Four key concepts for effective risk management
- Published: Friday, 16 September 2016 10:01
Alexei Sidorenko provides an overview of four key criteria that are essential for effective risk management. The criteria are: integrating risk into decision making; strong risk management culture; disclosing risk information; and continuously improving risk management.
Lately everyone, from government agencies to regulators to corporate board members, seems to be talking about the need for better, more effective, risk management. The challenging part is that, despite the guidance provided in ISO 31000:2009, the concept of risk management effectiveness still remains vague. This article attempts to summarize the main components of effective risk management which should help risk managers to respond to the challenges set by regulators and shareholders.
The team at the Institute for Strategic Risk Analysis in Decision Making (ISAR) and www.risk-academy.ru has been studying risk management for more than 15 years, and we firmly believe that effective risk management is only possible when all four criteria below are met. Each of these criteria is based on ISO 31000:2009, the most widely used risk management standard in the world.
Integrating risk into decision making
One of the most important tests of true risk management effectiveness is the level of risk management integration into decision making. ISAR research shows that companies capable of systematically integrating risk management into planning and budgeting decisions, investment decisions, core operational business processes and key supporting functions, achieve long-term sustainable advantage. Just consider an example of a large investment fund, which makes investment decisions only after an independent risks analysis and does simulations to test the effect of uncertainty on key project assumptions and forecasts. Another example is a large airline, which makes strategic decisions based on several quality alternatives with a risk assessment performed for each alternative.
Strong risk management culture
Human psychology and the ability of business managers to make decisions in situations of great uncertainty have a huge impact on risk management effectiveness. Nobel laureates, D.Kahneman and A.Tversky, have conducted some exceptional research in the field of risk perception, showing that most people, consciously or subconsciously, choose to be ignorant of risks. A robust risk management culture is therefore fundamental to effective risk management. Take for example a large petrochemical company, which used online and face-to-face training to raise risk management awareness and competencies across all staff levels. The company also allocated resources to integrating risk management principles into the overall company culture. Another example is a government agency, which documented transparent discussion and sharing information about risks as one of their corporate values, which were later communicated to all employees.
Disclosing risk information
Another criterion for effective risk management is the willingness and ability of an organization to document and disclose risk-related information both internally and externally. A mature company not only documents the results of risk analysis in the internal decision making processes, but also discloses information about risks and their mitigation to relevant stakeholders, where appropriate, in external reporting or on the company website. It is important to note that since actual risk information may be sensitive and contain commercial secrets, the focus of disclosure should not bethe risks themselves but rather on the risk management framework, the executive commitment to managing risks, and the culture of the organization.
Remember that disclosure of risk management information allows companies to both make and save money. For example, the insurance market positively reacts to a company's ability to disclose information about the effectiveness of its risk management and control environment, offering a reduction in insurance premiums. Banks and investors also see risk disclosure in a positive light, allowing companies to lower their financing costs.
Continuously improving risk management
The final criterion for effective risk management has to do with the continuous improvement of the risk management framework and the risk team itself. One investment fund was able to do this with the help of regular assessment of the quality and timeliness of their risk analysis, annual risk management culture assessments as well as periodic review of risk management team competencies. For example, professional risk management certification helps to boost risk team competencies. One of the reasons behind the need for constant risk management improvement is the rapid development of the risk management discipline. The ISO 31000:2009 standard is currently being reviewed by more than 200 specialists from 30 different countries. Some of the suggestions for the new version of the standard include the greater need for integration of risk management into business activities, including decision making and the need to explicitly take into account human and cultural factors. These changes could have a significant impact on many modern non-financial organizations, raising questions about their risk management effectiveness.
Risk management, just like any other element of corporate governance, must be integrated into the overall management system of the organization. ISO 31000:2009 explicitly talks about the need for risk management to be adaptive, dynamic, iterative and able to react to change. As organizational risk maturity increases, so will the tools used by the organization to manage risks in decision making. Professional risk managers should not only develop risk management processes for their organizations, but also improve their own risk management competencies.
I recommend that executives and risk managers evaluate the current level of risk management maturity in their organization using the criteria for effective risk management presented in this article. If at least one of the puzzle pieces is missing, it is probably a bit premature to talk about effective risk management being in place.