Tag Archives: risk management

Hindsight is Foresight Foregone

It’s not that we can’t see the future; it’s that we don’t bother.

Granted, none of us can predict it, nor do I presume that some magic algorithm applied to some special pile of Big Data can ease the Fog of the Future.

In part, it’s laziness. Here in the USA, we’re predisposed to the here and now and me, and the rest will sort itself out.  As indeed it does.  But often not as we hoped.

In part it is because we know from abundant experience that too many pious prognostications by proselytizers of progress have turned to sink-holes of time, effort and money.  So why bother.

In management we have evolved the discipline of ‘risk management’ which is part institutionalized experience and part pseudo-science.  ‘Risk management’ is somewhat of an oxymoron like ‘military justice’, ‘artificial intelligence’ and ‘virtual reality’. It trades on a figment of truth to create the illusion that it is more than it is.

Risk management has some level of foundation in its effort to deal systemically with known and knowable risks, but today’s world is increasingly subject to unknowable risks for which there is no statistical basis of quantification of either loss, cost of prevention or remediation.   But that’s not the real problem.

Many in my profession of accounting and auditing gravitate to the  ‘risk management’ mantra, and strive to incorporate it into their mission statement. After all, if you can’t be a ‘risk taker’, being a ‘risk manager’ or a ‘risk something’ is the next best thing. It’s sexier than mere accounting and auditing.  And besides, there’s plenty of precedent for the need for ‘risk management’ given the losses that businesses have incurred for themselves, and more frequently for others in their carefully contrived relationships.

But, truth be told, even the growing cadre of risk management acolytes have trouble peddling their wares to the C suite where hype and hope too often trump (no pun intended) reality and even the crudest calculations of probability.

Let’s take a few examples out for a test drive:

  •  Does anyone see any problem with Jeff Bezos and Elon Musk and Larry Paige and the other space cadets filling the skyways and byways with their latest magical brain-farts without benefit of adequate regulation and incubation for proof of concept within laboratory controlled settings, much less in the free-fire environment of that freaky place we call the ‘real world’?
  • Is the latest episode of the Theranos melodrama really a surprise?  Or was it the highly probable outcome of a flaky premise sold to incredibly greedy people willing to believe and suspend critical judgment?
  • And let’s not beat unduly on Theranos. It’s just one of a number of Unicorns in the magical kingdom of Silicon Valley and other tech redoubts where people with more money than brains can throw it at the wall, hope that something sticks in the lottery of high-tech chance,  and praise themselves that their failures are really essential tuition and down-payment for future greatness.  In their magical kingdom, failure is virtue.  In the real-world, failure gets you fired.
  • Where is China going, and where is it taking us?  The West lost that gambit four decades ago with an essential, but ill-conceived opening of relations.  The drive of corporate greed for access to a billion consumers overtook any attempt of western governments to modulate the normalization in a manner that would minimize the foreseeable disruptions we have experienced economically and strategically.  Accordingly, China has grown into an unruly adolescent (in modern world terms, its considerable historical lineage notwithstanding).  Given its desperate economic and environmental constraints, and it’s likely belief that its salvation is in expansion, military conflict with its neighbors and the West seems inevitable in the near to intermediate term.  Trump and China should easily understand each other: a coercive bully that believes he\it has a right to dominance on its terms without obligations to others. I suspect that this is in part an act China has found it can get away with because, unlike with Trump, no one has yet drawn a firm line in the land, the water or the air that they are prepared to defend (although we are beginning to with questionable allied support). Corporate executives are now marveling at how they could possibly have lost their technological edge (which they often willingly gave away in many cases for access to that one-billion consumer market)  and now are losing the market itself in a tightly controlled totalitarian environment where the ‘rule of law’ is more a farce than even a mere political fig leaf of cover.  Who’d a thunk?
  • Was the Shell Oil retreat from the Arctic really a surprise,  or merely unfettered stupidity colliding with reality?  When we have so much evidence of failure to properly engineer and install  and monitor and regulate and mitigate such ventures in much less hostile and much more stable environments, what would make any prudent executive or government think that Arctic exploitation would be just another hole in the ground?  Did BP’s experience give anyone in Shell’s HQ pause for concern?
  • How about them GMOs?  Scientists are complaining that the average clod on the streets is unjustifiably suspicious of the risks of GMOs.  But when we look at the recent history of our ‘conventional’ food supplies, the engineering of obesity, the evisceration of regulatory oversight and quality control, is there not reasonable cause for concern by the public of what will next be foisted upon them in the guise of progress at their ultimate risk and cost?  This is actually a case of the person on the street exercising ‘risk management’ in the suspicion that those in the Corporate suite will not. At least, not in the consumer’s behalf.
  • And then there’s fracking; a mindless grab for resources beyond any exercise of prudence, with costs to society measured only in financial terms to date, with studied ignorance of the collateral environmental, social and economic costs beyond the measure of defaulted securities.

