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AJ Buono
Dr. Miller
Corporate Risk Management
Project #2 – Risk Treatment and Analysis
19 April 2016

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To: Steve Miller, CEO, Caterpillar INC.
Executive Summary:
In my last report identified several risks that our corporation Caterpillar INC. could incur
(which can be found in Appendices A and B). Furthermore I narrowed down the three risks in
which I recommended to be further analyzed (Products Liability, Natural Disasters, Labor
Disputes / Expiring Collective Bargaining Agreements) (“Caterpillar 10K”). In addition, I have
provided several risk treatment techniques for each risk to reduce the loss if the risk occurs.
For products liability exposure I used the risk treatment techniques through both risk
control and risk financing. My analysis and treatment suggestions included analysis in the case in
which we were to purchase a general liability policy for products liability with limits up to $200
million dollars and conducting extensive inspections bi-quarterly.
Similar to our products liability I used risk control and risk financing techniques in
treating our natural disaster risks. Using a visual approach in the analysis I was able to identify
probabilities of certain linked scenarios occurring as well as the costs / benefits of purchasing a
Cat Bond.
Finally, for our labor disputes and expiring collective bargaining agreements the analysis
conducted visually as well as quantitatively shows how the probability of certain scenarios if the
risk were to occur and the success of planning a funded retention to treat this exposure
Thank You,
AJ Buono
Chief Risk Officer, Caterpillar INC.

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Risk Analysis/ Treatment In-depth Analysis:
Risk #1 Products Liability
As previously discussed in my initial report I identified product liability as a top risk our
company faces. It’s our duty as a global leader in manufacturing construction and mining
equipment that we produce the best quality products in the market that are safe for the client’s
use. From my initial findings I found the frequency of the risk to be a 3 and the severity at a 4
giving this risk a medium impact on the firm (Appendix A & B). Furthermore, through my
identification process when looking at the previous loss histories we faced up to $100 million
dollars in losses. This number became important in the process of accurately treating this risk
which included purchasing general liability and umbrella coverage as well as bi-quarterly
inspections. By treating this exposure it’ll considerably reduce the impact of this risk on our
firm.
As stated earlier to properly treat this risk I decided do this dually through both risk
financing and risk control. First, through risk financing I am suggesting we should purchase a
general liability policy along with several excess levels to properly cover our product liability
exposures. Insurance is one of the more popular risk financing and risk treatment techniques
used in cases such as these. Overall, insurance helps provides the funds needed to meet the
financial consequences of when a hazard risk occurs (Corporate Risk Management 6.8). The
commercial general liability policy covers for several exposures one of them being products
liability, including the legal costs for settling products liability cases until the limits are
exhausted. Our previous losses suggest we should only purchase $100 million dollars in limits
however I disagree with the assumption. In my view at this time, we need to prepare for the
worst case scenario until we have the risk under control. Henceforth, I recommend we purchase

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around $200 million in limits of a general liability policy because we may run into cases where
the losses exceed $100 million dollars during the policy period. This is why I suggest we
purchase an extra $100 million in limits compared to our loss histories, otherwise we will have to
pay losses after the limits are exhausted. The insurance program I have put together includes;
primary general liability coverage of $1 million limits, a buffer umbrella policy that has limits of
$10 million, and six layers of excess coverage to bring the limits up to $200 million with the
assumption we will pay the first $500,000 of any products liability claim through a deductible.
Later, I will discuss how this insurance program will lower our expected losses by $80 million
through discrete loss distribution over time. Moving on from risk financing, I have also
recommended a risk control technique to treat this risk. This suggestion is to hire outside
inspectors to visit our manufacturing facilities twice a quarter. This is a loss prevention technique
that aids in reducing the frequency of a risk from occurring (Corporate Risk Management 7.5).
By having inspectors coming in to our manufacturing facilities 8 times a fiscal year, they’ll be
able to look over our manufacturing equipment, evaluate the common practices of our production
employees and provide us better suggestions for our operations within manufacturing. Through
this loss prevention technique it will not only lower the frequency of our products liability
exposure it can assist in lowering our insurance premiums as well as possibly considering a
reduction in limits needed in the insurance policy in the future.
In order to analyze this risk I used a discrete loss distribution and an NPV analysis to
decide if the risk treatment techniques would be beneficial for the firm. With the given
deductible and program structure I assumed in the case a products liability loss occurred 50% of
the time the claim would simply reach our deductible meaning we’d pay at most $500,000
dollars for the claim (Appendix E). From there 40% of the time the claim would not only reach

