Do we really understand risk?

Do we really understand risk?

A recent report from the National Audit Office revealed the government failed to understand the risk to the Treasury for the HS2 rail project from the outset in 2010. Shortly afterwards the Defence Minister openly disagreed with the Prime Minister over the risk posed by Huawei for its 5G roll out for the UK. Two major infrastructure projects within which the risk assessment was controversial, to say the least.  What does this tell us about the way we view the future and the way we treat risk?

Forecasting public demand for faster rail travel or faster broadband should not be too challenging, however policy makers rarely predict the future accurately – there is more scope for getting the numbers wrong than getting them right, hence the risk-aversion default. Public service demand could be very different in forty or fifty years’ time, yet assumptions are often made using a cost-benefit analysis driven by a political timetable seeking ‘quick-wins’ and positive media coverage.

We view the future in terms of what we know. The accuracy of any forecast declines with distance into the future, we can be more certain about tomorrow than a month away or five years ahead. This is why scenario planning and horizon scanning are so important to policy makers, those tasked with making decisions about projects whose benefits will be felt forty or fifty years into the future. The challenge is to factor in increasing uncertainty with time as a variable without succumbing to ‘the self-delusion that the future is fully measurable and has been tamed’ (Skidelsky).

Risk is only a forecasting exercise around future uncertainty, an estimate of a future outcome, there can be no definitive answer on risk as it lies in an unknowable future.  In the same way strategy indicates future direction, risk identifies future uncertainty so an assessment of risk is always an estimate of an unknown future.  There are only two types of risk forecast: lucky and wrong. The discipline of risk management focuses on procedures to manage or mitigate future impacts, but there are many possible future outcomes, the challenge is to identify the most desirable.

As the future cannot be controlled, the term risk management is in reality an oxymoron. Risk has become an important topic on the boardroom agenda and expanded into a management discipline; but it is not a profession; a Chief Risk Officer (CRO) or Chair of the Risk Committee will probably have a career in another discipline: finance, internal audit, business assurance, compliance or Health & Safety. There is no professional body, the Institute of Risk Management (IRM) promotes Enterprise Risk Management, but this covers operational risk as a control function, not strategic risk as enterprise vision and how to cope with uncertainty.

Boards manufacture certainty in order to secure a mandate to operate. Their certainty aims to demonstrate competence, however as many investors have ‘skin in the game’ there is little appetite to question the basis for such certainty.  A risk committee, department or office informs and advises the board but in so doing can all too easily be seen as point of expertise, and awarded undeserved deference for what is only one perspective on a future outcome. The risk advisory body should not be mistaken for Nostradamus, and boards need to retain their ownership of risk perception.

Boards are made up of a group of talented directors and NEDs with different views about the future, some optimistic some pessimistic, yet they are collectively charged with setting risk appetite. Agreeing appetite for risk is a challenge, a concept that is as helpful as defining how hungry you will be next week. How much time do boards really allocate to forecasting future scenarios or likely time horizons? Time spent debating risk is often seen as unprofitable given the absence of any definitive answer, valuable board time could be better spent on simpler yes/no or go/no go decisions where certainty and decisiveness are more rewarding. Risk is often regarded as a ‘Wicked’ problem or TD3 issue: Too Difficult To Do Today!

The word ‘Risk’ derives from the Italian verb ‘to dare’. In the middle ages traders dared to explore new markets in search of gain, and embraced risk to achieve this. Risk is thus a price for gain and should be accepted as an operational cost, however risk aversion is a human weakness that plagues financial decisions and distorts our propensity for risk. ‘How can we avoid loss’ is a more common default than ‘How much could we gain’. We need to make bolder decisions about the future and embrace risk as a strategy enabler: entrepreneurs are optimists.

The risk of doing something has always been set against the risk of not doing it, but the time horizon for any cost-benefit analysis is the key, especially in health, transport and education spending. Much depends on the future one is envisioning and the circumstances that impact this view.  Sadly short-termism is prevalent as is factional interest in contrast to the wider public benefit. The future deserves more foresight attention, and reducing uncertainty is where this should start.

Written by Garry Honey, SAMI Associate and founder of Chiron Risk 

The views expressed are those of the author(s) and not necessarily of SAMI Consulting.

SAMI Consulting was founded in 1989 by Shell and St Andrews University. They have undertaken scenario planning projects for a wide range of UK and international organisations. Their core skill is providing the link between futures research and strategy.

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