There are a number of simple questions that executive management could ask itself and save a lot of grief when contemplating a new venture or circumstance, or coping with an existing or intractable situation  (like Palestine):

  • Has the situation ever happened before, and what can we learn from it.
  • Are there any parallels, if not direct precedents, to this situation that can give us a clue of dynamics and outcomes?
  • Do we understand the context (historical and present circumstances) of our intended act, and do our assumptions take that context into account?
  • Have we tested our assumptions about what should happen if we take this action?
  • Have we defined performance standards for our expectations that will give us quick feedback if we’re going off the rails of our expectations.
  • Have we asked ourselves how the opposition/competition/stakeholders/regulators are likely to respond, and have we taken appropriate steps to address reasonable concerns.
  • What could possibly go wrong, and what’s the worst that could happen….?
  • ….and if it does, what are we prepared to do about it?

These are so simple, they don’t even deserve to be sexified as ‘risk management’.  They’re basic management, or even common sense.  Yet the frequency with which they are ignored and often even disdained by the supposedly educated meritocracy has numbed us of any sense of amazement.  Rather, it has implanted a cynicism and contempt and suspicion of all forms of authority: legal, moral, scientific, political, religious, social that accounts more for the rise of Trump, Sanders and Br-Exit than any conventional political explanation.

We could go on, but I’ll trust the point is made, if not accepted.  In the corporate, government and personal world, risk-taking trumps risk management more often than not, and often with predictable consequence.

It’s not that our capacity for foresight is so bad.  It’s that we don’t bother to seek answers we know we’re probably not going to like. And when they’re thrust upon us, we often find ingenious ways to ignore them rather than to deal with them.

So, to say that hindsight is 20/20 because we have the benefit of knowledge that is not previously available is at best half the truth.  As often as not, we just don’t give a damn.

*  *   *

Word of the day:  de-escalate.

Onward

20160710

 

Advertisements

Climate Change Impacts: Risk Assessment Trumps Scientific Uncertainty

The science of climate change appears at the moment to be in a bit of a muddle. But the risk assessment of climate change is beginning to clarify in critical industries and institutions.

The scientific muddle surrounds deviations of some observed conditions from model predictions; specifically, the correlation and causation of increases in atmospheric CO2 emissions to atmospheric warming.  While the reason for an apparent divergence has been credibly attributed to a hypothesis of accelerating warming in deeper regions of the oceans, this hypothesis is not likely to be proven or disproved with sufficient data for some time.

This touches on a fundamental challenge of science in the public arena.  While our various media have no problem rushing to judgment on the basis of utter speculation, science done properly requires a measured pace, defensible methodology, and opportunity for independent verification, none of which happen in a 24/7 news cycle.  To gain a greater appreciation of where the science is, I recommend a recent interview in Der Spiegel with climate scientist  Hans von Storch.

