Risk Manager Focus

ERM: Concept to Reality

Risk managers share hard-learned lessons on implementing enterprise risk management.
By: | October 15, 2016 • 13 min read

Ask risk executives about the challenges of implementing an enterprise risk management program and they will tell you it’s no easy task.

“It’s definitely an uphill battle,” said Morgan Keane, general manager, enterprise risk management division, Port Authority of New York and New Jersey.

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Michael Liebowitz, senior director of insurance and enterprise risk management at New York University, said it is “extremely” difficult.

“I had a lot more hair when I started,” he joked.

But for all of the difficulties, the rewards are immense. A study commissioned by RIMS found that companies with mature ERM programs boast a 25 percent higher shareholder value than those that do not.

The study by researchers at Queen’s University Management School and the University of Edinburgh Business School looked at the maturity of risk management efforts at companies from 2006 to 2011.

“For those entities that have not yet embraced ERM, the arguments to do so are compelling,” the researchers wrote in “Testing Value Creation Through ERM Maturity.”

Yet, it’s not an easy argument to make.

Michael Liebowitz, senior director of insurance and enterprise risk management, New York University

Michael Liebowitz, senior director of insurance and enterprise risk management, New York University

“How do you show the value of something that is not happening?” asked Keane.

“Mostly, I think of ERM as a cultural change within an organization in that I am trying to win hearts and minds of people, not just produce a great process,” she said.

When she began at the Port Authority, enterprise risk management was mostly an ad hoc process. And even though ERM began as a board-driven initiative, she focused on a bottom-up approach “because the culture of our organization does well with a grass-roots approach.”

She worked with every department to identify risks that “are usually within their ability to manage.” When there were successes, she shared them with other departments to demonstrate the value of ERM, until the word spread and her input was sought.

One of the lessons she learned along the way was the need to build relationships. “You have to talk to people in language they understand,” she said. “Language that resonates with them. One message for everybody does not work.”

Not everyone understands risk management from the perspective of a risk executive, she said.

Creating a risk library, she said, helps give business leaders a standard vocabulary. “When you identify the risk, you identify the root cause. That’s a standard language and everybody uses the same terms to describe the situation.

Making it as easy as possible for employees to discuss the likelihood and impact of a risk is important, Liebowitz said. He likes to use photos and plain language to share the complex ERM and risk management frameworks created by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and ISO 3100 by the International Organization for Standardization.

Gaining Buy-In

Making changes to an organization requires an understanding of the social systems within it, according to the “Harvard Business Review.” That involves letting employees at all levels of the organization propose solutions based upon “their own logic and clear pathways for change execution.” It requires making allies of key influencers and encouraging conversations about execution of the change.

Liebowitz said that “getting buy-in from strategic people [will] … help you advance a particular program or idea. First, you identify who those people might be. You get them to buy into the idea that ERM is something that an organization can find value in.

“Mostly, I think of ERM as a cultural change within an organization in that I am trying to win hearts and minds of people, not just produce a great process.” — Morgan Keane, general manager, enterprise risk management division, Port Authority of New York and New Jersey

“If there is value, then there’s a need and a want for it, and those people are easier to convince that maybe they want to take a chance,” he said. “What I am saying is, start small.”

Instituting ERM is increasingly a board-driven process. Nearly three-quarters of business leaders surveyed by the Enterprise Risk Management Initiative at North Carolina State’s Poole College of Management, said that boards of directors are asking for increased senior executive involvement in risk oversight. For large or public companies, the percentage is 88 percent.

Implementing ERM, however, needs to be a slow process, said Jack Hampton, professor of business at St. Peter’s University in New Jersey and former executive director at RIMS. It’s a common error, he said, to push too hard.

“What you see is, if you try to sell ERM across all departments, eyes really glaze over. … It doesn’t gain any traction,” he said. “The mistake risk managers make in-house is they talk about the big picture of all risks being managed without silos, in one comprehensive viewpoint,” he said. “That’s not how to explain it. You explain it by illustrating a story of how one group of people can do something.”

