The Failure of Risk Management: Why It's Broken and How to Fix It
Sep 14, 2023
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Douglas Hubbard, author of 'The Failure of Risk Management: Why It's Broken and How to Fix it,' discusses the challenge with Risk Assessments, problems with the traditional risk matrix, analysis placebo, using information incorrectly, risk and impact, risk neutrality, value statistical life, and tips to improve current risk practices.
Organizations should move away from ineffective risk assessment methods, such as risk matrices, and adopt more quantitative and probabilistic approaches to decision-making.
By monetizing risk and quantifying risk tolerance, organizations can make consistent and informed risk-return tradeoffs and optimize decision-making based on measurable probabilities and impacts.
Deep dives
Risk Management and the Failure of Risk Management
In this podcast episode, author Douglas W. Hubbard discusses the failure of risk management and how to fix it. He emphasizes the need for organizations to move away from ineffective risk assessment methods, such as risk matrices, and adopt more quantitative and probabilistic approaches to decision-making. Hubbard highlights the importance of accurately assessing probabilities and impacts, rather than relying on subjective scales or qualitative rankings. He also emphasizes the need for organizations to quantify risk tolerance and make risk-return tradeoffs based on a holistic decision analysis framework. Hubbard provides practical recommendations for improving risk management, including using the one-for-one substitution model, calibrating subject matter experts, and leveraging statistical methods. Overall, this episode challenges conventional risk management practices and urges organizations to embrace more effective and evidence-based approaches.
Risk Assessment Methods and the Illusion of Understanding
Douglas Hubbard explores the limitations of popular risk assessment methods, such as risk matrices, and highlights their tendency to add error to decision-making. He discusses the illusion of agreement or communication that these methods create, where individuals may define risk levels differently, even when using carefully defined scales. Hubbard argues that subjective estimation methods, when calibrated and trained properly, can outperform qualitative approaches and provide more accurate estimates. He emphasizes the importance of quantifying risk tolerance and adopting a mathematical approach to risk assessment. By doing so, organizations can make informed decisions based on measurable probabilities and impacts, rather than relying on ambiguous and error-prone methods.
Monetizing Risk and Quantifying Risk Tolerance
Douglas Hubbard challenges the traditional approach to risk assessment by advocating for the monetization of risk and quantification of risk tolerance. He argues that organizations should assign monetary values to risks, even for intangible factors like the value of human life. Hubbard suggests that by monetizing risk, organizations can make consistent and informed risk-return tradeoffs. He highlights research indicating that individuals already unconsciously assign values to risks in their personal lives. By explicitly quantifying risk tolerance and using mathematical models, organizations can optimize decision-making and allocate resources more effectively. Hubbard stresses that this approach aligns with established utility theory and can lead to better risk management outcomes.
The Need for Change: A Call for Improved Risk Management Practices
Douglas Hubbard concludes the podcast episode by urging risk managers and corporate leaders to implement immediate changes in their risk management practices. He recommends the adoption of more quantitative and probabilistic approaches, such as the one-for-one substitution model, which replaces ineffective risk matrices. Hubbard emphasizes the importance of calibrating subject matter experts to improve subjective probability assessments. He also highlights the need to incorporate statistical methods, better data analysis, and measurement techniques to enhance risk assessment. Additionally, he encourages organizations to establish explicit risk tolerance statements and consistently apply them in decision-making. Through these changes, organizations can overcome the failures of traditional risk management methods and make more informed and effective decisions.
Risk Management - it's a really hot topic right now. I'm joined by long-time management consultant, the inventor of Applied Information Economics (AIE), and author of 'The Failure of Risk Management: Why It's Broken and How to Fix it', Douglas W Hubbard. During our chat, Douglas talks about: 1. The challenge with Risk Assessments, 2. Probability defined (not as easily defined as you think), 3. Problems with the traditional risk matrix and matrices (sure to surprise you!), 4. Analysis placebo, 5. Using information incorrectly, 6. The long definition and short definition of risk management, 7. The 4 responses to risk action...can be ...a little murky, 8. Risk neutrality, 9. Changes in risk tolerance, 10. Risk and impact, 11. Value Statistical Life (VSL), 12. Tips to chat current risk practices. Effective risk management plays an essential role in effective decision-making. By applying the insights Douglas provides, you'll find yourself (and your organization) making smarter decisions based on techniques that have shown measurable benefit. (Adapted from the back cover sleeve). Enjoy!
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