Bad number to end 2008 with

The Japanese stockmarket has closed out the year 42% down.

42 is a very bad luck number in Japan as in Japanese it is Shi Ni which also means death.

Fortunately risk managers are not superstitious.

A headache in the making?

There is a report on Bloomberg today that Rhodia, the French pharmaceutical company is closing down the last paracetamol factory in Europe, unable to match the prices of Chinese and Indian product.

The checks on the overseas factories are apparently fairly frequent and rigorous so that's alright then, or is it?

We wouldn't feel comfortable having all baby milk production based in China at present, we would want a reliable alternative probably based in Europe. The pressures on factories to cut costs can result in all sorts of quality issues and somewhere in the supply chain there could be a rogue company supplying a number of producers. The drug retailers are no longer willing to pay a premium for paracetamol from a plant with decades of contamination free production. The consumer is not getting a choice, but is taking the risk, unlikely though it may be, of ingesting something toxic. Many would be willing to pay more to avoid this.

Paracetamol is widely used by millions of people each year, if there is ever a major product recall because of contamination it will create panic as there may be no suitably trustworthy substitute available in the volume required.

This is one headache we should seek to avoid. Keep a stock of US made paracetamol to hand.

Kimche and Christmas

On Christmas Day the risks are all well known and there is a process in place to manage them in most households. The turkey has been bought, the oven is working, the guests have arrived, what could possibly go wrong?

This Christmas morning just passed I happened upon one of those low probability high impact risks which could create havoc. Opening one of the cupboards I came on a pack of kimche brought by my son for New Year with the instructions " keep refrigerated". As it was at ambient temperature it had started to ferment and the bag was puffed up like a balloon. I gingerly carried it outside and duly puctured the bag which produced a singularly revolting smell of fermented garlic. Imagine if it had exploded during Christmas lunch - we would have had to evacuate the house!

Market reacts badly to deleverage risk

When risks are poorly understood and therefore even more poorly communicated – markets can get hold of the wrong end of the stick and PANIC.

Replacing toilet paper

A report in a US newspaper mentioned that the demand for satellite base stations was so constant it was like toilet paper - something that will always be required.

But not even toilet paper has a permament market demand. Every new home and every hotel room in Japan now comes equipped with plumbed in toilet seats which replace toilet paper with water and a blast of hot air.

Moral hazard and statistics

For statistics to have any value for decisionmaking they need to be verified and checked for consistency and accuracy.

It is heartening to see Sir Michael Scholar, the head of the new statistics authority, rapping the Government's knuckles for overriding the concerns of the National Statistician and her staff and publishing unverified statistics for the decline of knife crime.

There is a lot of moral hazard in this area for politicians. They can select the statistics which suit their case, knowing that even a rebuke from Sir Michael will go unreported by the tabloids because it is all far too technical. The risk is that public confidence is further eroded in Government statistics - Sir Michael needs a regular platform, probably on the BBC where he can explain the use and abuse of statistics. Then the public will wise up to this kind of chicanery.

Do it at home.

Continuining the theme of Japanese risk management there are moments when the micro-management tendencies in Japanese life start to grate.

There is sense is setting out angled lines on narrow platforms to encourage orderly queues three abreast and something that London underground should consider. However the posters suggesting that people pay attention when walking and texting because their line of sight is curtailed seem rather excessive, unless there are lots of manholes left uncovered, which there aren't.

Most Japanese of all was a large poster displayed prominently at many of the subway stations in Tokyo which showed a drunk salaryman ( office worker) lying across several seats on a train having just vomited . The message is "Don't do it on the train, Do it at home". This does not seem to support family values and is just an example of trying to sweep the problem under the tatami.

Gullible grannies

There has been a 60 minute documentary on Japanese morning TV to educate Japanese grandmothers on the dangers of a telephone scam. The con artists dial at random and just by saying "Hello it's me" persuade elderly women that they are talking to their grandson. They then tell her that they are in trouble with their company and need money,usually around Yen 4 million (Stg 30,000 at present exchange rates) or face the sack. They give details of where the money should be sent.

Despite checks at the banks where they try to explain that this is a scam the grandmothers have parted with over Yen 14,200,000,000 (over Stg 100 million) this year alone. The TV progamme is yet another way of trying to protect them from this scam. It is doubtful that it will have much impact.

