business if it experiences a consistent monthly income shortfall for 90+ days. The business is in obvious distress and most likely the owner is in denial.

Decisions will have to be made at this point. Line item expenses need to be reviewed objectively in order to reduce or eliminate unnecessary costs. Operations need to be objectively reviewed for redundancies and efficiencies. Income deficiencies need to be objectively addressed to determine the nature and extent of the product or service “saleability”. Indeed, some very difficult activities need to be undertaken to thwart dissolution and ensure survivability.

Keep an open-mind. There is a solution to almost every business problem. Unfortunately, as we all know, sometimes the rational decision is closure, but that should be a last resort only after exhausting all other options.

Being tax time, I’m reminded of a piece of sage advice I’ve acquired along the way that I’ll share with you. At one time many years ago, there was an ice cream parlor in my town called “White Mountain Creamery”. It made some of the best ice cream I ever tasted and was always packed with people. By all outward appearances it was a thriving small business. Until one day, that is, when it closed without warning.

I always wondered what happened behind the scenes. Was it the sudden death of the owner who lacked a buy/sell agreement? Was it a lease renewal negotiation that soured? But if that was the case, why didn’t the business move and reopen at a new location? What would cause a seemingly very successful business to shutter “overnight”?

I came to learn it was simply a matter of too much money going out and not enough money coming in. And it simply doesn’t matter how much you’re earning, whether it’s $30,000 a year or $30,000 a month. It’s not what you make, it’s what you keep.

So remember the lesson of White Mountain Creamery whether you’re evaluating new business opportunities or simply living your life. It’ll never let you down.

Now that we’re conversant with the 3 general types of risk, it’s instructive to understand the basic tenets, or “truths”, of risk management. They may seem simple in concept but you’d be amazed at how many people don’t stop to consider, forget, disregard or plainly ignore them in their daily lives.

• Don’t take on more risk than you can handle (afford to lose);

• Don’t risk a lot for a little gain;

• Consider the odds of the risk you’re taking; and

• Don’t confuse, mistake or substitute insurance for proper risk management and risk control.

Remember that many of the pure risks (risks where there only is a chance of loss) we face in our daily lives are easily handled by insurance. When I consider these tenets, I think back to an experience I had with a trucking company owner who operated a small fleet. During my initial meetings with him and review of his current insurance plan, I noticed that most of the vehicles were being insured for liability only. He explained that as a matter of policy, he took off collision and comprehensive coverages once the loans were paid off and he was no longer required to maintain the insurance coverage.

Seemed reasonable enough, but it’s important to know that many of these trucks (he had about 8 at the time) were still worth in excess of $20,000 *each* and I think we can all agree that a very large financial loss would be suffered should even a *single* truck get totaled in an accident. So, I asked the owner to explain his thought process. He shared that it was his experience that none of his trucks were ever totaled in an accident and he had saved a substantial amount of money in insurance costs throughout the years.

We got to talking more about this. I asked about where the vehicles were kept overnight. He explained that he would back them up into the warehouse dock at night and over the weekend. I asked if he considered what would happen if he woke up one morning to find that the warehouse suffered a fire and 6 of the 8 trucks were destroyed because they were so close to the building itself. He thought about it for a moment…

“I would probably be out of business“, was the response.

The owner never considered that possibility/peril and it changed the whole equation and perception of risk in his mind. Well, I don’t know about you, but I consider going out of business for a peril we can prevent or reduce to be an undesirable and wholly unacceptable outcome.

Premiums on truck collision and comprehensive coverages are *heavily skewed* to the collision portion, meaning the cost of collision coverage was about 4-5 times more expensive than the cost of comprehensive coverage. I explained that for about $300 per year, per truck, we could add on comprehensive coverage only which would cover the vehicles for “just about” every physical peril, including fire- with the exception, of course, of colliding with another object. He said his current insurance broker never had this kind of discussion with him or offered comprehensive separately.

