Despite the endurance of global economic stresses, a surprising number of risk managers rely on their own intuition and experience rather than external data. Aon’s 2009 Global Risk Management Survey found that out of 551 respondents, an astonishing 40 percent chose senior management and intuition as their primary means of identifying risk, and 35 percent also chose this method as their primary means of assessing risk. With potential risks becoming absolute realities for companies across various industries, now is an especially dangerous time to make risk management decisions—which ultimately come down to numbers—without empirical data such as analytics.

YOU CAN'T QUANTIFY "GOING WITH YOUR GUT"

Individuals who are motivated by their own historical experience or a “gut feeling” when making risk management decisions either tend to dislike data or don’t have access to it. These risk managers lean toward a more subjective method, especially in organizations with smaller revenue. According to the survey, about half of organizations with a revenue of USD18 billion or less use senior experience or intuition as their primary method to either identify or assess risk, while that percentage decreases to about 25 percent for larger organizations with a revenue of USD25 billion or more. The reliance on intuition or experience can easily be explained by the smaller amount of resources available to small organizations, but this doesn’t validate this tendency. Indeed, without analytics, the risk manager cannot know if intuition has any objective basis.

Dennis McLaughlin, CEO of the Aon Center for Innovation & Analytics in Dublin, reflects on this conundrum, explaining, “Analytics can be quite difficult to get your arms around, and these risk managers are in their comfort zone with their intuition. But how can they validate their intuition if they don’t have some kind of fact-based empirical way of thinking about risk?”

RELYING SOLELY ON INSTINCT HAS ITS PROBLEMS

Unfortunately, that comfort zone can throw an organization into uncomfortable territory. For instance, the power crisis in the California energy market during the late 1990s underscores the potential consequences of overlooking analytical data. The energy traders, who were accustomed to a regulated environment in which the price remained stable, continued to trade on intuition after deregulation. They didn’t consult basic analytics to foresee the results of price hikes, which could occur during peak times, such as on hot California days when air-conditioning would be maximized. Though the price could jump extremely within a day—or even an hour—traders made shortsighted decisions that ultimately contributed to the bankruptcy of utility companies and the power crisis that culminated in 2001. Analytics could have helped utilities understand the risks and potential future outcomes in order to devise a solution to help manage risks involved in energy deregulation.

In this case, as well as many others, the reliance on intuition and experience may simply be rooted in the inadequacy of a company’s data set. A limited data set can’t provide insights for worst-case scenarios. So senior management may find the most effective method of predicting risks involves constructing its own business intelligence analyses.

McLaughlin and Lambros Lambrou, CEO of Aon Analytics, agree that another threat to stability stems from companies expanding into new product or service sets, reaching into non-core-area risks. The mortgage crisis, for example, could have been lessened or prevented with analytics, since financial companies expanded into new loan areas without exploration of data. “I think the lessons of recent times have shown that as far as the business community is concerned, often it’s non-core activities that get companies into trouble,” Lambrou says.

ANALYTICS OPENS A WHOLE NEW DIMENSION

In the current economic climate, insurance purchase decisions must be carefully calculated and risk portfolios need to be scrutinized. “Obviously with the turmoil we’ve just had, risk has entered a whole new dimension,” Aon's McLaughlin says. That dimension supports risk profiles that are realistic and competitive.