This was published 13 years ago
Risk management in the era of unpredictability
Urbanisation, climate change and globalisation are leading to more and bigger catastrophes.
By Leon Gettler
THE floods that ravaged Queensland and Victoria are a warning for businesses to overhaul their risk-management strategies. They are events that tell us we are now in a very different world.
How different? Erwann Michel-Kerjan, managing director of the Wharton Business School's Risk Centre in the US and chairman of the OECD secretary-general's advisory board on financial management of catastrophes, says that in the 21st century there has not been a six-month period without a major crisis that simultaneously affected several countries or industry sectors. We are seeing more and bigger catastrophes created by increasing urbanisation, climate change and globalisation. The world has become an interdependent village.
Examples include September 11, hurricane Katrina and the global financial crisis. The floods in Australia and Brazil are more of the same. Also, more crises, natural or otherwise, seem to be interconnected. Accounting firm Andersen was destroyed by Enron's accounting tricks. The world's biggest insurer, American International Group, nearly collapsed because of a 377-person London unit, run with almost complete autonomy from the parent company. Wall Street has plunged to its lowest in six months with anti-government riots in Egypt.
It's fair to say that the floods did not figure highly in risk-management strategies. Woolworths has cut its net profit growth guidance to a range of 5-8 per cent, from 8-11 per cent, partly due to uncertainties presented by the floods. Virgin Blue announced a $40 million hit because of floods and fragile consumer sentiment. Treasurer Wayne Swan says the floods will have a ''dramatic'' effect on the budget and IBISWorld has downgraded Australia's GDP forecast from 2.9 per cent to 2.6 per cent.
We now see forecasts of a worldwide impact on the supply and prices of commodities such as cotton, wheat, sugar and other foodstuffs, and coal, which will in turn put pressure on utilities reliant on coal-based energy generation.
Climate specialists say global warming has contributed to the disaster, with record ocean temperatures around Australia and, from July to October, record rainfall and humidity.
Alarmingly, the climatic variability is coming at a time when fuel and food prices are soaring.
The United Nations Food and Agriculture Organisation's food price index reached a record high at the end of last year, topping levels from the food crisis in 2008. The floods will only add to this.
Grain shortages will send food prices soaring, spreading hunger and destroying governments. The coup in Tunisia started with food riots. The food crisis also shows the lines of connection holding a globalised economy together. The greater interdependencies mean that disasters and crises will affect many more people. They are no longer local accidents. Multinational
co-ordination will become more critical. The attempt to create a global solution for climate change is just the start.
Some commentators describe the floods and La Nina as a ''black swan'', the kind of low-probability event like natural disasters, pandemics and terrorists slamming planes into buildings, described by Nicholas Taleb, events that no one predicted. That is not strictly true, though. In Australia, floods, droughts and bushfires are hardly unpredictable. They are part of the natural system.
Still, like the black swan, the floods created by La Nina show us the world has changed. Classic risk-management strategies are out of whack with the new order and the interconnectedness of the global economy. The conventional risk-management approach lists possible events and determines the probability of their occurring based on experience. You measure the costs and benefits of specific risk-protection measures and implement these measures for each risk. The problem is that it assumes risks are local and routine and fails to take into account the impact they may have on different organisations and states. It does not factor in the impact of the growing number of unlikely but potentially devastating events. It is an outdated approach that robs organisations of their agility.
Clearly, these sorts of events are impossible to predict. So, how should organisations respond? It is a subject that should be reviewed by boards regularly. Companies should have scenario-mapping teams that report to the board and work with suppliers and customers to identify potential threats. Twenty-first century risk management is not about predicting the future. It is about systems and relationships that create an organisation agile enough to respond when disaster strikes. As it will.