Waking up to a new risk reality

Report delineates interconnectivity of global risks

By Michael J. Moody, MBA, ARM

Inrecent years, risk management has been gravitating to a more holistic approach. Serious efforts to move away from risk management’s traditional siloed approach of managing risks have been encouraged by rating agencies, regulators, stock analysts and other interested stakeholders. And while it has not been an easy transition, the movement has been gaining significant traction.

One of the key aspects to a holistic approach (a.k.a. enterprise risk management) is the development of a relevant and robust risk assessment segment. Several national consulting firms as well as numerous software programs have been introduced to assist organizations in performing this assessment phase.

But whether it is a software program, a consultant or even internal resources that are used, there is typically one major flaw in the assessment. That flaw is the limitation of the assessment to a three-year to five-year time frame.

Even in rare cases where longer time horizons are used, the assess­ment usually fails to consider the effects of larger, global systemic risks. However, following the recent worldwide financial meltdown, more organizations are beginning to see their vulnerability to these larger, long-term systemic risks.

Changes to the risk landscape

Fortunately for risk managers, there is an excellent resource that can provide significant insight into the broader, long-term view of risks. The publication—“Global Risks Report, Global Risks 2010”—is prepared by the Global Risk Network of the World Economic Forum. The 52-page document is a collaboration between Citi, Marsh & McLennan Companies, Swiss Re, Wharton School Risk Center and Zurich Financial Services.

At its most basic, the report presents details on the most significant risks facing the global community. Published for the past five years, in advance of the World Economic Forum, this report focuses on three themes:

• A higher level of systemic risks

• Slow failures or creeping risks

• Global governance gaps

These three themes serve as a backdrop for most of the discussion incorporated in the report.

A common issue for all three themes, as well as most of the other risks discussed in the report, is their interconnectivity. In fact, it’s this interconnectivity that results in the higher level of systemic risk. According to Reto Schneider, Head of Emerging Risk Management at Swiss Re, “It is important to realize how tightly economic and societal issues are connected.” And he says that the report has a unique method of portraying this connection via an interactive Risks Interconnection Map (RIM). He also points out that as a result of this new information, “Loss estimates need to take this interconnectivity into consideration as they may result in increases in some severity calculations.”

The report also shows that while sudden shocks can have a huge impact on the global community, the greatest risks facing the world today may be from slow failures or creeping risks. The primary reason for this is the long-term nature of these risks as well as their potentially enormous impact.

These are the types of risks that everyone is aware of. For example, climate changes and global population growth represent major shifts that can take many years to become completely evident. For the most part, these types of risks are not new; however, the report finds that these slower develop­ing risks are much more complex than originally thought and they are also more interconnected than earlier believed. Additionally, the report indicates a concern that these longer-term risks will be lost in the face of overwhelming short-term challenges faced by organizations today.

The third major theme highlighted in the report is “governance gaps,” or that gap that remains between short-term pressures on governments and businesses and the need for long-term decisions. The report questions whether: “In light of ongoing short-term pressures, can the necessary reforms of global governance be achieved across the range of issues where it is required?”

Schneider points out that what is needed is “a framework to assure that all factors are compatible and can be achieved.” And he goes on to say, “While local and national governance can differ greatly, if we have a global economy and global issues, we need a global framework to manage the risks accordingly.” He believes the report provides this framework.

New risk assessment tools

One of the most important contribu­tions made in the “Global Risks 2010” report is providing a number of important risk assessment tools.

The first tool is the Risks Interconnection Map (RIM) which is interactive and provides graphic proof of the increasing complexity of global risks. All risk management starts with risk identification and assessment, but, as Schneider points out, “In order to do this properly, you must be able to visualize the risks.” And he adds, “Risk mapping is one of the best methods of visualizing risks,” so the RIM was designed to assist risk managers to better visualize a broader, more holistic view of global risks.

The 2010 version of the RIM also illustrates the growing interde­pendency of global risks and thus should be considered an important addition to any risk manager’s toolbox.

A second tool that has been provided in the report is the Global Risks Barometer. This is another tool to assist risk managers in determining the extent to which global risks can impact their operations. The Barometer, which is presented as Appendix 2 in the report, provides a plethora of critical information on a large variety of risks.

Among the more important data provided is a brief description of the risks. The Barometer then enumerates the various drivers and alerts the risk manager of developments to watch. Finally, the Barometer provides a summary of the global impact of the risks and indicates the likelihood of an event occurring, as well as its potential severity.

Taken together, these tools can greatly assist organizations in highlighting the current trends as well as connections between emerging risks and their underlying drivers. When properly used, the insight provided by these two tools can assist in analyzing the complexity of the global risks faced by any organization.

Conclusion

As noted in the report, “The objective of the work is to raise aware­ness of the level of interconnections among risks and the global impact of those interconnections.” As such, the report “offers a framework for decision makers to look at risks in an inte­grated manner and to provide an impetus to different stakeholders to focus on ways to manage systemic risks more effectively.”

In fact, managing the systemic risks is where the rubber meets the road. While most of the risks identified in the report are long-term issues, Schneider says that these “risks or challenges may remain on the RIM for many years.” As a result, the RIM, “represents the highest level of aggregation” of long-term risks. But if that is the case, what can be done in the short-term?

Schneider suggests that “there is no easy solution for most of these complex risks,” but he says, if properly managed, “it is possible to avoid any accompanying shock.” And further to the point, “By investing in prevention, it is possible to lower the loss costs at the end of the day.” He indicates that it is no longer acceptable to merely wait for catastrophic losses to occur; it is now time to begin to invest in prevention.

The “Global Risks 2010” report is an excellent example of what can be accomplished through a collaborative effort. It is extremely well written and includes recent and relevant information worthy of considera­­tion by any risk management professional. Additionally, the report is a logical starting point for any serious, holistic risk assessment effort. As such it should be considered required reading for anyone involved with the risk management process.