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Scenario Analysis. A Risk Management Methodology Gert Cruywagen. What do the following have in common. Sail ship companies Stage coach operators Steam railroad companies Beta VCR machines Barings Bank Nokia Greek corner cafes.
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Scenario Analysis A Risk Management Methodology Gert Cruywagen
What do the following have in common • Sail ship companies • Stage coach operators • Steam railroad companies • Beta VCR machines • Barings Bank • Nokia • Greek corner cafes
“Risk comes from not knowing what you are doing”Warren Buffet
Remember • A risk is not only a bad thing happening, • It is also a good thing NOT happening
STRATEGIC OPERATIONAL GROWTH EFFICIENCY PROTECTION GROWTH EFFICIENCY PROTECTION COMPLIANCE PROTECTION EFFICIENCY GROWTH PROTECTION EFFICIENCY FINANCIAL HAZARD GROWTH Diversification/ Wrong strategy Loss of key staff Supply chain failure Changes in demand/ demographics Low employee productivity Technology change Employee dishonesty Increased competition Legal/ Contractual compliance Major customer default Pollution Major destruction of assets Loss of suppliers Exchange/ interest rate fluctuation IT security breach Physical security breach Employee safety Commodity price fluctuation Business interruption/ Lack of recovery plans Product liability/ recall
False Expectation • How can you expect Management to deal in a confident, structured and planned manner with unexpected catastrophic events or unexpected opportunities; • if these events were not identified and assessed, if there are no plans to deal with the events and if no provision is made to deal with the effects of the events.
UNIVERSITY OF OXFORD STUDY SHOWED: • During times of disaster, the performance of the company’s share price is totally independent from the presence or absence of insurance cover • The share price was influenced by the market’s perception of management’s ability to manage the disaster (risk)
RISK ASSESSMENT The systematic identification of undesired events and their causes, as well as real and potential opportunities, analysing their likelihood of occurrence and potential consequences or upsides in order to make a value judgement as to the acceptability or tolerability of the risk.
Risk Evaluations • Deliverable of risk assessment must be a risk profile: • Risks measured in terms of “deviation from business objectives” • Risks prioritised according to criticality to company • Can only deal with 10-15 critical risks at any one time • Both upside and downside of risks are identified and measured (each with own identity) • Each risk must show KPI’s • Integral part of risk profile must be potential risk responses to address the risk
Risk Integration and Planning • Identify for each risk scenario interventions required to reduce the probability of the risk occurring and /or reduce the severity (impact) if the risk manifests: • The Past Today • Treat Avoid • Transfer Treat • Terminate Take / Exploit • Tolerate Transfer . Tolerate . Terminate Integrate
Spectrum of ERM Strategies Compliance Regulatory Business Imperative Best Practice Strategic Tool
Potential Risk ScenariosA critical part of ERM is identifying all potential risk scenarios that may impact the organisation, to enable risk mitigation planning and definition of Key Risk Indicators SAMPLE Frequency Retained/ Captives Workers' Comp. > 1 x per year Interest Rates Negative Publicity Clinical Trials Regulatory Product Recall R&D Investment Patent Infringement Employers' Liability > 1 x per 20 year Product Recall D&O Environmental Risk Nat. Cat. Political Risk Product Liability Medium Low High Severity (% of Earnings Affected)
HIGH MODERATE LOW Risk MeasurementChoice reflects the data available and the view on the value of quantification efforts Degree of Sophistication Risk Measurement/ Analytical Techniques • Statistical Analysis (Probabilistic Models)/Bayesian Modeling • Scenario Analysis/Simulation/Influence • Sensitivity Analysis • Position Reports (Exposure Measurement/Volumetric Measurement) • Risk Rating or Scoring • Risk Indicator Analysis • Group Facilitated Qualitative Prioritization • Individual Qualitative Self-Assessment Key Factors Impacting Selection of Risk Measurement Methodologies • Severity or Volatility of Risk • Complexity • Availability of Data • Desired Capability • Cost of Implementation
Scenario planning for global economy Hard Times 30% 20% One World 10% Forked lightning Divided world (Ultra violet) 40% Emerging economies Old world
Scenario planning for global economy Hard Times 30% 20% One World Below 5% China’s growth rate Drop in US unemployment Drop in debt to GDP ratio Divided world (Ultra violet) 10% Forked lightning 40% 8-10% US 10yr bond above 5% • OTHER EVENTS: • War in ME (Iran) • Major EU defaults Emerging economies Old world
Current SA Game Board Premier League Internal Conflict (Visible war) Ruled Out 60% 2006 37/55 2010 43/55 2009 48/55 2007 50/55 2008 53/55 10% 40% Failed Sate (Afghanistan, Somalia, etc) Second Division (Poor but peaceful)
Current SA Game Board Internal Conflict (Visible war) Ruled Out 60% Premier League 2006 37/55 2010 43/55 2009 48/55 2007 50/55 2008 53/55 Harmony Conflict Violence Inclusive leadership Pockets of excellence Balanced economy Nationalisation Media tribunal Second Division (Poor but peaceful) Failed Sate (Afghanistan, Somalia, etc) Land grabs /ownership 40% 10%
Closer to home • Risk Scenarios • Opportunity scenarios
Closer to home • Risk Scenarios • What is the worst thing that can happen? • What do you wish never happens? • How will it look? • Best case • Worst case • Probable case • What will cause it to happen? • What do you do about it!!
Closer to home • Opportunity scenarios • What is the best that you can hope for? • When will your business fly? • How will it look? • What new opportunities are there? • What will cause it to happen? • What can you do to help this along?