Dr. Von Storch states unequivocally his conviction that climate change is real and is subject to human influence, but he has also been known to take his peers to task for advocating their concerns beyond the hard science that can support them. Der Spiegel did its best to put  Von Storch to the point on recently reported statistical discrepancies between global warming and the rise in CO2 emissions.  Dr. von Storch addressed many of the questions with a studied neutrality; he recognized the questions yet to be resolved in climate science but emphasized that anomalies in the climate change models do not in themselves negate the validity of climate change. They reflect the inevitable refinement of scientific theory that comes with inquiry and observation. The broad theory of climate change remains credible in many of its aspects. It is the underlying mechanics that need further exploration, refinement, and reconciliation to an integrated whole, and that takes time.

Political and economic communities, by comparison, seek greater certainty in shorter time spans.  Here, the current dilemmas in the climate change dialogue pose frustration for public and business officials, even though risk is an inherent part of their economic and political environment on a good day. But, while the scientific debate churns on, the economic imperatives are beginning to coalesce in some quarters into uneasy but growing consensus.

*   *   *

The Biggert-Waters Flood Insurance Reform and Modernization Act of 2012 is a good place to start.  It recognized that, whether one believes in Climate Change or not, the cumulative losses of progressively more severe weather events are taking a financial toll that can no longer be ignored, (though some would like to defer the proposed insurance rate increases just a bit longer).  And then along came Sandy to put a rather large exclamation point on that thought in bold.

A report from the Geneva Association, an insurance industry group, makes a critical point that global warming/climate change (by whatever other euphemism or rhetorical dodge, like ‘extreme weather’) has reached a statistical milestone of criticality that can no longer be ignored, or managed based on historical trends alone:

“Historical data-driven (or climatological) approaches to estimate the background risk of different events will fail in a non-stationary environment as they don’t adequately incorporate recent changes. Even if some of the changes might not be significant yet, risk estimation has to include the consequences of what current physical understanding can tell us about the implied changes of the observed ocean warming. New methods in risk estimation, such as scenario-based approaches and tail risk modelling, are becoming an  essential part of the insurance business with a variety of different applications, such as capital requirement determination, pricing and/or risk mitigation.”

This statement is critical from this industry because it not only reinforces the thrust of Biggert-Waters; it should send a warning to other financial intermediaries and governments of the need to project forward and plan forward and not merely manage the climate progression with an eye solely on the rear-view mirror.

However, another report from CERES indicates that the insurance industry worldwide is significantly unprepared to deal with the financial consequences of climate change. It conducted its second annual survey of insurance industry preparedness for risk exposures of climate change.

“The answer, unfortunately, has not changed since our first report analyzing the insurance industry’s readiness in September 2011 concluded: “not very.” The implications are profound, for the insurance industry is a key driver of the national and global economies. If climate change undermines the financial viability of the insurance industry, it will have a devastating impact on the economy, as well.”

Only 13 out of 184 insurance companies have a comprehensive plan to address climate change as it will impact their operations administratively or from an underwriting and investment perspective. Many consider it an extension their normal underwriting and investment management processes. While this may be true in certain qualitative respects, it ignores the order of magnitude and the possible variance from traditional statistical patterns that are critical to decision-making, as noted in the quote from the Geneva Association’s report.

When we talk about economic resilience to catastrophes, the insurance industry is a critical player. Katrina, Irene and Sandy have already illustrated the weaknesses of our current system operating within its traditional parameters.  While the storms have been within the industry’s economic capacity to handle, the administrative processes of rapid and reliable response have been disheartening in many cases, and have been a major element inhibiting resilient response for many communities, businesses and individuals. If we add to this condition a failure to build adequate reserves for future trends, we worsen an undesirable situation.

This was further confirmed in a warning by the Geneva Association, which noted that parts of the UK and the State of Florida are now regarded as uninsurable, with more likely to follow. It further noted:

“…insurers warn premiums have been kept artificially depressed in the short-term because capital has flocked to the sector in the face of historic low-interest rates.”