So how does all of this relate to the basic risk management tenets? Clearly, the business owner was unwittingly taking on more risk than he could afford to take and was risking a lot for a little premium savings. He didn’t consider the odds of the risk because he didn’t even *consider* the risk! But once presented, the responsible action was clear.

And no, tenet #4 was not ignored: We discussed moving the trucks away from the building as a loss control measure, but he was concerned about vehicle theft issues and the lighting in the truck-yard was sketchy. Since it was a leased building, there were landlord issues which did not allow him to add more lighting. So, while we didn’t confuse insurance with controlling the risk, we *used* insurance as a risk transfer technique because it was economically reasonable to do so given the circumstances.

The business owner was also happy to learn that comprehensive coverage would also pay in the event one of his trucks was stolen. He said it was always a concern, but one “he lived with”. As you can imagine, his warehouse wasn’t exactly in the best part of town.

It is no small feat to operate a small business successfully today. The risks faced by the business owner seem in many ways more formidable now than every before. Many new entrepreneurs are in some small way naive to the risks they face. And perhaps that’s a good thing, otherwise many new startups simply wouldn’t. No new small business owner *expects* that their business will be a party in litigation, but every seasoned owner knows the truth: it is a *virtual certainty* that the business will be sued. How these risks are managed can and will sometimes be the determiner of corporate survival.

Which leads us to the “Risk of the Day”: E-Discovery.

When litigation commences, depending on the circumstances of the stated complaint, the parties to the lawsuit engage in a process called “discovery”. Basically, this is a form of “You show me yours and I’ll show you mine”. During the process each party is required to provide documentation that it has in its possession to the other side for review. In complex corporate litigation, the documentation to be reviewed can be absolutely voluminous- (I know this from personal experience!). But what happens when the documentation requested doesn’t “exist” in the physical world and is “electronic” evidence?

Some estimates suggest that greater than 90% of all evidence is electronic evidence. To instruct parties in litigation of their responsibilities under the law as it relates to electronic evidence, Federal Rules of Civil Procedure have recently been amended and can be found here if you’re willing (or daring).

E-Mail is an easy example of electronic evidence, but it is far from the only one. I have heard attorneys on both “sides” (whether defending or prosecuting) state that even if one was to print out every email, it might not necessarily be “enough” because your adversary (and the court) might not be convinced that *every* email was in fact printed and that you may have ‘inadvertently” retained certain emails that you think might hurt you. Even if you do not use email with customers (this is why many financial advisors will not utilize email, not to mention it is inherently insecure), attorneys are going to want to review internal emails between staff to get a flavor of the discussions “behind the scenes”.

“Legacy” computer systems is another area of concern. When systems are upgraded, many times “old” data is not imported into the “new” system. And even if some is, it is not uncommon that not all of it is. As litigation can deal with multi-year issues, this can be a particular problem area.

Your head spinning yet?

It’s probably helpful to boil down E-discovery risks into three basic trouble areas. Briefly, they are:

• Documentation Over-Production: Costs of legal review can be enormous if you produce *everything* and more often than not, documents that should not have been produced are now released into the public domain;

• Documentation Under-Production: Court sanctions and fines may be substantial for failure to produce documents that should be produced;

• Spoliation of Evidence: Spoliation is essentially actively destroying or modifying documentation or evidence, but it can also be a failure to avoid a destruction of evidence. So, in this case, the sin can be one of omission or commission.

The best general advice is to discuss e-discovery issues with competent legal counsel well before you *need* to. And, as a brief reminder, I am not an attorney and this post is not (nor is it meant to be) legal advice, but just a general overview and discussion of E-Discovery risks.

It would be instructive to know what “counterparty risk” means since it’s the reason the Federal Reserve decided on the unprecedented act to lend $29 Billion dollars to JPMorgan Chase so that it could buy Bear Stearns. Counterparty Risk is the answer to the question, “Why did the Federal Reserve do this?”. I danced around this topic in a previous post.

OK, so what exactly is counterparty risk?