Hampton added, “The starting point is to find out what operating managers need to know in terms of information to manage what they perceive to be the key risks affecting their areas. If you approach it as a colossal task, it doesn’t work very well. You don’t put the system together by bringing everybody to the table at once.”

That’s what Liebowitz of NYU learned along the way to creating an ERM program that credit rating agencies have called best in class, he said.

After an initial attempt to convince the executive vice president of finance to implement an ERM program — who responded that it was a passing fad — Liebowitz cut back his focus to just one department, with the idea of using his success there as a selling point.

He chose the finance and treasury departments and worked with directors and managers to identify risks and mitigation strategies that “either brought efficiencies or identified potential exposures for the organization. And we fixed them,” he said.

That got the EVP’s attention, but it wasn’t until nearly two years later when the board’s audit committee approached the EVP to ask whether NYU had an ERM program, that the initiative really took off.

“Now, it looked like the greatest thing since sliced bread,” Liebowitz said.

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“We put together a plan and began to roll out ERM throughout the operations division of the university,” he said. “It was about building traction to get this running.”

After successfully focusing on operations for about 18 months, the academic side invited him to develop an ERM strategy for a new academic site in China.

“We continue to roll out our program in the operations division and we rolled out ERM to a third of our other international [academic] locations,” he said, as the program reaches the 5-year mark.

Mistakes Will Be Made

John Phelps, director, business risk solutions, Blue Cross and Blue Shield of Florida, began his ERM program 17 years ago “before ERM was a household word. … I have made every mistake you can make with this,” he said.

“That’s the best instructor I have had, the mistakes I have made.”

John Phelps, director, business risk solutions, Blue Cross and Blue Shield of Florida

John Phelps, director, business risk solutions, Blue Cross and Blue Shield of Florida

A few of the lessons he has learned: “If certain levels of management are not ready for the ERM thing, they are just plain not ready. Sometimes it takes an end run or for them to observe successes in another area to bring them around.

“Another is without upper management endorsement of what you are doing, you can go nowhere. You are just having a nice exercise. To be sustainable, it has to be cultural.”

Phelps said he also learned that senior leaders give “much higher deference … to identifying and evaluating risk at a strategic level than at the operational level. That’s also where the greatest value of the ERM program can be exposed.”

He said that he unsuccessfully tried to “integrate risk-taking criteria into annual performance planning and the organization just would not do it. I tried it twice. … Me trying to turn a chicken into a duck isn’t going to get the job done. I backed off.

“It was two steps forward, one step back, in implementing something both conceptual and tactical within the organization in order to move up to the strategic level where the greatest value of ERM can be exploited,” he said.

Phelps said it took four or five years to convince his senior leaders to move to a rudimentary form of ERM 17 years ago. His persistence combined with a market event caused the leaders to endorse the initiative, he said.

Now, the ERM program includes a scorecard for the 10 most critical strategic risks over a one-to-three-year period. Each risk scorecard has key risk indicators on it, and each is owned by a senior vice president. He updates his board three times a year and updates the VP ranks quarterly.

“We are pretty focused at the strategic level trying to find the greatest value for our organization as we continue to work on supporting strategy development and strategy execution at the company. We are doing this in a post-Affordable Care Act environment, and a pretty dicey and dynamic market,” Phelps said.

“There is also the other side: It’s not just preventing something bad from happening. It’s understanding a project or an organization at a strategic level so you can be more successful. … We come along with ideas to help improve chances for success.

“I have made every mistake you can make with this. That’s the best instructor I have had, the mistakes I have made.” — John Phelps, director, business risk solutions, Blue Cross and Blue Shield of Florida

“No one will ignore you when you explain that we are trying to make them more successful,” he said.

Keane said one of the biggest lessons she learned was to “try things out. Fail fast and course correct.”

Liebowitz said the two biggest mistakes he made were “biting off more than I could chew and thinking that more was better. Now, I have a card on my desk that says, less is more.”

Answering the Call

Risk managers know their ERM initiative is built into the organization when their advice is sought, experts said.

