Does ERM add value?

Robert-HoytFounded in 2011, the Milliman Risk Institute provides scientific-based thought leadership on all facets of enterprise risk management (ERM). Composed of senior risk executives, actuaries, and university professors, the Milliman Risk Institute Advisory Board meets semiannually to discuss ERM trends, research, and key topics.

In this ongoing blog series, members of the Milliman Risk Institute Advisory Board share their views on ERM research and development and how it can support business insights.

Over time I have focused on assessing whether or not there’s a value proposition to enterprise risk management (ERM), examining it at a corporate level. My research as well as the work of others documents that there are ERM efforts that do create value. However, how can companies use ERM to create value for their organization?

I think companies should use ERM to look at opportunities that positively add value to the company. In terms of adding such value, some trends have shown intriguing potential. For example, the notion of identifying and steering away from compensation that directly incentivizes employees or management to undertake behaviors that ultimately are value-destroying—the kinds of perverse incentives we saw leading up to the global financial crisis of 2008 in the major banks.

At present, the breakdown in these efforts appears to be regarding a willingness to acknowledge that a harmful environment was created and existed in the first place. There are some very interesting questions that need to be addressed around why that is, but it’s clear, going back to the global financial crisis, that many of the issues came down to people undertaking the behaviors they were incentivized to take. If you compensate them for taking on mortgages and all you care about is the number of mortgages and not the quality of them, then they’re going to put as many mortgages on the books as they possibly can.

For most organizations, my sense is they’re very open to moving ERM from something mandatory for regulatory compliance and are more taking a view that ERM can actually help them gain competitive advantages. Companies need to be alert to identifying opportunities to integrate ERM more tightly with strategic missions. The changes may be process-related or they may address issues of compensation, incentives, and corporate culture. ERM is more and more moving away from playing a defensive role, and increasingly becoming a proactive element with the potential to add value.

Robert Hoyt is a member of the Milliman Risk Institute Advisory Board. He is the Department Head and Dudley L. Moore, Jr., Chair of Insurance, Risk Management and Insurance Program, at the Terry College of Business, University of Georgia. Robert is also the Department Heads of the Legal Studies Program, and the Real Estate Program at the Terry College of Business.