Blogs and senile dementia

With very large numbers of people living beyond the age of 80 the Japanese have a series of initiatives designed to reduce the incidence of senile dementia. Besides the community clubs for the elderly they also have a Silver Centres which supply 70+ aged workers for jobs such as tidying up the roadside verges or clearing out streams . Japanese society does not have the charity culture of the UK which provides so many people with a worthwhile voluntary activity, nor, in the cities does it have allotments.

There are daytime television programmes dedicated to exercises for the aged and you will have seen the adverts for Japanese computer games to exercise your mind on a daily basis. These are yet other examples of how the Japanese are tackling the risk of senile dementia. Me, I write a blog.

A sign of age

Drivers in Japan from their 75th birthday need to display a momiji (Japanese maple leaf) sign of autumnal red and gold on the windscreen or on the back of the car whenever they get behind the wheel. There is no rule as to where the sign should be put which means that it can get overlooked. Presumably the thinking is that, like learners, elderly drivers need to be identified so that the other road users will drive more defensively. There will come a time if it hasn't already when momiji signs considerably outnumber learner signs as the elderly have perhaps 15 to 20 years to display whilst learners are usually finished within six months.


As the display of these signs will be soon compulsory it will be interesting to see if "age discrimination" issues arise or whether insurance is declared invalid if an elderly person has an accident when no momoji sign is displayed.

After 75 no one fails a driving test

Awaji Island, where I am currently staying, is linked by very grand bridges to the main Japanese island Honshu in the North and one of the three other main islands , Shikoku in the South. This rural area is famous for its onions and chrysanthemums. It has a slowly declining population, first because like the urban areas of Japan the birth rate is below replacement level, but also because many young people do not want to be farmers and leave for the bright lights of Kobe and Osaka.

The small population of Awaji and its relative isolation until the bridges came means that there are no railways and in most areas only three buses a day. This means that old people have to drive if they want to go anywhere.

In Japan you have to take a driving test every 3 years from the age of 75. In Awaji those about to be tested are told that "no one fails"! Those who have had so many accidents that they can no longer get insurance have the government as insurer of last resort. There are no convictions for dangerous driving such as facing your friend in the passenger seat whilst driving on the wrong side of the road. As Awaji people drive rather slowly, 40 mph is really going some, it appears that the accidents that occur are not usually severe. However there are almost no pavements in the villages and the chances of being run down would be high except that when they see you walking ( I have done 11 kilometres in the last 2 days) the drivers cross into the other side of the road if there is nothing coming.

In many ways this deliberate fudging by the authorities is a humane response to the difficulties old people face in getting about. It will be allowed until someone runs over a school party and then the authorities will start enforcing proper tests. Maybe there should be silver roads where super senior citizens can drive, knowing that the risks to children have been properly accounted for.

Some 80 year olds still have mothers

In Kobe, last Saturday, where I am visiting with my wife, 4 of the 9 dinner guests, all aged over 60, had mothers still living. Amazingly not one but two of them, one aged 80, have mothers aged over 100. The other two mothers are 94 and 90 next January (this last is my mother ). The only other Brit present lost his mother when she was 98, so we represented at that table the future, not just of Japan but probably of all developed societies.


As I travel around Japan over the next two weeks I shall be looking for examples of how Japanese society, the world leader in the number and percentage of senior citizens, is managing its aged population risks. The Japanese joke that once someone gets to 90 they forget how to die.

One hand is better than two.

Following on from the Nansen blog and hearkening back to an earlier one about Will Rogers I came across the following pithy bit of advice in Anne Fadiman's marvellous little book " ex libris", culled from a naval manual ,

"Do not touch cold metal with moist bare hands.If you should inadvertently stick a hand to cold metal, urinate on the metal to warm it and save some inches of skin.If you stick both hands,you'd better bring a friend along."

Nansen and the Polar risks

Great programme last night on Nansen's voyage in his ship,the Fram, in an effort to reach the North Pole by using the movement of the Polar ice cap to ferry them there. The voyage started in 1893 and was completed over 3 years later .