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our deductible but the reach the policy’s limits (Appendix E). Multiplying that 40% by the
proposed policy limits ($200 million) I calculated the expected loss to be $80 million dollars
(Appendix E). Calculating the expected loss was useful for my NPV analysis of the risk
treatment techniques. Appendix H has the NPV analysis that was conducted for products liability
in which a positive $359,666,340 was calculated. In this analysis my assumptions included the
cost of the insurance which upfront cost of $2.9675 million dollars, and $8 million dollars for the
bi-quarterly inspections at our manufacturing facilities as well as the $80 million expected loss of
the insurance company which was all assumed as the loss reduction for implementation of these
risk treatment techniques. Overall within the next 10 years these treatments will provide a
positive investment to Caterpillar
Risk #2 Natural Events
Natural Events were the second risk I had recommended to be further analyzed. The
occurrence of one of these events could severely impact us operationally and financially
(“Caterpillar 10K”). From my initial report with the assistance of a cross functional team we put
together a Scenario Analysis and Scenario Tree which helped illustrate all the scenario’s the
could occur as well as which scenarios that are linked if a natural event occurs. (Appendix C). In
treating this risk we use a similar approach for what I did for our products liability exposure.
In this case I am recommending treating this risk again with risk financing and risk
control. Using the financial instrument of a CAT Bond and investing in a disaster recovery plan.
A CAT Bond is similar to insurance, however is specifically designed to cover for catastrophic
losses. The bond overall issued through a special purposes vehicle (SPV) to the company looking
to purchase the bond. If there is a catastrophe the party who purchased the CAT Bond gets paid
to cover the lose via the SPV and if the catastrophe doesn’t happen those who have been

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investing in the CAT Bond from the outside receive a good return on the bond. In addition to the
CAT Bond, I recommend Caterpillar should invest in a disaster recovery plan. Investing in this
plan will put together a set of procedures for when a catastrophe hits such as emergency
responses, other pre-loss procedures as well as post-loss procedures to continue operations while
reducing further losses from occurring (Corporate Risk Management 7.8). This disaster recovery
plan is a form of loss reduction, meaning the severity of the loss would decrease from
implementing this disaster recovery plan (Corporate Risk Management 7.6-7.7). For us at
Caterpillar, investing in a disaster recovery plan can help us reduce the damages to our facility,
responding to emergencies in the appropriate way and continue our operations such as boarding
up some of the vulnerable areas within our facilities, educating our frontline employees in how to
respond in the case that a catastrophic event occurs in the facility they are working in.
In my further analysis I used an event tree analysis to get a better understanding on the
consequences if a natural catastrophe were to affect our firm as well as conducted an NPV on
potential investments of a CAT Bond and a disaster recovery plan. Having already identified the
different scenarios if a natural catastrophe were to occur in Appendix C, I took this to the next
level and ran two event tree analyses, one for manufacturing facilities and one for distribution
facilities (Appendix F). The event tree analyses are another great visual to look at different
scenarios in case of if an event occurs, the linkages between different scenarios and providing a
probability measurement. In Appendix F, 9 linked scenarios were created with ranging
probabilities between 40% to .4%. This further illustrates the many situations Caterpillar could
possibly face if effected by a natural catastrophe. Moving on to the investments in risk treatment,
an NPV analysis calculated a positive $162,136,960 NPV (Appendix I). Some key assumptions
made were if our firm were suffering losses in the worst case scenario, ($500 million dollars)

