Global Risk Analysis 2014–Quantitative Analysis


1.  INTRODUCTION–A PROJECT MANAGEMENT PERSPECTIVE

As part of this series on Global Risk Analysis 2014, I wanted to look at the report from the framework of the risk management processes that are done in the course of managing a project.

The processes for Risk Management are as follows:

11.1  Plan Risk Management

11.2  Identify Risks

11.3  Perform Qualitative Risk Analysis

11.4  Perform Quantitative Risk Analysis

11.5  Plan Risk Responses

11.6  Control Risks

The first five of these processes are in the Planning Process Group, and the last of the six processes is in the Monitoring & Controlling Group.

Of course, the events of the world are not a “project” because they have no beginning and no ending, but I’m writing these posts from the standpoint of project management because risk management concepts are involved in it, and it is a framework I am familiar with.

The posts this week have been about the methodology of the report (analogous to the Plan Risk Management process), the identification of the 31 global risks and their classification into 5 categories (analogous to the Identify Risks process), and the ranking of these risks based on their probability, impact and the product of these two factors (analogous to the Perform Qualitative Risk Analysis process).

2.  GLOBAL RISK ANALYSIS 2014 and Quantitative Risk Analysis

This post is brief because it discusses the discussion in the Global Risk Report 2014 of what would normally be the next step, which is Quantitative Risk Analysis.   This would be where you take the probability of each risk and assign a probability to is from 0% to 100%, where you estimate the dollar impact of that risk if it were to occur, and multiply this quantitative estimate of the probability and the impact to achieve the EMV or expected monetary value of that risk.   For example, if the chance of a hurricane hitting the East Coast of the US of the same magnitude as Hurricane Sandy (the same one that hit in November 2012) in 2014 were 5%, then we know the dollar value of the impact of that hurricane, let’s say, $70B, then we can say that EMV of that risk is 5% x $70B or $3.5B.

Here’s what the Global Risk Report says about the this on pages 42-43:

“In the finance and insurance sectors in particular, there is strong reliance on quantitative measures of risk probability.   Some other firms, wary of being blindsided by erroneous assumptions in the numbers that go into calculating the likelihood of adverse events, prefer to focus solely on the severity of risks and disregard any attempt to estimate their probability of happening.”

However, since the risks that the Global Risk Report 2014 are discussing are a) global (by definition) and b) interconnected, it is hard to achieve a quantitative measure in terms of a dollar figure for the impact, so the Global Risk Report 2014 says that the team putting together the report decided not to try to have the respondents do such an analysis.

The important point of the quote from above is that you do not need a quantitative analysis to proceed with the next step, which is Risk Response.   However, in the case of an organization, the cost of the risk response measures has to be justified by the EVM of the risk were it to occur.   For example, in the case of an insurance company where I worked, the company paid for a “hot site” that would retain a duplicate of the data in its home office and be able to be used as a temporary headquarters were the home office to be temporarily (or even permanently) incapacitated in the case of an earthquake.   The probability of an earthquake is small but not negligible since the office was in Southern California near the San Andreas Fault.   The impact, however, of losing all the financial data would be ruinous to the company, so the expense of maintaining the hot site was justified.

Now, if you are a government and advocating for mitigating climate change as a risk response, then arguing for the funds for these measures, especially in a time of economic adversity, is a difficult task.   Getting a qualitative measure of the damage that would caused by climate change would allow someone arguing for such measures to justify the expenditure, but pointing to the cost of NOT doing those measures, if the risk were to occur.

So although it is understandable that the Global Risk Report 2014 is not getting quantitative risk analysis from the respondents, reinsurance companies are doing such analysis.   Munich RE, a multinational reinsurance company, attributes the rise of extreme weather related events to climate change.  Their records show a nearly quintupled number of weather related events in North America over the past three decades.  They estimate a loss of US $1,060 billion (in 2011 values) from 1980 to 2011 (from the website http://www.thisisclimatechange.org/extreme-weather/).

3.   Risk Responses

Rather than talk in general about risk responses for all 31 global risks, I will take a look at three specific risks that the report discusses in depth and discuss the risk responses that the report suggests for these risks.

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