“P & I Mortality Surveillance.” To accounting and finance professionals, it sounds like a term for tracking the principal and interest payments on your loan agreement, until that wonderful day when your payoff is imminent, and you have the funds or credit to repay it or refinance at today’s lower rates! Sadly, the term is better known to the Centers for Disease Control and Prevention (CDC), who have the grim task of tracking pneumonia and influenza deaths, as reported each week in 122 cities across the United States. For the week ending January 12th, 8.3% of all reported deaths were attributable to P & I, marking the 2nd consecutive week that this rate was above the 7.3% threshold that denotes a flu epidemic.
The decision on whether or not to take the shot is the ultimate expression of personal risk management. Three groups emerge every season – the “always get the shot” group, the “never get the shot” group, and a vast middle swath of individuals who “may or may not get the shot.” The always group consists of people who believe they are at greater risk, or simply don’t want to take any chances, and need no convincing by the CDC or others. The never group of individuals have already decided not to get the shot, for reasons of personal belief, perceived excellent health, or from their review of the available information (and in some cases misinformation). Last year only 42% of the population received a flu shot. But with a target goal of 80% of the population, the CDC must do more to get the vast middle swath of America to take the shot. Perhaps there are lessons for the CDC in understanding how a business would determine whether or not to hedge their commercial risks.
Catalogue the risks. You would think that the “risk of dying” would be sufficient to motivate people toward taking the shot. But as flu seasons come and go, more people than you would imagine decide to take just that risk. A full accounting of the risks, however, could be quite useful and could sway some folks on the fence to take action. A business risk manager can’t take five steps without coming across a litany of hazards to his or her employer: there’s operational risk, legal, regulatory, interest rate, currency, commodity, counterparty, liquidity, market, price, and basis risk, to name a few! That same person could look at the flu and come up with at least the following: the aforementioned risk of dying, risk of complications (i.e., pneumonia), expensive hospital stays and medical bills, and risk of passing the flu virus to loved ones, coworkers, and at-risk populations like children and the elderly. Before you decide to do anything about them, you must first understand what you face.
Exposures, probability, and severity. Though some people will say otherwise, business is not a life or death matter. Simply put, the stakes are not the same, in comparing the risk of death from influenza versus the risk of rising interest rates eating away at your working capital, for example. Nevertheless, enterprise survival does depend on understanding your exposures to identified risks, and assessing how they could negatively impact your business as they change. If you have FX risk in the form of EUR receivables, for example, does a negative move in the USD-EUR currency pair cause a short term cash crunch, or worse – would you go insolvent? Or, what happens if a key vendor defaults? Can you get more parts or product elsewhere, or do you go down with your vendor? Or, given that the Fed claims to be on hold through mid-2015, what happens to your interest expense if rates rise quicker than planned? Does this just delay investment, or cause you to rethink your strategy entirely? Assessing the probabilities and severities associated with bad outcomes, even if only as estimates, lets you understand which risks can be managed and which need to be taken off the table. And so begins a hedging program.
Hedging your flu related risks. Once a business decides to hedge a commercial risk, a whole new set of questions arise. What is the best, most effective hedge, given my situation? For example If rate risk is your concern, you can fix your floating rate debt with an interest rate swap, float up to a maximum rate with a cap, or float within a narrow band using an interest rate collar, with rate never to be greater than “X,” but also never less than “Y.” Risk managers appreciate choice, and appreciate that OTC derivatives can be tailored to their specific risks, structure, and needs. Which choice gives you the risk mitigation you seek, at the most reasonable price, and allows you to focus on growing your business? This question is no different when deciding how best to combat the flu. The CDC recommends that everyone get vaccinated, but most people still have the choice between a flu shot or flu mist vaccine. For people that may not be good candidates for the vaccine due to prior severe reactions to the shot or due to certain allergies or illness, there are other solutions to combat the flu that can be considered. The point is that one size does not fit all, whether you are hedging your seasonal flu risks or your business risks. It’s always good to consult with your doctor, or independent hedge consultant, respectively!