Companies Lag on Forecasting Critical Risks

Most risk managers are using insurance claims histories to predict emerging risks.
David KatzApril 13, 2016
Companies Lag on Forecasting Critical Risks

SAN DIEGO — Echoes of the controversy surrounding the introduction of fair-value accounting in the wake of the 2008 financial crisis have begun to crop up in corporate risk management, a new survey issued at the annual Risk and Insurance Management Society Conference here suggests.

Similar to how historical-cost accounting was found wanting as a way to assess the financial risks lurking in current and future market conditions, basing forecasting of corporate operational risks on insurance claims histories (as they are based now), will be of little help in capturing fast-changing exposures like cyber risk, the thinking goes.

And like advocates of the fair-value revolution in financial reporting, insurance brokers and some risk managers want to drive a sea-change in corporate risk assessment by using a new way of doping out future perils. In the latter case, it’s predictive analytics, including such things as stochaistic modeling and game theory.

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One of the questions asked in the report, which is based on more than 700 responses to an online survey and a series of focus groups of “leading risk executives” and C-suite officials conducted by Marsh, the big insurance broker, and RIMS in January and February, was “Which risk management techniques does your organization use to assess/model emerging risks?”

The answer given by the most respondents, including 60% of the risk managers and 43% of the C-suite was “claim-based reviews,” while 45% and 30% use analyses “developed by third parties,” and 38% and 19% use analytics. (The report gives no breakdowns of respondent job titles.)

“The wide use of claims-based reviews … may indicate that  companies are not quite assessing and modeling critical risks,” according to the report. “The overwhelming use of claims-based reviews suggests that organizations are relying on studying past incidents to predict how emerging risks will behave.”

At the same time, boards are asking more and more of risk management departments, including “everything from leading enterprise risk management to providing better risk quantification and analysis,” according to the report.

That’s creating a need for risk managers to intensify their ability to forecast previously unforeseen risks and consequently to change from “the analytics of a retrospective [view] to a prospective view, ” Brian Elowe, Marsh’s U.S. client executive leader and co-author of the report, told CFO at the RIMS conference.

Relying solely on insurance-claim-based reviews is “a fully retrospective” way of modeling risks, he said. “It’s not good at telling where the next issue is coming [from].

A more prospective way for risk managers to proceed is to look at “leading indicators,” such as observing that “organizations that do X,Y, and Z tend to have less [risk] exposures than organizations who don’t,” Elowe added, and then to “build algorithms” to aid in their companies’ quantitative analysis of future risks.

Elowe also suggested that corporate risk management need not be driven by near-term insurance industry complacency on such difficult to quantify, but potentially global-scale risks like climate change.  His firm’s clients have shown a greater tendency to look at risk from the finance perspective of overall capital application, and are “tired” of insurance-product-oriented approaches “coming at them through the lens of the insurance industry.”

The Marsh/RIMS report notes that while such risks as “climate change, water crises, and large-scale involuntary migrations” are highlighted in the World Economic Forum’s 2016 report on global risk, they “tend not to appear on many organizations’ radar

Nevertheless, “respondents who consider these areas may be giving their organizations a chance for a competitive advantage and to plan more effectively,” according to the report.

The report’s authors note, for instance, that one of the respondents, an unidentified vice president of risk management at a health care organization, said a recent incident had spurred him to think more about water supplies. “It’s something that I never really saw
on the horizon. Now it’s going to be an exercise to say how are we going to address this as a company rather than letting each individual facility or operation try to figure out what
they’re doing,” the risk manager reportedly said.

Marsh’s Elowe says that a way of gauging the significance of potential water scarcity and other looming, but hard-to-forecast risk requires risk managers to specify the potential impact of the problem on their companies. For instance, a manufacturer might calculate that a 10% loss of water availability in a certain region might curtail production 12%. “It boils down to business metrics,” he says.