ERM Chapter 8

Question 1

What are three examples on how risks can be included in strategic decisions?

Answer 1

1. The degree to which risky products and projects are undertaken
2. The degree and type of risk transfer and hedging to use
3. Management of the company’s borrowing and gearing ratio

Question 2

What companies would benefit most from active management of corporate risk?

Answer 2

• those that offer products with high ‘added value’ e.g. having high production quality
• those that offer products for which there are high costs of switching to another line
• those that offer products for which the value to customers depends on complementary services or products supplied by other independent companies
• those that have high sales growth opportunities

Question 3

Why is active management of risk so important to companies seeking higher returns based on a higher overall degree of risk?

Answer 3

• these companies are more likely to find themselves in difficulties
• such financial distress may cause management to take actions that conflict with the interests of other stakeholders, such as producing poor quality goods, operating a less safe work environment, cutting back on longer term investment spend, exiting promising lines of business or even liquidating an operation that otherwise would have continued to operate adequately
• volatility in earnings or profits can affect the share price and the ability to take full advantage of tax credits

Question 4

In addition to financial areas, in what other areas might businesses seek structural change to be more robust and flexible?

Answer 4

• increase the use of outsourcing
• spread operations over various sites/countries
• shift distribution channels e.g. from physical stores to online
• move away from grouping individuals into specialist teams and operating more using multi-discipline project teams

Question 5

Outline the actuarial control cycle.

Answer 5

Specify the problem, develop the solution and monitor the experience, all while acting professionally in the general commercial and economic environment.

Question 6

Outline Sweeting’s risk management control cycle.

Answer 6

Identification: defining and recording all risks in a consistent way
Assessment: considering/quantifying risks in the context of the risk appetite
Management: ongoing treatment of the risks
Monitoring: continuous recording, review and reporting of risks, losses and effectiveness of treatments and external audit
Modification: alter approach as business and risk environment changes

Question 7

Outline the three lines of defence structure.

Answer 7

First line of defence - like management staff in the business units:
- accountable for measuring and managing risk in individual business units on a daily basis (in line with the company’s stated risk appetite and risk policies)

Second line of defence - CRO, risk management team and compliant team:
- accountable for establishing risk and compliance programmes and policies, supporting and monitoring the line management and reporting to the board.

Third line of defence - board and audit function:
- accountable for effective governance of the RM process, setting risk management strategy, approving policies and ensuring that ERM is effective.

Question 8

What are the features of a silo-based approach to RM?

Answer 8

• variety of risk classifications used
• different documents used to record risks in different departments
• no centralised record of risks faced by company as a whole
• no appreciation of total risk faced, after allowing for interactions
• no stated risk appetite
• same risks being treated in different ways in different departments
• no account for diversifying effects of risks in different departments
• different tools for assessing and measuring risk in each silo
• no senior member of staff responsible for considering risk as a whole across the company
• lack of reporting to the board on risk due to inability to do it in a structured way
• risk not taken into account when making strategic decisions that affect the business as a whole