Enterprise Risk Lagging Globally, Study Finds

Despite a widening range of risks faced by organizations globally, less than 35% of companies say they have an enterprise risk management (ERM) plan in place. What’s more, 70% would not describe their oversight as mature, according to the Chartered Global Management Accountant (CGMA) report Global State of Enterprise Risk Oversight 2nd Edition.

The study found that 60% of boards of directors globally are pressuring their companies to increase involvement of senior management. The U.S. is lagging in some areas, with only 46% of its boards assigning risk oversight responsibilities to a committee compared to 70% globally.

One survey conclusion:

Unfortunately, many executives view risk management as mostly focused on compliance and loss prevention with little connection to strategy and value creation. As organizations evaluate their risk management processes, they may benefit from providing an honest assessment about the extent to which risk management in their organization is an important input to the strategic planning process. Given executives understand the importance of taking risks to generate returns, shouldn’t risk management be an important strategic tool by providing risk insights that inform strategy?

Other key findings of the study include:

Navigating the risk landscape infographic

Gauging the Impact of Reputational Risk

The following article is part of a continuing blog series that will explore ideas, concepts, discussions, arguments and applications associated with the field of enterprise and strategic risk management.

In my previous article, I made the point that the public discussion of reputational risk lacks a set of common standards or definitions. This lack of consistency allows organizations to interpret or define the concept of reputational risk in very different ways. For some, reputation is beginning to be viewed as something like the “risk of risks” in the same way people are starting to discuss the concept of the “internet of things.” I questioned whether reputation or brand is actually a risk or a residual event stemming from other extenuating risk domains or actions.

Upon further reflection and discussions with academics and risk professionals who are thinking carefully about this issue, I would go further now to suggest that reputation or brand risk involves perceived or real human behaviors that are, to some extent, measured against societal, economic or moral standards. The adherence or deviation from established standards generates the basis for the risk, and the variability from the standard influences the duration of the outcome.

The bigger question is: What impact does reputational risk have on economic performance when possibly mitigated by the existence of a robust enterprise or strategic risk management methodology? Is the data available to see the “correlates” between a reputational risk event that trigger or influence operational key process indicators like EBIT, ROA, ROE and share price (public or private)?

What we do know from the Aon 2015 Global Risk Management Survey is that business leaders are concerned about reputational risk in general and the possible linkages with other hazard and operational risks within their organizations.

The respondents to the survey said that they worried that a reputational risk event would significantly impact financial performance.

reprisk1If reputation/brand risk was identified as a precipitating event, the respondents identified regulatory change, increasing competition, talent retention, cash flow/liquidity and share price volatility as “follow on” risk consequences. In effect, reputation/brand risk might constitute a “gateway” risk, where other related “follow on” risk consequences are triggered and serve to increase the overall volatility/impact of the reputation event.

Another way to view the data is to see what events could trigger a reputation event.

reprisk2In this case, the survey respondents identified nine non-correlated risks that could precipitate a reputation/brand event. Here social media plays an important role. The speed by which information, accurate or not, is transmitted, consumed and iterated across the nine risk categories may have a material impact on the basis and duration of the reputation/brand event. There is also an error component associated with social media. How many times have we witnessed an initial media report of a brand damaging event that turns out to be prematurely reported and the facts distorted, only to be corrected in a later reporting cycle?

Next up: Fat vs. thin tail distributions.

Defining Reputational Risk

The following article is part of a new blog series that will explore ideas, concepts, discussions, arguments and applications associated with the field of enterprise and strategic risk management.

One of the more striking conclusions contained in Aon’s 2015 Global Risk Management Survey is that damage to reputation and/or brand was considered by the survey cohort to be the most significant risk to the enterprise. The survey was conducted in Q4 of 2014 and received input from over 1,400 respondents coming from both the private and public business on a worldwide basis.

The “Top Ten” most identified risks included:

  1. Damage to reputation/brand
  2. Economic slowdown/slow recovery
  3. Regulatory/legislative changes
  4. Increasing competition
  5. Failure to act or retain top talent
  6. Failure to innovate/meet customer needs
  7. Business interruption
  8. Third-party liability
  9. Computer crime/hacking/viruses/malicious codes
  10. Property damage.

The survey results should not come as any real surprise given the number of sensational news stories coming from around the world that highlight potential or real reputational or brand problems. We have witnessed data breaches ranging from credit card identity theft in consumer retail, to serious product recall notifications in the food and beverage industry, to product performance/ warranty failures in the automotive arena, as well as “hints of reputational quality,” defined as “trust” in the early stage politics of the presidential selection process involving private vs. public use of email servers. There is little doubt that news, sensational or not, impacting reputational or brand, will continue for some to come. The real question is: Should anyone care?

Defining reputational/brand risk is hard to accomplish:

Based on some additional research done by my colleague Sylvesto Lorello, reputational risk is not a new concept, but it arguably has no established or universally agreed upon definition. Academic and business thinking about this subject continues to evolve. Within the insurance underwriting community that I have been in touch with, reputational or brand risk is being compared in scope to contingent liability risks, but with a serious caveat: the basis of the risk is highly variable and the duration of the risk event/loss event is difficult to pin down economically.

The concept of reputation and brand for example, are notably absent from the 2004 framework for enterprise risk management proposed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). It is also overlooked in the Basel II international accord for regulating bank capital, which was also issued in 2004.

