Risk appetite is increasingly important to boards but it is inconsistently defined and applied
While there is no ‘one size fits all’ approach to defining and applying the concept of risk appetite, case studies show that there are some common elements of good practice. This was a message that clearly emerged from a report commissioned by AIRMIC.
The research, carried out by Marsh and the University of Nottingham, concluded that the concept of risk appetite was increasingly important to company boards but that there was inconsistency in how it is defined and applied. However, there was a strong desire among practitioners to share best practice and agree consistency of terminology and methodology.
‘The focus tends to be on two different sets of metrics with their own risk appetite thresholds – economic prosperity measures and environmental integrity/social contribution and reputation measures,’ said Eddie McLaughlin, a managing director in Marsh’s risk consulting practice for Europe, Middle East and Africa.
‘Increasingly, we are seeing organisations integrating risk appetite within their overall enterprise risk management maturity framework and their annual performance appraisal process,’ he added.
The report said the main benefits of understanding risk appetite include: supporting the better allocation of resources; improving decision-making and making it more consistent, and encouraging more effective risk taking, thereby ultimately supporting the organisation’s reputation.
The research identified elements of good practice in the area of risk appetite as follows:
? Start with a ‘top down’ approach as this aligns better to strategy setting processes in an organisation.
? Balance the requirements of various stakeholders (not just shareholders).
? Understand an organisation’s strategic objectives and associated risks.
? Align risk appetite with existing management processes (especially personal performance management process).
? Differentiate between short-term and longer term risk appetite.
? Broadly communicate risk appetite in an organisation (beyond senior management).
? Monitor risk appetite changes over time (retrospectively and prospectively).
‘Risk appetite is certainly a useful concept within my own organisation and one that we’re able to convert into practical benefit,’ said AIRMIC deputy chair Paul Howard. ‘This research is helpful in putting our activity into context.’
AIRMIC technical director Paul Hopkin concluded that the concept is still developing. ‘It’s one of the fundamental building blocks of risk management.
‘This research provides a status report on the progress that organisations have made so far as well as giving some practical guidance. It should increase understanding of this area and help organisations develop deliverable objectives,’ he said.