Archive for the ‘Change Risk’ category

Keys to ERM – Adaptability

April 3, 2017

keys

Deliberately cultivating adaptability is how ERM reduces exposure to unexpected surprises.

There are four ways that an ERM program encourages adaptability:

  1. Risk Identification
  2. Emerging Risks
  3. Reaction step of Control Cycle
  4. Risk Learning

Many risk managers tell RISKVIEWS that their bosses say that their objective is “No Surprises”.  While that is an unrealistic ideal objective, cultivating Adaptability is the most likely way to approach that ideal.

More on Adaptability at WILLIS TOWERS WATSON WIRE.

New Year’s ERM Resolution – A Risk Diet Plan

December 31, 2014

Why do you need an aggregate risk limit?

For the same reason that a dieter needs a calorie limit.  There are lots and lots of fad diets out there.  Cottege Cheese diets, grapefruit diets, low carb, low fat, liquid.  And they might work, but only if you follow them exactly, with absolutely no deviation.  If you want to make some substitution, many diets do not have any way to help you to adapt.  Calories provide two things that are desparately needed to make a diet work.  Common currency for substitutions and a metric that can be applied to things not contemplated in the design of the diet.

So if you do a calorie counting diet, you can easily substitute one food for another with the same calorie count.  If some new food becomes available, you do not have to wait for the author of the diet book to come up with a new edition and hope that it includes the new food.  All you need to do is find out how much calories the new food has.

The aggregate risk limit serves the exact same role role for an insurer.  There may be an economic capital or other comprehensive risk measure as the limit.  That risk measure is the common currency.  That is the simple genius of VaR as a risk metric.  Before the invention of VaR by JP Morgan, the risk limit for each risk was stated in a different currency.  Premiums for one, PML for another, percentages of total assets for a third.  But the VaR thinking was to look at everything via its distribution of gains and losses.  Using a single point on that distribution.  That provided the common currency for risk.

The diet analogy is particularly apt, since minimizing weight is no more desirable than minimizing risk.  A good diet is just like a good risk tolerance plan – it contains the right elements for the person/company to optimum health.

And the same approach provided the method to consistently deal with any new risk opportunity that comes along.

So once an insurer has the common currency and ability to place new opportunities on the same risk basis as existing activities, then you have something that can work just like calories do for dieters.

So all that is left is to figure out how many calories – or how much risk – should make up the diet.

And just like a diet, your risk management program needs to provide regular updates on whether you keep to the risk limits.

 

Supporting Success with Risk Management

May 12, 2014

Risk Management is often seen as the Business Prevention Department and the Chief Risk Officer as the Wizard of NO.

But in some ways that can be seen as a glass half full, half empty sort of thing.

A major and sometimes neglected aspect of risk management relates to dealing with the planning for and execution of major changes.  We call this CHANGE RISK MANAGEMENT.

If we think of the Control Cycle as the major manifestation of risk management, Change Risk Management is the special process that is followed to make sure that important new things get on to the Control Cycle without stumbling.

Many times, these changes are the future of the company.  They are the new products, new distribution systems, new territories and acquisitions that will change the course of the company’s path forward.

The Change Risk management process can be performed as Business Prevention or it can be a support to the success of the company.  A good Change Risk Management process will help to identify the ways that the new activity might fail or might harm the firm.  If the Change Risk Management process is designed properly, the Risk Management inputs of that sort can be brought into the process in plenty of time to correct the problems that cause the concerns.  In that sense, fixing those problems adds to the potential success of the company.

But if Risk Management is brought very late to the process, many people have become invested in the change as it is currently planned and any input from risk management that something might go wrong is seen as an attempt to scuttle the project.

Listingship

So timing and attitude are the two things that make the Change Risk Management process something that supports the success of the company.

 

 

The biggest Risk is that the rules keep changing

December 27, 2013

RISKVIEWS played the board game Risk Legacy with the family yesterday.  We were playing for the 8th time.  This game is a version of the board game Risk where the rules are changed by the players after each time playing the game.  Most often, the winner is the person who most quickly adapts to the new rules.  Once the other players see how the rules can be exploited, they can adapt to defend against that particular strategy, but at the same time, the rules have changed again, presenting a new way to win.

This game provides a brilliant metaphor for the real world and the problems faced by business and risk managers in constantly having to adapt both to avoid losing and to find the path to winning.  The biggest risk is that the rules keep changing.  But unlike the game, where the changes are public and happen only once per game, in the real world, the changes to the rules are often hidden and can happen at any time.

Regulators are forced to follow a path very much like the Risk Legacy game of making public changes on a clear timetable, but  competitors can change their prices or their products or their distribution strategy at any time.  Customers can change their behaviors, sometimes drastically, most often gradually without notice.  Even the weather seems to change, but we are not really sure how much.

