Risk Taking Appetite - Don't Let Your Eyes be Bigger Than Your Stomach

While every organization is unique, there are some components that all companies share.  One such item is the organization's risk appetite.  While you may not share the same risk appetite as your peers, the truth is that every company has one.  Perhaps you have heard the term in the past, perhaps you haven't.  Regardless, your organization has a risk appetite and you deal with that on a daily basis.  By definition, an organization's risk appetite is their willingness to accept or tolerate risk.  In the case of your company, it may be your decision to take a larger deductible, buy a loss limit on a property exposure, self-insure for an exposure, or decide to buy guaranteed cost insurance on lines of coverage (no appetite for risk).  Refining your risk appetite is something that should be of ongoing concern as the economy continues to struggle.  There are three things that we will address regarding risk appetite: internal factors, external factors and risk ability.

As you begin to define and refine the risk appetite of your organization, there are several things you need to consider. After going through the risk identification phase of the risk management process, you need to consider the internal factors that can have an effect on your risk appetite. Things to consider are:

• What is the company's history of risk-taking?

How has your company approached taking risk in the past? Have you been aggressive? Have you been conservative? How has this approach performed? Could you have done something different?

• What are the organization's long-term objectives?

What types of goals has your company defined for it's risk management function? Have you made decisions to become more aggressive in your risk-taking? Have you decided to become more conservative? Have you outlined steps you need to take to get there?

• What stage are you in the organizational life cycle?

1. Start-up Stage
2. Growth Stage
3. Mature Stage
4. Declining Stage

• Are you financially stable?

1. Assets
2. Income
3. Cash Flow

• Management's willingness to take risk versus the organization's financial ability to assume risk.

In addition to the internal factors that affect your risk appetite, there are external factors that need to be considered as well.

While internal factors are able to be controlled or manipulated to some extent, external factors are a little more difficult to manipulate.  External Factors that need to be considered are:

• Market Maturity
• Competition and the need to take business risk
• Public Image
• Stakeholders' attitudes (owners, creditors, government, beneficiaries, etc.)

Risk ability is the financial capacity for assuming risk.  If you have been through the risk identification phase, and have done some good data analysis and benchmarking, you should have a pretty good idea about your organization's risk ability.  Things to consider are:

• Likelihood of loss, both frequency and severity.
• Predictability of loss, the variance of actual from expected
• Cash flow
• Income levels 
• Asset levels and liability levels.

Knowing your risk-taking appetite and having a handle on your risk-taking ability is vital for the success of your risk management program.  If you are not in complete alignment between the two, you can expect a coupe of deficiencies:

1. The willingness to assume risk without the financial capacity to assume the risk.  

An example of this would be a start-up company that decides to take a $10,000 retention on their third part exposures.  While it seems like a good idea to do this because they are able to save $3500 in premium expense, one claim could put the company out of business.  They have the appetite for this, they don't have the ability.

  2.  The financial capacity to assume risk without the willingness to assume risk is underutilized capacity.

An example of this would be the opposite of the example listed above.  Your company has taken the time to identify its exposures and has also employed data analysis and benchmarking for ten years, yet you have always purchased guaranteed cost insurance. You have had the risk ability to assume up to a 100k deductible on your third part exposures, yet you have never taken that step.  It has cost you over 250k in premium savings over the course of the last five years.  That is money that could have gone directly to your bottom line.

This information is a pretty good overview that needs to be considered as your company enters the different stages of its life cycle. As with all other concepts discussed in my hubs, if you are not a professional with experience in this space, it is always a good option to engage the help of an experienced professional. The risk management process is comprised of many moving parts, each affecting the other. You should never attempt to compartmentalize or isolate one piece and think that you are not affecting the others. You must maintain a global view of your organization while influencing the areas that need your attention the most.

David R. Carothers, CIC, CRM is a Risk Management Consultant and Licensed Insurance Agent with Praxiom based in Tampa, FL. To contact David Directly, please email him atdrc@praxiom-rm.com.