Risk Management Lectures 1-5 PDF

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Risk Management Lectures Lecture 1: Introduction: o o o

Risk Management: a versatile skill-set a skill you are likely to need, no matter what your career Module reading study skills–what are the best journals? Module assessment three-hour exam–choice of three from five questions

Managing Risk: the insurance perspective Risk management is a relatively new term. Consider that the history of risk management is really the history of insurance… Risk ‘Pooling’ or ‘diversification’ Chinese merchants travelling on the Yellow River, instead of transporting their own merchandise, used to distribute their merchandise amongst each other’s boats. Hence the loss of a boat meant that each merchant would lose only a small proportion of their cargo. Babylonian merchants adopted the same practice for their camel trains to more widely distribute risk of loss from wind storms and bandits. (J.F. Outreville (1998) Theory and Practice of Insurance, Kluwer). More insurance terms: o o

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Peril: “The cause of a possible loss” Hazard: “A circumstance that increases the likelihood or probable severity of a loss. For example, the storing of explosives in a home basement is a hazard that increases the probability of an explosion” Source: AM Best’s Glossary of Insurance Terms: http://www.ambest.com/resource/glossary.html Risk Transference: In insurance, a contract is drawn up whereby, in return for the payment of an insurance premium, the insurer promises to reimburse the insured for financial losses caused directly by a specified peril. In other words, risk of financial loss is said to be transferred from the insured to the insurer through the mechanism of the insurance contract.

Retain or transfer? Retain risk of loss? o o o o o o

Charge to operating costs (i.e. pay for losses from cash flow); Set up a ‘contingency fund’ or ‘self-insurance fund consisting of ‘near cash’ assets; Sell assets; Take out a loan; Set up a ‘captive’ insurance company; Reduce hazards (e.g. install sprinkler systems to reduce fire risk)

Transfer risk through insurance. Insure against loss? Insurance is frequently a preferred ‘first choice’ risk financing option. This may be due to ignorance of alternatives, or because it is a ‘safe’ option which provides ‘peace of mind’ and allows the organisation to benefit from the RM expertise of the insurer or its appointed loss adjuster. Insurance can be particularly appropriate for new initiatives. Initial risk costing linked to the market price offered by the insurance company can be used as a basis for the later review of

alternative risk financing options. However, insurance can be VERY expensive! Consider that around 40-50% of the premium might easily go towards the insurer’s admin costs and profits! Why develop risk management? o o o o o o o o o o

to self-insure (because insurance is expensive) to comply with regulation to get better credit ratings shareholders and markets want it regulators want it to improve governance to improve strategic decision-making to add value across the organisation but perhaps the best reason is to enhance management Can you have management without risk management?

Lecture 2: what is risk? First, we will look at the basic meanings of ‘risk’ and closely related concepts. We will see that there are diverse ways of thinking about ‘risk’. We don’t need to choose between them. What matters is that: o o o

we find can some value in each approach; we can compare and critique different approaches; we know what we mean each time we talk about ‘risk’.

Some Risk definitions o

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Combination of the probability of an event and its consequence (….) consequences can range from positive to negative. (British Standard BSI PD ISO/IEC Guide 73: 2002, and UK AIRMIC/ALARM/IRM Risk Management standard 2002) Uncertainty of outcome, whether positive opportunity or negative threat. (UK Office of Government Commerce, MoR, 2002) Uncertainty of outcome, within a range of exposure, arising from a combination of the impact and probability of potential events. (HM Treasury 2001, Management of risk - a strategic overview, January, ‘the Orange Book’) An uncertain event or condition that, if it occurs, has a positive or negative effect on a project’s objectives. (PMI, 2000) An uncertain event or set of circumstances that should it occur, will influence the achievement of... objectives. (Simon, Hillson and Newland, PRAM Guide, UK Association for Project Management, 1997) The chance of something happening that will have an impact on objectives. (Standards Australia/standards New Zealand AS/NZ 4360: 1999) A significant uncertain occurrence... defined by the combination of the probability of an event occurring and its consequences on objectives. (UK MoD Risk management guidance, 2002) Potential inability to achieve overall programme objectives. (US DoD DSMC 2000) Something happening that may have an impact on the achievement of objectives... it includes risk as an opportunity as well as a threat. (NAO, 2000) The possibility that an event will occur and adversely affect achievement of objectives. (Opportunities: the possibility that an event will occur and positively affect the achievement of objectives.) (COSO 2004)

Risk as ‘uncertainty that matters’ because it brings possibility of loss Possibility of loss to a person or group? “Risk emerges from situated cognition that establishes a relationship of risk between a risk object and an object at risk, so that the risk object is considered, under certain contingent circumstances and in some causal way, to threaten the valued object at risk” Risk as threat of loss Risks can be viewed as ‘threats’ that can produce ‘loss’. In each case we can ask who or what is ‘exposed’ to the threat of loss. o

Risk as something that matters to someone or some ‘thing’ … ‘risk to

And we might also ask questions about the loss: o o

What is the ‘probability’ or ‘likelihood’ of the loss event occurring? What are its ‘consequences’ or ‘impacts’?

