Businesses operate in an environment where risk is inevitable. In order to navigate these risks effectively, companies must adopt a risk management strategy that suits their specific industry and size. Some industries, such as financial services and insurance, have well-established risk management functions due to the nature of their business models and regulatory requirements. However, in industries where risk is not as central, companies may take a more varied approach to risk management.
When it comes to planning strategies, businesses have a choice between traditional risk management and enterprise risk management (ERM) approaches. Traditional risk management is a formal business function typically found in larger companies. It focuses on basic business risks related to finance and operations. Early forms of risk management included areas like credit risk, financial risk, and operational risk.
On the other hand, ERM is a broader framework that encompasses various types of risks within an enterprise, including cybersecurity risks and issues related to governance, risk, and compliance (GRC). ERM addresses risks such as regulatory compliance, operational issues, cyber-risk, financial risks, and reputational risks. By considering the interconnectedness of these risks, ERM enables companies to gain a better understanding of potential risks and their impacts on business events and decisions.
There are several key differences between traditional risk management and ERM. One major distinction is that traditional risk management often operates in silos, with each business area independently managing its own risks. This fragmented approach can lead to a lack of understanding about the potential effects of risks across different areas of the business. In contrast, ERM takes a more holistic approach by bringing together different risk owners to identify and map out risks. This allows for a better understanding of overall risks and their implications, enabling companies to make more informed decisions and seize opportunities while managing risks effectively.
Another difference is the risk-taking approach. Traditional risk management tends to focus on risk avoidance, while ERM enables organizations to take calculated risks. Risk appetite and risk tolerance play a crucial role in determining whether a company is risk averse or risk-taking. ERM helps companies strike a balance between risks and rewards by considering growth strategies, innovation, and other opportunities that come with inherent risks.
Furthermore, traditional risk management tends to be reactive, responding to risks as they manifest. This approach carries its own risks, as companies may face unexpected challenges that could have been anticipated with a proactive approach. In contrast, ERM takes a proactive stance by using a combination of people, processes, and technology to identify, assess, monitor, and report risks. ERM applications integrate with GRC software and other risk-specific tools to provide a higher-level view of business risks, allowing companies to mitigate potential risks before they occur.
Lastly, insurability is another factor that distinguishes traditional risk management from ERM. Traditional risk management often relies on insurance to cover financial risks, such as workers’ compensation insurance for workplace injuries. However, some risks, such as cyber-risk, may not be covered by traditional insurance policies. ERM helps identify uninsurable risks and provides a platform for risk functions to collaborate in managing the company’s entire spectrum of risks.
While traditional risk management still has its place, more and more companies are recognizing the need for a comprehensive ERM approach. ERM not only helps companies manage risks effectively but also provides a potential competitive advantage. However, implementing an ERM program takes time and patience, typically requiring two to three years to establish. As businesses navigate the dynamic landscape of risk, embracing ERM can better position them to thrive in an unpredictable world.