Marcel Melo- 3.3 Assignment- ERM Challenges

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1 3.3 Assignment: ERM Challenges Marcel Melo Embry-Riddle Aeronautical University HROM 510 – Enterprise Risk Management Professor Chris Mandel November 06, 2022

2 Almost all organizations are affected by risk, and my organization (the Army) is no different. Most successful Enterprise Risk Management (ERM) implementation occurs by recognizing three core challenges: the inability to quantify strategic & operational risk, unclear definition of risk appetite, and a lack of integration of ERM into decision making (Segal, 2011). Although some risks are easily identifiable, they might be challenging to quantify. In this paper we will identify two particular organizational risks and discuss how these three challenges above can help to address these issues. Let’s start with the inability to quantify strategic and operational risk. The difference between strategic and operational risk is that a strategic risk is one which is outside the control of the organization that is within the operational environment. This includes the legislative, regulatory, and competitive environment to name a few. This means that strategic risks for a government organization could be a reduction in funding without any commensurate reductions to responsibilities. On the other hand, we have operational risks which might be similar but are things like major fraud events or a death. It is true that these operational risks might have strategic implications which could affect the organization, but they still need to be managed down at the lower levels of the organization and reported up to higher members or the board. It is not the responsibility of higher to manage those types of risk. Higher level leaders or board members need to be focusing outwards to establish the strategic direction of the organization. These members need to be aware of the operational environment so that they can manage the strategic direction of the organization. If they continually focus on the operational capabilities, then they could miss certain triggers that would cause them to change their strategic direction.

3 The Army is no different in this aspect of ERM. Because of the ranking structure set forth in the military, leaders at lower levels will continually monitor for operational risks, report to higher level leaders, and these higher-level leaders will focus on the strategic implementation of that risk. When military leaders are not able to quantify this strategic risk because they are hyper focused on operational risk, they negate their internal subject matter experts. Although this value-based approach has many advantages, this approach is not really risk-based because a lot of time it cannot account for metrics, data, or financial implications. The Army often utilizes this strategic and operational risk when planning for day-to-day operations and on the battlefield. While the Army does plan for these risks, they are not so concerned about the financial aspect of these. Contrary to most financial originations who don’t quantify the strategic & operational risk because they are focused on the financial risk. This will lead many organizations to focus their limited mitigation resources on the wrong priorities. “The basic and standardized indicators identified by the Basel accord to address quantification of operational risks are not risk based. They are totally unconnected to the operational system and control within the company.” (Amin, 2016). Next, we’ll discuss risk appetite or risk acceptance level. While the definition of risk appetite may vary from organization, the principle remains the same. An organization must define their risk tolerance prior to taking the next step in making risk decisions. This is an important step within ERM so that an organization can calculate and report risk exposure within that origination’s risk appetite. Risk appetite is a decision to set the parameters within which the organization manages risks, and then they can calculate the tolerable risk exposure. To quantify an organizations risk appetite, leaders should ask the question: what levels of risk am I willing to accept in the pursuit of my objectives? While certain organizations might be willing to accept a

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4 slightly lower risk for safety or their reputation, they might be willing to accept a higher risk for performance levels or financial management. Identifying these various risk categories and associated levels of risk that you are willing to accept, will ultimately become your targeted level of risk. That way, one the risk is identified, your organization can take steps to reduce the amount of risk acceptable to that particular category. These categories are what the organization will ultimately measure their consequence against. By identifying these categories, it will allow the organization to visualize what a sever consequence looks like against each category. This is going to express the organizational threshold for risk. The Army’s approach to risk appetite is no different to most organizations. In the Army, we have different risk appetites for training exercises in comparison to war time operations. While the main goal is still safety and a reduction of injuries, the situations vary between the two environments. Thus, the level of acceptable consequences during a training exercise will vary in comparison to a war time operation. There is little margin for error, and we utilize a risk matrix for acceptable levels of risk. The Army’s risk appetite varies from organization to organization and environment to environment. While lower commands can accept lower levels of risk, higher commands sign off on accepting higher (or extreme) levels of risk. This risk matrix empowers units to define what their individual risk appetite is and gives commanders at all levels the ability to sign off on this risk. This matrix is heavily used in the Army and is how we apply ERM based solutions to address challenges in the different environments that we operate in. This fundamental outcome is the same in both civilian organizations and the Army and allows both to decrease the level of risk exposure by changing certain tactics or strategies.

5 Lastly, the inability to use ERM for decision making is the most prevalent core challenge and the most important one. If an organization is utilizing ERM but it is not making effective decisions or providing actionable information, then it is not being utilized properly. ERM is a critical aspect for an organization to ensure that they meet their outcomes and objectives. This means that ERM is not simply used for financial risk, but for overall risk within an organization. If an organization only implements ERM into financial decision making then it’s simply a more glorified version of a financial risk management program, rather than a holistic enterprise risk management (Segal, 2011). Organizations need to integrate ERM into all facets of the decision- making process once strategies are developed, risk is weighed, and measures implemented to minimize the amount of risk. This shouldn’t create a barrier for an innovation within an organization, but it should be utilized with making decisions to enable innovation by taking more calculated risks. The Army is no exception to the concept of enabling innovation by utilizing the ERM process into decision making. Leaders on all levels evaluate risk into their decision-making process by integrating ERM into strategies which might work better with a slightly higher risk. The strategic planning process is the time where a lot of fundamentally important decisions are accepted by leaders within the Army. After the decisions are made, it is a lot harder to make any additional risk analysis because once the strategy has been created, it is pushed to lower command teams to work within those perimeters of that decisions. Because a lot of time, money, and effort goes into this decision making at the highest levels, the Army is slow to change or these decisions. Therefore it is critical that the Army integrates strategic planning and ERM into all major decision making. When hasty decisions are made or there is a lack of ERM into the

6 decision-making process, the consequences could be dire in the Army considering it could literally be a life-or-death decision.

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7 REFERENCES: Amin, Z. (2016). Quantification of operational risk: A scenario-based approach. North American Actuarial Journal , 20 (3), 286–297. https://doi.org/10.1080/10920277.2016.1176581 Segal, S. (2011). Corporate value of enterprise risk management : The next step in business management . John Wiley & Sons, Incorporated.

Marcel Melo- 3.3 Assignment- ERM Challenges

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