The attempt was full of wonderfully inventive risk management ideas - the Fram was designed so that the pressure of the ice would, instead of squeezing it until it cracked, push it up and out on top of the ice. There was a wind driven propellor mounted on the mast to produce electricity. The food was varied which contributed to the health of the crew and helped relieve the monotony of the Arctic nights. Nansen had studied how the Inuit survived in the Arctic and used their techniques of building a shelter when he and a single companion had attempted to make it by dog sled to the North Pole. They turned their sleds into kayaks when, realising they were being taken away from the Pole by the movement of the ice ,they turned their attention to finding a way back, not to the Fram whose position after several weeks of ice movement was completely unknown to them' but to the nearest inhabited island.

Three and a half years after the Fram set out Nansen and all his companions returned safe, having made numerous important discoveries, including the existence of a deep ocean under the polar ice cap, but yet unable to claim the title of first men to the North Pole.

Truly the Norwegians were the pre-eminent risk managers of polar exploration.

Here is the map of Nansen's voyage.
http://www.fram.museum.no/en/default.asp?page=142

90 years on

On this day, Armistice Day, the 90th anniversary of the ending of the first World War watching Henry Allingham at 112 laying his wreath at the Cenotaph the final words of King Lear came to mind

"The oldest hath borne most: we that are young,
Shall never see so much, nor live so long."

Florence Nightingale sets the standard for ERM

On Tuesday this week I went to the Florence Nightingale Museum, just across Westminster Bridge from the Houses of Parliament, tucked behind St Thomas' Hospital to view their archives which they very generously made available.

FN didn't go in for snappy titles but her "Notes on matters affecting the Health,Efficiency, and hospital administration of the British Army" packs many punches that a tabloid editor would relish. Some she borrowed

"If you don't send shoes, the army can't march." Wellington.

Some she coined herself

" But habit and ignorance make all men in all professions wonderfully acquiescent in evils, which, if once known and felt are remediable."

What comes across is that no detail relating to her subject was too small to be considered and then improvements proposed. In three hours of reading I noted her observations and proposals on sanitation, barracks and hospital construction, ventilation,statistics' use and veracity, medical education, clothing and equipment, laundries, procurement, diet, cooking facilities ( bread should be baked by the regiment), recreation and discipline, sick transport,climatic considerations, finance, malingering ( there isn't any to speak of), soldiers' wives and their treatment, the need to remit soldiers' pay home and then, as you would expect, proposals for nurses and their training.

There really was nothing that escaped her eye, except perhaps mental health issues and probably that is covered in another volume. If you want to understand how thorough enterprise risk management could be you need look no farther than this book.

Cleaning up anthrax

The tragic death of a drum maker from anthrax, reported on today's news, raises the issue of who is qualified to decontaminate the site.

Probably in this case someone from the Porton Down laboratories will be given the job. In the event of a major outbreak of anthrax or an equivalently nasty disease then the public authorities would be very stretched. There are a few private experts and if you had need of one then Jeff Charlton at http://www.999team.org/ is among the best. No I am not on a retainer, but this kind of capability deserves wider recognition.

A day to remember

October 27th is the anniversary of Vasili Arkhipov's intervention that prevented a Soviet submarine firing nuclear torpedos at a US destroyer at the height of the Cuban missile crisis. Raise a glass in remembrance of a very gallant officer.

Regulation

The Americans are busily searching for the culprits of the financial meltdown and the SEC, FBI and others are beating the bushes, but in the UK the heads of the Bank of England, the FSA and the Government make speeches - various people from the Bank of England and the FSA are moving on, but it is safe to predict that no one will be found to be responsible except, of course, the bankers and hedge funds. It is fortunate for them that burning at the stake is out of fashion.

Lloyd's of London has had some experience of failed regulation and after the failure to recognize the imbecilic behaviour of a lunatic fringe, major reconstruction became necessary (without any contribution from the taxpayer). After this near death experience Lloyd's passed hundreds of new regulations and imported herds of regulators - there were more at Lloyd's than were considered necessary for the rest of the UK insurance industry - with dire consequences. The market again sustained many billions of losses but since corporate capital had arrived and the losses were overwhelmingly sustained by this capital rather than the Names, it did not attract much notice However, it was obvious that the legions of regulators were ineffectual and the missing key component was knowledge, which was in short supply, not power, which they had in abundance.

The current Franchise Board at Lloyd’s was created in response to this so that now regulation is firmly practitioner led. The Franchise Board came to power in a fast improving market environment but the current signs are promising: it has the power and the knowledge.

