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Reshaping the discipline: 'risk management agonists.'

What is risk management? To many social analysts, politicians and academics, it is the management of environmental and nuclear risks, those technology-generated macro-risks that appear to threaten our existence. To bankers and financial officers, it is the sophisticated use of such techniques as currency hedging and interest rate swaps. To insurance buyers and sellers, it is coordination of insurable risks and the reduction of insurance costs. To hospital administrators, it may mean quality assurance." To safety professionals, it is reducing accidents and injuries.

All of these definitions are correct but incomplete. With its multiple definitions and practices, risk management is in competition with itself. Thus, the term "risk management agonists" conveys a sense of struggle or conflict. To the public, its meaning is unclear, thus reducing the effectiveness of the term and the discipline that is receiving increased attention.

The rise of multiple forms of risk management is hardly surprising. It is in large measure a growing response to the world of unprecedented uncertainty in which we live. They are expressions of the many new techniques that we are beginning to use to manage our lives and our organizations more intelligently in the face of this uncertainty.

Each facet of risk management has its deficiencies. Each has too narrow a focus. The old" forms of risk management, concentrating as they do on the specific problems or skills that spawned them, have as yet been unable to meet our broader, societal needs.

A synthesis-a new form, definition and understanding of risk management-is needed. Out of it may come a new function focusing on the management of risk, one that may well take a position of significant organizational importance in the next decades.

The World of Uncertainty

"Unprecedented uncertainty," the term recently used by Tom Peters, is the environment in which we work today. Rapid changes in technologies, economics, social values and political situations affect us all, and are accentuated by the instant communication that is the hallmark of our global village.

As Mr. Peters states in a March 1989 Economist article, "Today's management wisdom is predicated on stability. [Yet] none of its tools-basic accounting practices, patterns of organization, formulation of strategy or work force care-can cope with the new rates of change." To Mr. Peters' list of outmoded tools should also be added "traditional" risk management, including those forms that have grown out of insurance, finance and risk analysis.

Mr. Peters' thesis is hardly new. Others have made the same point. Two futurists, Roy Amara and Andrew Lipinski, wrote in 1983: "The environment corporations face today-and will face increasingly in the future-is markedly different from the past. The most important difference is the much higher level of uncertainty in which they operate. Corporate managers are now confronted with a much wider variety of economic, social, regulatory and competitive factors influencing performance. At the same time, the level of understanding of how these factors, singly and jointly, influence achievement of corporate objectives is not keeping pace with management needs."

Understanding risk and uncertainty is but the first step; adjusting organizational structures to respond is the next. The magnitude of uncertainty is also a concern.

We had supposed, as rational children of the modern scientific age, that the rising tide of economic well-being and technological achievement might reduce the risk of catastrophe, our exposure to monumental calamity. The reality is that the magnitude has probably increased ! A new theory is that catastrophe is a continuing and perhaps increasing element in an uncertain life. According to William McNeill: "Famine, epidemic and/or war have affected nearly every participant in civilized society at some time. Despite all the skills we now command, a life immune from exposure to one or more of these catastrophes remains unusual. Perhaps, we should recognize that risk of catastrophe is the underside of the human condition-a price we pay for being able to alter natural balances and to transform the face of the earth through collective effort and the use of tools.

He goes on to say in the winter 1989 issue of Daedulus that "It certainly seems as though every gain in precision in the coordination of human activity and every heightening of efficiency were matched by a new vulnerability to breakdown. If this is really the case, then the 'conservation of catastrophe' may indeed be a law of nature like the conservation of energy."

As if unprecedented uncertainty and the conservation of catastrophe were not enough, the ability of the human animal to handle and cope with these changes may be in question. Many current social and organizational responses may be direct results of our inability to live with uncertainty: * There is clear evidence of a resurgence in

religious fundamentalism throughout the

world. Individuals, faced with an in - creasingly complex life, become more

willing to accept an authoritarian interpretation

of events and actions. * We are beginning to recognize the vulnerabilities

of living in a complex, interrelated

global village. The Chernobyl

failure directly affected much of Europe,

and indirectly, the rest of the world. A

death threat from a single mullah in Iran

had worldwide repercussions, as has

political terrorism from the Middle East. * Stress, along with its symptoms and repercussions,

is becoming a major concern

in developed economies. However, it

may well be the price we pay for our uncertain

society. * The international epidemic of alcohol,

tobacco and drug abuse is a further indication

of the attempt to escape from an

unacceptable reality and an unpredictable

future. * Even organizations are not immune. The

current fetish of managing only for the

short term may be a form of corporate escapism,

when long-term planning appears

to be an exercise in futility. Risk and safety issues have moved to the forefront of public discussion. Almost daily the front pages of newspapers and television news broadcasts announce the problems of risk and loss in our modern society. Water pollution and acid rain, the greenhouse effect and environmental cleanup are but a few of the continuing issues that are now high on our social and political agenda.

