Enterprise Risk Management (Preview)

Chapter 1 – Risk Management Awareness 35 Similar findings are observed in other studies. In 2011, academics from the University of Georgia and the University of Mississippi published a study that analyzes the effects of ERM on the market value of publicly-traded insurance companies. The study examines the correlation between ERM adoption by insurance firms and their Tobin Q ratio (which compares market value with asset replacement costs). After controlling for other variables associated with value creation, the researchers observe that “insurers using ERM are valued as much as twenty percent higher” 49 than other insurers. The researchers conclude that the valuation premium is “statistically and economically significant.” 50 ERM protects value and creates value. It protects value by managing threats that can deplete assets, limit growth, reduce profitability and damage reputation. Conversely, it creates value by helping organizations improve their performance, including achieving their goals, strategies and objectives. Measuring the value of ERM is challenging because it involves trying to measure the effects of risks that did not occur, and trying to isolate the contribution of ERM from other sources of value creation. However, when risks materialize, the consequences are known and sometimes catastrophic. For example, the Deepwater Horizon oil spill of 2010 resulted in costs and liabilities exceeding $60 billion for British Petroleum. In early 2007, Lehman Brothers had a market value of approximately $45 billion that entirely vanished as a result of its bankruptcy. In 2015, Volkswagen reported costs of approximately $18 billion directly associated with its emission scandal. Volkswagen also predicted a five percent decline of its revenues for 2016. These examples are stark reminders of the value that can be lost when risks associated with complex operations, financial assets and organizational culture are not managed. When trying to define and measure the value or benefits of ERM, it is useful to reflect on the outcomes that are sought (Figure 1.4). Risk management professionals should define these outcomes and develop objectives for achieving them. They may also wish to adopt indicators for measuring the achievement of the outcomes. Indicators can be developed by asking: How will we know if/when the outcome is achieved? and What kind of evidence do we need as proof that the outcome is achieved? Outcome statements are typically worded in a manner that reflects the desirable end state. The most important benefits of ERM are the ability of organizations to achieve a collective understanding of organizational risks and make better decisions. With ERM, organizations design approaches to identify, analyze and prioritize risks that affect performance. Process Outcomes: • Risks are identified in relation to objectives. • Risks are aggregated from all business units. • Known and emerging risks are analyzed. • Risks are analyzed using proven methods. • Risks are prioritized using dependable criteria. • Actions are taken to address significant risks. • Risk management solutions are integrated. • Risk management results are monitored. Framework Outcomes: • There is consensus on the most important risks. • Risks inform strategic planning and decision making. • Risks are assumed in accordance with directions. • Risk ownership and accountability are assigned. • Performance is managed taking risks into account. • Meaningful risk information is reported to stakeholders. • Risk management compliance requirements are met. • Risk management protects and creates value. Figure 1.4 – Examples of Outcome Statements Reflecting the Benefits of ERM