The last several years have seen an uptick in both understanding and application of enterprise risk management (ERM) concepts in nonprofits, higher education institutions, and government organizations. However, the conversations about risk in these sectors are often still tied to financial reserves.
When confronted with risks or opportunities, the first tool organizations often turn to is financial reserves. With the Great Recession behind them, a lot of organizations have rebuilt their reserves, in many cases with increased sophistication, a longer time horizon, and with application of larger capitalization strategies. But determining an adequate level of reserves has always been more of an art than a science.
We’re seeing organizations ask important and smart questions about their risk tolerance:
- Having survived the Great Recession, what is our risk tolerance?
- What level of reserves do we need for our organization?
- What risks — strategic, operational, and environmental — are driving these needs?
- Can we develop a reserves model that can be updated in real-time based on changing variables?
A risk assessment primer
To keep things simple, let’s define risk as the chance of something happening, measured in terms of probability, and any impact that may adversely or positively affect the achievement of an organization’s long-term strategic or business objectives. Remember, risk is neutral. It can come out of a period of intense organizational growth and activity, repositioning, or any number of other triggers.
Enterprise Risk Management: A Definition
Enterprise risk management is a process, effected by an entity’s board of directors, management, and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.
All organizations face inherent risk and uncertainty: economic slowdown, regulatory changes, increased competition, and failure to innovate and meet public demands, to name a few. The challenge for management is to determine what level of risk to accept as the organization strives to grow and deliver value, and what costs to incur to effectively manage and mitigate risks along the way.
Many organizations have responded by enhancing their governance related to risk management. At its core, ERM is about establishing the oversight, control, and discipline to drive continuous improvement of an entity’s risk management capabilities in a constantly changing operating environment. As you can guess, the scope of ERM is wide as it relates to an entire enterprise.
Where risk and reserves meet
We are seeing trends in how organizations are rethinking their financial reserves in the context of risk management. Rather than saying, “three months of expenses sounds about right,” they’re taking the time and effort to articulate, quantify, and translate their risks into activity-based reserve targets. They’re also developing practical tools to use on an ongoing basis to revise their reserve targets based on changing operational and environmental risks and variables. The dialogue about risks and uncertainties is much more nuanced, and now includes:
- Sources of protection, whether reserves, insurance, or litigation
- Concrete dollar amounts
- Factoring methodologies recognizing that not everything is going to happen at once
When all of these issues are rolled up into an ERM strategy, organizations are armed with a financial reserve philosophy, approach, and tools that are dynamic enough to stand up to realities that vary in severity and business impact.
How we can help
Our risk management professionals can provide guidance and tools to develop your organization’s risk profile, assess your current risk management processes against best practices, and design a risk management program tailored to your organizational needs.