Global risk 2011: Help for a desperate world

Reports from the World Economic Forum are a starting point for addressing macro risk

By Michael J. Moody, MBA, ARM

It's no secret that as the world becomes more interconnected and risks grow more complex, one overriding fact continues: Risk management has become a critical imperative. And from a macro view it is also easy to see the interconnectivity of these global risks. Many people think that trying to deal with these complex, interconnected risks is just too difficult. Luckily, a small group of thought leaders, who operate under the name World Economic Forum (WEF), have not hesitated to wade into the middle of today's most complex global risks and launch an awareness campaign that is needed to move this important agenda forward.

Despite the fact that the WEF is still quite young—it produced its first report in 2006—it is beginning to make meaningful progress in calling attention to these global risks. Recently, it has published Global Risk 2011, which provides "a unique and timely analysis of the risks that are shaping the global environment." Publication is made possible through the sponsorship of Marsh & McLennan Companies, Swiss Reinsurance Company, University of Pennsylvania's Wharton Center of Risk Management and Zurich Financial Services.

The global risk landscape

The recent worldwide financial crisis has left the international economy in sad shape. Among other things, the report notes, it has "reduced global economic resilience, while increasing geopolitical tensions, and heightened social concerns." Bottom line, "The world is in no position to face major, new shocks." Unfortunately, it also notes, the global community faces a dire situation of "ever-greater concerns regarding risks," due in large part to "the prospect of rapid contagion through increasingly connected systems and the threat of disastrous impacts." 

The report notes the significance of two specific risks that have an inordinately high degree of interconnectedness and thus can cause a significant impact. These two groups of risks—economic disparity and global governance failures—are the central focus of the Global Risk 2011 report; and because of the size of their potential impact, they will require new capacities in risk analysis to make certain that they are properly assessed and managed.

Economic disparity and global governance failures emerged in last year's Global Risks Survey 2010 as "the two most highly connected risks, and were perceived as both very likely and of high impact," according to Kurt Karl, Swiss Re's Chief U.S. economist. In addition, these two risks have a significant influence "in the context in which global risks evolve and occur in two critical ways. First, these risks can easily exacerbate the likelihood of, as well as impact, other risks. Additionally, they can also inhibit the capacity to respond effectively to them."

The report also highlights three important clusters of risks, Karl points out. The first cluster of risks is macroeconomic imbalances and currency volatility. These risks grew out of fiscal crises as well as asset price collapse that can arise from tension between the increasing wealth and influence of economies. The current savings and trade imbalances within and between countries are becoming increasingly unsustainable. And while there are potential resolutions to these situations, they are "challenging, given the conflicting interests of different stakeholders."

Illegal economies make up the second cluster of risks. Among the risks associated with this cluster are state fragility, illicit trade, organized crime and corruption. Governance failures and economic disparities create and, in many ways, encourage opportunities for such illegal activities. The report indicates that in 2009 these activities generated over 1.3 trillion U.S. dollars.

The final cluster that the report identified was the "water-food-energy" nexus. Both growing populations and prosperity "are putting unsustainable pressures on these resources." This cluster of risk illustrates the true scope of interconnectivity and, as such, could result in "worldwide social and political instability, geopolitical conflict and even irreparable environmental damage." Again, the report points out that a possible resolution that does not consider the "interconnections of risks could result in serious unintended consequences." Karl says that a classic example is that, for the most part, "There is already a lot of food in the world; however, there are distribution issues that are causing problems." 

The report also provides insight into what they call "risks to watch." These five growing risks include:

• Cyber security—"issues ranging from the growing prevalence of cyber theft to the little understood possibility of all-out cyber warfare."

• Demographic challenges—"add­ing to fiscal pressures in advanced economies and creating severe risks to social stability in emerging economies."

• Resource security—"issues causing extreme volatility and sustained increases over the long run in energy and commodity prices, if supply is no longer able to keep up with demand."

• Retrenchment from globalization—"through populist responses to economic disparities, if emerging economies do not take up a leadership role."

• Weapons of mass destruction—"especially the possibility of renewed nuclear proliferation between states."

These "risks to watch" are areas that may require close monitoring for changes. They are also risk areas where proper assessment is sometimes difficult. Cyber security is a good case in point. "A lot of these types of losses are never made public, since they may prove embarrassing to the parties involved," Karl notes. As a result, many people believe that it is a much worse problem than most people think. Continued vigilance over all the risks noted above will be needed to avert major shock losses.

All is not lost

One of the most encouraging items to come out of this year's report is the formal introduction of the Forum's Risk Response Network (RRN). The RRN is being established to be a platform to assist global decision makers "to better understand, manage and respond to complex and interdependent risks." Without question, Karl points out, "There is a clear need for better coordination." In addition to proving a rigorous approach to understanding the complexity of risks, the RRN "provides tools enabling world leaders to better mitigate risks and capture associated opportunities."

RRN will provide assistance to global leaders by proactively addressing the causes, rather than the symptoms of global risks. By devising coordinated response strategies, Karl says, the RRN will "address difficult trade-offs and the threat of unintended consequences." While the RRN is still in its early stage of development, it is intended to take a longer-term approach to both assessment and responses, by viewing risks over decades, rather than months or years.

For its part, the insurance industry has an important role in dealing with these new risk realities. Karl points to his own company, Swiss Re, for a current example. He says that pension and retirement programs have historically been provided by corporations worldwide. However, these programs have been complicated by the changing demographic of an aging population. Because people are generally living longer, Swiss Re has begun using longevity bonds, which are available through the capital market, to assist in dealing with this unique issue. Additionally, insurance and reinsurance has also helped support imbalances created by differing investment yields. Bottom line, the insurance industry has taken a leadership role in coordinating the response to these interconnected risks.

Conclusion

Looking at the work of the World Economic Forum, its annual Global Risk publication and now the introduction of the Risk Response Network, it is interesting to note that the majority of the primary sponsorships are supplied from insurance-related entities. Information provided and research offered is critical for forward-looking organizations, whether public or private, in a worldwide economy that continues to change and adapt to the new risk landscape.

The one overriding theme that is recurring throughout the report is the futility of trying to solve risks of this magnitude in a vacuum. The report clearly illustrates that, "It is impossible for any one stakeholder to address these challenges in isolation." But prospects are good for resolution of some of the more pressing issues, in concert with other interested parties. Karl notes that at "a macro risk level, it is going to be a tough couple of years; however, this will ultimately sort itself out, including many of the physical imbalances noted in the report."

He says that the first step in this process is creating awareness of the risks. One of the key roles of the annual reports is to create awareness and, "All this speaks to how well we have done." He goes on to say, "We are making major progress in this important awareness area." The supporting meetings have also gone a long way towards communicating with other interested parties, which Karl says is "the second step in this process."

The report does an excellent job of providing an overview of the wide range of risks and the interconnectivity of these risks. However, it also notes that, "An effective risk response is not only about proactively reducing the downside associated with these global risks; it is also about seizing the opportunities for innovation and growth that may arise." Swiss Re's Karl indicates that this is an important aspect. "While these are huge risks, there are also huge opportunities."

It is this opportunity to participate that is the foundation for a more holistic risk management approach such as enterprise risk management. As such, the Global Risk 2011 report makes an outstanding starting point for anyone who is embarking on an ERM risk assessment journey.