Meanwhile, risk managers have been forced into a universe of their own design with the movement towards heavy metal complex risk models.  Those models are most often based upon the premise that when it comes to risk, things will not change.  That the future will be much like the past and in fact, that even inquiring about changes may be difficult and may therefore be discouraged due to limited resources.

But risk can be thought of as the tail of the cat.  The exact path of the cat is unpredictable.  The rules for what a cat is trying to accomplish at any point in time keep changing.  Not constantly changing, but changing nonetheless without warning.  So imagine trying to model the path of the cat.  Now shift to the tail of the cat representing the risk.  The tail has a much wider and more unpredictable path than the body of the cat.

That is not to suggest that the path of the tail (the risk) is wildly unpredictable.  But keeping up with the tail requires much more than simply extrapolating the path of the cat from the recent past.  It requires keeping up with the ever changing path of the cat.  And the tail movement will often represent the possibilities for changes in the future path.

Some risk models and risk management programs are created with recognition of the likelihood that the rules will change, sometimes even between the time that the model assumptions are set and when the model results are presented.  In those programs, the models are valued for their insights into the nature of risk, but of the risk as it was in the recent past.  And with recognition that the risk that will be will be somewhat different because the rules will change.

Real Resilience is not what you think it is

January 30, 2013

There is confusion about the term Resilience.  To many people, it means the ability to withstand stress. To some people, the ultimate resilience comes from thick walls (or huge capital requirements).  The picture above is one of many thousands like it that shows the ultimate result of seeking resilience in a static manner.

The dictionary has something slightly different:

the power or ability to return to the original form, position, etc., after being bent, compressed, or stretched; elasticity.

But Holling, a prominent ecologist, suggests something much more robust.  He suggests that a resilient species will survive all of the stressors that attack it from its environment and thrive when conditions become benign.

“a major strategy selected is not one maximizing either efficiency or a particular reward, but one which allows persistence by maintaining flexibility above all else. A population responds to any environmental change by the initiation of a series of physiological, behavioral, ecological, and genetic changes that restore its ability to respond to subsequent unpredictable environmental changes. Variability over space and time results in variability in numbers, and with this variability the population can simultaneously retain genetic and behavioral types that can maintain their existence in low populations together with others that can capitalize on opportunities for dramatic increase. The more homogeneous the environment in space and time, the more likely is the system to have low fluctuations and low resilience.”  CS Holling, Resilience and Stability of Ecological Systems

Real resilience is ADAPTABILITY.  The ability to change your approach.  To find the way to survive the extreme adverse scenario without devoting so much resources to safety that you miss the chance to “capitalize on opportunities for dramatic increase” as Holling says.

Does your ERM program build walls, thicker and thicker, or does it build adaptability?

How many people in your organization do you think would know what to do in the event of an adverse situation that has never happened before?

But what is this adaptablity?  In two studies in the late 1990’s, researchers studied thousands of crisis situations and identified 8 dimensions of adaptability for individuals.  See study here.

Handling emergencies or crisis situations

Reacting with appropriate and proper urgency in life threatening, dangerous, or emergency situations; quickly analyzing options for dealing with danger or crises and their implications; making split-second decisions based on clear and focused thinking; maintaining emotional control and objectivity while keeping focused on the situation at hand; stepping up to take action and handle danger or emergencies as necessary and appropriate.

Handling work stress

Remaining composed and cool when faced with difficult circumstances or a highly demanding workload or schedule; not overreacting to unexpected news or situations; managing frustration well by directing effort to constructive solutions rather than blaming others; demonstrating resilience and the highest levels of professionalism in stressful circumstances; acting as a calming and settling influence to whom others look for guidance.

Solving problems creatively

Employing unique types of analyses and generating new, innovative ideas in complex areas; turning problems upside-down and inside-out to find fresh, new approaches; integrating seemingly unrelated information and developing creative solutions; entertaining wide-ranging possibilities others may miss, thinking outside the given parameters to see if there is a more effective approach; developing innovative methods of obtaining or using resources when insufficient resources are available to do the job.

Dealing with uncertain and unpredictable work situations

Taking effective action when necessary without having to know the total picture or have all the facts at hand; readily and easily changing gears in response to unpredictable or unexpected events and circumstances; effectively adjusting plans, goals, actions, or priorities to deal with changing situations; imposing structure for self and others that provide as much focus as possible in dynamic situations; not needing things to be black and white; refusing to be paralyzed by uncertainty or ambiguity.

