Assessing The Cost Of Prevention

In anticipation of what the media has been describing as the worst blizzard in the history of the Northeast, I scurried to buy firewood, extra batteries, matches, bottled water, blankets and non-perishable food. I cooked ahead of time in case we lost power. I regularly boiled water and stored it in a large thermos. Somewhat amusingly, my husband went about his work, commenting that my outlays and extra efforts seemed unnecessary and would result in wasting time and money. He went on to say that we could survive for a long time on very little and did not have to prepare.

Notwithstanding a few chuckles we shared about our clear differences in getting ready for inclimate weather, this duality of risk perception and related mitigation activity can be an advantage for investment managers and its institutional investor clients. In "Why the Most Successful Leaders Find a Yin for Their Yang" (July 31, 2012), Forbes contributor Mike Maddock describes the need for operation (and I would add compliance) gurus to encourage innovators and rainmakers to focus on details as they make their magic. He adds that creative types "are usually impotent on their own" and "need a partner to leverage their superpowers and eliminate their blind spots."

Based on my experience, there is often a tug of war that repeats itself. Traders get told by risk managers to curtail positions. Product developers are urged by the Chief Compliance Officer to modify any features that could violate existing rules. As I wrote in "Life in Financial Risk Management: Shrinking Violets Need Not Apply" (AFP Exchange, Association for Financial Professionals, July/August 2003), "...a good risk manager is persistent, diplomatic, creative, knowledgeable and thick skinned." Somebody has to be able to say "no" with crumbling under pressure as naysayers push back. As we experienced firsthand in 2008 and 2009, bad things can happen and being ill-equipped to respond can be a death knell for a company.

In "Strengthening Enterprise Risk Management for Strategic Advantage" authors of a COSO study point out that "Times of economic crisis often generate significant discussion and debate surrounding risk management in all types of organizations, with particular emphasis on the role of the board of directors in strategic risk oversight." Absent evidence that advanced planning took place, board members could be further scrutinized and perhaps even sued. Waiting until the last minute to react might that a problem can no longer be solved, certainly at an affordable level.

Not every risk is material. There is a cost to prevention and a critical assessment must be made to balance costs and expected benefits of managing risk. In "Risk Management Top Concerns" by Dr. Susan Mangiero (November 28, 2014), a list of effective risk avoidance steps includes the use of a risk map. With this tool, one can categorize uncertainty events by likelihood of occurrence and associated dollar impact, if realized. A danger is to underestimate the seriousness of an adversity, especially one that is predicted to come true.

One snow storm may not destroy enterprise value but a dramatic contraction in credit availability, a spike in commodity prices or any other type of seismic market shift could be ruinous. For now, I will stick with my "worst case" philosphy and plan accordingly.