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while multiplying it by 10%, (the assumed frequency of the risk) to get expected losses of $50
million dollars. Additionally, I considered the cost of a million dollar disaster recovery plan and
a $67.9 million dollar CAT Bond in the analysis. All things considered, these two risk treatments
would provide a positive investment for our company and can be put up to the test as losses
could grow rapidly with this risk.
Risk #3 Labor Disputes / Expiring/ Renegotiating Collective Bargaining Agreements:
The third and final risk I suggested we did further analysis on is our labor disputes and
expiring collective bargaining agreements exposure. At Caterpillar we have 8,200 production
employees who are covered under a collective bargaining agreement in which are set to expire in
the fiscal years of 2017 and 2018 (Appendix D). Without frontline employees our firm could see
delays in operations and a loss in profits due to any work stoppages from this risk. In order to
properly treat this risk Caterpillar must plan ahead in case we are unable to renegotiate terms
with the labor unions.
As stated earlier, Caterpillar needs to plan ahead for this risk due to uncertainty, if
settlements can’t be made before a collective bargaining agreement expires. In order to do so I
am recommending we plan a complete funded risk retention for this exposure. As we are
planning ahead this would be an investment thought and planned out ahead of time, and is
completely funded and accounted for, not partially (Corporate Risk Management 6.9-6.10).
Creating this planned funded risk retention will allow us to hire temporary workers in times of
dispute with the labor unions and work stoppages due to an expiring collective bargaining
agreement.

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Similar to my previous analysis I used a visual to explain the different situations our firm
would be put in if this exposure were to occur. Using a Decision Tree I was able to further
illustrate the different outcomes if we were to put together a planned funded retention for this
risk. Appendix G contains the Decision Tree analysis conducted for this risk. In the case that we
decided to follow through with financing the retention there are 3 outcomes that could possibly
happen. First, there might not be a dispute at all in which we are still holding on to the retention
we planned for. Secondly, if there is a full dispute with all 8,200 covered employees, then we
have a completely funded retention to go and hire temporary workers to continue our operations
while we settle the labor dispute or expiring collective bargaining agreement. Finally, if there is a
partial labor dispute and/ or work stoppage with some but not all covered employees (since not
all of them are covered under the same collective bargaining agreement), we have funding to hire
workers to temporarily keep operations going as we settle the dispute. The other decision we
have is if ultimately as a firm we decide not to not follow through with the funded retention,
Caterpillar can suffer major losses due to operational delays if there’s a labor dispute. From the
NPV analysis on this risk treatment technique I calculated the NPV to be approximately $226.5
million dollars (Appendix J). After taking into consideration the average annual salary of our
production employees ($92,365), legal and contact negotiation fees as well as the assumption
that we’d need temporary workers for about 1 month before a settlement was made. Our firm
would need to finance about $63.1 million dollars for fully funded risk retention for this
exposure.

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Conclusion:
Through my extensive analysis I was able to provide treatment solutions for these top
priority exposures Caterpillar faces. Although the NPVs for our potential investments in risk
management are great, we always need to consider conducting risk management. The costs may
be high but it doing it allows us many benefits such as providing us stability in contracting with
all our stakeholders and gain easier access to resources such as capital.

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Key: 3 Key Risks Identified
Risk Description Risk Type Method Identified Likeihood (1 to 5 Severity 1 to 5) Risk Impact (combining both likelihood and severity)
Union Disputes / Collective Bargaininig
Agreements - Some of our employees
are represented by a Union in which
their collective bargaining with varying
experation dates. Failure to renegotiate
existing collective bargaining
agreements could lead to interruption
in business operation and other issues
with labor unions
Operational
Employee Survey's /
Interviews /
Compliance Review
3 4 Medium
Natural Disasters- Large unexpected
events such as natural disasters, war,
terrorism and pandemics could lead into
manufacturing and distribution centers,
as well as disruptions in operations,
supply of key compnent products
Hazard
External Expert/
Scenairo Analysis
1 5 Medium
Lawsuits / Investigations regarding
Products Liability
Hazard
Onsite Inspections /
Loss Histories
4 5 High
Failure to Realize all benefits associated
or benefits materialize later than
expected with joint ventures,
acqusitions, and other strategies
Strategic
Scenairo Analysis /
Document Analysis-
Financial Statements
1 3 Low
Cyber Liability Hazard /
Strategic /
Operational
Cyber Assesment /
Scenairo Analysis
3 5 High
Severity /
Frequency
1 (Low) to 5 (High)
Appendices
Appendix A: Risk Register
Revisited from project 1 Appendix A contains a shorten risk register highlighting the 3 key risks
that are analyzed in this report.

