"We look at risk at the beginning of the quarter, risk at the end of the quarter, and which variables changed," says Shaun Hazen, manager of treasury and capital markets. "If our risk increases, we can see whether it's because we've lowered our coverage on a commodity where risk is up, or because volatilities are higher, or because the correlations in the model have weakened. That makes for a more informed discussion when we meet with the business."

Including the lines of business in financial risk management is another key tenet of the Starbucks approach. "At Starbucks, risk isn't something treasury comes up with in a vacuum," says Drew Wolff, vice president of treasury and risk management. "We're looking to make risk a true dialogue with the business. We discuss the impacts of financial risks on earnings per share, and we discuss the trends and the correlations between risks."

Google also set out to take a comprehensive view of its financial risks. The treasury team developed a "sanity check" to determine how much value it was achieving through its FX hedging program. Also like Starbucks, the Google team intentionally involved managers outside of treasury in the effort. They worked particularly closely with investor relations to make sure that the company's shareholders still considered FX hedging to be valuable.

"We are always looking for ways to stay on top of the markets, improve our policies and processes, and maintain a best-in-class approach to all of our financial and risk management programs," says Tony Altobelli, assistant treasurer.

All three of these winning projects demonstrate best-in-class approaches to managing financial risks. Congratulations to Starbucks, HCSC, and Google! Read on to learn more about their financial risk management success stories.

Modeling Financial Risks in a Dynamic Industry

Health Care Service Corporation (HCSC) prepared for the implementation of the Affordable Care Act by transforming its treasury function. The nation's fourth-largest health insurer, like many other companies in its industry, spent the early years of the Obama presidency preparing for an influx of individual insureds, who would make individual premium payments.

"Historically, HCSC's business was primarily focused on group accounts," says Forrest Vollrath, executive director of treasury operations. "But with the introduction of the Affordable Care Act, we expected the proportion of our business comprised of individuals to grow. Collecting premiums for individual policies is much different from doing it on a group basis."

In anticipation of this shift in its business model, HCSC centralized treasury activities across its Blue Cross and Blue Shield divisions within five states, as well as across its 30-plus subsidiaries. It also implemented a new treasury management system and customized the software to meet its specific needs for liquidity management.

Prior to this transformation, a disjointed technology infrastructure demanded that treasury staff manually key in the same data multiple times, across multiple systems. Visibility into the company's cash position was limited, and management faced challenges in obtaining key treasury data in a timely, efficient manner. Among other goals, the treasury transformation initiative set out to institute a single, consistent methodology for viewing bank balances; to standardize reporting of bank transaction data; and to revamp the manual processes associated with cash management.

HCSC implemented a software-as-a-service treasury workstation that offers daily updates on the company's cash activity. By 9 a.m. each day, the system provides managers with accounting and cash positioning information on 100 percent of the company's cash flows. This data is then uploaded into a regression model that automatically calculates variances and incorporates three years of historical data to produce a rolling 13-week forecast. Having better visibility into cash flows enabled HCSC to substantially reduce its working capital balances, which significantly increased the amount available to the company's long-term investments.

Next, the company built upon the improvements in cash visibility and working capital management by developing a new investment allocation strategy for its $2 billion short-term portfolio and its $8 billion in long-term investments. The investment management initiative was designed to expand the investment alternatives available to portfolio managers, and to give the portfolio management team more autonomy to make tactical and strategic adjustments to corporate investments. The idea was that a more autonomous portfolio management group could potentially improve the company's investment performance and risk by exploring new asset classes.

The project started with a comprehensive review of the company's investment allocations. Insurance industry best practice requires such a review on a two- to three-year cycle, or whenever business conditions change materially. The advent of the Affordable Care Act certainly qualified as a material change in business conditions, so HCSC launched its review in early 2015.

