A misunderstanding of models and exposure data is not the primary cause of most modeling failures. Indeed, many companies that have suffered in recent catastrophes, both physical and financial, had substantial and sophisticated resources invested in risk analysis. What is often missing is the connection between analysis and management decisions, and this is the link that the rapidly evolving practice of enterprise risk management (ERM) is meant to create.
ERM is not new, but its value is newly recognized. Even a quick overview of the risk-analysis world reveals the need for a systematic approach, the tools to support the effort, and substantial expertise resident in the firm. But these will not exist in a firm without a high degree of commitment. ERM demands a culture of risk awareness that begins with senior management. Such a top-down approach increases the likelihood that a holistic and well-supported risk-analysis process will take root in a company. It also should decrease the friction that can exist between decision-makers and technical risk experts when unpalatable results are traced to valid, but esoteric, analytics.
A failure of the imagination does not always come from a lack of creativity; it often emerges when the time and energy required for creativity cannot be found. Fortunately, expertise, technology, and best practices have evolved that can help firms overcome the inertia that keeps them from implementing a holistic risk management framework. In the current economy, the possible penalties for inadequate risk management could not be more obvious. It is the potential for profits, however, that make risk management a fascinating pursuit.
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