A lack of common standards or definitions of reputational risk mean that companies perceive it in different ways. Some risk practioners are beginning to view reputation as a “risk of risks” similar to the dialogue surrounding the “internet of things/objects.” Interestingly, an emerging dialogue is developing around whether reputation or brand is actually a risk or a residual event stemming from other extenuating risk domains or actions.

The ISO 31000 (2009)/ISO Guide 73:2002 definition of risk is the “effect of uncertainty on objectives.” In this definition, uncertainties include events (which may or may not happen) and uncertainties caused by ambiguity or a lack of information.

The U.S. Federal Reserve in 1995 defined reputational risk as “…the potential that negative publicity regarding an institution’s business practices, whether true or not, will cause a decline in the customer base, costly litigation or revenue reductions. In this case, the definition points to the potential for hard data from which basis and duration can be calculated.

Definitional issues aside, eventually societies will develop benchmarks with which to measure reputational or brand acceptability. One way of thinking about this approach is shown in the following exhibit.

UntitledHere we ignore some of the more difficult definitional discussion around a combined reputation/brand perspective, and limit our view to reputation alone. From a practical early stage standpoint, an entities reputation could be view from potential threat and potential impact perspective. On the threat side, it may be possible to segregate threats into four categories:

  • Risk to reputation stemming from employment activities;
  • Risk to reputation coming from product or customer issues;
  • Risk to reputation derived from governance; and,
  • Other less easily classified risks to reputation.

These categories appear for graphical purposes as if they are mutually exclusive, but in reality, there are good examples of causal overlap that increased risk volatility and severity. Recent oil spills and automobile product failure/recalls are enduring situations where more than one causal category created a economically catastrophic reputational problem.

On the other side of the graphic we outline the potential impacts to reputation coming from the threat categories. Again, while not mutually exclusive or exhaustive, the impact areas include:

  • Customer base
  • Financial valuation
  • Brand and media
  • Staf
  • Other less easily defined impacts.

Coming next, who are the stakeholders and how might one approach measuring reputational risk.

Survey Finds Alliance with Organizations and Risk Reporting Structures

NEW ORLEANS—Seventy-nine percent of companies are aligned with their risk management reporting structure, however, only 27% of risk professionals believe that emerging risks will be a company priority in the coming year, according to the 12th annual “Excellence in Risk Management Survey” released here by Marsh and RIMS.

In the last five or six years, “We have seen significant narrowing of the gap, where there is better alignment of what risk managers and risk executives are providing their organization and what their C-suite and management is looking for and needing in this riskier world that we all live in,” said Brian Elowe, a managing director at Marsh and co-author of the report. Findings are based on more than 300 responses to an online survey and a series of focus groups with leading risk executives.

Elowe explained that the study focused on organizational alignment, risk management effectiveness, data analytics and technology and cyberrisk.

In their study of organizational dynamics, he said, “We looked at priority setting, organizational structure and performance measurement standards to understand effective execution of a risk management strategy.”

The first insight was in respect to structures risk management reports to inside an organization. “We also asked whether the people responding to the survey felt risk management was reporting to the correct area inside the organization. We found that 79% of the respondents said they felt risk management was reporting into the appropriate area inside their organization,” Elowe said.

Looking deeper, he said the survey found that 50% of executives report into the finance area. The other half reports into a wide number of areas inside the company–12% report to general counsel, 8% to other C-suite members, 5% to internal audit, 5% to operations, 2% to human resources and 11% to “other” functions.

“We found that while they are all in the risk management function, those that report to areas outside of finance tend to be involved in areas deemed to be more strategic in nature. So they are more likely to be involved with things like ERM strategies, IT, privacy and security.”

Elowe said, “We think that finance executives might be well-served to help facilitate greater connections inside their companies to help broaden the perspective that risk executives reporting into finance might be able to have inside their own companies.”

In addition, only 27% of risk professionals reporting to the CFO or treasurer said they expected an increase in spending for training risk management staff. This is compared to 46% in increases expected by those reporting to other areas.

The top-five programs reporting to risk management were insurance management (92%), claims management (88%), enterprise risk management (67%), captive operations (65%) and emergency response (63%).

Looking at functions that report into risk management, he said that while the traditional functions of insurance and claims were well aligned, there is a significant alignment with IT. This is compared to several years ago when IT “operated in and of itself in an organization. That is an outcome of the growing cyberrrisk and the need for organizations to have a multi-disciplinary approach to how cyber is affecting their organization.”

Discussion groups agreed that the “here and now” is most important to their companies and that more needs to be done to develop understanding of emerging risks. “Risk managers are concerned they are not looking far enough ahead,” Elowe said, adding that company focus is largely directed to regulations and compliance. Carol Fox, director of the strategic and enterprise risk practice at RIMS and co-author of the report observed that organizations focused on operations are generally not as involved in strategy. She said management understands risks, but fell off in actually planning for emerging risks.

Findings include:

  • Risk management departments that do not report into finance are generally better aligned with other strategic functions within their organizations — most notably in the areas of enterprise risk management, compliance, information technology (IT) risk management, privacy, and security.
  • Despite the importance placed on emerging risks by many board members, senior leaders, and risk executives, only 27% of survey respondents said that identifying emerging risks would be a priority in the coming year.
  • Over the next two years, 42% of organizations expect to increase the level of investment in risk analytics, according to our survey, with 57% saying it would remain flat.
  • Nearly 60% of respondents said their organization has no formal communications plan in anticipation of a cyber event.
  • Risk professionals who report into the CFO or treasurer are much less likely to expect an increase in spending for training risk management staff in the coming year compared to those reporting elsewhere.