Good governance demands organisations know their limits
By Ross Ivey
A key element of good governance in all organisations is that management and directors maintain a clear-eyed view, not only of the opportunities ahead, but also the risks that surround them.
In small organisations with a handful of employees, a concentrated geography and predictable demand patterns, getting to grips with risk may seem simple enough.
- But how many charities or schools anticipated the impact the Royal Commission into Institutional Responses to Child Sexual Abuse would have?
- How could Samsung have predicted the challenges it would face with the recent Samsung 7 smartphone recalls and the resultant customer churn?
- How many SMEs understand the devastating impact cyber-attacks can cause and the liabilities it may prompt?
Even the most seemingly established organisations face the risk of the unknown – and that applies to organisations of all scales and in all sectors.
Multinational organisations, particularly ones that are part of a global supply chain are by their nature complex, and face the most unknowns and greater risk. In addition, we are living in volatile world and this has forever shifted the goalposts on risk.
Prudent organisations have always looked to insurance to transfer at least some of the risk associated with the unknown. But experience demonstrates that typically businesses have only 50 to 75 per cent of the correct value insured, simply because they are challenged to more accurately scale their exposure – and know their limits.
Back-of-the-envelope calculations relying on gut feel and anecdotal evidence fail to account for often complex interdependencies, or the pace of change in certain markets. If those envelope calculations are then taken as a foundation for future years and rolled over with perhaps a 10 per cent buffer added for good luck, the risk of being profoundly underinsured compounds rapidly.
Benchmarking against similar organisations can also significantly underestimate unique risks while budget pressures conspire to an organisation’s willingness to fall for the “she’ll be right” mantra.
What's required instead in scoping the limits of risk is discipline, rigour – science even. Good governance and organisation sustainability relies on proper limit analysis, conducted to ensure that any coverage would adequately insure against loss and effectively transfer risk.
Comprehensive limit analysis also requires investigation beyond the borders of the organisation to assess potential impacts on third parties, and resultant liabilities. Attaining that level of perspective is an enormous challenge for even the most dedicated company risk manager or director.
The alternative to this well intentioned, but inevitably best-guess approach, is to seek independent counsel from skilled analysts.
Independent limit analysis offered as a service, grounded in data and analytics, as well as using well founded simulation risk modelling can more comprehensively assess the risks that an organisation faces.
Scenarios can be mapped out featuring realistic circumstances with proper attention to variables in order to better approximate reality.
Triple point estimates of minimum, most likely and maximum impacts of a range of scenarios allows skilled limit analysts to provide clarity regarding true corporate exposure and delivers a framework that allows insurance coverage to be sought which is more appropriate to the organisation needs.
It’s for good reason that this same modelling approach is widely used in financial risk analysis – the stress testing now required from the banks to ensure they are operating prudently and pose a reduced risk to the financial system at large. It’s also standard practice for project risk analysis, and the potential for budget and time overruns is estimated using these techniques.
The true value of limit analysis is now being recognised across a number of sectors, particularly agriculture and food production where there may be significant supply chain issues; in utilities where the impact of failures and associated liabilities can be extensive; for bush fire modelling and more accurate property insurance.
Independent, comprehensive and clear-eyed assessment of complex risk profiles and effective limit analysis deliver greater confidence about organisation sustainability and inject the good into governance.
Aon’s Risk Consulting team can assist you at any stage of the risk journey, from risk identification and profiling through to risk management and claims consulting. You can find out more about our offering here.
Aon plc (NYSE:AON) is a leading global provider of risk management, insurance brokerage and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 72,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative risk and people solutions. For further information on our capabilities and to learn how we empower results for clients, please visit: http://aon.mediaroom.com.