“I’m getting calls instead of me calling people,” Keane said. “I’m getting invited to meetings instead of inviting myself.”

Liebowitz agreed: “You know you are successful when people want to come together to discuss risk.”

NYU’s program began as “an island in a vacuum,” he said. “Today, we collaborate at a very high level with internal audit. We exchange ideas back and forth. We do the same with our compliance department.”

He sees ERM as “a three-legged stool,” with ERM as the seat, atop the legs of compliance, internal audit and operational risk.

Morgan Keane, general manager, enterprise risk management division, Port Authority of New York and New Jersey

Morgan Keane, general manager, enterprise risk management division, Port Authority of New York and New Jersey

“That’s when you know the program is working right and you can identify risks and share risks and we’ve come to the point now where we jointly work on risks together,” he said. “This year, for the first time, we are going to provide to our governing body a combined risk map that will have compliance risks and operational risks together, instead of reporting separately,” he said.

Liebowitz noted, however, that some risk manager colleagues prefer not to work as closely with internal audit.

Succeeding at ERM is grounded on the achievements of traditional risk management, Liebowitz said. His risk management team has eight employees, including him. Two are focused on ERM.

The team places all insurance for the university and its medical center, except for some employee benefits. It has self-insured workers’ compensation, a captive, an extensive international program including construction, as well as other coverages.

“None of this [implementing an ERM program] could have happened unless there was trust in what the traditional risk management department was doing,” he said. “The organization needs to trust you and your expertise to identify what are the right risks.”

That means being able to differentiate between challenges at the organization, such as employee retention or recruiting, and issues that present real risks. It also means differentiating between risks that can be mitigated within a set period of months or years, and those continually on the risk register, such as cyber security or geopolitical risk.

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“It’s just being one step ahead of the bad guys,” Liebowitz said.

As traditional risk management evolves into an ERM program, some risk managers use the RIMS Risk Maturity Model to measure their progress.

“It’s very helpful,” said Keane of the Port Authority. “It focuses the efforts of the [risk management] team so we don’t get pulled into so many different directions. It shows progress and can increase buy-in.”

The model characterizes the five-step evolution of ERM maturity — from ad hoc, initial, repeatable, managed and leadership — taking into account the degree of formality and effectiveness of the processes.

The RIMS research on linking shareholder value to ERM maturity found that two attributes of ERM maturity create the most value for organizations: performance management and ERM process management. They contribute 23 percent and 20 percent, respectively, to a firm’s valuation, according to the study.

ERM process management addresses both the downside of risk and the potential upside or opportunity, while performance management is the degree to which the organization is able to execute on the ERM vision and strategy.

“The maturity model is a tool,” Phelps said. “It’s not going to develop a program for you. It gives you a way to map out where the enterprise risk management program for a particular company is, and … where it should go.

“It takes ERM from abstract to tangible.”

Phelps, a former president of RIMS, said Blue Cross and Blue Shield of Florida used the RIMS model as a base to create its own framework that adds in some additional factors important to the organization.

Robust ERM Programs

Mature ERM programs are fairly rare. Even though most executives believe risks are becoming more complex, only one-quarter of business leaders say their organization has a “mature” or “robust” ERM program, according to the 2016 NC State study.

“This year we observe that the maturity of enterprise-wide risk oversight processes remains relatively stable at levels consistent with the past few years … ,” the report stated. “Most notably, organizations continue to struggle to integrate their risk oversight efforts with their strategic planning processes.”

It noted that large organizations, public companies and financial services companies were “significantly more mature” than other entities, but even there, only one-third of such companies say their programs are mature.

Nearly half of the companies targeted “insufficient resources allocated to ERM” and “other priorities that compete with ERM” as the main barriers to success.

Organizations have scarce resources, Keane said. That’s why it’s important to present a business case on the need for mitigation activities. “It must have a connection to the budget,” she said. “If you do a good job in the ERM risk register, you can use that to advocate for resources for further risk mitigation.”