It is not clear that the Bank of England or the FSA really understood the nature of the risks which financial institutions were accepting or, if they did, that they had any clue what to do about them. The new regulations and armies of new regulators which will arrive on the scene as a response to current events will be similarly handicapped. Unless the regulators are really up to speed with what the markets are doing they will prove to be as ineffectual as before.

History – In 1929 the Willcox Syndicate at Lloyd’s insured the solvency of secondhand car dealers – with predictable results. Lloyd’s, thereafter, insisted that all businesses operating in Lloyd’s should agree not to accept Financial Guarantee risks. This interdiction has been slightly modified since but is still in force – some people do learn from history.

Thou shalt not underwrite financial instruments

A very knowledgeable friend remarked last week that ever since the 1920's when one Lloyd's syndicate caught a severe cold insuring some financial instruments which went badly wrong ,not to underwrite such has been one of the commandments which all Lloyd's underwriters must very consciously obey.

Not in front of the children

Blue Peter, the children's television programme, has celebrated its 50th anniversary this week. During this half century its presenters have climbed up Nelson's Column, jumped out of aircraft, gone into ice pot holes, caressed pythons in the studio and exposed themselves to all mannner of dangers. Unless I have missed something, which is quite possible because I have never been a regular viewer even when my children were of the appropriate age, there has never been a fatality connected with any of the myriad of stunts that they have done. Says something for the BBC's risk management - I wonder if Blue Peter were the orginator of the famous risk advice " Don't try this at home."

Risk Management and Pay

"If [remuneration] policies are not aligned with sound risk management, that is unacceptable. Immediate action will be required to change the policies".

FSA, 13 October 2008

Long term survivor

Some years ago, to celebrate an anniversary, I decided to plant a tree.

I chose a Ginkgo Biloba, which are to be found all over Japan and whose nuts when fried are delicious. They have a downside in that in season the females can be quite pungent so I have planted the tree well away from the house and close to the fence, so it will create a problem for any new neighbours if the farmer ever develops his fields for housing.

Not only is the tree fruitful, and very beautiful, particularly in Autumn when its leaves change to bright yellow, but also it is an example of one of the great survivors in nature, for there were ginkgo biloba trees growing over 270 million years ago when the dinosours were around. Some individual specimens can live to more than 3000 years; there are some ginkgos still living which were only 1-2 kilometres from ground zero in Hiroshima.

It seemed to me that anything that could survive the vicissitudes of such a long period would be a good bet against whatever climate change could come up with. It also appears in today's newspapers that ginkgo extract halts the onset of alzheimers - good risk management all round.

High Impact, low probability risk

For more than 10 years the Council of the Association of Insurance and Risk Managers ( AIRMIC) have insisted that their reserves be placed with three separate banks, despite their lead bank offering significantly better interest rates. An example of risk managing for what, for the last ten years, would have been seen as a high impact but low probability risk.

Who decides on the risk?

A Chief Executive and his Chief Financial Officer, faced with a deteriorating situation in their markets, decide on a drastic course of action, supported by their banker.

Under their governance rules they submit their plan to the risk management committees. The first risk management commitee, having talked through the proposals with the stakeholders refuses to support the plan, which almost causes an apoplectic fit from the Chief Financial Officer who is not used to such detailed risk management consideration of his proposals.

The second risk management committee, composed somewhat differently, then refines the plan, adds some additional controls and benefits and confirms their agreement with it.

It then remains for the first risk management committee to decide whether their concerns and those of the stakeholders have been sufficiently addressed.

Is this a model for future corporate governance and for putting the risk manager right in the centre of the risk management process at the point of the decision?

Spreading the risk

Here's a risk management story from Tom Cahill's report on Bloomberg today;

"John James, who runs the Chicago-based firm with $25 million of assets, didn't buy Lehman stock or debt. Instead, his potentially fatal mistake was to rely on the bank's prime brokerage in London, a unit that provides loans, clears trades and handles administrative chores for hedge funds. He's one of dozens of investment managers whose Lehman prime-brokerage accounts were frozen when the company filed for protection from creditors on Sept. 15. "

Never rely on just one provider, if you can help it.

Pass the radioactive parcel

The ATCA thought piece today quoted the world derivatives' market at $1.14 quadrillion ( that a thousand trillion ) which equates to $190,000 for every person on the planet or 22 times the global GDP.

The unravelling ( unwinding seems far too controlled a word) of such a large market which is based on nothing more than confidence starts to look like a radioactive version of pass the parcel, whereby everyone involved is blighted. Don't expect your $190,000 soon.

