Monday, April 26, 2021

Risky Business

 Charles Ungerleider, Professor Emeritus, The University of British Columbia

[permission to reproduce granted if authorship is acknowledged]

 The Delta School Board deserves praise for its vigorous pursuit of environmentally friendly technologies. But it also deserves admonishment for neglect of risk management.

Delta School District finds itself “on the hook” for millions of dollars. To diminish its carbon footprint, Delta entered into an agreement with FortisBC Alternative Energy Service for the installation of more environmentally friendly technologies. The technologies were expected to reduce emissions by 69% which would be equivalent to taking 450 cars off the road each year. When it approved the agreement, the B.C. Utilities Commission expressed concern about the financial risk the school district was assuming. Years later, FortisBC applied for and was granted a rate increase by the B.C. Utilities Commission that required the school district to pay about $1million dollars more each year for energy.

My hunch (and it is only a hunch) is that the Board neglected to think about the risks associated with the commitment they made. When you do not think about risks, you are really self-insuring – saying in effect that we can pay the price or suffer the consequences if something goes wrong.

It has too often been my experience that school boards do not think about risks. Early in the pandemic I wrote a blog about its economic impact on international student enrollment and school board budgets. In a more recent blog, I wrote about post-pandemic budgetary belt-tightening.

It is prudent to think about risks. When we buy a appliance, the salesperson often asks, “do you want to buy an enhanced warranty?” They are asking us to consider protecting ourselves against the cost of repair or replacement if the appliance malfunctions after the normal warranty period has expired. The protection is the extended warranty. The manufacturer has protected itself against the risk of appliance malfunction by excluding from the warranty operator error or misuse of the appliance. If we decline the extended warranty or the rental car insurance, we are choosing to self-insure.

Thinking about what could go wrong sounds pessimistic but is simply being cautious about protecting oneself. People living in areas that flood in the spring have sandbags at hand to protect their homes from flooding. Drivers purchase insurance in the event their cars are damaged or stolen, or they are involved in an accident in which people have been injured.

Thinking about what could go wrong needs to be coupled with thinking about the likelihood of the risk occurring and about the consequences of the occurrence of the risk. How likely is the anticipated risk? What impact will the anticipated risk have if it is does occur? Answering these questions is a probability/loss impact assessment. That is what actuaries who work for insurance companies do for a living. They ask, “what can go wrong?” and ‘how likely is it that will go wrong.” Once they determine that, they establish a premium that the insurance company charges to protect itself from losing money paying off the claims people make when whatever it was they were protecting themselves from takes place.

When Delta chose to install the new energy systems, they must have decided that those systems would work. I know this because they removed the systems the new technology replaced rather than keeping them as a parallel backup system. That calculation is just like the calculation computer users make when the decide to back-up their files. Among those who protect themselves from loss of information by backing up their files, there are those who calculated the impact and cost of having the back-up stolen or destroyed. They back up their files to the cloud. Back-up systems, extended warranties, automobile insurance, and running parallel systems are all strategies to mitigate the risk of loss.

Monitoring risks is another consideration. If I did not take the extended warranty, I had better begin putting money aside to replace the appliance as it ages because eventually it will need to be replaced. If I do not, I run the risk of making an unanticipated large expenditure. The lawyer representing Delta in its dispute with Fortis said, “The impact on my client's financial position is going to be very significant… the estimated $1 million in additional costs . . .  is going to have to come out of the program budget by which the district operates its schools.”

I said earlier that my hunch was the Delta Board neglected to think about the risks associated with the commitment they made. I said that because I do not think that, having evaluated the risks, they would have chosen to self-insure against them knowing the potential impact on programs and services for students.

Of course (and I say this tongue in check) the Delta Board could have attempted to protect itself against the annual loss of $1million by buying a lot of stock in Fortis!