Scarce resources and budgetary pressure make it an uphill battle to advocate for the purchase of technology — and that is a crucial element to ERM success, said Hampton.

Jack Hampton, professor of business, St. Peter’s University

Jack Hampton, professor of business, St. Peter’s University

“You need technology,” he said. “You can’t do ERM without it. … Managers need real-time access to the status of risks that are actively being monitored or managed. A risk management information system (RMIS) is a tool that is both efficient and cost-effective. It is silly to implement ERM without building on the right technology foundation.”

Liebowitz said NYU has a traditional RMIS system as well as an ERM system that houses all the data around the risks and shows historic changes in risk scoring and mitigation efforts. It also allows “risk owners” to self-monitor risks.

“It takes a lot of the human element out of a lot of things,” he said. “Instead of people sending emails or making phone calls, we let the system do it so we can spend more time doing the analysis work than the ‘chasing for information’ work.”

Creating a reporting structure for ERM is also important, he said.

NYU has several risk management and compliance committees at the operating level that funnel information into committees at the risk management, compliance or audit level. Those committees, in turn, report to a senior risk and compliance steering committee that reports to the board of trustees.

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“Having the structure keeps everything orderly,” Liebowitz said.

“If someone is just starting out, the best thing I could say to them is, be organized. Be forward-thinking. Show value to your organization and just keep trying.

“There is a need, not only within our profession, but within your company and it will take time for them to realize what you are doing and then they will say, why weren’t you doing this before?” &

Anne Freedman is managing editor of Risk & Insurance. She can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Black Swan: Cloud Attack

Breaking Clouds

A combination of physical and cyber attacks on multiple data centers for cloud service providers causes economic havoc. Even the most well-prepared companies are thrown into paralyzing coverage confusion.
By: | July 27, 2017 • 10 min read

Scenario

By month 16 of the new presidential administration, the Sunshine Brigade is more than ready to act.

Stoked by their anger over rampant economic inequality, the mostly college-educated group of what might best be called upper-middle-class anarchists — many of them from California, Oregon and Washington State — put in motion the gears of a plan more than two years in the making.

Their logic, to them at least, is unimpeachable. Continued consolidation of economic power into the hands of fewer and fewer corporations is creating a world where the rich increasingly exploit and shut out the poor.

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The rise of the techno giants is accelerating this trend, according to the Sunshine Brigade’s de facto leader Emily Brookes, an All-American rugby player and a graduate of Reed College in Oregon.

With a new presidential administration seemingly bent on increasing the economic advantages of the rich with no end in sight, nothing to do then but break things up; and in so doing break the hold of this technology oligarchy.

As Emily Brookes so forcefully put in her instant messages to the other members of the brigade: Break the Cloud.

With more than 500 members, many of them with ample financial and technical resources, the Sunshine Brigade is very capable of delivering on its plan for a two-pronged attack.

It is also radicalized enough to justify the loss of some human life, even its own countrymen, to “save” — in its collective logic — the tens of millions of global citizens that are living as virtual slaves in this callous, exploitative global economy.

With websites and digitally connected services large and small down for days, irritation turns to fear.

The first wave in the attack is an attempt to infect and shut down the data centers for the top three cloud service providers. It takes months to set up this offensive.

Rather than rely on a phishing scam from outside the firewalls of the service providers, The Sunshine Brigade uses its social and business connections to place three members on each of the cloud provider’s payrolls. An infected link from someone you know, someone in the cubicle right next to you, seems like an unstoppable play.

It only partially works. Only one of the cloud service providers is harmed when an unsuspecting employee clicks on a link from their traitorous co-worker. The released malware manages to cripple a major cloud service provider for 12 hours.

With millions of users affected, the act creates substantial disruption and garners global headlines. Insured losses are around $1.5 billion. But this is just the beginning.

The morning after, the Sunshine Brigade unleashes a far more devastating and far more ruthless Round Two.

Using self-driving trucks, the Sunshine Brigade smashes into five data centers; three on the West Coast, and two in the Midwest. Fourteen employees of those cloud servers are killed and another 23 injured; some of them critically.