Financial consequences? Reputational consequences? Starting with this simple view of risk as ‘threat of loss’, it is notable that we start thinking about risks in relation to ‘events’ that ‘happen’, ‘occur’ or ‘eventuate’. Do we overuse the word ‘risk’? Jack Dowie argues in his (1999) ‘Against Risk’ that the children’s rhyme ‘Humpty Dumpty’ illustrates well how the term risk can mean very different things… do we need to use the word ‘risk’ at all to make sense of the choices Humpty has to make?

Dowie’s argument highlights the need to differentiate between two perspectives: Risk Listing Follow the RM Process options…. (identify, assess, control, then monitor risks) List the risks in a risk register…. Keep following the process cyclically… Maintain the register as a ‘living document’ Consider the pros and cons of each approach... Risks as statistics, events and causes of events?

Decision Making under Uncertainty Consider specific decision (focus on utility and probability)

Risk ‘Realism’ Bhaskar’s ‘layered ontology’ suggests that ‘risks’ can be considered as very different sorts of ‘thing’, depending upon where we situate them within the above three ‘layers of reality’. o o o

The ‘Empirical’: risk statistics The ‘Actual’: risk events The ‘Real’: risks as ‘generative mechanisms’/potentialities

Discussion Point: Is it helpful to differentiate between risk statistics, risk events, and the generative mechanisms that produce risk events? Risk ‘Realism’: how important is it to consider the divide between appearance and reality? o o

Risk management must struggle to overcome problems of subjectivity/social construction? What roles for ‘corrigibility’ and ‘iterativity’ as guiding principles for risk management practice?

Lecture 3: from ‘risk management’ to ‘uncertainty management’

Uncertainties Threats Opportunities

More than just threat or opportunity management

Understand where and why uncertainty is important in a given performance context, before seeking to manage it.

Uncertainty about: o o o o o o o

Relevant aspects of performance Nature of causes (possible intended actions, conditions, events) The current and future state of causes The possible effects of causes on different aspects of performance The probability of a particular cause producing a particular effect Linkages between various causes and/or various effects System Components (and decomposition solutions)

A very simple cause-effect chain:

Effect 1 = effect on performance attribute 1 etc. A knowledge perspective - Relevant to all management processes. Address roots of uncertainty o o o o o o o o

What do we need to know – for what purpose? When do we need to know it? What knowledge have we got? When is knowledge available? Where is knowledge? Who has it? How do we get it? What resources do we need to get it?

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What is the value of different pieces of knowledge? How does this change over time as the situation changes?

Four types of uncertainty o o o o

Event uncertainty–possibilities due to specific events or conditions Inherent variability –in factors that are always present Systemic uncertainty–associated with relationships between sources of uncertainty Ambiguity uncertainty –associated with lack of knowledge, understanding or agreed plans, and a residual of all uncertainty not included in 1-3 above.

Sources of uncertainty associated with estimates o o o o o o

Lack of clear specification of what is required Novelty or lack of experience Complexity – number of influencing factors and associated interdependencies Limited analysis of the processes involved Possible events or conditions which might affect the activity Bias

‘Push’ threats and opportunities through risk management processes? The 2002 ALARM/IRM/AIRMIC RM process … and enter them in risk registers? • One step- revise common practice risk management terminology – Replace the term ‘risk’ with ‘uncertainty’ – Replace • Problem • Weakness • Impact • Mitigate • avoid risk issue issue consequence modify resolve uncertainty Moving from Risk Management to Performance Uncertainty Management  Expose and investigate pertinent uncertainty  transparent analysis  clarify the quality of estimates  variability assessment  Clarity efficient effort in analysis and planning  Address uncertainty about priorities and tradeoffs  clarify priorities and tradeoffs  motivate efficient tradeoffs  Opportunity efficient planning and plans...