Outside the Box – 10 ERM Questions from an Investor – The Answer Key (4)

Riskviews was once asked by an insurance sector equity analyst for 10 questions that they could ask company CEOs and CFOs about ERM.  Riskviews gave them 10 but they were trick questions.  Each one would take an hour to answer properly.  Not really what the analyst wanted.

Here they are:

  1. What is the firm’s risk profile?
  2. How much time does the board spend discussing risk with management each quarter?
  3. Who is responsible for risk management for the risk that has shown the largest percentage rise over the past year?
  4. What outside the box risks are of concern to management?
  5. What is driving the results that you are getting in the area with the highest risk adjusted returns?
  6. Describe a recent action taken to trim a risk position?
  7. How does management know that old risk management programs are still being followed?
  8. What were the largest positions held by company in excess of risk the limits in the last year?
  9. Where have your risk experts disagreed with your risk models in the past year?
  10. What are the areas where you see the firm being able to achieve better risk adjusted returns over the near term and long term?

They never come back and asked for the answer key.  Here it is:

4.  The outside the box risks, also called emerging risks, are the things that will ultimately cause the largest losses.

Once a health insurer CEO who was belligerently opposed to thinking about the world changing in any material way said that they did not think that a pandemic would be a concern for their business.  Find out why at the bottom of this post.

They are the new competitors, new laws, wars, financial market flops, government defaults, hurricanes, earthquakes, volcanoes and so on that could throw your business for a loop.  In the past three years, it is hard to imagine a firm that has not been negatively impacted by one or more likely several of the mostly unforeseen calamities from that list or otherwise.  It is also hard to imagine a board that is happy with a management team that does not have a few emerging risks in their sights.  When this question is answered, however, the trick is to notice whether management thinks of themselves as hapless victims of these sorts of things or as masters of their own fate who will take the steps needed to anticipate and prepare for such things.  Generally the market gives a pass to the firms who suffer losses from such major events, but investors should prefer the firms who will not need that pass.

This is usually a very easy question for management to answer – but the answer will be very telling about how seriously that they take the idea of seeking to manage emerging risks.  The most common answer will usually be the emerging risk that was last on the cover of Time or some other popular magazine.  So when you get that sort of answer, you know that management cannot think outside the box.  Then you need to listen to hear if they have done anything other than read the Time article to prepare.  One CRO once went so far as to say that the CEO worried about emerging risks almost every day while he drove to and from the office.

But while those answers are easy, they are not good answers.  An emerging risks program is probably better if it involves some staff time, in the office, if they have taken the trouble to determine how badly some of the possible emerging risks might hurt them, and figured out what that they might do. A good answer indicates that management’s plan is not to settle for that pass that the market gives to the unprepareds.

Back to that health insurer CEO, his excuse for not worrying about a pandemic, even though his business was directly effected by fluctuations in health care costs, was to suggest that the scenario in the case of a pandemic would be that the hospital beds, that were already at over 90% utilization in his area, would fill up fast – and then no one else could get treated by the hospitals – so there was a cap on the amount that hospitals could possibly bill!  His plan was a variation on Marie Antoinette – let them die at home (untreated).  He hadn’t checked with any of the hospitals in his coverage area to find out what their plans were or even what they thought that their maximum capacity actually was in the event of a pandemic.  He didn’t check to see if there were public health plans that would have converted schools and firehouses into clinics.  Not did he imagine what the reputational risks were to going into a pandemic with no plan whatsoever.

Those firms whose emerging risks thinking comes from the cover of Time magazine are doubtless going to be followers as far as response to the emerging risks goes.  They will wait and see what different other similar businesses are doing and follow someone whose response that they think that they can at look like they are doing.  They will be unable to follow the prepared firms.  They will find that the best responses may have become much more expensive in the event of a broad emergency.  And they will be looking around for that pass from investors.

The health insurers who were actually preparing for a pandemic decided to become a proactive part of the solution.  They send information about pandemics to their insureds, they participated in public health preparedness in their area, they planned for how to keep their business going with 25% of their employees sick and many of the rest afraid to come to work.

Even in the case of the front cover of the magazine emerging risks, there is a huge difference between the answers of a prepared firm and an unprepared firm.  A difference that you can easily discern if you ask this question.

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