Risk Management in Troubled Times

Managing risk is difficult enough but can be exceptionally challenging with all we are facing now. We live in a double Black Swan period. A “Black Swan,” as defined by author

Nassim Taleb (2006), is that rare event we never see coming, but changes everything. It could be a war, an assassination, a storm, an earthquake, a tsunami, a major economic event, or an epidemic. The Black Swan produces chaos, upsets entire societies or nations, and creates uncertainty. One such event is extremely difficult to manage, but two at the same time becomes an existential threat. The extreme nature and the unpredictability of these events upsets the calculations for risk management analysis, and forces new thinking and hopefully new solutions.

            Risk managers know that assessing risk, and making risk calculations, depends as much on what we do not know, as on what we do know. Risk considerations must include uncertainty (Tversky and Fox, 1995). But when big events occur, such as the COVID19 pandemic, along with the social unrest in many major cities, even the most proficient of experts can be stymied in their attempts to provide effective solutions for their clients. They strain to find outcomes that provide realistic options, and more importantly, hope. If the event is immediate, and the uncertainty is high, the risk manager may be faced with either recommending a quick, mitigating plan, or a more well-reasoned, longer term strategy that has a higher probability of actually solving the problem. She most likely must do both.

            One of the oldest sayings in the military is that amateurs talk strategy absent logistics, but professionals know that strategy depends on logistics. Risk professionals manage logistics in such a way that their clients’ probabilities of avoiding loss are enhanced. It’s the critical mission of such risk professionals to manage logistics in such a way as to maximize security and mitigate damage. Let’s use retail loss prevention (LP) as an example. LP managers cannot allow bias to alter their judgment when evaluating risk and determining strategy. Emotions are useful, but not in a cognitive process, thus LP professionals must remain mentally focused or “they could both misspend precious resources and be no more prepared for the next disaster” (Seivold, 2020). Further, managers cannot allow the most recent event to control disaster planning as such a focus is usually “to the detriment of preparing for more probable events” (Seivold, 2020). Such biases as these, based in emotions and recency, are harmful to problem solving as a risk manager must “determine the proper calculus for each location based on risk” and ensure that all “estimated costs and probabilities” are included in the calculus (Seivold, 2020). Thus, when it comes to pandemics, mass social unrest and widespread economic hardship, the effective risk manager will understand that making the correct judgment depends, not just on the calculation and the relevant factors, but on choosing the method by which the calculation is made.

            We tend to worry when faced with large negative events as described above, whether or not the damage potential is certain, as “people tend to focus on the potentially harmful outcome, rather than on the probability of occurrence (Seivold, 2020). Human beings tend to discount or ignore the damage from severe catastrophic events in order to defer the pain and anxiety of having to face dramatic consequences (Festinger, 1962). The events of 2020, with two Black Swans, underscores such human tendencies. The professional risk manager therefore must not only contend with the negatives from the COVID pandemic, the social unrest in big cities and the serious economic problems resulting from both, but also the stress and pressure overwhelmed clients suffer in the face of these multiple crises.

References

Festinger, L. (1962). Cognitive dissonance. Scientific American207(4), 93-106.

Seivold, Garett. ( July 13, 2020). Maintaining a Reasoned Approach to Risk in Highly Charged

Times. LPM Magazine. https://losspreventionmedia.com/maintaining-a-reasoned-approach-to-risk-in-highly-charged-times/

Taleb, Nassim. (2010). The Black Swan. Random House, New York

Tversky, A., & Fox, C. R. (1995). Weighing risk and uncertainty. Psychological review102(2),

269.

Topics: Risk Management, consulting, coronavirus