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Module 8: EMR Processes and Structures

Module 8 Objective

Describe and assess the elements and structure of a successful RM function

  • ERM roles and responsibilities of the people within an organization

  • How the different groups should interact

  • Recommand a structure for an organization’s RM function

Describe how financial and other risk and opportunities influence the selection of strategy

Discuss the application of the RM control cycle, including the relevance of external influences and emerging risks

Focus is on some high level processes and structures that support effective RM

  1. Look at how the overall strategy of a company may be influenced by risks, and how implementation of RM control cycles can enable it to deal appropriately with such risks

  2. Consider how RM might be organized within a hierarchical role-based structure

Corporate Strategy

The degrees to which risks are embraced or mitigated forms an important part of the overall corporate strategy

Corporate Strategy

  • Involves assessing its value chain, core competencies and the risk/return economies of the overall business to decide where in the value chain it ought to compete

  • Strategy covers a wide range of different corporate decisions

    (e.g. sales growth, product choices,distribution, target markets etc)

Where RM comes into play

  • Risk organiztion, retention, and transfer can form part of the overall business strategy of the organization even thought they have a transactional context

  • The degree to which risks are embraced or mitigated can be a key part of the overall strategy above, e.g.:

    • How much risky products to undertake
    • How much risk transfer or hedging to use
    • Managing the company’s borrowing and gearing (leverage) ratio

Problem with taking on too much risk

Companies that takes on and retain more risk can achieve higher return but might find themselves in difficulties more often

  • Problems in one area can quickly disrupt operations in other areas, reducing future profits further

  • Company that is in difficulty may take decisions that adversely affect some stakeholders
    \(\hookrightarrow\) Can reduce the profitability and value of the company

Cost of financial distress

  • Encourage management to take actions that conflict with the interest of other stakeholders, e.g.:

    • Produce poor quality goods

    • Operating in unsafe environment

    • Cut back on long term investment

    • Exiting promising LoB

    • Liquidating operations that was adequate

  • Volatility in earnings can also affect the share price and ability to take advantage of tax credits

Companies that can benefit from active RM

Probability of financial distress can directly affect the value of a company

Companies that benefit most from active RM:

  • Offer products with high added value (e.g. having high production quality)

  • Offer products for which there are high costs of switching to another line

  • Offer products for which the value to customers depends on complementary services or products supplied by other independent companies

  • Have high sales growth opportunities

Managing uncertainty: Horizon Scanning and Flexibility

Attention is increasingly being paid to the management of uncertainty in the widest sense

  • World is highly unpredictable
  • Unexpected pressures may develop quite suddenly and have major impacts on organizations

Systematic management of corporate uncertainty is becoming more prevalent

  1. Techniques (horizon scanning) to ensure potential problems are spotted early so that appropriate mitigating actions can be taken

    • Horizon scanning:

      Knowledge gathering to try to spot pressures at the earliest opportunity and to give the organization time to adapt

  2. Embedding resilience and flexibility into corporate structures

    • Help deal with problems that aren’t spotted sufficiently early to facilitate appropriate mitigation

    • Since adaptation is not always possible, some organizations are looking strategically at structural change so they become more flexible and can better withstand pressures when they arise

    • Particularly applies to financial robustness and flexibility

    • Operational flexibility examples:

      • Increase use of outsourcing

      • Spread operations over various sites/countries

      • Shift distribution channels

      • Move away from grouping individuals into specialist teams and operating more using multi-discipline project teams

Risk Management Control Cycles

Control Cycle:

  • One way of developing and implementing strategies to manage risk
  • The cycle should be capable of taking account of changes in risk

Will discuss key points about control cycles from a number of different sources

Process and cycles are typically developed to meet an organization’s specific needs (so no single right answer)

Actuarial Control Cycle

Applying the actuarial control cycle to risk management to get the ERM process

ERM Process

The cyclical structure of the process through analysis (+ identification of risk), quantification, management, monitoring, and modification is directly applicable to ERM

All the key components are discussed in details in later modules

Need well defined risk metrics and risk reporting systems to ensure the the monitoring stage is robust

Organizational Structures Supporting ERM

3 Lines of Defence

  1. Line management staff in the BU

    • Accountable for measuring and managing risk in individual BUs on a daily basis

    • Should be in line with the company’s stated risk appetite and risk policies

  2. CRO and risk management team

    • Centralized RM function and compliance team

    • Accountable for establishing risk and compliance programs and policies

    • Supporting and monitoring the line management and reporting to the Board

  3. Board and audit function

    • Accountable for effective governance of the RM process, setting RM strategy, approving policies, and ensuring that ERM is effective

The Risk Management Function (RMF) doesn’t have to be one department

  • Can be a virtual team comprising distinct functions from different parts of the business
  • But it’s best to have a Central Risk Function CRF headed by a CRO