Ponzi and Rolling Stone Risk Management

Managers of some firms just know that they do not need that risk management stuff.

They can tell because they have positive cash flow.

A firm with positive cannot possibly go out of business.  They know that.

Many young firms that are growing quickly utilize this sort of thinking to put off any development of risk management.  Because they just know that risk management would create real risk.  Risk management could put a stop to the positive cash flow.

Early in its history, insurance carriers thought that this positive risk management idea was just great.  It was so easy to keep the cashflow positive for an insurer.  Steady growth helped.  And the natural process of collecting premiums now and paying out claims later helped even more.

But then some spoilsport came along and ruined things and discovered the idea of reserves.

So the game had to shift to positive net income risk management.  As long as your net income was positive, there was no problem.  That sort of risk management created tensions between the positive net income folks and the actuary setting the reserves.  But many firms found a way around that and could set lower reserves and keep up the Ponzi Risk Management for a few more periods.

But periods of slower growth, due to economic slow downs or other issues were especially troublesome for the Ponzi Risk Management firms.  Or like its namesake, the real Ponzi scheme, Ponzi Risk Management runs into trouble as soon as the flow of new customers slows for any reason.

A variation on Ponzi RIsk Management is the Rolling Stone Risk Management.  Under Rolling Stone Risk Management, the firm keeps acquiring new smaller firms.  The chaos that exists through the transition is good to hide the waning growth and fundamental unprofitability of the Rolling Stone company.  If they can keep rolling, they gather no Loss.

But Rolling Stone risk management requires larger and larger acquisitions to be big enough to hid all of the prior sins because the backlog of problems keeps getting larger and larger.  And the compulsion to acquire means that the Rolling Stone company pays more and more for the acquisitions because those purchases are really a life and death matter for them.  They desperately need more Good Will to amortize.

But to be slightly clearer, Ponzi Risk Management is not real risk management.

The difference between Ponzi Risk Management and real Risk Management is that real Risk Management provides protection to firms that are growing and to firms that are not growing.  Real risk management means that the risk manager has taken into account the risks of the firm in both a going concern basis to help to maximize value of the firm as well as the potential risks of a stoppage of growth.  Real risk management means that the firm has made provision, not just for the profitability of most parts of the business on a stand alone, more or less static basis, they have also made sufficient provision for the risks of that business both in terms of margin to compensate the firm for the risks and to provide a cushion against the fluctuations of profitability and even the extreme loss potential of that business.

Explore posts in the same categories: Growth, Risk Management


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