Mod 02: Why ERM?

Question 1

State the claimed benefits of RM (as distinct from ERM)

Answer 1

The claimed benefits of RM
1) RM can benefit society as a whole (eg by reducing contagion risk).
2) It’s part of the job of the Board to optimise risk / return decisions on behalf of shareholders.
3) Earnings volatility can be reduced (eg by reducing the likelihood and impact of unpleasant surprises).
4) Shareholder value can be maximised (eg by reducing the cost of capital and allocating capital more effectively).
5) Job security and rewards can be enhanced for senior executives .

Question 2

State the claimed benefits of ERM (emphasis on the ‘E’!)

Answer 2

The claimed benefits of ERM

1) improved reporting of risk, hence improved transparency, understanding and decision making by the Board
2) increased operational effectiveness of the organisation (eg through improved co-ordination via a central risk function)
3) improved business performance (eg through better use of capital)

Question 3

Outline in more detail the benefits of senior management being better informed

Answer 3

Benefits of being better informed
Senior management:
1) better understand the organisation’s aggregate risk exposure, ie allowing for interdependencies
2) better comprehend the links between business growth, corporate risk and return
3) better understand the impact of changing external factors, such as interest rates
4) can assess more accurately the risk / return trade-offs of a particular decision
5) can align strategy more closely with risk appetite.

Question 4

Outline in more detail how an organisation’s operational effectiveness might be improved by ERM

Answer 4

Improved operational effectiveness

1) by co-ordinating risk management activities across all parts of the organisation
2) by encouraging and facilitating the sharing of risk information
3) by identifying and assessing interdependencies between risks managed by various teams
4) by improving efficiency (eg with respect to management time and business resources)

Question 5

Outline in more detail how an organisation’s business performance might be improved by ERM

Answer 5

Improved business performance

1) using and allocating capital more efficiently
2) minimising losses and unpleasant surprises
3) reducing earnings volatility
4) incorporating risk into business processes, eg pricing, business acceptance
5) optimising risk transfer and other risk mitigation decisions (eg allowing for natural hedges between business units)
6) reacting more quickly, eg seizing opportunities, emerging risks
7) deriving value from the time, effort and money spent on risk management, rather than it being viewed as a box-ticking exercise
8) reducing risk of regulatory intervention
9) positive impact on credit rating

Question 6

Outline reasons why an organisation may decide to implement ERM

Answer 6

Reasons for implementing ERM

1) increased expectations from stakeholders that companies will manage risk effectively
2) tools to assess and manage risk more widely available
3) pressure to improve risk management practices as a result of:
a) previous risk management failures
b) a ‘near miss’ within their own organisation
c) a high-profile disaster in another similar organisation
d) a regulatory requirement
e) pressure from (other) stakeholders