This time the Brigade gets what it wanted. The physical damage to the data centers is substantial enough that it significantly affects three of the top four cloud service providers for five days.

With websites and digitally connected services large and small down for days, irritation turns to fear.

Small and mid-sized banks, which host their applications on clouds, are shut down. Small business owners and consumer banking customers immediately feel the brunt. Retailers that depend on clouds to host their inventory and transaction information are also hit hard.

But really, the blow falls everywhere.

In the U.S., transportation, financial, health, government and other crucial services grind to a halt in many cases.

Not everyone is disrupted. Some of the larger corporations are sophisticated enough in their risk management, those that used back-up clouds and had steadfast business resiliency plans suffer minimal disruption.

Many small to mid-size companies, though, cannot operate. Their employees can’t get to work and when they can, they sit idly in front of blank computer screens connected to useless servers.

For the man on the street, this is hell.

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Long lines blossom at the likes of gas stations, banks and grocery stores. A population already on edge from a steady diet of social media provocation becomes even more inflamed.

By nightfall of Day Five, the three major cloud service providers are recovered, and digital “normalcy” begins to creep back. But for many small and medium-sized businesses, the recovery comes way too late.

Economic losses promise to register in the tens of billions. It’s not being too imaginative to think that losses could hit the $100 billion mark.

Two multinational insurers based in the U.S., three Lloyd’s syndicates and a Bermuda insurer signal to regulators that their aggregate cyber-related losses are so great that they will most likely become insolvent.

Emily Brookes and her cohorts were willing to kill more than a dozen people to promote their worldview. In their youthful naiveté, they could not know just how much suffering they would cause.

Observations

For some commercial insurance carriers, the aggregated losses from a prolonged disruption of cloud computing services could be catastrophic, or close to it.

“It’s on a par with any earthquake or hurricane or tornado,” said Scott Stransky, an associate vice president and principal scientist with the modeling firm AIR Worldwide.

AIR modeled the insured losses for the Fortune 1,000 were Amazon’s cloud service to go down for one day. They came up with a figure of $3 billion.

Now consider that most businesses in this country are small businesses, with not nearly the risk management sophistication of the Fortune 1000. Then consider a cloud interruption of five days or more.

Mark Greisiger, president, NetDiligence

“Almost any company you talk about today would rely to some extent on the cloud, either to host their website, to do invoicing, inventory, you name it — the cloud is being used across the board,” Stransky said.

“It’s a significant issue for insurers and one we think about a lot,” said Nick Economidis, an underwriter with specialty carrier Beazley.

“Should a cloud service provider go down, everybody who is working with that cloud service provider is impacted by that,” he said.

“Now, pretty much every software maker is on the cloud,” said Mark Greisiger, president of NetDiligence.

“In the old days, someone would come in and install software on your servers and come in annually for maintenance. That’s all gone bye-bye. Everybody who makes software is forcing you onto their private cloud,” Greisiger said.

The aggregation risk for carriers is complicated by the degree of transparency they have into which insured’s applications are hosted on which cloud provider.

Now here’s the even trickier part. Clouds outsource to other clouds.

“It’s almost becoming a spider’s web of interdependencies on who has access to what in terms of upstream and downstream providers,” Greisiger said.

Determining which of their insureds is hosted on which cloud, and in turn, where that cloud is outsourcing to other clouds can be very difficult for carriers to determine.

Even if a company is careful to diversify the risks they’re taking, they might not realize that a high percentage of insureds are even with the same cloud provider. They could be hit with devastating losses across their entire portfolio of business, said an executive with BDO consulting.

AIR’s Stransky said his company launched a product in April, ARC, which stands for Analytics of Risk from Cyber, which is designed to help carriers gain that much needed transparency.

Among insureds, surviving an event of this magnitude will depend not only on the sophistication of their risk management department, but on the company’s overall ability to negotiate contracts with vendors and suppliers that will indemnify the company in the case of a cloud outage of this duration.

