Strategic Exposure Group
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Organizations and people make decisions in the context what they know. However, experience shows that catastrophic problems – man-made or natural, financial or non-financial, the ones that make headline news or go unreported – almost always arise from events that cannot be envisioned and defined until they happen, as they emerge from the unknown. While Fukushima, Katrina and the consequences of the 2008 crash are the well-known examples of such catastrophic events arising from the unknown, there are many other examples of catastrophes arising from little-known ordinary events. No organization can afford to ignore extreme exposure from the unknown because of its potentially existential implications.
In dealing with risk and uncertainty, most managers confuse extreme circumstances of the known risk with extreme exposure from the unknown, and thus mistakenly believe that their risk management emphasis addresses extreme exposure from the unknown. The former is an extreme scenario that can be envisioned and thus incorporated into operating decisions. The latter, on the other hand, is an extreme scenario that is impossible to envision as it defies all expectations, and thus can’t be incorporated into operating decisions.
Traditional risk management and ERM rely fundamentally upon the ability to simulate and predict possible scenarios: once possible future events are simulated, their adverse impact can be either prevented or absorbed in the normal course of business. However, the unknown can’t be envisioned and simulated; can materialize anywhere anytime; and cannot be predicted or prevented. In addition, the vulnerability arising from the unknown cannot be assessed, measured or gauged with traditional metrics. Therefore, the traditional approach fails to address extreme exposure from the unknown. This also represents a critical gap in how entities are evaluated by rating agencies and regulators. Hence a different approach is needed to deal with the unknown.
While it can’t be simulated, extreme vulnerability from the unknown can be addressed. It just requires an approach quite different from those employed by traditional risk management and ERM. This approach constitutes our primary focus.