How to make your decision-making more efficient

By Anton Kapel

A key finding from Towers Watson’s 2010 Global Enterprise Risk Management survey was that having a clear understanding of risk appetite is important to ERM (Enterprise Risk Management) success. More than half of respondents indicated they had a documented risk appetite statement in place, with these respondents being significantly more likely than others to be satisfied with the performance of their ERM capabilities. Reflecting the dynamic nature of the insurance industry and the risks faced, most of these companies planned to further develop their risk appetite statements over the following year.

Amongst European insurers ― who are arguably the most advanced in the world in embedding risk management into their businesses as a consequence of the Solvency II initiative ― the most commonly identified area of ERM for development/improvement was risk appetite. Well over half of the respondents cited this as an area of focus for 2010-2011. This indicated that companies recognized that getting the risk appetite statement right is critical to ERM success.

There is also support from academic and professional bodies for setting an organization’s risk appetite down on paper ― almost all risk management process standards identify the articulation of a risk appetite statement (or its equivalent) as a fundamental step in establishing a working ERM framework within an organization.

There has also been a push in recent years from many regulatory bodies to require documented risk management frameworks, including a risk appetite statement. And in some markets (notably in North America) ratings agencies have provided a further external incentive for companies to develop formalized ERM processes and policies with a risk appetite statement being a key element.

However, producing a risk appetite statement is only an initial step in sound, comprehensive ERM. To be of value, the risk appetite needs to be embedded in the organization. This requires communication, training, policies and procedures, limits and controls, and implementation of monitoring systems and processes (including escalation procedures should limits be breached). Finally, a risk appetite statement is not static ― it must be regularly reviewed and modified as necessary.

Risk limits and controls, consistent with the overarching risk appetite, are critical to ensure that risk appetite is cascaded effectively throughout the organization, in a manner that can influence behaviours at a level at which day- to-day business decisions are made.

Some limits can be relatively easily implemented via policies and processes. For example, certain insurance risks can be controlled through the establishment of underwriting limits.

Other limits require quantification of a metric, in which case systems and processes need to be in place to produce the required results in an appropriate time frame reflecting the nature of the decisions to be made. For example, asset/liability management decisions often have to be made quickly, but do lend themselves to statistical analysis. With appropriate systems, risk metrics can be assessed with some precision to provide real-time information.

In these ways, the risk appetite statement can be made tangible and can assist and enhance decision-making within the organization. And ultimately, better decisions will lead to better outcomes for all stakeholders.

Anton Kapel is the head of Risk Consulting for Towers Watson in Australia and is a co-leader of the practice’s risk management initiatives in the Asia-Pacific region.