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ERM vs GRC: The Right Tool for the Job

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You may be able to use one tool with multiple functions, such as a multi-tool (a type of Swiss Army knife). However, the convenience afforded by these tools is achieved by reducing the effectiveness and efficiency for more complex projects. Most of us would rather have a tool belt with specific tools suited to the project, such as a hammer, screwdriver and utility knife. Why? Independent tools with specific uses are more powerful, more efficient and more effective at completing the tasks for which they were specifically designed. The tool belt acts as an integrator, a common platform on which the other functions are based.

ERM is the tool belt on which specific governance and compliance functions can be based. These two functions can exist independently, but when driven by risk-centric and data-grounded ERM practices, they become more efficient and effective.  ERM-driven governance divisions utilize risk intelligence to promote risk awareness and attitude throughout an enterprise.  ERM-driven compliance divisions utilize risk intelligence to bring all levels of enterprise into agreement with regulations, audit recommendations and corporate policies.

In today’s “risk-centric” business landscape, why is the combined approach of governance, risk and compliance (GRC) favored over ERM? GRC, like the multi-tool, has the capability to serve several functions — governance, risk management and compliance — in a holistic manner. This is meant to integrate silos and reduce redundancy, bureaucratic conflicts and work overlaps.

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However, reality has shown that these benefits are often rarely or never realized. Real-world GRC implementations have been marred by repeated failures to anticipate or mitigate adverse risk events.

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These events occur due to failures caused by the priority given to executive, governance and compliance objectives over solid risk-based business intelligence. Unable to effectively and efficiently drive a risk-centric organization, GRC is a tool weakened by its complexity.

The problems with multi-tools are the same problems faced by GRC. Most people — in this case, organizations — use only one or two tools, regardless of effectiveness or efficiency. More often than not, in current business implementations, GRC has a tendency to be driven primarily by regulations and largely bureaucratic objectives. The priority given to governance and compliance objectives over risk management has reduced the effectiveness and efficiency of ERM divisions. ERM has been demoted to an endorsement tool, one that is used to validate executive, governance and compliance processes and functions. This reversal of priorities costs organizations billions of dollars.

Don’t believe me? From the infamous Ford Pinto memo, to BP Deepwater Horizon, to the $6 billion JPMorgan debacle and most recently Hurricane Sandy, we have seen how the focus on governance and compliance above real risk has substantially increased the effect of adverse risk events. These failures point to fundamental problems within GRC framework and implementation.

These problems suggest:

  1. There is not enough attention paid to the exhaustive discovery of risk, how risks are connected, and how risks are integrated into all business processes, functions and strategies.
  2. If governance and compliance functions continue to be given priority over enterprise risk management, organizations can expect to pay massive penalties to cover mistakes.
  3. Third, but by no means last, truly risk-centric organizations should have a belt of effective and efficient tools, each specifically suited to a task and driven by risk intelligence.

Without addressing these points, all-too-frequent and massive failures will continue to be a factor in business environments and a continued source of material for news media outlets. These failures should be anomalies. Driven by proper ERM implementation, a successful governance and compliance function can produce effective and sustainable benefits for all stakeholders.

JP Morgan’s Poor Risk Management

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JP Morgan’s $6.2 billion “London Whale” trading loss was a much-publicized event in 2012. In the aftermath, some called for the resignation of CEO Jamie Dimon, while others pointed their finger at lax risk management standards within the bank. Yesterday, we finally found out what JP Morgan’s opinion on the matter is in a lengthy report. Their conclusion: inadequate risk management financial oversight within the chief investment office (CIO) and JP Morgan as a whole.

To be more specific, on page 97 the report states, “CIO Risk Management lacked the personnel and structure necessary to properly risk-manage the Synthetic Credit Portfolio, and as a result, it failed to serve as a meaningful check on the activities of the CIO management and traders.

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This occurred through failures of risk managers (and others) both within and outside of CIO.”

The head of the CIO, Peter Weiland, resigned quietly in October while others involved either left the bank or their positions were rearranged over the past several months. But Jamie Diamond escaped partly unscathed (he did have to testify before Congress and recently had his pay cut to a tiny $11.5 million from $23 million). Interestingly enough, so did JP Morgan’s chief risk officer and the CIO chief risk officer, which is confusing considering the statement on page 97.

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Two top CFOs were held responsible for the costly blunder, however.

As CFO reported yesterday:

The report, released Wednesday, said JPMorgan’s former top CFO, Douglas Braunstein, “bears responsibility” for weaknesses in financial controls related to the investment portfolio and could have asked more questions about changes in its value and its increasing exposure to adverse movements in the financial markets.

The other former finance chief criticized in the report was John Wilmot, who headed the CIO’s finance function.

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Wilmot and his team failed to set up robust reporting controls, the report said, “including sufficient circulation of daily trading activity reports, [which] made early detection of problems less likely.”

While the task force noted that the “primary control failures were risk management failures,” the finance organizations headed by Braunstein and Wilmot “could have done more.” In the case of the CIO’s finance team, the task force stated that in part it took “too narrow [a] view of [its] responsibilities,” believing the issues related to the CIO’s credit portfolio “were for the risk organization and not finance to flag or address.”

