Archive for September 2014

Communicating with CEOs

September 24, 2014

 The point of communication isn’t to speak. It’s to be heard and understood — to have influence and motivate action. Effective communication requires knowing what information you want to convey and what action you want to motivate, but that’s not enough. You must also know your audience — in this case CEOs—well enough to determine what factors will truly resonate and motivate them to take the desired action based on your information.

CEO’s often are not thinking about their key decisions in the same statistical terms that a risk manager or other quantitative analyst would favor.   Several different studies show that most experienced decision makers do not apply statistical thinking either.  Instead they apply a natural decision making process assisted liberally by heuristics. 

CEO’s and other leaders also commonly have different perspectives on priorities than risk managers and analysts.  Analysts will tend to see the world “realistically” with a balance between risks and rewards, while CEO’s may have reached their position, in part, because they see the world “optimisticslly” as containing plenty of opportunities where rewards are much more likely than overstated risks.  Of course, from the perspective of the CEO, the analysts are “pessimistic” and they themselves are “realistic”. 

To communicate with CEO’s, risk managers and analysts need to learn to frame the results of their work in terms that make sense to CEO’s.  That will often be in terms of Natural Decision Making, Heuristics and Opportunities. 

For more on this topic, see Actuarial Review “How to Talk to a CEO“. 

 

Risk Culture, Neoclassical Economics, and Enterprise Risk Management

September 22, 2014

Pyramid_of_Capitalist_System copyFinancial regulators, rating agencies and many commentators have blamed weak Risk Culture for many of the large losses and financial company failures of the past decade. But their exposition regarding a strong Risk Culture only goes as far as describing a few of the risk management practices of an organization and falls far short of describing the beliefs and motivations that are at the heart of any culture. This discussion will present thinking about how the fundamental beliefs of Neo Classical Economics clash with the recommended risk practices and how the beliefs that underpin Enterprise Risk Management are fundamentally consistent with the recommended risk management practices but differ significantly from Neo Classical Economics beliefs.

Hierarchy Principle of Risk Management

September 8, 2014

The purpose of ERM is NOT to try to elevate all risk decisions to the highest possible level, but to master discerning the best level for making each risk decision and for getting the right information to the right person in time to make a good risk decision.

This is the Hierarchy Principle as it applies to ERM.  It is one of the two or three most important principles of ERM.  Why then, might you ask, haven’t we ever heard about it before, even from RISKVIEWS.

But most insurers follow the hierarchy principle for managing their Underwriting process for risk acceptance of their most important risks.  

You could argue that many of the most spectacular losses made by banks have been in situations where they did not follow the hierarchy principle.  

  • Nick Leeson at Barings Bank was taking risks at a size that should have been decided (and rejected) by the board.
  • Jerome Kerviel at Soc Gen was doing the same.
  • The London Whale at JP Morgan is also said to have done that.  

On the other hand, Jon Corzine was taking outsized risks that eventually sank MF Global with the full knowledge and approval of the board.  Many people suggest that the CRO should have stopped that.  But RISKVIEWS believes that the Hierarchy Principle was satisfied.  

ERM is not and cannot be held responsible for bad decisions that are made at the very top of the firm, unless the risk function was providing flawed information that supported those decisions.  If, as happened at MF Global, the board and top management were making risk decisions with their eyes fully open and informed by the risk function, then ERM worked as it should.  

ERM does not prevent mistakes or bad judgment.

What ERM does that is new is that

  1. it works to systematically determine the significance of all risk decisions, 
  2. it ranks the significance and uses that information, along with other information such as risk velocity and uncertainty, to determine a recommendation of the best level to make decisions about each risk,
  3. it assesses the ability of the firm to absorb losses and the potential for losses within the risks that are being held by the firm at any point in time,
  4. it works with management and the board to craft a risk appetite statement that links the loss absorbing capacity of the firm with the preferences of management and the board for absorbing losses.

ERM does not manage the firm.  ERM helps management to manage the risks of the firm mainly by providing information about the risks.  

So why have we not heard about this Hierarchy Principle before?  

For many years, ERM have been fighting to get any traction, to have a voice.  The Hierarchy Principle complicates the message, so was left out by many early CROs and other pioneers.  A few were pushing for the risk function to be itself elevated as high as possible and they did not want to limit the risk message, deeming everything about risk to be of highest importance. But RISKVIEWS believes that it was mostly because the Hierarchy Principle is pretty fundamental to business management and is usually not explicitly stated anywhere else, even though it is applied almost always.

ERM now receives a major push from regulators, to a large extent from the ORSA.  In writing, the regulators do not require that ERM elevate all risk decisions.  But in practice, they are seeing some insurers who have been elevating everything and the regulators are adopting those examples as their standard for best in class.  

Just one more way that the regulatory support for ERM will speed its demise.  If regulators advocate for consistent violation of the Hierarchy principle, then ERM will be seen mainly as a wasteful burden.  

 

Risk Culture and Enterprise Risk Management (1/2 Day Seminar)

September 2, 2014

Afternoon of September 29 – at the ERM Symposium #ERMSYM

Bad risk culture has been blamed as the ultimate source of problems that have caused gigantic losses and corporate failures in the past 10 years. But is that a helpful diagnosis of the cause of problems or just a circular discussion? What is risk culture anyway? Is it a set of practices that a company can just adopt or does culture run deeper than that? How does risk culture vary between countries and continents? How do risk cultures go bad and can they be fixed? This is, of course, a discussion of the human side of Enterprise Risk Management. 

This half-day seminar (1 – 4:30 p.m.) will draw together materials from business organizational theorists, anthropologists, regulators, rating agencies, investors, corporations, insurers and auditors to help define risk culture and diagnose problem causes. The objective is to provide the attendees with multiple perspectives on risk culture to help them to survive and thrive within the potentially multiple risk cultures that they find themselves operating alongside – or against. In addition, the speakers will draw upon their own experiences and observations to provide a number of practical examples of how risk cultures can and do go wrong. This discussion may help you to identify the signs of devolving risk culture if they start to appear in your organization. Finally, the difficult topic of fixing a bad risk culture will be discussed. That part of the discussion will help attendees to attain a realistic perspective on that extremely difficult process. 

The seminar will be presented by three speakers from very diverse backgrounds. Andrew Bent, Risk Coordinator for Suncor Energy Inc. has also worked in multiple levels of government in New Zealand and Canada. Bent has co-authored several articles and papers on strategic risk assessment and the use of root cause analysis in risk management. Carol Clark is Senior Policy Advisor at the Federal Reserve Bank of Chicago where she has most recently been focused on operational risk issues associated with high speed trading. Her research has been published in the Journal of Payment Systems Law, the Federal Reserve Bank of Chicago’s Chicago Fed Letter and Economic Perspectives as well as Euromoney Books. Dave Ingram is Executive Vice President at Willis Re where he advises insurers on ERM practices. Ingram has worked extensively with both Life and Property and Casualty insurers on various aspects of risk management over the past 30 years. He has recently co-authored a series of articles and papers on risk culture and has had a number of experiences with the risk cultures of over 200 insurers.

Speakers: 
Andrew Bent, ARM-E, ARM-P, CCSA, CRMA, Risk Coordinator, Suncor Energy
Carol Clark, Senior Policy Advisor, Federal Reserve Bank of Chicago 
David Ingram, CERA, PRM, EVP, Willis Re

Registration


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