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5 Natural Disasters * Cyber Liability
Manufacturing's high
dependance of the
demand of the cyclical
Construction Industry
Lawsuits regarding
Products Liability *
4-5
Employee Injured on
the job / Worker's
Comp.
High Steel Prices
4
High dependance on
Consumer Spending
Union Disputes /
Colletive Bargaining
Agreements *
Failure to maintain
postive credit ratings
3-4
Interest Rate
Fluctuations / Cost of
Acessing Capital
Oil Prices
3
Failure to Realize all
benefits associated or
benefits materialize later
than expected with joint
ventures, acqusitions, and
other strategies
Failure to comply with
Environmental
Regulations
Exposure to political
risks in the countries we
operate in
Must follow inventory
and sourcing decisions
of our dealers and
original equipment
manufacturer
customers- can impact
CAT positively or
negatively
Operating within a
highly competive
industry
2-3
2
Currency Exchange Rate
Fluctuations
1-2
1
Changes is US GAAP
Accounting Principles
1 1-2 2 2-3 3 3-4 4 4-5 5
Frequency
Severity
Key
High Severity /
Frequency
Medium Severity /
Frequency
Low Severity /
Frequency
* after risk is identified
as a Top 3 Risk
Appendix B Heat Map
Revisited from project 1, Appendix B contains the Heat Map has all 18 risks listed in the risk
register in Appendix A illustrates where each risk stands in regards to one another, factoring both
the frequency and severity of the risk. From the map and key the risks in red are considered
highly impactful, risks in orange have a medium impact and risks in green have low impact. The
top 3 identified risks have an asterisk next to them.

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Appendix C
Revisited from project 1 in Appendix C is a scenario tree for Natural Disasters which was
constructed together by a cross functional team that includes myself, our CFO Bradley
Halverson, V.P. of our Global Supply Network Frank Crespo, V.P. of Middle East, Asia and
Africa Distribution Raymond Chan, V. P. of Americas & European Distribution Phil Kelliher,
and Qihua Chen V.P. of China Operations. While taking in consideration several different
unexpected natural events we put together several different outcomes based on if the event were
to occur or not. As illustrated above there is at least 9 different situations that Caterpillar could
face in the case of if a natural event occurred near their operations.

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Appendix D
Appendix D is a snapshot of all the employees Caterpillar has, the footnotes below share how
many production employees are covered under a collective bargaining agreements as well as
when some of the agreements expire. (“Caterpillar 10K” 7).

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Ocurrence Probability Loss Payment Expected Loss / Cost
No Products Liability Claim Made 10% $0.00 $0.00
Products Liability Claim Made and payed by us through a deductible 50% $500,000.00 $250,000.00
Products Liability Claim Made and payed by insurer ($200 million in Limits) 40% $200,000,000.00 $80,000,000.00
Total 100% $200,500,000.00 $80,250,000.00
Appendix E: Discrete Loss Distribution Products Liability
Above is a discrete loss distribution for our Products Liability risk. In this case it analyzed the
risk treatment technique of the purchasing of a general liability insurance policy with $200
million dollars in limits for products liability. Through this loss distribution we were able to use
the expected loss for products liability claims to be paid by the insurer as our assumption for loss
reduction in our NPV analysis for this risk treatment technique in Appendix H.

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Appendix F: Event Tree Analysis: Natural Disaster
Appendix F is an Event Tree Analysis Specific to Natural Disaster Risk that was identified. From
Appendix C the Scenario tree, several of the scenarios that were selected were those that had a
common link or domino effect to them. The Event Tree Analysis was conducted twice once in
the case of if a manufacturing facility became destroyed as well as if a distribution center was
destroyed.

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Appendix G: Decision Tree Analysis: Funded Reserve For Replacement Workers
In Appendix G there’s a decision tree analysis conducted for our expiring collective bargaining
agreements and labor disputes. This illustration displays visually some of the different scenarios
which could occur if or if not a planned retention is in place for this risk.