Let’s set the stage: Two large, competent and experienced organizations enter into an agreement (contract). Let’s say, as an example, Bear Stearns and a major national bank. The bank has no reason to believe that Bear Stearns won’t be able to fulfill its duties under the contract. And Bear Stearns has no reason to believe the bank won’t be able to fulfill its duties under the contract. In this example, so far, both parties are fairly confident in each other’s abilities to “perform” their contractual duties. Now let’s imagine for a moment that Bear Stearns had thousands of such agreements. All based, in part, that Bear Stearns was a financially able organization valued in the marketplace at about $19 Billion dollars. Until one day, it wasn’t.

Very simply, counterparty risk is the risk one party in a contract has that the “other” party in the contract will not be able to fulfill its obligations as outlined in the contract. I have mentioned previously that there is a crisis of confidence present in the markets today. At the core, the problem is that we can’t trust the numbers. A corollary to that is that we can’t trust the companies providing those numbers because it seems that *they* don’t even know the value (or lack of value) of the holdings on their books.

The Federal Reserve had to be concerned that a Bear Stearns failure might intensify the confidence crisis further. I am not alone in thinking this. Meredith Whitney, a bank analyst at Oppenheimer, as reported in the NY Times, had this to say: “The rescue was absolutely all about counterparty risk. If Bear went under, everyone’s solvency was going to be thrown into question. There could have been a systematic run on counterparties in general”. The emphasis is mine.

Remember the stories of the 1920’s depression “runs” on banks? Things are a lot more complex today. Back then we only had to worry about banks. How about a “run” on every financial institution: banks, credit unions, savings and loans, mutual fund firms? Only history will tell if the Federal Reserve made the “right call”, because right now, I’m not so sure.

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UPDATE April 2, 2008: Well, we just heard from the Federal Reserve Chairman himself on the previously unprecedented Bear Stearns bailout plan: “With financial conditions fragile, the sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions ….and could have severely shaken confidence.” Doesn’t that sound familiar?

So, I promised some info related to my CRM Principles of Risk Management course that I recently attended. The instructors were bright, articulate and engaging and as a result, the 20 hours of instruction went by fairly quickly. As you may deduce from a “Principles” class, the essential focus was the basics of risk. The class was a fairly large one, with about 90 people. It was also a very highly credentialed group, with about 120 designations granted to these folks. Definitely no slouches here.

The first risk concept explored is an identification of the three generally accepted types of risk, each with their own unique characteristics. They are:

• Pure Risk;
• Speculative Risk; and
• Gambling.

Pure Risks are those where there’s a chance of loss *only* with no possibility of gain. An example of this might be an airplane falling out of the sky wiping out a city block or the death of a loved one. With respect to individuals, insurance does a good job of protecting against many pure risks we face in our daily lives.

Speculative Risks are those where there is a chance of a loss OR a gain. These risks include a *variation* of outcomes where profit is possible. An easy example of this is investing. We invest money in stocks, bonds, commodities, etc. with the hope of a positive result (profit), but where exists the possibility of loss. To spin this concept to financial academia, having the majority of your investments in one company or one industry group, is called “speculating” (and not investing), and we all know how dangerous that can be!

Starting and operating your own business is another form of speculative risk. For my money, this is, for most individuals,  the most “risky” speculative financial risk. Since I have been a “serial entrepreneur” (stop me before I start another business again!) all my adult life, I guess this is why stock market investing seems nowhere near as risky as the commitment and deployment of capital in my own business.

The last risk group is gambling, where there is the chance of loss or gain, but the probabilities strongly favor a loss. I highly doubt this type of risk needs any explanation. Anyone who has ever been to Las Vegas or Atlantic City (or watched CSI: Las Vegas on television) understands this type of “risk”. In the real world, I’m not sure that gambling is really a form of risk. I don’t consider shooting craps or “putting it all on red” to be forms of risk, as I think it’s a virtual certainty that a loss will occur.