Determining Acceptable Risk Levels

By Leytens, Anthony | Risk Management, October 1993 | Go to article overview

Determining Acceptable Risk Levels


Leytens, Anthony, Risk Management


An organization daily faces risks that can disrupt the continuity of its operations. It is generally accepted that the objective of risk management is to treat these risks in the most economical way. This is most often effectively achieved through an integration of these risks into the management of the organization rather than through a pure transfer to an insurer. In this context, the question of whether a risk management approach should be adopted is not a topic of primary importance.

There is another principle, however, that is implicit in the risk management approach: if a large loss happens tomorrow, is the organization going to survive despite all existing insurance contracts? Chances are, the answer is no, according to figures from the Chubb Group of Insurance Companies, a recent statistic revealing that 85 percent of the organizations that have suffered a major loss in their largely computerized administrations are going to go under within the following three years.

It is logical to assume that these organizations have considered the risk of a loss on their computer system to be "acceptable" and this has turned out to be a serious mistake. The again, these organizations may not have considered the possibility of a loss at all (a mistake in the identification of the risk). Perhaps these organizations may have thought that the probability of a loss was so small that it be neglected (a mistake in the evaluation of the risk). Or these organizations may not have considered all the consequences of a loss, and therefore the risk has been underevaluated (a second mistake take in the evaluation of the risk). It is also possible these organizations may not have treated the risk by developing the necessary recovery measures in order to have their computer systems operable shortly after the loss (a mistake in the treatment of the risk). Furthermore, these organizations may have failed to anticipate the financial resources necessary to get the company up and running again after a loss (another mistake in the treatment of the risk).

When this group is contrasted with the 15 percent of the organizations that survived, one learn that the main difference between the two groups has been in the survivors' prior creation of necessary recovery measures. This action implies that the survivors had correctly performed risk identification and evaluation. Since there were no significant differences in the insurance policies owned by the 85 percent that folded and by the 15 percent that survived, it appears that, in this case, financing was not a relevant factor. Thus, it is because the survivors correctly performed their risk analyses that they were able to determine the risk level, consider it to be unacceptable and therefore take recovery measures.

Defining Risk

Management

Besides the economical treatment of the accidental risk, there is a more significant objective in the definition of risk management - to secure the survival of the organization. The risk management process itself can likewise be defined: the various technical and economic analyses and treatment operations for accidental risks that can threaten the existence of an organization. Here, "analyses" means identification and evaluation; economic "treatment" means lowest cost. Moreover, "existence" can mean the organization's ability to achieve its objectives, as well as its survival.

In the first definition of risk management, where the objective was to treat risks in the most economical manner, the "acceptable risk" was an implicit and rather vague concept. Under the definition of the process itself, an acceptable risk now becomes a criterion against which all risks need to be assessed. The question of staying in business or disappearing becomes a direct responsibility for the organization's top management, who then often rely upon the advice and experience of the risk manager.

If computer risks, as well as liability risks for environmental impairments or products defects, are considered major risks today, it is precisely because these risks exceed the "acceptability" level for a large number of organizations. …

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