Risk Management Reports

December 1996
Volume 23, Number 12

Strategic Risk Management
Strategic risk management is beginning to coalesce as a practical multi-disciplinary function in major organizations. It's been dragging its feet for too long, but the movement may be now irresistible. I first raised the idea thirteen years ago, in a speech to a Management Centre Europe conference in London, and later published it in Risk Management, March 1984, as "Risk Management: 1990 and Beyond." I suggested then that "within the next ten years, risk managers, in many organizations, will be highly placed officers, perhaps even senior officers, reporting to the chief executive officer or to the Board. They will have a broad mandate to review all forms of risk and to develop plans to respond to changing uncertainties."

My prediction was roughly accurate, but premature. Today the idea of an integrated function has been born. One of the best examples comes from Canada. The Executive Vice President, Risk Management, for the Royal Bank Financial Group (RBFG), in Toronto, Murray Corlett, heads a worldwide group of 425 staff responsible for all forms of corporate risk. He discussed his program in a speech at the Canadian Risk & Insurance Management Society meeting in Montreal on September 26.The Bank's recognition that fragmented system of risk management was simply "not good enough" was the genesis of the new program.

RBFG operates a bank, trust company, and securities, insurance and mutual fund operations in 200 countries. Its integrated risk management function , now three years old, is "intimately involved with the strategy of the organization." Corlett reports to the Chairman and CEO, a relationship fundamental to the success of the function. He chairs a Risk Management Committee composed of representatives of all operating groups. It sets corporate risk management policy. Its goal is "to ensure effective risk management groupwide, working in partnership with the businesses, geographies, and functions" to enhance the "risk-return equation."

The "risk framework" of RBFG is similar to those previously described in Risk Management Reports (January 1994; March, September, and November 1996). It is reproduced in the preceding diagram.

It is all-inclusive. Beginning with "Systemic" risks at Level 1, it moves to "Competitive," "Reputational," and "Regulatory/Legislative" risks at Level 2, and finally to "Credit," "Market," "Operating," and "People" risks at Level 3.

While the RBFG framework is expressly adapted to a major global financial institution, its outline should fit any organization, with modification. The Group has completed its first three year plan and will meet in January 1997 to develop its next triennial agenda. A major issue will be to integrate risk assessment systems for operating risks.

Corlett attributes the progress at Royal Bank to the meetings of the Risk Policy Roundtable of Robert Morris Associates and the Council of Risk Management of the Canadian Conference Board. H eis also a prime mover in the newly-developed Global Council on Risk Management, also a Conference Board initiative. He will be a speaker at an Aviation Safety Conference in Washington in January 1997. While this may appear some distance from his experience in a financial institution, Corlett is a believer in the importance of cross-pollination in the development of risk management. As he says, his internal group is "increasingly eclectic."

The role of risk management within RBFG is simple: "identify and assess risk; ensure that it's managed; monitor results." My belief that risk management is essentially common sense shows in the simplicity of the Royal Bank approach.

Risk management is present in all functions and activities, including interest rate swaps, brand management, new product launches, major capital expenditures, and board room decisions. Risk management should be a regular agenda item at board meetings. At Bass, we have combined the internal audit and risk management functions to form a group-wide major business risk process. We prioritize the risks and develop action plans and timetables.

Philip Thomas, Director of Risk Management, Bass Plc, as quoted in

The Minet Report, October 1, 1996

Negative Comments
Risk managers concerned with the security of their counterparties and the breadth of protection in their risk financing arrangements face difficult choices. The older and traditional avenue for most operational and liability risks is the insurance and reinsurance market. The newer and unconventional approach is through capital markets. Both have warts.

The non-life (or property/casualty, as it is known in the US) insurance industry faces a gloomy forecast. Myron Picoult, the acerbic industry commentator and analyst from Wasserstein Perella Securities, Inc., in New York, wrote recently in Business Insurance that "the industry's fundamental outlook can only be described as poor. Commercial insurance prices are under increasing pressure, and contract terms and conditions are being subjected to varying degrees of tinkering. In short, underwriting practices in the commercial sphere are deteriorating." He believes the market is over-populated with insurers. This leads to a "polarization between stronger and weaker companies."

"Capital is inefficiently distributed among the many industry participants," and "with few exceptions, most property/casualty companies do not control their distribution systems." These two factors, in Picoult's opinion, make it impossiblefor insurers to control their premium volumes and costs. I believe this prognosis is correct. Can a risk financing director really depend on the insurance market? Is it headed for greater instability? Will there be more CIGNA-like spin-offs of "bad" companies, to the disadvantage of policyholders?

