“Exploring management buy-in to the risk of catastrophic loss” – Stefano Tranquillo:
There is no doubt that business’ exposure to natural catastrophes is on the rise. According to recent annual research into the effect of natural catastrophes and man-made disasters, insured losses have increased from, on average, less than £6 billion to more than £60 billion in recent years. Further, the globalisation of business has meant that the number of organisations exposed in high risk areas prone to flooding and earthquakes has also increased dramatically.
Despite these alarming statistics, the risk management industry is still facing a challenge when it comes to getting senior management level buy-in to risk protection against catastrophic loss. Why is it that some C-Suite executives ignore the enormous potential risks that natural hazards bring? More importantly, how can we work to change board members’ attitudes to risk?
Earlier this June, I took part in a breakfast briefing discussion organised by Post Magazine where Paul Taylor (Director of Risk Assurance), Graeme Lee (SIG Chair and Former Council Member of Airmic) and myself considered why C-Suite executives are often slow to act when it comes to mitigating the risk of natural catastrophes. Below are some of the most important points we discussed that provide reasons as to why this might be happening, as well as how risk managers may communicate the threat of natural disasters to the C-Suite more effectively.
Natural catastrophes can affect bottom line / market share
Natural catastrophes can have far-reaching implications on entire business models. An illustration of this can be seen in many high street technology retailers where the cost of hard drives has increased substantially. The increase in prices late last year stemmed from the severe floods in Thailand, which destroyed nearly a third of the world’s hard drive manufacturing capacity. Furthermore, many IT analysts have forecast that the production of hard drives will not be back to normal until 2013, by which time its main competitor, the solid-state drive, may have already taken the majority of the market share. This single event of flooding in Thailand demonstrates the impact that natural disasters can have on businesses in both the short term and for years to come.
In a recent FM Global survey, 96% of executives said their companies have operations that are exposed to natural catastrophes like hurricanes, floods and earthquakes, yet fewer than 20% said that they were “very concerned” about such disasters negatively affecting their bottom line. Why do C-Suite Executives acknowledge these risks, yet fail to take the necessary action in reducing the possibility of property damage and ensuring their company’s business continuity?
Human psychology behind risk
Human psychology, in terms of its manifestations in behaviour, appears to be the foremost factor in why people underestimate the risk of a natural disaster. Moreover, the assumption is that if a natural catastrophe occurs, the consequences of that incident will have greater repercussions elsewhere. There is also the curious human behaviour, known by some psychologists as “Gambler’s Fallacy,” which assumes that because a disaster has now happened, it won’t happen again. An example of this form of irrational behaviour can be seen in post-Hurricane Katrina New Orleans, USA. Despite the disaster’s human and financial devastation, much of the city still remains ill-prepared to withstand another major hurricane.
A psychological study by the Wharton School of Risk Management provided the following reasons as to why people take these unusual attitudes to risk:
- Risk underestimation
- Procrastination of risk prevention (especially when investing time and money)
- Short term focus
- Hyperbolic discounting (people place more emphasis to things that happen immediately)
These inherent attitudes to risk are magnified when they are coupled with the emphasis placed on C-Suite executives to deliver results on a quarter by quarter basis, often meaning that businesses make fast growth and profit a priority, rather than looking at ways to protect their assets. These pressures will often make C-Suite executives hesitant to invest in comprehensive preparation for a natural disaster, believing it to be too expensive. The reality is that the overall costs incurred from a natural disaster are far greater when the loss of business, drop in share price and damaged reputation are taken into account.
Obtaining buy-in from the C-Suite into loss prevention strategies
Risk managers are faced with a great challenge in obtaining buy in from C-Suite executives, and it is often perceived that there is a ‘glass ceiling’ for risk managers trying to get their message into the boardroom. Part of the problem is that some C-Suite executives view insurance alone as the all-encompassing solution to managing risk, rather than loss mitigation programmes, which are generally perceived as too costly and surplus to requirements. Insurance on its own doesn’t take into account reputation, market share and share price, and cannot fully protect an organisation from the effects of business interruption following natural catastrophes. Risk managers must approach the C-Suite with relevant loss prevention strategies to potential disasters and clearly define the competitive advantage that could be gained as a result.
One action risk managers can take is to change the language they use when communicating with the C-Suite by presenting risks relevant to the lifetime of a property, rather than on a year-by-year basis. For example, there may only be a 1% chance of flooding at a site each year, but if a site has a lifetime of 50 years, then the risk of that site encountering an event of flooding is increased to 39%. Statistics of risk presented in the context of a building’s lifetime are far more compelling and much more likely to make C-Suite executives sit up and take note of them. Furthermore, presenting statistics like this will help the C-Suite consider physical risk as a future reality rather than just a probability.
Risk can also be discussed in a more positive framework. Instead of approaching the boardroom with down-side risk and stories of doom and gloom, risk managers should present the upside risks and how becoming resilient to them can help build real competitive advantage. For example, rather than focusing on potential losses, risk managers could focus the conversation on the importance of preparedness and prevention for ensuring that a company can retain its sustained growth and financial long-term sustainability.
It is interesting to note that companies are very good at quantifying business opportunities with exact figures of potential profits. However, some are less competent at understanding and accurately quantifying the damage that a natural catastrophe could cause in terms of business operations and reputational losses.
C-Suite executives have a crucial role to play when it comes to developing an approach to loss prevention. They should work alongside risk managers to ensure that across their organisations, risk management is not viewed as a box-ticking exercise, but is embedded into all business decision-making and becomes a key part of corporate strategy. To improve the resilience of their organisations, C-Suite executives must work closely with risk managers to build a strong corporate culture that embraces the critical importance of business continuity and focuses on sustainable success.