HCSC modeled returns on its investment portfolio across five investment-allocation options: the company's actual portfolio as of June 30, 2013 (pre-change baseline); the company's actual portfolio as of December 31, 2014 (interim); a hypothetical portfolio termed "current plus," designed to increase investment income and returns within the organization's current investment policy; a hypothetical "income portfolio," which was designed to substantially boost investment income and was not restricted to current policy; and a "total return" option designed to maximize the long-term total rate of return on HCSC's investment portfolio.

The company developed an analytical framework to evaluate the risks a portfolio faces by delineating the degree of exposure for each of the portfolio's securities across a range of risk factors including interest rates, credit spreads, equity, and foreign exchange. Portfolio stress testing and scenario analysis are key tools used to consider investment risk relative to business risk. Actual and potential portfolios are evaluated using macroeconomic-factor analysis and historical market shocks. The outputs frame risk relative to long-run upside potential.

Using outputs from the risk-analytics framework and the index-based allocation model, the HCSC team developed a dynamic framework for evaluating investment-allocation options. The framework incorporates investment objectives, risk tolerance, operating cash-flow projections, long-term balance sheet projections, governance and regulatory considerations, and the impact of different investment scenarios on credit ratings and the company's ability to secure financing. Incorporating inputs in each of these areas provides a clear view into the risk and potential returns of different investment allocations.

The investment team plugged its five real and hypothetical portfolios into the framework to model optimal investment allocations. The team analyzed asset classes in which the company already invested, as well as new asset classes, and they were able to establish the impact on performance and risk of each possible change to the portfolio. As a result, the HCSC team decided to assume marginally higher interest rate and credit risks in exchange for higher expected returns in the long run.

The foundational portfolio structure has been executed. The long-term goal of the initiative was to increase investment income on the company's investment portfolio by 1 percent to 2 percent annually, over the long term. Results to date have been substantially better than base-case expectations. The new strategy empowers HCSC to better manage its capital base in a very dynamic industry environment.

Viewing Exposures Through a Big-Picture Lens

Coffee is complicated, at least when managed on a global scale. With operations in 74 countries, Starbucks faces the same types of foreign exchange issues as other global businesses: risks around individual transactions with customers and suppliers, and around translating earnings back into U.S. dollars. In addition, the company faces exposures around the prices of coffee, dairy, diesel fuel, and other commodities.

Two years ago, Starbucks measured risk using a macro-based model. "We would enter all our exposures and hedges into an Excel workbook, and then we'd run a macro that calculated value at risk [VaR] for the immediate- to near-term only," explains Shaun Hazen, manager of treasury and capital markets. "It was an algorithm that was created for banks. However, we needed to look at risks far beyond the near-term—we're hedging coffee 12 to 18 months into the future, in some cases—so we would scale the VaR out to two years."

The Starbucks treasury team would gather all the necessary data and run the macro once a quarter. It was a time-consuming process, and it generated results that often needed further analysis and refinement because the model wasn't designed for scaling, Hazen says: "For example, it would model coffee at prices that linearly extrapolated short-term results. But because the model was macro-based, we couldn't customize it."

Hazen joined the Starbucks treasury team at around the same time that Drew Wolff became the company's vice president of treasury and risk management. The pair brought a new perspective to financial risk management processes. "We were doing a lot of work trying to make this tool fit our business, but it was evident that there had to be more suitable alternatives for our needs," Wolff says. "The tool was signaling risk where we didn't feel there was risk, and vice versa. Coming up with an alternative approach took a new way of thinking about our financial risks."

They launched an initiative with dual goals: to improve the modeling of volatility in their longer-term simulations of FX and commodity risks, and to take a more comprehensive view of the company's overall exposures. "We wanted to build a model that we could present to the company's leaders in a way that would be actionable and understandable, and would make sense," Hazen says. "We wanted to be able to show the output to anyone—whether it's a coffee trader, the head of our channel development business, or our CEO—and know that they would see the inputs as reasonable, the outputs as meaningful, and they would recognize the potential impact to earnings."