So while the JP Morgan task force noted that there were errors made on both the risk management side and the finance side, the bank ultimately held the finance department responsible. Braunstein stepped down while Wilmot resigned and will be leaving the bank this year.

The roles of CRO and CFO are often intertwined and overlapping. Do highly risky decisions involving potentially large losses or gains require the oversight of the finance or risk management department, or both? It likely remains a case-by-case basis and this JP Morgan fumble will likely remain the industry’s glaring example of what not to do.

RIMS President John Phelps Outlines the Society’s Future

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January marks the changing of the guard for the acting President of the Risk and Insurance Management Society (RIMS).

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This morning the RIMS office in New York welcomed John Phelps, the 2013 RIMS President.

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Phelps is currently the director of business risk solutions for Blue Cross and Blue Shield of Florida and has been a member of RIMS for close to 33 years and served on its board of directors for nine years.

“For far too long, the mention of ‘risk’ has struck fear in board rooms around the world,” said Phelps. “As President of RIMS I want to focus on the resources and services that will better equip our members to demonstrate how a more comprehensive understanding of risk can help straighten the path for an organization’s success and exploit the opportunities risk offers every company.

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I sincerely look forward to the year ahead and to helping our members advance their organization’s risk management capabilities in all business disciplines.”

In the meeting, Phelps stressed that what he sees for the future of RIMS consists of:

  • Being a global leader in all aspects of risk management, which aligns with the vision of RIMS
  • Helping RIMS members add value to their organizations, which will advance risk management in their organizations and help them connect at the c-suite level, which connects to the RIMS mission
  • Bring the next generation of risk management leaders into the fold now, so they can network with risk managers that have lived through the evolution, access the education available to them to enhance their skills and utilize practical resources

The Largest Natural Hazard Risks of 2012

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2012 was a year of natural catastrophes. From Hurricane Sandy to the record-setting drought to the third most destructive wildfire season on record, the year was fraught with disasters that took a toll not only on communities nationwide, but on some of the world’s largest insurers. Today, CoreLogic issued its annual Natural Hazard Risk Summary, which details the most significant natural disasters that struck the United States in 2012. It notes the following:

Hurricanes

  • The single most destructive natural disaster in 2012 was Hurricane Sandy. In late October, the Category 1 storm generated record levels of storm surge along the northern New Jersey coast and in the New York City area, impacting more than five million residents across the region.
  • The first hurricane to make landfall in the U.
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    S. in 2012 was Category 1 Hurricane Isaac in late August, which caused an estimated $2 billion in insured losses around the New Orleans metro area.

Floods

  • Flood losses are expected to total approximately $10 billion in 2012, which would result in the third consecutive year of increasing flood damage in the U.S.
  • Earlier in the year, Tropical Storm Debby tracked slowly across the Florida peninsula in June, dropping at least 25 inches of rainfall along its path.
  • After months of sustained, widespread drought, Hurricane Isaac brought heavy rainfall and flooding to Louisiana in late August before continuing northward into the Midwest.
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Wildfires

  • The 2012 wildfire season was the third most destructive on record in the U.S. in terms of total acres burned as of early December.
  • The 15-year trend of fewer, but larger fires continued into 2012 with fewer than 51,000 individual wildfires across the country—the lowest number recorded since 1989.
  • Several of the individual fires that occurred in 2012 set records, including Colorado’s Waldo Canyon Fire, which damaged or destroyed 346 homes, and New Mexico’s Whitewater-Baldy Fire, which burned more than 297,000 acres.
  • NOAA continues to predict a pattern of drought conditions through the start of 2013, suggesting the potential for another increase in wildfire risk across much of the country. In the chart below, “SL” stands for short-term drought (typically less than six months) and “L” stands for long-term drought (typically more than six months).

Tornadoes

  • Tornado activity in 2012 was not strictly limited to the region commonly referred to as “Tornado Alley.” States located outside the central and southern Great Plains experienced a significant number of tornadoes this year. The chart below, from CoreLogic’s report, represents states with 30 or more tornadoes in 2012. States in orange are not typically considered part of “Tornado Alley.”
  • January 2012 was one of the most active Januaries since recording began in 1950, with a total of 79 tornadoes reported across the country.
  • In late February, tornadoes struck Illinois, Indiana, Kentucky and Ohio. Harrisburg, Ill., experienced the most concentrated destruction, with more than 225 homes and businesses damaged or destroyed and an estimated $475 million in total damage.

“Because the strength, severity and geographic impact of natural disaster events will change from year to year, an understanding of patterns in hazard activity, geographic vulnerabilities and the properties exposed to each different type of disaster is crucial to managing risk,” said Dr. Thomas Jeffery, senior hazard scientist for CoreLogic.

As we’ve seen with the natural catastrophes of 2012, it is important for insurers, homeowners and businesses to develop a more comprehensive evaluation of risk — one that includes typically non-traditional locations.

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