UGG (United Grain Growers) started implementing enterprise rise management by forming a risk management committee. This committee then met with a representative from Willis Risk Solution, a unit of Willis Group Ltd. UGG hired Willis Risk Solution to identify and qualitatively rank the firms major risk. This process identified 47 exposure areas and got the top six risks: 1. Environmental Liability 2. The effect of weather on grain volume 3. Counterparty Risk 4. Credit Risk 5. Commodity price and basis risk 6. Inventory Risk
The analysis conducted by Willis Risk Solution led to the conclusion that, of the six risks originally identified, UGG’s main source of unmanaged risk was from the weather.
Weather becomes the main source of unmanaged UGG’s risk because it can’t be controlled. Indirectly weather risk affects the UGG’s profit because the main business of UGG is in the farm industry. UGG’s Profit depends on the Grain volume that can be sold by the company. Grain volume comes from crop yield that very affected by weather condition.
To summarize, Ken and Michelle established a relationship between weather and UGG’s gross profit using the following steps and information:
Weather Crop Yields UGG’s Grain Volume UGG’s Profit
Exhibit 10 Exhibit 4 Exhibit 6
They illustrated their results by graphing UGG’s actual gross profit and what gross profit would have been if the effects of weather were removed. Their graph is reproduced as Exhibit 12.
To manage the exposure to weather risk UGG managers explored several options:
The retentions approach meant continuing operating as they had been and not trying to reduce their weather exposure. Retention exposed their profitability to large swings due to the weather. This option made the UGG’s financial perform will be very fluctuate. The high fluctuation is a bad news for investor.