| | | The Truth about
Enterprise Risk Management "Risk" is uncertainty regarding future events; "risk management" is taking action against the uncertainty to assure that outcomes are more certain or less financially devastating. "Enterprise risk management" (ERM) is applying risk management techniques across all operations, risks, and departments. Article continues after the jump | | | | |
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| | | More specifically, ERM is an entity's use of finite resources (money, time, and talent) to accomplish business goals (progress goals) while simultaneously protecting it from unmanageable or unrecoverable financial harm (protection needs). ERM can be valuable, provided the entity understands and accepts certain truths about ERM: - The creation of an ERM process is time consuming;
- The impact of ERM;
- The pitfalls inherent in ERM; and
- The impossibility of absolute application of ERM.
Time Required to Develop an Effective and Efficient ERM Program Before any entity can entrench ERM into its standard operating procedure (SOP), it must commit to taking the time necessary to create a useful ERM program. This initial step is a long process. In fact, maintaining an ERM program (even though time consuming) requires less time than creating the program initially. Article continues after the jump | | | | |
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| | | The Impact of ERM
Enterprise risk management has more than just a financial impact on organizations. Ultimately, the impact of ERM is the loss (or use) of time and money-or "opportunity cost." Money spent on salaries for risk management professionals, insurance premiums, alternative financing sources, loss control or safety, training, analysis, or any other ERM activity is no longer available for other business-related progress needs. Likewise, time spent planning for, managing, or recovering from an unexpected event is lost and can't be used for other endeavors.
The Pitfalls of ERM
ERM two major pitfalls are: 1) a pessimistic view of advancement; and 2) paralysis by analysis.
The chief risk officer (CRO), or person charged with ERM duties, can be viewed as a pessimist; or at very best a very cautious optimist. The reason: this person's job is to look for the risk in every opportunity, present those risks, and work to manage the risks. Sometimes the CRO might recommend not undertaking a certain course of action because its outcome is too "uncertain."
Secondly, ERM can produce paralysis by analysis. Too much time devoted to finding, analyzing, and managing every risk associated with a particular activity or decision can result in a missed opportunity. ERM analysis must be tempered and balanced in light of the reality of business.
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| | | Total ERM Cannot be Accomplished Full and total ERM, as originally conceived, is nearly impossible to accomplish. Decisions must at times be made without knowing every detail of the potential effects. ERM, to be successful, must be broken into two subgroups: 1) Speculative Risk ERM (the business side); and 2) Pure Risk ERM (the protection side). Speculative risk ERM cannot be fully accomplished if the business wants to accomplish its business goals. Pure risk ERM must be accomplished if the entity is to attain its business (speculative risk) goals. Because of the imperfect nature of business, ERM can only be partially accomplished. The Reality of ERM Enterprise risk management creates a powerful framework for consistent, repeatable assessment pointing towards the best options and away from the least favorable options in the entity's pursuit of its progress (business) goals. Likewise, ERM is a powerful instrument for directing the entity towards the best options for managing its protection goals. But even the power of a properly developed and managed enterprise risk management program is: - Limited by time: Some decisions require quick or relatively quick action without the time required for ERM-depth analysis;
- Limited by the unknown: Incidents occur that may have never been considered, or outside forces may materialize that were never anticipated;
- Limited by resource availability: No entity has unlimited resources; all have a finite amount of time, talent, and money;
- Detrimental to decentralization: For ERM to be fully implemented, all "major" decisions must be made at one a central location to assure that all possible or reasonable outcomes are studied.
- Subject to human error: No person or board is perfect, mistakes are made;
- Subject to dishonesty: Agendas can lead individuals or groups to withhold information or provide false information so that the findings of the ERM process results in the conclusion desired;
- Injured by apathy: ERM is not a "once-and-done" process, it requires daily monitoring and management. Additionally, ERM must be supported by all senior and mid-level executives. Without this support, ERM will die or, at best, exist only on paper.
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| | | ERM, while a potent tool, does not and cannot provide any entity an absolute answer to every opportunity or threat faced. Business realities diminish ERM's effectiveness, and experience may be a better judge than a set formula. In short, ERM does not create gospel, it's only as good as the people who create the process, provide the data, and maintain the program. An in-depth and simplified discussion of ERM takes place tomorrow. The Academy of Insurance is conducting the class, "The Agent's Role in ERM." Get more information and Register. I would love to hear your feedback, please send me an email cboggs@ijacademy.com. Until next time, Christopher J. Boggs, CPCU, ARM, ALCM, LPCS, AAI, APA, CWCA, CRIS, AINS Director of Education Academy of Insurance cboggs@ijacademy.com | | | | |
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