Regulatory agencies are playing a growing role in risk assessment and risk control, following the leadership of legislatures in creating new laws defining the social limits of risk and the evolving interpretations of courts in defining its economic limits. Society is more risk-conscious than ever before, maintains Ward Edwards and Detlof von Winterfield in "Risk Evaluation and Management," a 1986 collection of articles. Witness the dramatic public response to the recent Chilean grape (cyanide), American apple (dominozide) and British egg (salmonella) incidents.

The repercussions following each of these incidents have been exacerbated by instant worldwide communications. Perhaps, the public has been well-served. However, the economic and social costs of instant alert may have been excessive when weighed against the real risk. Each new situation raises a serious question as to when and how to advise the public. When should information be withheld? What are the repercussions of crying wolf before we are certain of the facts?

The challenge of the next decade will be to learn how to live with uncertainty and to develop means of managing our lives and organizations so that risk can become an acceptable stimulus rather than an unacceptable threat. As Mr. Peters has pointed out, this will mean a thorough review and revision of many of our institutions and habits. Today, in the United States, auditing firms assess publicly-held corporations against GAAP (generally accepted accounting principles). Tomorrow, we may live in the "world according to GARP" (generally accepted risk principles).

Response of the "Old" Risk Management

Risk management, in its multiple forms, has developed most rapidly over the past 30 years, although it can be argued that it has been a natural aspect of human evolution and reaction since the Garden of Eden. Initially, it began as an outgrowth of more sophisticated insurance purchasing by larger corporations. The term first appeared in the Harvard Business Review in 1956 in an article by Russell Gallagher, then insurance manager for Philco in Philadelphia, although it had been in use several years earlier. This strain of risk management grew under the attention of both insurance academics (initially at the University of Pennsylvania and later at such institutions as Ohio State, Temple, Wisconsin, Georgia and Georgia State) and the corporate practitioners who created the Risk and Insurance Management Society. An Institute of Risk Management has also been formed in London for individuals, complete with qualifying exams. Academics have their own organization, the American Risk & Insurance Association, with its quarterly publication, The journal of Risk and Insurance.

In the 1970s, several other significant strains of risk management appeared. Financial officers, banks, investment firms and other financial institutions began developing new tools to mitigate growing financial risks. Currency hedging, interest rate swaps, collars and similar techniques now fall under the generic term "financial risk management." The advertisements of these organizations use the term frequently, and many financial officers now equate it to this particular specialty. It too has its own publication, Corporate Risk Management, whose initial issue appeared in September 1989. It focuses on "financial risk, the risk that commodity prices and interest rates might rise or that exchange rates will move against them, negatively affecting the bottom line," according to the editorial in its premier issue.

Another expression of risk management has been the continuing effort to understand the risks of new technology. Nuclear, aerospace and, more recently, environmental risks have received the increasing attention of decision risk and analysis specialists in industry, universities, think tanks and government. As the literature has grown and the public awareness of macro-risks has skyrocketed, these practitioners formed the Society for Risk Analysis and contributed to its quarterly journal, Risk Analysis. Within the past two years, a Center for Risk Management has been formed in Washington, DC, to focus attention on the more urgent environmental issues of the day.

When the medical malpractice crisis of the mid-1970s led to the creation of numerous doctor and hospital-owned captive insurance companies ("bedpan mutuals" was the derisive term of insurance officials) and to a heightened awareness by hospital administrators of the public demand for higher quality" in health care procedures, "risk management" became a term synonymous with quality assurance." In the past decade, sophisticated procedures and protocols have been developed by the American Hospital Association, the joint Commission on Accreditation of Healthcare Organizations and others, leading to a requirement in many states of annual risk management continuing medical education credits for health care professionals.

And from the "system safety" approaches of the 1970s to the more recent "hazard scenarios" and "risk totem poles" of Vernon Grose, safety professionals have explored their own brand of risk management. Is there any wonder that the term "risk management" causes considerable confusion? The difficulty is that each of these forms of risk management addresses only a portion of the entire risk spectrum. Each has a deficiency. Each has a focus that is too limited.

