2 December 2008, Wolfgang Boffo, Risk Consultant, Special Enterprise Risks, Munich Re

Recognising new types of risk – Developing innovative solutions

Companies are coming under increasing pressure to meet the expectations of investors, rating agencies and other stakeholders. At the same time, their operations, and with them the risks involved, are growing in complexity. The ability to recognise and understand change and initiate the required action is not only an absolute prerequisite for exploiting growth potential to the full, but is also critical for survival.

In principle, the assessment of material risks, such as loss of production due to claims events, is relatively straight-forward – this has long been the insurance industry’s core business. However, nowadays intangible losses such as lost profits and reputational risks are gaining in importance. Contaminated food or toys containing noxious substances can have dramatic consequences for producers, as can business interruption, where a company might be forced to suspend production for weeks or even months, possibly losing customers to competitors as a result. Whilst the loss itself and running costs during the interruption can be insured, the loss of customers or market share cannot.

The problem with intangible losses is that lost profits and reputational risks are considerably more difficult to assess and have so far not been the object of mitigation. Estimating the costs incurred until reputation or market share is reestablished is even more complicated. Many managers have so far been insufficiently aware of the changed risk profile of their company because in most cases it is not transparent. As a result, they unwittingly expose themselves to higher risk in pursuit of overriding goals such as growth and increased profits.

While banks and insurers have been grappling with holistic risk management for a number of years because of new supervisory requirements being introduced with Basel II and Solvency II, other sectors have not been subject to formal regulatory requirements. For most companies, risk management, if they consider it at all, involves covering specific, traditional types of risk, such as interest-rate or foreign-exchange risk, or taking out buildings insurance. Risk management is often part of the purchasing department.

An understanding of the need for holistic risk management is developing only gradually, especially in small and medium-sized companies, but in future, companies of any size in all sectors of activity will have to address the issue of holistic risk management, i.e. risks will not be considered separately, but as a whole. This paradigm change is supported by the following arguments:

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  New types of risk and chains of cause and effect can no longer be properly managed using traditional separate assessment.
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  Decision-makers in companies need a clear understanding of the overall risk situation and the effectiveness of any possible action they might take. In the context of risk management, they must be in a position to carefully consider and decide which risks to retain and which to transfer.
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  Risk culture is changing. At many companies, an exclusively negative perception of risk is giving way to a desire to manage opportunities.
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  The methodologies and models required for holistic risk management are becoming more reliable and take both qualitative and quantitative information into account. Ideally, capital and risk-transfer costs should be transparent, providing a sound basis for decisions.
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  Stakeholders take a positive view of holistic risk management, which, for example, can have a direct positive impact on a company’s finance costs or rating in relation to its competitors.

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