Establishing risk tolerance is a key component of risk management: Zurich CRO

Establishing an organization’s risk tolerance level is a critical component of an organization’s risk management process, in much the same way brakes are a necessary component of winning car races, according to John Scott, chief risk officer of Zurich Global Corporate.
Scott delivered his speech, ‘Zurich’s approach to Enterprise Risk Management,’ at a seminar for clients held on Feb. 9 in Toronto.
“In the insurance business, you can’t prosper without taking risks,” Scott said. “A racing car driver does not handle risk by driving slowly around the track. He drives as fast as he can.
“But of course a racing car goes extremely fast, and not just because it has a powerful engine and light tires. It also has brakes that, used judiciously, means that car gets faster around the track than somebody else who doesn’t have brakes.
“That’s kind of what risk management brings. They are kind of like brakes. Setting strategic risk and risk tolerance levels is key.”
Scott observed many people do not understand their company’s tolerance of risk. And yet, that should be one of the very first discussions a risk manager has with his or her board.
“The reason why it’s very important is because [the outcome of that discussion] has to make it into your strategy,” he said. “What type of company you want to be will depend on your risk tolerance.”
Whereas one insurance company may feel safer investing its money in relatively safe hedge funds, for example, another may opt to invest its premium into something riskier like credit derivatives. For its part, Zurich had to make “some tough decisions” back during the 2008-09 credit crisis, which prompted several insurers to de-leverage their balance sheets, moving out of some of the riskier investment strategies.
In this context, Scott cautioned: “You may make $10 million in one investment and $100 million in another, but if the $100 million is so risky that next year you’re going to make a $100-million loss,” an insurer’s risk tolerance may cause it to cease the riskier strategy because it’s not sustainable over the long term.
Once the tolerance level is established, it should be incorporated directly into the company’s strategy and policies.
Scott said Zurich has posted its risk policy, a national document, on the Internet. The document currently runs around 15 chapters, Scott notes.
“If you are an underwriter, and you look at Chapter 2, which is underwriting risk, it defines exactly what you are and are not allowed to do.”