The public risk assessment form clearly has the lead in sophisticated techniques of risk analysis and the ways in which cost-risk-benefit comparisons can be made. Yet, too little of its literature addresses the question of how society, organizations and individuals can actually finance losses when and if they occur. There is almost a tacit understanding that government will, in some equitable and mysterious way, pick up the tab! As Martin Katzman stated in Risk Analysis last year, "conventional PRA (probabilistic risk assessment) stops at the distribution of real losses."

The "financial" risk managers, in turn, are too focused on currency levels and interest rates. Health care practitioners are too frequently wound up in their medical jargon. Safety people do not admit that "financial" risk management exists.

Even insurance risk management, the oldest form of the discipline, has been notorious in its overconcentration on various types of risk financing, paying too little attention to either risk assessment or risk control. It has overlooked many significant forms of new risk, primarily because of a resilient unbilical cord to the insurance industry. This has created the chronic inability of this form of risk management to address major risk issues. A cogent and perceptive criticism by Chris Best in the spring 1989 issue of Risk Management goes as follows: "The truth, as risk managers know, is that as soon as the insurance industry is faced with major risks-latent diseases, product liability, AIDS, among others-it runs for cover and leaves industry to its own devices. Basically, society cannot expect much help from insurers in sorting out its risk problems because insurers are interested not in risk reduction ... but in risk predictability."

So here we have an industry trying to build its edifice on the sands of certainty and predictability in a world in which uncertainty and unpredictability are the bedrocks. Inevitably, therefore, all of us appear to be prisoners of our pasts. What is to be done?

The "New" Management of Risk

Given the undeniable need for new ways of grappling with uncertainty and the acknowledged inability of the "old" risk management to meet these challenges, it is obvious that a new function must be developed. We are seeking a new definition of risk management, a new description of its breadth, a new place for it within organizations and, finally, a synthesis of techniques to allow us to live with the future.

In a paper delivered at the 1989 Conference on Product Life Cycles, William W. Lowrance of Rockefeller University defines risk as the "compound estimate of the probability and severity of harm." Rae Zimmerman of New York University argues in "Risk Evaluation and Management" that the process is one "by which decisions about risk are made linking analytical procedures with the administrative, legal, political, organizational and human dimensions of the decision-making process." She also raises the critical issue of credibility: "The important question is how one gains the benefit of hindsight before an event occurs, without incurring the loss of credibility associated with being wrong!"

A new definition is required. According to William Rowe's "An Introduction to Risk Assessment," risk management is a discipline for living with the possibility that future events may cause adverse effects.

The important words here are "living with." Risk will not disappear. It cannot be legislated out of existence. Technology cannot make it vanish, because inevitably new risks arise from every old one we think we have overcome. And insurance does not really transfer it; it only apportions some of its costs through an imperfect funding mechanism. The thrust of the discipline will be educating the public to understand the risk trade-offs that are a part of modern life. Risk management will then become a composite discipline of multiple and sequential steps, already well outlined.

The risk management process includes three steps: risk assessment, risk control and risk financing, or as Mr. Lowrance describes it, risk assessment, risk appraisal and risk response." Risk assessment is the description of the likelihood and severity of threat. Risk appraisal is the evaluation of the personal or societal burden from the risk and the cost required for protection. Risk response is the prescription for what to do about the risk. Risk response presumes not only preventive but also funding steps, because some risks will inevitably result in losses, and losses must be paid for through both public and private purses.

It is not a question of whether a new risk management will evolve: The process has already started. Where will this new function be positioned within the organization? Will it report to human resources, treasury operations?

Ideally, given the breadth of responsibility, risk management should become a senior position, on an equal par with finance and personnel, or perhaps an internal part of strategic planning. The difficulty is that any organization must deal with existing skills and reality, not an abstract ideal, no matter how convincing that ideal may be. The evolution will probably continue to be based on the form of risk management most pertinent to a particular company. For those with strong managers from the insurance side, it will undoubtedly continue to report to finance for the foreseeable future. In health care settings, it will probably report to the administrator. For financial institutions, it may be a part of operational management.

Yet, risk management should be seen more as a "function" than a specific position. It should be practiced by many levels of management, with coordination and guidance from a senior level. If practiced this way, its benefits will be significant. How will the new risk management process function? In another paper presented at the Conference on Product Life Cycles, Ted Ferry of the University of Southern California suggests: "We need an overview system of checks and balances that studies every interface and assures that all risk elements are considered. We need persons who can see the big picture, overview, coordinate, assimilate and bring every aspect of risk into focus."

