General Session III: "At the Nexus of Strategic and Operational Risk"
Jim Allison of ConocoPhillips:
Strategic risk: 1. Gap between what you actually did and what you said you were going to do. 2. Mistake made in estimation process.
Operational risk: 1. Doing things that ought not be done. 2. Not doing things that ought to be done.
Business creates value from opportunities, with proper execution, subject to constraints.
New regulatory environment post-financial crisis is increasing operational risk substantially. For example: Imposed margins to reduce risk to financial systems, which simply transforms counterparty risk into liquidity risk. An energy firm may have a better handle on counterparty risk than liquidity risk, in which case this trade doesn't make sense. Efficiency and transparency resulted in more reporting. Abuses/fraud have always been illegal, but authority to punish is increased. Prevent inappropriate marketing resulted in special protection for municipalities and other "special entities."
Attitude of regulator tends to be to punish rather than coach to improve compliance. Reason is that Congress attacks regulators whenever something goes wrong unless they can demonstrate that they were "all over it." Then of course these are all expensive things to implement, the cost of which is most likely to be passed on to consumers.
Frans Valk of GE Oil & Gas (Enterprise Risk Leader):
Industrial risk management at GE is new. Even the Oil & Gas part of GE is relatively new. It was built out of a number of acquisitions. Now all divisions have an ERM leader and adherence to risk policies are audited. Believes that the important thing for the risk team to do is bring a different perspective to business discussions.
The see the four main risks as operational, strategic, financial, and legal/compliance. Then he asks each department "What's your current status? What is your goal?" Sometimes you have to accept a trade-off between what you want to achieve and the risks you're willing to take in order to achieve it. Because of the nature of a product manufacturing type business, his focus as a risk manager is on the hand-offs of risk as products move through the process.
His main point was that in the traditional product market, they have to set risk appetite in a different way than in insurance. They think of risk in terms of outcomes. For example if our product is defective, how many people lose fingers? Are we willing to tolerate 1? 100? 0? The answer needs to relate explicitly to your goals and strategy.
Lindene Patton of Zurich:
Greenhouse gas emissions as a potential emerging liability. She thinks climate change risk needs to be addressed in a broader way. Further if we don't, society will deal with it for us in a less economical way.
Bottom line regarding increasing natural disasters: assets are increasingly ending up in harm's way. Despite this, we haven't allocated more capital to dealing with that. Instead we're essentially insuring less and less. Thus the bigger the event, the less relevant insurance becomes. This probably doesn't make the most long-term sense for society. We need to be talking about the amount of capital that should be allocated to this risk. When losses are uninsured, it tends to lead to long-term macroeconomic losses. Even as we improve disaster response, it's not a substitute for insurance, because it doesn't make you whole.
The tort risk comes in when people who experience a disastrous loss and aren't insured start to feel frustrated and angry over the bad thing that happened to them that wasn't their fault. This is the starting point of litigation. Unhappy people will look for someone to blame, and the emissions angle has already been tried, albeit dismissed at the trial court level. There is a lot of testing of this possible argument going on. Outside the US as well, for instance climate change rights are part of the constitution of Bangladesh as of 2011. She thinks this is unlikely to go away. Also recommends reading the GAO Highest Risks series.
Most likely, it will be cheaper in the long-run to write insurance for disasters (or use some other ex-ante funding strategy.)
End Panel 4.
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