About a decade ago, the now popular study performed by Mercer Management Consulting firm cited the primary causes of significant stock price failures amongst the Fortune 1000 Companies in the booming ’90s as events more descriptive under strategic and operational failures than events traditionally categorized as hazardous and financial. Ninety percent of the cases were categorized under causes that represented strategic and operational failures as the primary reasons for the stock drops. In almost every instance, the study cited multiple reasons for each of the individual stock collapses. In addition, in virtually every instance, the reason for the stock decline was categorized as a market reaction to a series of unanticipated and correlated events that generated non-fortuitous domino effects–bringing down the value of the firm.
Traditional risk management has viewed risk as a series of single elements, or silos. Each risk stood alone and was not related to the others. Optimizing risk management individually in each of the business units of a company meant optimizing risk management in the company overall.
Financial risk management continues today as it was then–a growing venue and opportunity for our profession as actuaries continue to manage risk through the use of financial hedging instruments. It is also a ripe opportunity for our profession to address the increasing fallout in credibility of traditional financial models and instruments in use today. At the same time, we also need to address the increasing need for improved tools and strategies to gauge the correlation of financial events that have dominoed into a series of correlated outcomes and recently crippled the financial and credit markets.
The Evolution of Risk Management truly represents the motivational evolution within business communities. This motivational evolution has transcended the traditional goals of reducing costs and reducing/avoiding/transferring risk to the more contemporary vision of maximizing revenue at reasonable risk to add value, the essence statement of an ERM framework. From the realization that silo-based risk management has its flaws, the emergence of new and larger risks (e-commerce, man-made and natural catastrophes, Enron-esque risk), the steady consolidation of insurance and financial institutions and the increased pressures on management accountability and corporate governance, the ERM evolution continues to affect us today with opportunities for our profession to make a difference.
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