Will unrealistically low prices lure risk financing officers to buy "cheap" insurance when they should be spending more on retentions and more solid credit? It's a gloomy picture.
The other side is equally unpromising. The optimists point to the incredible resources of capital markets and suggest that the products of these markets could replace conventional insurance. Ned Bowers, of Marsh & McLennan Financial Markets, Inc., argued in the August 1996 issue of Captive Insurance Company Reports that it's a matter of comparative resources: "it's a numbers game. The top 25 U.S. companies made $82 billion in net income last year, while the entire U.S. insurance industry made only $20 billion." The chart puts these resources into perspective.

Yet with these enormous capital market resources, buyers have yet to see many concrete risk financing arrangements. There is much talk but little public action. The critical factors of tax treatment, counterparty reliability and accounting oversight cause many schemes to be eliminated from active consideration. Many seem to be only salespersons' ploys or wishful thinking, rather than realistic solutions to long-term risk financing problems.

The organizational risk manager is caught between an insurance and reinsurance industry that appears unable to overcome its latent weaknesses and an incipient capital market with ample resources but insufficient workable plans. Is internal retention the only safe means of risk financing?

More often than not, political speech is about the complete denial of reality. It's about putting a happy face on dark situations. So the possibilities for comedy are endless. Politicians are funny the way parents are funny: because they're not supposed to be.

Douglas McGrath, as quoted by David Remnick, "The Jim Carrey of Politics," The New Yorker, October 21 & 28, 1996

Crime, Computers and Women
Seventeen days traveling to California and Washington gave me a fresh appreciation of certain aspects of risk management. Insight comes from travel and its new perspectives.

First, crime. We complain vigorously about the frequency and severity of lawlessness, in spite of recent reductions in criminal activity. We read the headline stories of drive-by shootings, office assaults, molesters preying on children, and scams defrauding the aged and the unwary. Our national consciousness of our criminal propensity has stimulated both police and better policing. I saw an example of this walking along the Oakland Estuary one afternoon. A group of thirty police officers, all clad in shorts, were learning how to handle mountain bikes in preparation for their duties in neighborhood law enforcement. They appeared reasonably fit, hardly the stereotype of the overweight policeman. I stopped to talk with one officer. He explained that being on bicycles made police officers more approachable than when in cars, while still having mobility, both important pieces of neighborhood policing, the newest idea in crime prevention. Isn't this a return to the basic precepts of Sir Robert Peel and his "bobbies" in England in the nineteenth century? Nevertheless, the bicycle police officers of Oakland were a refreshing example of an innovative response to crime.

Second, computers. The pages of computer and software advertising in U.S. newspapers are clear evidence that this new technology has enveloped our lives. Ten years ago, my family had no computers at home; today we have four: an Apple Mac Performa for this publication, an unused Mac Powerbook, a Compaq that my wife uses for transcribing in Braille for the blind, and her Mac SE, comparable to a Model T Ford, on which she writes her novels. My fresh look at the computer generation came from a lunch with my personal computer guru, Allen Munroe, in Larkspur, California. Allen is far more computer literate than me. He manages one of the best risk management Web sites: http://www.riskinfo.com. It's also the Risk Management Reports site, where you can find electronic copies of all of the 1996 issues of RMR. RiskInfo houses other publications, like Practical Risk Management and Smart's, a review of the California insurance scene, as well as an on-going RiskForum.. I acknowledge that I am still scratching the surface of the new medium of the Internet and that Allen is light years (or at least five years) ahead of me. He reminds me that our rapid transition into an information economy carries with it increased uncertainties as well as awesome opportunities.

We tend to overlook the risks, the fears and uncertainties inherent in a major technological, economic, and social revolution, lured by its promised riches. Jobs will be destroyed, but new ones will spring up. On my flight west I read the World Market Survey in The Economist ("The Hitchhiker's Guide to Cybernomics," September 28, 1996). Allen's forecasts reminded me of the costs as well as the benefits of this transition to an information technology society.

What will happen to our old-fashioned knowledge dispensers: lawyers, accountants, consultants, insurance agents and brokers?

Are they destined to become "the modern counterparts of weavers, whose incomes soared after spinning was mechanized, only to crash when new machines emulated their own craft?" If the Internet, through Web sites and discussion groups, can provide immediate and continuous access to peers and specialists, do we need to hire these service providers at their outrageous fees? If we can reach banks, insurance companies, and capital markets through the Internet, why pay high commissions to intermediaries?

The Economist's answer: the lazy, slow and less educated will suffer the fate of the weaver; the well-educated will survive and prosper.

Will the computer, as everyman's access to the infinite world of information, condemn to oblivion the idea of the firm, the corporation, the gathering of numerous people in one location in joint pursuit of profit? Do we need these "artificial" groups when networking can be more efficiently achieved individually? This is infinite outsourcing! Employees, or better yet, independent contractors, can be linked through electronic networks.