Learning work tasks, technologies, and procedures

Demonstrating enthusiasm for learning new approaches and technologies for conducting work; doing what is necessary to keep knowledge and skills current; quickly and proficiently learning new methods or how to perform previously unlearned tasks; adjusting to new work processes and procedures; anticipating changes in the work demands and searching for and participating in assignments or training that will prepare self for these changes; taking action to improve work performance deficiencies.

Demonstrating interpersonal adaptability

Being flexible and open-minded when dealing with others; listening to and considering others’ viewpoints and opinions and altering own opinion when it is appropriate to do so; being open and accepting of negative or developmental feedback regarding work; working well and developing effective relationships with highly diverse personalities; demonstrating keen insight of others’ behavior and tailoring own behavior to persuade, influence, or work more effectively with them.

Demonstrating cultural adaptability

Taking action to learn about and understand the climate, orientation, needs, and values of other groups, organizations, or cultures; integrating well into and being comfortable with different values, customs, and cultures; willingly adjusting behavior or appearance as necessary to comply with or show respect for others’ values and customs; understanding the implications of one’s actions and adjusting approach to maintain positive relationships with other groups, organizations, or cultures.

Demonstrating physically oriented adaptability

Adjusting to challenging environmental states such as extreme heat, humidity, cold, or dirtiness; frequently pushing self physically to complete strenuous or demanding tasks; adjusting weight and muscular strength or becoming proficient in performing physical tasks as necessary for the job.

The questions that remains are:

Is adaptability of a company anything different from adaptability of the people in the company?

How does a company get adaptable people?  Are people born that way or can they be trained?

The Risk Embedded in Competitive Advantage

July 13, 2011

The term Competitive Advantage is popular with management gurus.  On the website, QuickMBA, they describe Michael Porter’s ideas on the topic as:

A Competitive Advantage exists when a firm is able to deliver the same benefits as competitors but at a lower cost (cost advantage) or deliver benefits that exceed those of competing products (differentiation advantage).  Thus a competitive advantage enables the firm to create superior value for its customers and superior profits for itself.

This is a major objective of most firms in a capitalist system, an objective far more desirable than risk and reward.  Going into the competitive marketplace and taking risks to get profits is a commodity approach to business.  That is why Market Consistent accounting regimes seek to show this activity as less desirable by recognizing those profits later.  Profits created by competitive advantage are reported immediately.

Once a firm has found a competitive advantage, they will seek to make it a sustainable advantage.  If the advantage is significant enough, they will also seek to eliminate all risk; turning it into a pure rent seeking activity.  In many cases, the managers of the business start to think of this as a PERMANENT RISK FREE BUSINESS.  

And that is risk that is embedded in Competitive Advantage.  It is a risk that comes with long experience with a favorable outcome.  Every day that goes by collecting those rents makes it harder and harder for employees and management to even imagine that there is any risk that the gravy train will stop.

Henry Ford had that sort of position until Sloan’s General Motors took advantage of Ford’s inability to imagine a different way of doing business than his “any color you want as long as it is black” approach.  IBM had that permanent risk free look 30+ years ago when everyone said that “no one ever got fired for recommending that the company buy IBM” for its computer needs.  Microsoft looked that way 10 years ago as well.  At the time that Microsoft was losing suits about their monopolistic behaviors, Gates was predicting Microsoft’s competition.  And he was right.

A business is not safe from this just because it is not a world dominating franchise.  Companies with small niches where they dominate have the exact same situation.

this does not mean that such competitive advantages are not a good goal for a business.  But it does mean that once you find one and you do the natural thing of eliminating risk to turn that business in a pure rent collection, there is always that one risk that you cannot eliminate.

10 ERM Questions from an Investor – The Answer Key (3)

July 8, 2011

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:

3.  The answer to this question requires several parts of risk management to be right.  First of all, the answerer needs to know which risk position grew the most.  Second of all, in a good risk management program, the position that grew the most should have had by far the most scruitny.  High growth does not always spark big blow ups, but big blow ups are always preceded by high growth.  A firm that is not paying lots and lots of attention to its fastest growing risk is not going to end up with good results.  The highest growth positions require a disproportionate large amount of attention, but most often they get a disproportionately smaller share of attention.  Risk management budgets are determined based upon the business at the start of the year.  Finally, to answer the question, the firm needs to have someone who they can immediately identify who is responsible for that risk.  Best practice is to have a senior person responsible for each major risk.  That should be a business person, not the CRO or CFO.  If it is not the same person who is responsible for sales and profits, then management has set up a fight.  On one side is the person responsible for bringing in the business and for achieving profits.  On the other side is the person responsible for preventing losses.  Not a fair fight in most firms.

In the end, the best practice firms recognize that in situations of great change, there needs to be a special ERM process that exceeds the regular ERM process.


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