It will also depend on organization’s understanding that there is no off-the-shelf solution that will prevent an event like this or make a company whole after it.

Shiraz Saeed, national practice leader, cyber, Starr Companies

Experts say contracts with cloud service providers, customers and suppliers must be structured so that a company is defended should it lose cloud access for as much as five days or more.

Best practices also include modeling just what your losses would look like in this area, and vetting your full portfolio of insurance policies to understand how each would respond.

One broker said buyers can’t be blamed if the complexities of the coverage issues at stake here are initially hard to grasp.

“It’s becoming a spider’s web of interdependencies on who has access to what.” —Mark Greisiger, president, NetDiligence

“I think it’s the broker’s job to inform the client of this exposure,” said Doug Friel, a vice president with JKJ Commercial Insurance, based in Newtown, Pa.

“You may have business interruption coverage for direct physical damage to your building. But have you ever thought about your business income if your IT structure goes down?” Friel said.

He said many buyers might not realize there is a difference.

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Large businesses should have the resources to demand from their cloud service providers that they be indemnified for the entirety of a cloud failure event. There will be a fee for that, but it will be well worth paying, Friel said.

“You have to push,” Friel said. “They are going to say, ‘Here is our standard contract, sign it.’ ”

Don’t settle for that, he said, although many do in ignorance, he added.

“Where possible, we would look for clients to negotiate their contracts. These business relationships should be mutually beneficial, even if one of these events occur,” said Shiraz Saeed, national practice leader, cyber, for the Starr Companies.

It’s a partnership, he said.

“It shouldn’t be a zero sum game on either side. I think there should be an understanding of what the potential loss might be and then designing a contract around that,” he said.

While cloud service providers are known for having high grade security systems, most average organizations don’t have the means for that. But no matter what a company’s resources, the first step is modeling where your digital assets are, and what you and your customers stand to lose if you lose access to them.

“Most insureds don’t seem to understand the amount of individual loss that you could be subject to,” said Jim Evans, leader of insurance advisory services at BDO Consulting. “Usually this stuff is measured in hours,” he said. “But what if a cloud provider is out for three or four days?” he said.

“Trying to quantify what you did lose in an event is hard enough. Trying to do a modeling exercise about what you could lose? It’s something that just doesn’t get done enough,” he said.

Once you have an understanding of what you own and what you stand to lose, the next step is prioritizing the protection of the assets you have. That means drilling into your contract with your cloud service providers to get the maximum indemnification.

It also means spreading your risk so that if at all possible, not all of your assets or your customers’ assets are housed by one cloud service provider. Cloud platforms can be public, private, or a hybrid of the two.

Understanding where your assets are in that architecture is crucial. Spending the money to insure that they are protected behind a diverse menu of firewalls is highly advisable.

Navigating the different iterations of business interruption coverage in property, cyber and kidnap and ransom policies is also important.

Make sure your broker can provide clarity on the different types of coverages and tailor them to your needs, experts said.

The concept of design thinking is really what’s in play here. Organizations have to work with vendors in every aspect of their operations to design a risk management system that can sustain this kind of hit.

“Build a better mousetrap to protect yourself,” said JKJ’s Friel.

“Depending on your service, you need to have the best and the brightest designing this stuff. Spread the risk.”

“Don’t be afraid to ask for more,” he said.

Postscript

In engineering an attack on the cloud, Emily Brookes and her cohorts accomplished the opposite of what they set out to do.

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Only the largest corporations with the most sophisticated risk management programs were able to survive the attempt to break the cloud with manageable losses.

Small businesses, the true backbone of the U.S. economy, suffered terribly. Entrepreneurs who put their life’s work into their business lost it in many cases.

Those on the lowest part of the economic scale, the working poor, lost their jobs and their ability to cover their rent and grocery bills. They joined the ranks of those subsidized by the government by the millions.  The attempt to break the cloud resulted in an even more polarized society. &

Dan Reynolds is editor-in-chief of Risk & Insurance. He can be reached at [email protected]