Enterprise Risk Management (Preview)

12 Part 1 – Concepts and Methods THE EVOLUTION OF RISK MANAGEMENT Every management discipline evolves over time, and risk management is no exception. Evolution happens incrementally as a result of pressures to resolve issues, and leadership to adopt innovative practices. Evolution is based on experimentation and lessons learned, sometimes through unfortunate events. Events and crises occur that trigger changes in attitudes and management practices. Such changes are referred to as paradigm shifts. Organizations continuously seek to implement better management practices to improve their performance and develop a competitive edge. Governments also influence mana- gement practices through laws and regulations for the public interest. Over time, practices improve, knowledge is gained, expertise develops, guidelines are established, profes- sional associations are formed and training becomes available. All of these factors cause management disciplines to evolve and mature gradually. Prior to the industrial revolution, organizational risks were managed mostly in relation to community and commercial activities. Whether such risks had to do with the building of cities, the education of children, the treatment of illnesses, the growing of crops, the defense of territories, or the transportation of merchandise using tall ships, risks relating to all of these activities had to be looked after. The industrial revolution caused organizations to grow significantly in size and complexity. The growth of organizations contributed to the development of traditional management functions such as accounting, production, human resources management, warehousing and sales. The business activities relating to these functions involved risks, however risk management was not recognized as a distinct discipline. During the industrial revolution, risk management was mostly left to individual managers as part of their ongoing responsibilities. Industry Influences Risk management as a functional discipline mostly emerged from the financial services industry, mainly because financial risks tend to be easier to measure and assess objectively. Financial services organizations such as banks and insurance companies continuously analyze market conditions. They price their products and services based on the income that must be generated to cover their operating costs, absorb losses relating to bad loans or insurance claims, and return an acceptable profit to investors. Financial services organizations quickly understood that a competitive advantage is gained by managing risks effectively. For example, they apply risk control techniques involving customer selection, loan diversification and monitoring activities. They also use risk financing techniques such as hedging, derivatives, investment reserves and reinsurance. Banks and insurance companies manage financial risks as a core business function. Over time, their knowledge and expertise contributed to the advancement of risk management. Health sciences also had a noticeable impact on risk management. For example, during the 1990’s, government health authorities in the United States and Canada developed frameworks and processes for the management of health risks. These risks are defined as the probability that a substance or situation may produce harm to human health under particular conditions. 6 Health risks have to do with communicable and non-communicable disease, the safety of prescription drugs and medical devices, the use of pesticides, the