The Evolving Role of the
Chief Risk Officer
Presented by
Allen Monroe
International Quality and Productivity Center
San Francisco, October 30, 1998
Risk I N FO
Session Objectives
Review
Need for integrated risk
management approach
Review
a Unified Conceptual
Framework that applies to all types
of risk
Show
how to leverage
contemporary technologies to
achieve integrated risk
management.
Risk I N FO
I. The NEED for Integrated
Risk Management
Would
you accept with 100% certainty:
Your Sales Director’s contention that sales
will increase 20% next quarter because the
product you are about to introduce “beats
the pants off the competition?”
• Your Nuclear Engineer’s contention that,
because of redundant systems, there is no
chance of an accident that would result in
explosion of release of radioactivity?
•
Risk I N FO
Most Jobs have a Singular Objective
Maximize
sales.
Cut expenses to the minimum.
Get the new product to market on time.
Meet the quarterly budget forecast.
With
such single-minded objectives,
WHO is weighing the tradeoffs?
Risk I N FO
The “Textbook” Approach
Five-step
risk management process:
• Identify risk exposures
• Quantify risks
• Avoid and Transfer risks through safety,
engineering, contractual, and other means.
• Retain those risks which remain to the
extent they are within the organization’s
financial capacity
• Insure risks above the organization’s own
retention capacity.
Risk I N FO
Shortcomings of
Textbook Approach
What
if insurance is currently priced at less than the
“burn rate?” (expected losses)
What if insurance is not available, or appears to be very
expensive for certain risks or certain limits?
What
if the rate of return on loss control investments
fails to meet company targets?
• With these thoughts in mind, let’s turn to a Unified
Conceptual Framework that applies to all types of risk.
Risk I N FO
II. Seeking a new definition
of Risk
Old
distinction between insurable risk and
“business risk” is becoming blurred.
Fortuitous
risks and non-fortuitous risks
not always separable
Defining
risk as the “chance of loss”
ignores the fact that frequency of small
losses can add up to a fairly predictable
annual cost.
Risk I N FO
Understanding Risk from a
Financial Perspective
Financial
theorists define risk as:
• Uncertainty as to achieving an
Expected Outcome, observed through:
• Variability from an Expected Result.
Risk I N FO
Risk is Integral to all
Economic Activity
The
VALUE of an investment,
such as a company’s stock is:
Based both on the
• Amount of the Estimated Future
Earnings Stream, and the
• Degree of Uncertainty in realizing
those estimated earnings.
Risk I N FO
Valuation Formula
Value =
E
arnings 1...n
__________
Required
Rate of Return
Risk I N FO
Components of ROI Analysis of Risk
Reduction or Transfer Expenditures
Stream
of after-tax Revenue over
time = each year’s Net Expected
Savings attributable to Risk
Reduction
Importance
of Timing
Importance
of after-tax Discount
Rate
Risk I N FO
Effect of Risk Reduction
Expenditures on Valuation Formula
Cost of Risk Transfer = “Premium” less
“Expected Losses”
“Benefit” of Reduced Risk translates into a
lower Required Rate of Return “discount”
factor applied to the stream of future earnings.
Net Benefit of Risk Reduction or Transfer
expenditure is the combined effect on V=E/R.
Net
Risk I N FO
Example
Before
Risk Reduction:
• Present Value of $1 billion annual after tax
income for 30-yr. horizon / .09 required rate of
return = $10.27 billion.
After
Risk Reduction:
• Present Value of $.95 billion annual after tax
income for 30-yr. horizon / .085 required rate of
return = $10.61 billion.
Decision:
Yes, proceed with risk reduction.
Risk I N FO
Effect of Differing Risk Characteristics
affecting Economics of Risk Transfer
Principal
•
•
•
•
Risk Characteristics:
Frequency of Loss
Average Severity of Loss
Degree of “Internal” Correlation with other risks
Relative “External” (I.e. Insurance or Capital
Markets) risk correlation.
These
factors affect the cost and benefit of
risk transfer.
Risk I N FO
Typical Risk Characteristics
Workers
Compensation:
• High frequency, low severity, good internal correlation except
for persistent exposures, good relative external correlation
except for long-tail exposures.
General
Liability
• Medium frequency, potentially high severity, moderate / high
internal correlation, good relative external correlation.
Property
• Low frequency, high potential severity, general lack of internal
correlation, excellent relative external correlation.
Currency
Risk I N FO
Risk I N FO
III. Leveraging Technology to achieve
Integrated Risk Management
Scott
McNealy: “The network is the
computer”
Ability of HTML web pages to
connect to any other computer
connected to the Internet
One web page can draw data or
applications from many computers
at the same time.
Risk I N FO
Consequences of the new
Technologies
Integration
of differing types of data
from varied systems can be achieved
at much lower cost than previously.
Routine tasks of gathering
information, processing transactional
data, and reporting are becoming
less demanding.
More attention is given to strategic
risk management.
Risk I N FO
Rapid Acceptance of StandardsBased Technologies
Corporate
Use of email
and Intranets /
Extranets has reached
nearly 100% in very
few years.
Rapid move toward
embracing standards.
Risk I N FO
Technology enables
Consolidation of Responsibility
Internet
Technology is highly
“scaleable”
Geographic
location of
personnel becoming much
less important
Risk I N FO
The Power of the New
Technology
Makes
possible a “Risk Management
Control Center,” with all relevant information
accessible via desktop computer.
•
•
•
•
•
•
•
Facilities database with GIS map interface
Loss data and modeling tools
Certificates of insurance data
Insurance policy summaries
Online Underwriting presentations
Accident / Injury reports, OSHA 200 log
Loss control / safety training via streaming video
Risk I N FO
Objective
Achieve
the best
combination of risk
reduction, risk retention,
and risk transfer;
consistent with the
optimum effect on the
firm’s overall Value.
Risk I N FO
Contact Us
Allen Monroe
Founder and CEO
RiskINFO
234 West Baltimore Avenue
Larkspur, CA 94939
(415) 927-8824
Email: allen@riskinfo.com
Web Site: http:www.riskinfo.com
Risk I N FO
Contact Us
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