Protect Against Risk – Hedging & Insurance – September 2016

This post is about internal controls

Many CFOs, when asked about internal controls, speak of procedural and structural matters. These include fundamental internal control principles such as segregation of functions, reconciliations, and authorization procedures. Any good internal control system must have such policies and procedures in place. That said, internal control policies are also necessary for broader functions undertaken by the firm. Such matters include hedging and insurance.

Hedging is a means of protecting against price, currency, and interest rate fluctuations. It entails an agreement to deliver or purchase a product in the future at a pre-determined price. In addition, hedges can assure an interest or exchange rate are effective for a future time period.
Hedges are used by producers and purchasers of goods, borrowers as well as transactions in foreign countries. If done properly, hedging can help prevent unexpected losses. Done improperly, hedging can be simple speculation, aiming for big gains at the risk of big losses (see Long Term Management, Barclays Bank, Enron, and the Credit Default Swap markets).

By not hedging the firm risks losing on price changes; currency fluctuations; changes in interest rates; and credit deterioration (Credit Default Swaps). A hedging program must have a policy, that with no exceptions, governs the type and scope of the program. It must ensure that hedges are utilized in a timely manner, authorized by appropriate personnel like the CFO, and reconciled to the proper benchmarks on a daily basis.

Business insurance is the means of exchanging a possible unknown loss for a definite, known cost. At the best, insurance can prevent a crippling or company-threatening loss. Insurance can be required contractually (lease) or statutorily (workmen’s comp), but the prudent CFO also examines the costs and benefits of insurance for other corporate matters.

In our view, all firms should have basic types of insurance including: worker’s comp, property and casualty, and general liability insurance. The latter includes a policy that covers product liability, errors and omissions, and employment practices. The CFO must also consider the wisdom of additional insurance based on the company’s specific needs. Among the many policies for such specific needs are: automobile, flood, business interruptions, key man life, fidelity bonds (employee honesty), and surety bonds (performance of tasks).

The firm can purchase insurance through a commercial insurance agent who can provide guidance on the cost and structure of the insurance program. The agent may also provide advice on riders for certain events or activities. The insurance can be purchased via separate policies or as an umbrella policy. Self insurance is also an option, but it is usually impractical for a small business

Many CFOs, when asked about internal controls, speak of procedural and structural matters. These include fundamental internal control principles such as segregation of functions, reconciliations, and authorization procedures. Any good internal control system must have such policies and procedures in place. That said, internal control policies are also necessary for broader functions undertaken by the firm. Such matters include hedging and insurance.

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