Starbucks partnered with the University of Washington's Computational Finance and Risk Management program on developing a model of FX and commodity risks that would be comprehensive, accurate, and would be a leading indicator. By bringing a UW graduate student on board as an intern, the treasury team gained both the student's technical prowess and regular input from the director of the UW Computational Finance and Risk Management program.

"This is a cutting-edge program, and we've gained access to their experience," Hazen says. "It's a great example of how the right partnership can deliver the same value as hiring consultants. This is one of several projects we've collaborated on with the University of Washington that have paid great dividends."

The intern used R, an open-source software platform, to back-test different statistical models using Starbucks' own data. Then she advised the company on which model provided the best estimate of its actual exposure set over time. "She recommended a mean-reverting model, instead of the near-term VaR scaled out to two years," Hazen says. "This made sense, as it acknowledged that there's a limited range of reasonable expectations for commodity prices."

The company replaced its VaR approach with a model that evaluates "earnings at risk" for both FX and commodity exposures. The UW intern proved the reliability of the model from a lot of different angles, performing an extensive analysis across historical data sets in each area of exposure.

Starbucks continues to test the validity of the model, and to make adjustments as needed. For example, Hazen says, the team recently tweaked it to accommodate an accounting issue: "A unique feature of coffee as a commodity risk is that we hold coffee in inventory," he says. "There are certain accounting methods for how coffee coming into the warehouse affects our cost of goods sold. We adjusted the model to reflect the accounting elections we've made so that the output on the model would more closely reflect what we can actually expect to impact earnings 12 months or 24 months out."

Treasury still models financial risk on a quarterly basis, but the process takes much less time than in the previous environment. "The need to make further adjustments and refinements is less frequent than when we were using the macro-based model, which was very sensitive," Hazen says. "And we can run the new model in less than two weeks. That means we can update the model more frequently if we need to."

This also enables the treasury team to more effectively analyze why risks are moving in a certain way. "When we are hitting a sub-limit, for example, we can model that risk in real time," Wolff explains. "Previously, we would have to re-run the model excluding a certain commodity to see the effect that commodity was having on the model, and that took a lot of time. Now we can run multiple iterations very quickly. So if we take an action, we can quickly assess whether it was impactful. Risk modeling has become a more interactive process."

Instead of focusing on specific risk numbers, treasury now focuses on how risks are changing over time. "We look at risk at the beginning of the quarter, risk at the end of the quarter, and which variables changed," Hazen says. "If our risk increases, we can see whether it's because we've lowered our coverage on a commodity where risk is up, or because volatilities are higher, or because the correlations in the model have weakened. We can get to that level of detail since we have a good view of all the underlying data and calculations. And that makes for a more informed discussion when we meet with the business."

Today the treasury team presents financial risk information using stoplight-like indicators of market risk. The team also developed a measure of how much risk the company is eliminating for every dollar that it's hedged. "People frequently think of hedging as a free lunch: If they're hedged, they're fine," Wolff says. "But nothing's free. We look at hedging in a similar way to how we look at insurance; we evaluate whether we're getting a good value on the degree to which we're reducing risk. As a result, Starbucks executives feel they have a much better view of the true risks the company faces."

Another benefit of Starbucks' new model is that it consolidates information across FX and commodity exposures. The treasury team looks at each commodity and currency risk in isolation, but then backs out of that view to look at the positions as a portfolio. "That paints a much more realistic picture," Hazen says. "When there are FX headwinds, there are often offsets in the commodity space. A lot of times, a corporation will focus on the outlier that's moving against it, but will miss where it's benefiting.

"As an example, we've seen that in our exposures to specific currencies and to oil prices," he adds. "We saw our risk changing, almost in real time, from more commodity-based risk to foreign exchange. That kind of shift is what our portfolio approach to risk is able to demonstrate."

