Risk Management Reports

June, 1999
Volume 26, No. 6
Reading Roundup

Some of the better articles on risk management in the past few months:

"Forewarned is Forearmed:" A well-written and thoroughly-researched monograph on identification and measurement in risk management, by Kimberley Birkbeck, of the Conference Board of Canada.

It is a good a single synthesis of the process (see Dilbert above as a caution!) as I have read. The author defines "integrated risk management," correctly identifying the goal of "maximum value to stakeholders" and uses numerous charts to illustrate her points on identification and measurement (from Standard Chartered Bank, Royal Bank Financial Group, NOVA Chemicals, Microsoft and Tillinghast-Towers Perrin). Telephone: 613-526-3280 or email: pubsales@conferenceboard.ca

"Organizing for Empowerment:" Written by Suzy Wetlaufer.

This article in the January-February 1999 issue of Harvard Business Review is an interview with Chairman Roger Sant and CEO Dennis Bakke of the Arlington, Virginia-based AES Corporation, a global electricity company. I groan when I hear the catch-word "empowerment" used, but AES has apparently employed it to extraordinary advantage. Consider a company that operates under four simple principles: "fairness, integrity, social responsibility, and fun." No mention of that other hoary phrase "shareholder value," thank goodness! It's a story of having everyone take responsibility for decisions and accountability for results: limited functional specialists; job rotation, use of qualification exams, and an innovative system of compensation (50% on technical factors and 50% on adherence to the four shared values). Corporate leaders are advisors, guardians of the principles, chief accountability officers, and encouragers. These two executives argue that "capitalism is in great jeopardy if people hold to the notion that a business exists to make money." It seems to work for all stakeholders, including shareholders, at AES. Roger Sant concludes that "Invariably, people will rise to the level of trust and dignity you invest in them. . . . Empowerment without values isn't empowerment." A remarkable article for all risk managers. Contact telephone: 617-496-1449 or email: custserv@hbsp.harvard.edu, Reprint Number 99109.

"Risky Business: Change and Challenge in the Modern Museum:" Chris Duble, of Fred C. Church Insurance.

A subscriber, sent me this article by I. Michael Heyman, the CEO and Secretary of the Smithsonian Institution, in Washington. It was published in the Winter 1998 issue of NEMA (New England Museum Association) News. Heyman challenges museums to take risks in both programming and resource-building, but with care, calling it "enlightened realism." He cites the critical role of the media in two recent situations for the Smithsonian, noting that the museum's role is to "engage rather than provoke our audiences." For a copy call NEMA et 617-242-2283.

"Thinking out of the Box:" A series of articles published by International Risk Management magazine in association with Zurich Insurance, describing the benefits of using advanced scenario planning for risk management.

As Pia Perkins, the editor states, "Envisioning the future is not just about extrapolating the trends of the past . . . but we need to be able to accommodate the unexpected . . . ." Some of the global alternative scenarios suggested by Peter Leyden and Peter Schwartz (see RMR 7/95 for a review of Schwartz's The Art of the Long View ) include "regionalization," "prolonged recession," and "re-emergence of dictatorships." Scenario analysis becomes the holistic way to assess risk. David Suzuki also offers a contrarian view of today's financial system: "People invest massive amounts of money buying money and then selling money to make more money, without adding anything to society or the environment. The problem is that money no longer represents anything tangible." Suzuki would be supportive of the AES Corporation way of doing things (see above). Put this on your reading list! Contact: +44-171-505-8173 or email piap@finance.emap.co.uk

"Risk, Time and Reversibility:" Last September Peter Bernstein sent me a copy of his paper for the 22nd Annual Lecture to The Geneva Association, in Paris, on October 1, 1998. It has now been published in the April 1999 issue of The Geneva Papers, Volume 24, Number 2.

As usual his cogent and pithy observations about the nature of risk, risk management, insurance and the stock market are worth studying. Consider the following: "views about the future are at the very center of economic activity. I mean that literally: nobody acts without a forecast." "We cherish the future rather than discounting it . . . ." "The demand for liquidity is a function of uncertainty." " . . . insurance is for pessimists, while the stock market is for optimists."