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NPV Analysis Risk: 1
Year 0 1-10
General Liability + Umbrella Coverage 2,967,500.00$
Bi Quarterly Inspections 8,000,000.00$
Deductible 500,000.00$
Loss Reduction 80,000,000.00$
Before Tax Cash Flow 80,000,000.00$
Tax (.245*70,000,000) 19,600,000.00$
After Tax Flow 60,400,000.00$
PV of Cash Flow Assuming 10% ROR
After Tax Flow 60,400,000.00$
Muiltplied by 10% ROR 6.1446
Present Value 371,133,840.00$
NPV
PV 371,133,840.00$
Intial Cash Outlay 11,467,500.00$
NPV 359,666,340.00$
Expected Loss Reduction (From Discrete Distribution) 80,000,000.00$
Inspections Cost Assumption 100,000.00$
Quarterly (X4) 400,000.00$
Twice a Quarter (X2) 800,000.00$
Total Inspection Cost Per Year 800,000.00$
For 10 Years (X10) 8,000,000.00$
Total Inspection Cost 8,000,000.00$
Appendix: H NPV Analysis Products Liability Risk Treatment
Appendix H is the NPV analysis for treating the products liability risk our firm faces. From
project one we already discussed our $100 million dollar loss history in regards to products
liability. A key assumption made was that the total loss reduction was $80,000,000 from
Appendix E. Through the NPV analysis this risk treatment plan will provide positive value to the
firm.

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NPV Analysis Risk: 2
Year 0 1-10
Disaster Recovery Plan 1,000,000.00$
Cat Bond 67,900,000.00$
Loss Reduction 50,000,000.00$
Before Tax Cash Flow 50,000,000.00$
Tax (.248*70,000,000) 12,400,000.00$
After Tax Flow 37,600,000.00$
PV of Cash Flow Assuming 10% ROR
After Tax Flow 37,600,000.00$
Muiltplied by 10% ROR 6.1446
Present Value 231,036,960.00$
NPV
PV 231,036,960.00$
Intial Cash Outlay $68,900,000.00
NPV 162,136,960.00$
Total Losses 500,000,000.00$
Freq of Risk 10% 10%
Total Loss Reduction 50,000,000.00$
Assumption Disaster Recovery Plan Cost 1,000,000.00$
Appendix: I NPV Analysis Natural Disaster Risk Treatment
Appendix I contain NPV analysis for the treatment of the Natural Disaster risk. From the
analysis we assumed the worst case scenario in which a natural disaster caused a domino effect
to our business causing a loss of half a billion dollars in which we took 10% of that as our loss
reduction as the frequency of natural disasters are low compared to other risks. From the analysis
with our treatment plan this investment contains a positive NPV.

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NPV Analysis Risk: 3
Year 0 1-10
Funded Retention for Replacement Employees 63,116,083.33$
Contract Negotiation Fees 2,000,000.00$
Other Legal Fees 2,000,000.00$
Loss Reduction 63,116,083.33$
Before Tax Cash Flow 63,116,083.33$
Tax (.248*70,000,000) 15,652,788.67$
After Tax Flow 47,463,294.67$
PV of Cash Flow Assuming 10% ROR
After Tax Flow 47,463,294.67$
Muiltplied by 10% ROR 6.1446
Present Value 291,642,960.41$
NPV
PV 291,642,960.41$
Intial Cash Outlay 65,116,083.33$
NPV 226,526,877.08$
Average Production Employee Salary 92,365.00$
Assumption of 1 Month Needed for Replacement Workers 7,697.08$
X 8200 CBA Employees on Strike that need to be Replaced 63,116,083.33$
Appendix: J NPV Analysis Labor Disputes and Expiring CBAs Risk Treatment
Appendix J contains the NPV analysis for treating the labor disputes and expiring collective
bargaining agreements. From Appendix D, we know there are 8,200 product employees covered
under CBA’s for the NPV analysis we adequately funded for the situation if we were unable to
renegotiate terms for 1 month in which showed a positive NPV.

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References
"Caterpillar 10K." Caterpillar. Caterpillar INC, 16 Feb. 2016. Web. <http://phx.corporate-
ir.net/phoenix.zhtml?c=92466&p=irol-
SECText&TEXT=aHR0cDovL2FwaS50ZW5rd2l6YXJkLmNvbS9maWxpbmcueG1sP2l
wYWdlPTEwNzQ0NzA5JkRTRVE9MCZTRVE9MCZTUURFU0M9U0VDVElPTl9FT
lRJUkUmc3Vic2lkPTU3>.
Corporate Risk Management. 1st ed. Malvern, PA: The Institutes, 2013. Print.