Using the new definition and these comments, risk management becomes a planning and strategic function, not solely an assessment, financial or safety one. As Peter Drucker has argued, "What we have to do today is be ready for an uncertain tomorrow. . . . Long-range planning should deal with the futurity of present decisions. "

The new risk management will be an outgrowth of earlier efforts and disciplines. It will be a true synthesis of many of the earlier ideas that have approached risk from a more limited vantage point. The synthesis will be composed of ideas and efforts from the following areas:

*insurance management and risk funding;

*general management theory and practice,

from Henri Fayol to Mr. Drucker;

*macro-risk assessment and decision risk

theory and practice, addressing such

areas as nuclear, natural disaster and environmental


*quality assurance methodology for both

products and services;

*loss prevention, safety and security engineering;

crisis management;

*financial risk maneuvers, including currency

hedging and interest rate swaps;

*risk psychology, education and communication;


*statistics and the actuarial sciences.

This synthesis will be applied to a wider range of loss exposures through a more systematic approach to risk assessment, risk control and risk financing. These exposures can be divided into operations, legal, financial and political categories. Operations exposures include direct loss of or damage to physical property, consequential loss (loss of use), criminal fraud, direct loss of, injury to, or disease to personnel and loss or compromise of information/data. Legal exposures include contractual liability, statutory liability (laws and regulations) and tort liability (judicial precedent and interpretation). Under the financial category are credit risk, interest rate fluctuation and currency fluctuation/convertibility. Under political, full expropriation, confiscation, nationalization, terrorism/war and regulatory change or instability.

The new risk manager will not have to be and certainly cannot be--an expert in each of these complex and diverse areas. He or she, however, will have to be a manager in the broadest sense of the word, one who is at the very least conversant with the applicable disciplines and willing to look broadly and holistically at risk as it affects the organization.

The Challenges

The first challenge is recognition that the most important resource of any organization is its public reputation, and that the most serious risk in the marketplace is loss of credibility. A solid public reputation is a critical asset, as well as the first line of protection. Several issues today require the attention of the new risk manager. They include: * the destruction of the ozone layer by

chlorofluorocarbons and the product

changes that will be required to reduce

the problem; * the direct and indirect costs of the new

pandemic of AIDS and how organizations

should respond; * substance abuse, particularly in the

United States, where drugs, alcohol and

tobacco kill more than 600,000 people annually,

and how organizations should respond; * the costs and effects of geriatric and

long-term health care for an aging population; * carcinogenic risks in both old and new

products, particularly chemicals; * automobile deaths, injuries, air pollution

and traffic congestion; * the growing public resistance to the

pollution of air, water and soil that is

creating a vast area of liability for which

there is no current funding solution; * an increasing realization that "dis-economies

of risk" can overwhelm

economies of scale" in the future; and

the uncertain stability of financial institutions,

including banks, insurers and


While some of these issues may appear to be external to individual organizations, they are nonetheless integral to their uncertainties. They must be addressed. The new risk management must focus on this broader range of uncertainties, not just on those that may be financiable through insurance or related mechanisms.

Some final thoughts: * First, as Mr. Lowrance points out, we

must be explicit and courageous in trying

to confront-not just fear or gripe

about-risks. Essential in this is accepting

"as a fact of life" that some risks are a

virtually irreducible price of maintaining

central aspects of modern civilization. * And second, he says it is essential that we

compare risks in order to develop context

and gauge importances. In this we

must view risk-response actions not as

wasted costs, but as investments that

generate humanitarian returns. These

returns include avoidance of pain, illness,

incapacitation, death, disruption

and medical costs; longer and fuller lifetime

contributions to society; reduction

of environmental damage; and the securing

of technological benefits as hazardous

impediments are reduced. * We must adopt a more holistic approach

to problems, looking at the whole and

avoiding the trap of dealing with specialties

with which we feel most comfortable.

Simply learning how to buy and manage

insurance, even the more sophisticated

methods in vogue today, is not risk management. * We must adopt a more systematic approach,

understanding the complex interrelationships

that exist in everything we

do. Systematic understanding is difficult

to achieve, but is necessary if we are to

survive in this uncertain world. * We must accept the thesis that risk is

probability and that probabilities are always

changing. * We must become more humanistic, reflecting

the multiplicity of values, viewpoints,

cultures and perspectives that

make the human race as interesting and

disturbing as it is.
COPYRIGHT 1990 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990 Gale, Cengage Learning. All rights reserved.

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Author:Kloman, H. Felix
Publication:Risk Management
Date:Apr 1, 1990
Previous Article:The emergence of financial reinsurance.
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