A reasonable inference from this statement would be that when interest rates rise, capital may seek better returns elsewhere unless insurance rates rise as well; and if exposures continue to rise as well at an accelerating rate, the insurance industry will either be caught short in capacity, or more likely will withdraw coverage to stay within its underwriting capacity.  Either way, the industry will likely raise rates significantly where it is still willing to underwrite (think of health insurance as an analogy), and the economy will lose critical financial liquidity which the insurance industry provides for resilience.

Reports such as CERES’ and the Geneva Association’s are important in recognizing that, while we do not yet have the answers to the climate puzzle that scientists are diligently working on, neither do we have the luxury of waiting for them. A recent statement from the World Bank added emphasis to this observation.

“Places such as Bangkok, Jakarta and Ho Chi Minh City are now considered “hot spots” that will bear the brunt of the impact as sea levels rise, tropical storms become more violent, and rainfall becomes both more sporadic and — in the rainy season — more intense.

Bank officials said this week that those effects are not considered a distant risk anymore, but rather are a near certainty “in our planning period” of the next 20 years or so.”

While the World Bank’s focus is on developing countries, the challenges they are addressing affect the globe in the same time frame.

Business and government must begin to plan across a wider range of contingencies and to a more distant time horizon consistent with the expected impact life-cycle of their decisions. But in this very statement is embedded an irony.  While we may project that sea level rise may reach four feet or whatever by 2100, it will reach a point of significant impact much sooner, and require responsive action. Given the complexity and number of exposures, and the challenges of planning and consensus-building, critical impacts which may occur as soon as twenty years from now will require us to begin planning and building responsive capacity now to meet the more likely near term, and anticipate the less certain long term.

*   *   *

Returning to the Der Spiegel interview, von Storch believes that:

“the more serious effects of climate change won’t affect us for at least 30 years. We have enough time to prepare ourselves.”

I would like to think he is right, but I don’t.  There are two categories of concern; one scientific, and one managerial.

In the scientific category, there are two issues other than the divergence of atmospheric warming from CO2 emissions that beg for clarification. One is, if the oceans are warming at deeper levels than previously believed, does this mean that the capacity sea level rise is greater than anticipated, and how might that affect the acceleration of rise over time? Will it hasten it?

The second issue comes from a somewhat muted reference in the USGS release projecting an increase and acceleration of sea level rise on the Atlantic coast.

“The report shows that the sea-level rise hotspot is consistent with the slowing of Atlantic Ocean circulation. Models show this change in circulation may be tied to changes in water temperature, salinity and density in the subpolar north Atlantic.”

If this is referring to a possible slowing or shut-down of the Thermohaline Conveyor, that poses a whole other set of interesting scenarios, many of which would affect the UK and northern Europe, but some might affect the US east coast, such as the possible influence of the current in steering hurricanes away from the east coast,….or not.  I remember when we convened a workshop on Climate Change for municipal officials in 2004 that this possibility was seen as serious-but-remote. It is apparently no longer remote.  Is it still serious? Pure speculation on this accountant’s part. Outside my skill set, except for the possible economic consequences.

In the managerial area of concern, I will repeat a skepticism voiced in prior posts.  There are two aspects to the Climate Change challenge.  One is figuring out what nature will deliver; the other is the issue of how we will respond, or what I call ‘capacity to act’.  While we wait for science to sort out answers to the first part, experience suggests to me that society as a whole has demonstrated decisively that we are unwilling to recognize the severity of the problem, and therefore unwilling to act to positive effect. Our capacity to act is at best questionable.

Dr. von Storch may have a good handle on the natural science end of the issue, but he is disturbingly complacent about the social and economic and political science end.

We can all have our opinions, but nature will have the final word.

Or, to borrow a baseball analogy that I recently read:  “Mother Nature always bats last; and she’s not limited to 9 innings.”

Onward

20130705