One of the ancillary benefits of this initiative is that it's brought together managers from across the company to talk about risk. "From what I've gathered in talking to other treasurers, there aren't a lot of other companies that have as good of a discussion with business leaders and senior finance executives," Wolff says. "At Starbucks, risk isn't something treasury comes up with in a vacuum. We're looking to make risk a true dialogue with the business. We discuss the impacts of financial risks on earnings per share, and we discuss the trends and the correlations between risks.

"Effective risk management requires a partnership across the company to get the 360-degree view," he concludes. "We've made a concerted effort to present risk information in a way that is understandable and actionable to the businesspeople, and we've made sure that the treasury team is getting out and meeting with leaders in sourcing and all lines of business. Shaun and I came from backgrounds outside treasury, which I think has helped us take an 'outside looking in' perspective with this project."

Staying on Top of Global Growth

Although Google is headquartered in Mountain View, California, the company makes more than half of its $75 billion in annual revenue outside the United States. So managing foreign exchange risk is a key responsibility for the Google treasury team.

In 2008, the company implemented a static FX risk management program to hedge cash flows in three currencies: the euro, the British pound, and the Canadian dollar. The cash flow hedging program was fairly prescriptive, locking in a fixed strategy based on timing.

As Google grew and its lines of business became more diversified, the program became less effective. Google began to need the ability to hedge exposures to additional currencies, including the Japanese yen and the Australian dollar. Also, given how much Google had grown, the program didn't have the flexibility to target risk mitigation levels, or to vary the amount that was hedged to meet the risk tolerance as market conditions changed. By 2014, the program wasn't dynamic enough to meet the future needs of the company and needed a systematic way of being a little more flexible.

The team set out to develop a more comprehensive approach to FX risk management. They started by analyzing the historical performance of their legacy hedging program and determining how its results compared with being unhedged, hedging with different instruments, and other possibilities. They evaluated which currencies they needed to protect. They considered whether the tenor was still optimal for hedges. And they looked at how much they were paying to mitigate FX risks.

Treasury involved financial planning and analysis (FP&A), investor relations, and accounting in the review of the hedging program. The team performed sanity checks to reassess what Google's risk appetite was and to better understand how well their cash flow hedging program was performing. This process helped educate management and the various internal business partners about FX risks and what the team was doing to mitigate them.

In particular, treasury had many conversations with investor relations about how shareholders were looking at FX exposures. The team looked at whether investors still value these types of programs, with the new non-GAAP constant currency reporting metrics that are starting to be used.

In addition to working on these analyses internally, Google treasury leveraged research staffs at some of its bank partners. The treasury team also undertook a peer benchmarking process designed to identify best practices and alternative approaches to FX hedging. They determined that many elements of Google's hedging program were still considered best practice, but that the program could do a better job of balancing the tradeoff between risks and cost to mitigate those risks. They also determined that they needed to increase the program's agility.

Google decided to add the Australian dollar and Japanese yen to its cash flow hedging program. As a result, the vast majority of the company's FX exposures are now covered. Google also built flexibility into the program. In the legacy program, the company used the same hedging strategy for all currencies, for all time periods, regardless of what was happening in the external environment. Now treasury has some discretion on how much risk to hedge, within limits set by the company's risk management policy.

The new approach paid dividends shortly after adoption. After the program was launched in 2014, a lot of the conversation was around the idea that FX volatility was no longer a concern, that central banks were controlling foreign exchange, and that the U.S. dollar would stay weak for the foreseeable future. But market conditions at the time made it an attractive entry point for Google to enter those hedges. Since then, the dollar has appreciated significantly with the new hedges performing as expected.

Tony Altobelli, assistant treasurer, notes that the company reviews its hedging strategy on a regular basis along with other key financial and risk strategies managed in treasury. "We are always looking for ways to stay on top of the markets, improve our policies and processes, and maintain a best-in-class approach to all of our financial and risk management programs at Google."