Allen Monroe was encouraging. Despite my relative ignorance of the electronic marvels of the information age, he assured me that I could learn (and that they will be simplified to meet the deficiencies of technologically-challenged Neanderthals like me). He reminded me, however, that I still must try to keep pace with this revolution. As The Economist concluded in its survey: Knowledge - finding better ways to do things - has always been the main source of long-term economic growth, from the agricultural revolution to the present day. What is different this time? "First, IT (information technology) has accelerated the shift towards a knowledge-based economy by allowing more information to be codified in digital form, making it easy to transmit over long distances at low cost. Second, production is increasingly in the form of intangibles, based on the exploitation of ideas, rather than material things."

Where once land, physical property, and financial resources were critical assets, now knowledge is the fundamental asset. The computer is our access to that knowledge.

Third, women. I attended (in the real sense of the word, as "attendant") my wife's Fortieth Reunion of her graduation from Mills College, in Oakland, California. Mills remains a women's college, even though it has, from time to time permitted a few especially qualified men as graduate students in its arts programs (Darius Milhaud and Dave Brubeck are two who attended Mills when my wife was there in the Fifties). These ladies, forty years on, were as exuberant, independent, and staunchly feminist as I remembered them in 1956, when I first went to its eucalyptus-scented campus. Their battles and victories against the curtain of male corporate exclusivity (and pomposity) reminds me that we still have some way to go before the extraordinary capabilities of women are fully realized in our economy. Even the most rigorous religious restrictions did not prevent women like Golda Meir, Indira Gandhi and Benazir Bhutto from leading their countries, and in Europe and North America their political progress has been greater. It reminds me that, as progress is being made, the failures to open opportunities will become more costly, in terms of both litigation and lost resources.

When you're young you prefer the vulgar months, the fullness of the seasons. As you grow older you learn to like the in-between times, the months that can't make up their minds. Perhaps it's a way of admitting that things can't ever bear the same certainty again.

Julian Barnes, Flaubert's Parrot, Vintage International,

New York, 1990

Stewardship Reports
For years I've argued that any service provider to an organization should prepare an annual "stewardship report" summarizing the year's work. Be it a law firm, consultancy, audit firm, insurance brokerage, engineer, or third party administrator, this requirement applies. A stewardship report is an opportunity to review mutually-set objectives, measure progress toward goals, discuss areas of responsibility, along with costs and benefits, and forecast the ensuing year.

I've just reviewed four stewardship reports prepared by insurance brokers. One was excellent, one satisfactory, and two disappointingly poor. Three appeared on time and one was delivered two weeks late, despite two reminders. The tardy broker's only excuse was that he was on vacation in August and couldn't start the report (due September 1) until his return! That amazes me: here is a chance for a broker to put a best foot forward, and instead the foot is put directly in the mouth!

Generally these reports summarized existing insurance programs, made suggestions for improvements, listed summaries of premiums, losses (paid and reserved) and claim numbers for five years, by year and contract, listed rating agency reports on insurers, gave evidence of errors' and omissions' liability insurance, listed the names and experience of the service team, and, finally, summarized professional time, costs, out-of-pocket expenses, and earned fees or commissions for the year.

Some weaknesses I noted:

o Columns of figures were not added up, or the additions were incorrect!

o The financial ratings were limited to Best's (no Standard & Poor's; Moody's; etc.).

o Premium and loss data were photocopies of insurer tabulations (no attempt to prepare a broker summary).

o Lack of comment about recent major financial changes to a insurer.

o No measurement of progress toward objectives.

Some strengths:

o Complete table of contents.

o Good graphics, making the report more readable.

o Detailed summary of professional costs with hourly rates for each person, actual time, and total costs.

o Color chart showing coverages and limits.

o Triangulation loss development chart for workers' compensation and liability claims for six years.

A stewardship report can be invaluable to a risk manager preparing a department's own internal annual report. It should be on time, accurate, complete, informative . . . and brief!

Very few people know how to listen. Their haste pulls them out of the conversation, or they try internally to improve the situation, or they're preparing what their entrance will be when you shut up and it's their turn to step on stage.

Peter Hoeg, Smilla's Sense of Snow, Delta Books,

New York, 1995

Fire Alarm
At many conferences with luncheon speakers, attendees dawdle after lunch. drifting late into the afternoon sessions. That's been my impression. The Nonprofit Risk Management Center's tried a different tack approach at its annual Risk Management Institutes in Baltimore in November. Just as the noon speaker closed his remarks to applause, the hotel fire alarm sounded, sending over 250 risk managers into the street. The "all clear" was announced shortly thereafter, and re-awakened and energized attendees flooded the afternoon sessions. It's an idea worth trying!