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Connecting Risk and Value
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As far as Sim Segal, FSA, CERA, is concerned, enterprise risk management (ERM) is not only an excellent career choice for actuaries; it is also a way of making a positive impact on the world around you.
Armed with 27 years’ experience of managing and measuring risk, Mr. Segal has been recognized for his expertise in the expanding field of ERM. Besides running his own consulting firm, Manhattan-based SimErgy, he is a published author (Corporate Value of Enterprise Risk Management), host of a weekly radio show (Risk Radio), and adjunct professor at Columbia University.
"I was drawn to ERM as a natural extension of one of my guiding principles to make the biggest possible positive impact that I can," he says. He synthesized two fundamental business disciplines—risk management and value-based management—to produce his value-based approach to ERM. He says that "risk-return" is the most common phrase in business, yet few have been fully integrating their risk management and decision making processes. He adds that when done properly, ERM has the ability to help organizations deliver on the risk-return management promise, which "enhances their strategic planning and decision making processes, improves the odds of achieving their goals, and increases their value".
ERM has its challenges, though, according to Mr. Segal, who was the inaugural chair of the Society of Actuaries’ Risk Committee and also served as chief editor of the international quarterly Risk Management. The absence of uniform standards has led to many suboptimal ERM programs that fall short of expectations. He says there are three questions organizations can use to diagnose whether their ERM program may have shortcomings:
ERM is a process that must encompass all sources of risk: strategic, operational, financial, and insurance, he says. Strategic risks include items such as a flawed strategy; an inability to execute the strategy; competitor risk; regulatory risk; etc. Operational risks include items such as technology risk, human resources risk, and disasters. "Every industry study I have seen, including one that I led and co-authored, shows that more than 80 percent of all organizational volatility is caused by strategic and operational risks," says Mr. Segal, "yet most ERM programs focus mainly on the financial and insurance risks instead. Without quantification of the strategic and operational risks, the ERM team cannot inform any decisions on strategy or operations, which represent the bulk of the important decisions in the firm."
- Is there a robust ability to quantify strategic and operational risks?
- Is there a clear, quantitative definition of risk appetite that can be used in the risk governance process?
- Is ERM integrated into a broad range of strategic and tactical decisions?
Another critical element is risk appetite, he added. Risk appetite is the maximum level of risk exposure with which management is comfortable. Unfortunately, many organizations use only vague language in their risk appetite statement. "Without a clear, quantitative definition of risk appetite, it is impossible to do the main job of ERM: managing exposures to within risk appetite."
Perhaps the most important challenge is that many ERM frameworks are not designed to integrate ERM information into a broad range of strategic and tactical decision making, he explains. The most common reason for this is that the ERM program was viewed as an extension of capital management. This often results in ERM models that are overly complex, too slow, and lack the transparency to gain buy-in from decision makers.
"In part, I designed the value-based ERM approach to address and resolve these three issues," he says. By connecting risk and value through an advanced yet practical framework, his value-based approach allows the quantification of all risks, provides a quantitative definition of risk appetite, and fully integrates ERM into decision making. "With the right framework, properly customized to the organization’s strategy and culture, ERM reaches its full potential. Many chief risk officers struggle to achieve internal buy-in for their ERM programs and often do not have a seat at the table when important decisions are being made. However, with the proper approach, the ERM team gets invited into discussions involving the most important business decisions in the company. Seeing this turnaround is part of what makes this such satisfying work."
Mr. Segal says that although ERM requires a range of skills and experience, it is well-suited for actuaries, who are really futurists, and to whom measuring and managing risks, making long-term projections, and handling the multi-dimensional complexity of risk combinations comes naturally.
In addition, he emphasizes that ERM represents a large expansion of opportunities for actuaries. ERM is being adopted in all corporate sectors, globally, as well as beyond the corporate sector. Mr. Segal says, "ERM is being adopted by non-corporate entities, such as government entities and non-profit organizations." He believes this is an area where actuaries have a nearly unlimited opportunity to get involved and make an impact. "The world needs people who are able to understand the numbers and who are willing to speak the truth. Actuaries have strong reputations in both of these areas—we are seen as number-savvy and ethical. Would we be better off if actuaries were more involved in government budget projections, for example? I believe so . . . and I’d certainly like to find out."