When approaching risk financing decisions, the first step is to establish your foundation for risk appetite. (SeeAon Risk Services. “If one of the key risks arising from the risk management program is similar to those evaluated in the risk appetite determination, the risk appetite model can then be leveraged in the analysis.”
In part two of a three-part series, Smart Business spoke with DeCoster about how to analyze your risks.
What is the initial objective of modeling key risks?
The initial objective should be to estimate their potential unmitigated impact. Begin without mitigation to provide a strong baseline for management strategy comparison. A supply chain risk such as a sole source supplier risk should be measured without the impact of mitigating factors such as safety stock or other business continuity strategies. Only then can strategies such as additional suppliers, safety stock for supplies, or additional inventory for finished goods be compared. When building a risk model, it is important to align it to three key management objectives:
- Maximize risk versus reward trade-offs
- Maximize success within risk appetite and risk tolerance levels, where risk tolerance is simply a portion of an organization’s risk appetite for an individual risk
- Mitigate catastrophic events that can prevent the firm from reaching objectives
These often do not work directionally together. An organization’s ability to analyze this balance can help guide a decision to select the best-suited risk management strategy.