If ever there was an idea whose time has come, it is this: risk is risk, comments Lee Coppack.
Many of the articles in this edition, and particularly the report of our seminar on managing reputational risk, show that the perceived boundaries between different types of risk are rapidly dissolving. The risk manager has in front of him or her an almost unlimited vista. The current drawback is that there are no maps.
Two routes appear to lead off to the horizon, however. One is in the direction of increasingly precise quantification of risk, the potential interaction between risks and the means of hedging or laying off those risks. The other route is towards ideas about risk. It is not very well paved or well signposted and seems to disappear into thick woods. Which way does the risk manager go?
Until now risk management has largely straddled the two trends. Risks do have to be identified, but while they have been compartmentalised by function within the organisation - property and liability, financial, credit, compliance and so on - the risk manager really had a finite number of reasonably well understood exposures to consider. In the initial stages of risk management, the emphasis was on quantifying those risks and buying insurance so, it is not surprising to find that, typically, risk management comes under the finance director or chief financial officer, at least in English speaking countries.
That traditional paradigm has been collapsing over the last few years as the primary objective of senior management has shifted from manufacturing televisions, building dams or producing films to become one of satisfying shareholders with the operations of the business now treated as a means to that end. Globalisation, mentioned by contributors as one of their biggest challenges, has been an integral part of the process.
Multi-national businesses have realised that they themselves now have a sufficiently wide spread of risk and large cash flow to fulfil much of the role that insurance has played. The sights of risk management have, therefore, been raised from protecting particular assets or operations to protecting the total value of the business, which could be its balance sheet, its continuing ability to meet shareholders' expectations or its share price over time.
Gaurav Bhandari, vice president of the insurance products group at Goldman, Sachs & Company in New York, spoke earlier this year at the 10th annual Arkwright global symposium held in Boca Raton, Florida. He told risk managers: "In an ideal world, a company would be able to focus on its core operations, its competitive advantages, while taking all the other risks and hedging them out with parties that are more efficiently able to absorb those risks.
"This unbundling of value within the company and the resulting transparency in its operations is ultimately of most value to a shareholder. For example, an investor in an oil company is really investing in the ability of the company to explore and develop fields or to cost-efficiently refine and distribute products rather than to take a view on oil prices.
"At a more practical level, the stock market rewards both stability of earnings as well as growth and to the extent a risk management strategy can contribute to either - that is of clear benefit to the shareholders."
As we have seen with Bermuda reinsurance companies, improved data and vastly increased computing power (less 3 Gb used by a mathematician to demonstrate that greengrocers really do stack oranges in the most efficient way) have enabled firms to model the effect of different variables on their assets and liabilities. In the event of a major catastrophe, retrocession can protect the reinsurer's revenue, but additional capital produced by an equity put will protect the balance sheet.
To reach the conclusion that a new financial instrument is better for your shareholders than a traditional (re)insurance product requires both conceptual thinking and the ability to put a range of numbers to particular scenarios and the cost of various options. A recent column in the Financial Times on the subject of intuition in business was illustrated by a cartoon of a man looking hopeful and holding a report which says : "Looks fine to me." The reply from the manager is: "You're an auditor. You're not supposed to rely on intuition."
However, the role of risk management in protecting shareholder value goes beyond finding innovative solutions to known risks, such as catastrophe losses in reinsurance. To be really effective, it must consider risks that could damage the perceived value of the business, which is most clearly manifested in its share price. The good reputation of the corporate name and/or its brands is seen as a critical element in that value, which is why we organised our seminar on that subject, and since reputation depends on perception, it needs imagination to think how it could be damaged. (See page 9 for the report.)
Risk managers of the future will need to have or to have available an unprecedented range of analytical and conceptual skills. Consultants can provide particular skills not available internally or just a wider range of experience and outside perspective. Therefore, the answer to the question which route should the risk manager take is not so important, as long as they keep both in sight.
Lee Coppack is editor of the Risk edition and co-editor of Global Reinsurance.