Risk Perspectives
By Leigh Doyle | August 12, 2009
Photo credit: Dave Starrett
Professionals prove there is more than one way to think about risk.
Engineers think about risk almost as much as risk managers do. Whether they are building a road or designing a transistor for a television, they need to take into consideration problems that may occur along the way.
The same is true for the airline industry, for doctors, in car manufacturing and in financial advice. Really, when you start to think about it, risk and the management of risk exists in every industry and in every individual's work and everyday life.
Doctors, for example, need to ensure they are getting their patient's history correct and they need to trust that they have enough experience and knowledge to diagnose a condition. They must be aware enough to recognize when they need support or input from a colleague. Doctors also need to be prepared for issues if their diagnosis is wrong or if care plans don't work out as expected.
For engineers, risk is linear—it's only a matter of time before a certain screw or beam will wear out and break. They can calculate expected risks and create plans of action to deal with them. They can also build in extra support to prevent the consequences of potential risks. For doctors, risk is often about themselves (their level of knowledge, experience and even their current state of mind), the people they are caring for (are they getting enough information and the correct details?) and those they are working with (do colleagues follow instructions properly?) in their practice.
Nauman Mahmood, the managing director of risk management for the Canadian Depository for Securities (CDS), says these risks are operational rather than financial.
Two Types of Risk: Financial and Operational
While all industries face different risks, they generally break down into two categories: Those that are financial and those that are operational.
Operational risks are things that can go wrong with the people, processes, technology or the regulatory rules involved in an industry. When it comes to operational risks, organizations use conditional solution planning for the risks they identify. This means contingency and response planning: If scenario X comes to pass, then action Y should be taken. Proactive behaviour is also taken.
At the CDS, Mahmood deals primarily with safeguarding the firm's physical, operational assets and financial assets. To deal with the financial side, complicated mathematical models are used to design strategies for responding to currency fluctuation and equity price volatility. He then back tests these models using historical data to see how accurate they are.
Mahmood has also identified another risk, related to the models themselves: "Almost all of the models out there are built for normal market conditions."
To mitigate this risk, he stress tests the models. "The stress test complements back testing by applying extreme but plausible market conditions [like current economic and market conditions] to the model and sees the results." Ultimately, he says, stress tests uncover any of the model's assumptions. "Any model uses assumptions as a starting point. When a stress test is applied, these can be challenged and discussed."
All of this is part of exploring the outcome of problems that might occur, and trying to uncover ways to avoid them—risk management.
But, whether you're measuring the risk of a foreign currency falling, a bridge collapsing, or getting cancer, fundamentally the same basic principles apply.
Five Steps of Risk Management
Cynthia Kett, a chartered accountant and certified financial planner with advice-only firm Stewart & Kett Financial Advisors Inc. in Toronto, says risk management generally breaks down into five steps:
- identify the risks;
- quantify the risks;
- find the probability of each risk occurring;
- understand the impact each will have; and
- create plans to mitigate the risk you want to or can address.
"Identifying the risk means uncovering where problems can happen; measuring it helps you manage which ones need more attention than others. You get a feel for the potential frequency of the risk by determining probability. Once you figure out the impact, you can decide if you're going to take on the risk or find a way to share it."
For David Luke, a certified financial planner (CFP) with Wellington West Financial Services, risk management is even simpler: "To deal with risks, you determine the ones that are most dangerous and you build systems and plans to reduce them, or you transfer the risk by buying insurance," he says.
In the end, though, for each company and each person, risk is very personal. With each person's understanding of risk being based on his or her own history, experience, sometimes employment expertise, future goals and the potential problems on the road to that future, it's worth contemplating broader and different understandings of the topic in order to have better conversations about risk going forward. |
