Risk Management Explicitly Addresses Uncertainty
By Bayo Babaloa, ERMCP
Uncertainty, as a general concept, reflects an inability to describe an existing state or predict an outcome with complete accuracy. We can separate the principal components of uncertainty into a lack of knowledge about the present state and lack of knowledge regarding how a system will change in the future.
These are not exclusive, of course, and uncertainty can be (and often is) driven by both elements. In general, the existence of uncertainty regarding knowledge or understanding of current conditions significantly compounds uncertainty in predicting future conditions.
Uncertainty plays a critical role in conceptions of risk. The nature of risk requires some degree of uncertainty; an event is no longer defined as a risk if it is guaranteed either to happen or not to happen. Whether the emphasis is on the probability of the hazard occurring or the likelihood of it causing harm, uncertainty is the underlying factor. While this difference in emphasis might significantly affect the way the risk is addressed, any effort to reduce the risk will face the various elements of uncertainty described above.
Risk management explicitly address uncertainty, the nature of that uncertainty and how it can be addressed. We live in an uncertain world and business practices need to be dialed in to this uncertainty. Many organizations have risk management programs which might address just part of the challenge
Different types of risks includes:
1. Strategic risks: These are risks that arise from the investments an organization makes to pursue its mission and objectives.
2. Operational risks: These risks can arise due to choices about design and use of processes to create and deliver goods and services. They can include production errors, substandard raw materials, and technology malfunctions.
3. Legal risks: These risks stem from the threat of litigation or ambiguity in applicable laws and regulations (including whether they are likely to change); these threats create uncertainty in the steps an organization should take to address its obligations to customers, employees, suppliers, stockholders, communities, and governments.
4. Financial risks: These relate to potential economic losses that can result from poor allocation of resources, changes in interest rates, shifts in tax policy, increases or decreases in the price of commodities, or fluctuations in the value of currency.
5. Other risks: Risks are very commonly associated with force majeure, or events beyond the control of the organization.
Risk management entails the following steps in addressing uncertainty:
1. Identify risk events
2. Assess the probability of each event
3. Make an analysis of response alternatives
4. Choose a response
5. Re-assess probability and impact with organization’s response
6. Ongoing monitoring of risk events