"Insurance itself contains no risk other than the solvency of the insurance company." "Risk and time are so intimately related that they are almost the same thing." "The planned society provided the illusion of a riskless society. . . . no society can escape the caprices of human nature." ". . . I replace my computer more frequently than I replace my business suits." Contact: +41-22-347-0937 or email: geneva.association@vtz.ch

"How Risky is Your Company?" Robert Simons, a professor at Harvard Business School, contributes new ideas to strategic risk management in the May-June 1999 issue of Harvard Business Review. He warns of the "paradox of success: in good times it's easy to forget about risk."

It's an admonition that we forget. When I ran Risk Planning Group from 1970 - 1985, I asked annually: "We made a profit this year: what are we doing wrong?" Simons suggests the use of a "Risk Exposure Calculator" that scores a qualitative response from senior managers for the likelihood of surprise in three major "pressure" areas: Growth: performance pressures, rate of expansion, inexperience of key employees; Culture: rewards for risk taking, executive resistance to bad news, level of internal competition; Information Management: transaction complexity and volume, gaps in diagnostic performance measures, degree of decentralized decision making Simons concludes with five questions on risk:

  • Have senior managers communicated the core values of the business in a way that people understand and embrace?
  • Have managers clearly identified the specific actions and behaviors that are off-limits?
  • Are diagnostic control systems adequate at monitoring critical performance variables?
  • Are your control systems interactive and designed to stimulate learning?
  • Are you paying enough for traditional internal controls?"

These sound like a mantra for risk managers. Contact: 617-496-1449 or email: custserv@hbsp.harvard.edu. It's reprint number 99311.

"Operating Risk Goes Systemic:" Ware Preston, a Marsh, Inc. vice president, has written a solid contribution to our understanding of operational risk in the Winter 1998-1999 issue of Viewpoint, the quarterly of the Marsh & McLennan Companies. He recognizes that operational risk can be systemic and encourages the use of scenario analyses for holistic risk assessment (see also Thinking out of the Box, above).

Risk assessment involves consideration of unintended consequences. Although I disagree with his emphasis on shareholder, rather than stakeholder, value, I agree that business continuity planning and crisis management will probably evolve as the central core of integrated risk management. Contact: 212-345-5644 or email: Ware_Preston@marshmc.com. His article is also on the website: www.marshmac.com

"Black Box: Annals of the Future:" Can a really sophisticated "black box" outperform the market, just as it defeated Gary Kasparov in chess?

Thomas A. Ross provides a partial answer in his fascinating history of the creation of such a "box" by physicists with the Prediction Company, in Santa Fe, New Mexico. It's in The new Yorker, April 26-May 3 issue. He recounts the convergence of physics and finance into what he calls "phynance," the evolution of our understanding of complex systems. But there is always a caveat: "Success in this endeavor can have paradoxical results. For one thing, success invites imitation, which in the world of black-box financial forecasting is a liability. Your edge is dulled as competitors pile onto your strategy, and if the strategy is too widely adopted it is no longer useful for playing the market; instead it becomes the market. To continue winning, one has to keep a few steps ahead of the competition." Contact: 800-825-2510 or website: www.newyorker.com. . . the wisest strategy for even the most dedicated of professional investors is to be concerned, not with the intrinsic value of the underlying assets, but to "beat the gun," as Keynes described it, by outguessing the valuation decisions that average opinion will be making. A single-minded focus on intrinsic value can get you nowhere unless other investors are at some time point going to agree with your appraisal. In this environment, however, the valuation of real productive assets in the marketplace readily becomes the victim of mass psychology. Peter L. Bernstein, "Risk, Time, and Reversibility," The Geneva Papers, Vol. 24, No. 2, April 1999.

Copyrightę 1999 by H. Felix Kloman and Risk Management Reports

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