Professional Documents
Culture Documents
OF RISK A
The Actuary
August/September 2010 – Volume 7 Issue 4
ERM is highly favored by academics enced no doubt by personality, individ- Such a model seems to be a reasonable de-
and consultants; Manager firms find ual differences in color perception, and scription of economic cycles—whether in
it appealing, but firms that hold any early experiences and associations. The the banking world, the insurance sector or
of the other three strategies do not. existence of the four different risk per- the broader economy. As the cycle moves
spectives may be easier to explain—and through these four different states, external
• Diversification. Spreading risk ex- clearly a key factor is that, over time, the conditions match the worldview of each of
posures among a variety of different risk environment changes. the four different risk perspectives. Each
classes of risks, and avoiding large risk perspective has been correct part of the
concentrations, is another traditional A simplistic model of changes in the risk time—and will be again, at some point in
form of risk management. Formal diver- environment might posit that either things the future. But none of the risk perspectives
sification programs will have targets are “normal” or they are “broken.” But peo- is perfectly adapted to external conditions
for the spread of risk with maximums ple do not necessarily agree about what is all of the time.
and minimums for various classes of “normal.” An observer viewing the world
risks. The newer ERM discipline adds through the lens of Conservation might say Purists with the Manager point of view
the idea of interdependencies across that extreme hazard and danger are the may object that their view takes into
classes, providing better quantifica- “normal” state of affairs—while a Maximiz- account the full range of the cycle. But
tion of the benefits of risk spreading. er, finding this view timid and overly pes- economic cycles are not sine curves; the
Pragmatists tend to favor diversifica- simistic, might argue that profitability is period and amplitude are irregular, unex-
tion because it maximizes their tactical “normal” and hazardous conditions prevail pected “black swan” events do occur, and
flexibility, but they avoid reliance on only when the market is “broken.” there are always “unknown unknowns.”
any particular risk mitigation process Model risk can never be eliminated, and
and often mistrust quantitative mea- Expanding the model to allow more than restricting ERM to a Manager-only view
surement of diversification benefits. two states allows for the possibility that obscures this important fact.
both the Conservation view and the Max-
We believe that limiting the field of ERM to imization view can make sense. Consider A Risk Steering ERM program works espe-
Risk Steering ERM alone would be a seri- a model with four risk regimes: cially well in the Moderate risk environ-
ous error. Such a restrictive definition of ment when risks are fairly predictable.
ERM would alienate firms and practitio- 1. Boom Times. Risk is low and profits But in a Boom Times environment, firms
ners holding any of the other three risk are going up. following such a program will unduly re-
strict their business—not as much as Con-
WE BELIEVE THAT LIMITING THE FIELD OF EN- servator firms, but certainly more than
Maximizer firms—and more aggressive
TERPRISE RISK MANAGEMENT TO RISK STEER- competitors will be much more success-
ING ERM ALONE WOULD BE A SERIOUS ERROR. ful. In the Recession environment, a Risk
Steering ERM program again advocates a
middle path; this may mean the firm sus-
perspectives. Moreover, such a limited 2. Recession. Risk is high and profits tains too much damage to be positioned
view is inherently incomplete, for reasons are going down. to take full advantage of the market when
that the Pragmatists know all too well. 3. Uncertain. Risk is very unpredict- it turns. When times are Uncertain, a firm
able; profits might go up or down. following a Risk Steering ERM program will
Simply put, the world does not stand still. 4. Moderate. Both risk and profit fall be frustrated by frequent surprises and a
within a predictable range. world that does not quite fit the model.
CHANGING RISK ENVIRONMENTS (These ideas are explained more fully in Competitors not tied to a particular view
Why do different people prefer different the article “The Many Stages of Risk,” De- of risk will fare better, making decisions in
colors? That’s a difficult question, influ- cember ‘09/January ‘10 The Actuary.) the moment with maximum flexibility.
such models. Most risk committees are certain regimes, the harmonious firm will president with Willis Re Inc. and leads the Actuarial
Services team for Willis Re North America. She can be
populated by Managers and Maximizers. be able to show reasonable success in each
contacted at alice.underwood@willis.com.
An unsteady coalition between those two environment and avoid unreasonable failure.
perspectives forms the core of most busi-
David Ingram, FSA, CERA, FRM, PRM, is senior vice
nesses, and experienced businesspeople CONCLUSION
president for Willis Re Inc. He can be contacted at dave.
can often tell stories of classic battles be- In the open market for goods and services,
ingram@willis.com.
tween the two points of view. the firms that are best able to adapt to the
market’s changing demands will enjoy the REFERENCES
Conservators and Pragmatists are usually greatest success. No firm can be all things to Douglas, M., & Wildavsky, A. B. (1982). “Risk and Culture:
present as well, but their views are not al- all customers, all of the time; but a firm that An essay on the selection of technical and environmental
dangers.” Berkeley: University of California Press.
ways welcomed in discussions about ma- too severely limits its offering, focusing on
jor corporate decisions. They may have too narrow a market segment, may wind up Dyson, S., Goldspink, C. & Kay, R. (2009).“Do Actuaries Have
learned to keep their ideas to themselves. making itself irrelevant. Philosophies of risk a Larger Role to Play in Enterprise Risk Management?”
Actuaries Australia.
However, they should also be represented management face much the same situation.
in the risk management process because Thompson, M. Ellis, R. & Wildavsky, A. (1990).“Cultural Theory.”
Boulder Colo.: Westview Press: Westport, Conn.: Praeger.
their views of risk will sometimes be more A recent study by Kay, Goldspink and Dyson
appropriate to the risk environment than sought to explore attitudes toward ERM by Verweij, M. & Thompson, M. (Eds.). (2006). “Clumsy solu-
the views of the Maximizers and Managers. assessing the predominant risk perspective tions for a complex world: Governance, politics, and
plural perceptions.” Houndmills, Basingstoke, Hampshire;
The trick to creating Harmony from these exhibited by various professional groups.
New York: Palgrave Macmillan.
various points of view is to get all members Their results show that “[k]ey aspects of
of the risk committee to acknowledge that the Hyper-Rational approach favoured by Thompson, M. (2008). “Organising and Disorganising.”
Triarchy Press.
each of the four perspectives offers value the actuaries were often seen as irrelevant
to the organization and to encourage each to, or explicitly rejected by, the Operational
of the four to speak out. and Strategic sub-groups.” While resistance