Wholely right

The following extract from Berkshire Hathaway's 2002 Annual Letter to Shareholders deserves the widest possible circulation. Warren Buffett should be required reading for all in the risk business. I have not abbreviated the extract - you need to read the whole section.


Derivatives
Charlie and I are of one mind in how we feel about derivatives and the trading activities that go with them: We view them as time bombs, both for the parties that deal in them and the economic system.

Having delivered that thought, which I’ll get back to, let me retreat to explaining derivatives, though the explanation must be general because the word covers an extraordinarily wide range of financial contracts.

Essentially, these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices or currency values. If, for example, you are either long or short an S&P 500 futures contract, you are a party to a very simple derivatives transaction – with your gain or loss derived from movements in the index. Derivatives contracts are of varying duration (running sometimes to 20 or more years) and their value is often tied to several variables.

Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counterparties to them. In the meantime, though, before a contract is settled, the counterparties record profits and losses – often huge in amount – in their current earnings statements without so much as a penny changing hands.

The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it
seems, madmen). At Enron, for example, newsprint and broadband derivatives, due to be settled many years in the future, were put on the books. Or say you want to write a contract speculating on the number of twins to be born in Nebraska in 2020. No problem – at a price, you will easily find an obliging counterparty.

When we purchased Gen Re, it came with General Re Securities, a derivatives dealer that Charlie and I didn’t want, judging it to be dangerous. We failed in our attempts to sell the operation, however, and are now terminating it.

But closing down a derivatives business is easier said than done. It will be a great many years before we are totally out of this operation (though we reduce our exposure daily). In fact, the reinsurance and derivatives businesses are similar: Like Hell, both are easy to enter and almost impossible to exit. In either industry, once you write a contract – which may require a large payment decades later – you are usually stuck with it. True, there are methods by which the risk can be laid off with others. But most strategies of that kind leave you with residual liability.

Another commonality of reinsurance and derivatives is that both generate reported earnings that are often wildly overstated. That’s true because today’s earnings are in a significant way based on estimates whose inaccuracy may not be exposed for many years.

Errors will usually be honest, reflecting only the human tendency to take an optimistic view of one’s commitments. But the parties to derivatives also have enormous incentives to cheat in accounting for them.

Those who trade derivatives are usually paid (in whole or part) on “earnings” calculated by mark-to-market accounting. But often there is no real market (think about our contract involving twins) and “mark-to-model” is utilized. This substitution can bring on large-scale mischief. As a general rule, contracts involving multiple reference items and distant settlement dates increase the opportunities for counterparties to use fanciful assumptions. In the twins scenario, for example, the two parties to the contract might well use differing models allowing both to show substantial profits for many years. In extreme cases, mark-to-model degenerates into what I would call mark-to-myth.

Of course, both internal and outside auditors review the numbers, but that’s no easy job. For
example, General Re Securities at yearend (after ten months of winding down its operation) had 14,384 contracts outstanding, involving 672 counterparties around the world. Each contract had a plus or minus value derived from one or more reference items, including some of mind-boggling complexity. Valuing a portfolio like that, expert auditors could easily and honestly have widely varying opinions.

The valuation problem is far from academic: In recent years, some huge-scale frauds and near-frauds have been facilitated by derivatives trades. In the energy and electric utility sectors, for example, companies used derivatives and trading activities to report great “earnings” – until the roof fell in when they actually tried to convert the derivatives-related receivables on their balance sheets into cash. “Mark-to-market” then turned out to be truly “mark-to-myth.”

I can assure you that the marking errors in the derivatives business have not been symmetrical.
Almost invariably, they have favored either the trader who was eyeing a multi-million dollar bonus or the CEO who wanted to report impressive “earnings” (or both). The bonuses were paid, and the CEO profited from his options. Only much later did shareholders learn that the reported earnings were a sham.

Another problem about derivatives is that they can exacerbate trouble that a corporation has run into for completely unrelated reasons. This pile-on effect occurs because many derivatives contracts require that a company suffering a credit downgrade immediately supply collateral to counterparties. Imagine, then, that a company is downgraded because of general adversity and that its derivatives instantly kick in with their requirement, imposing an unexpected and enormous demand for cash collateral on the company. The need to meet this demand can then throw the company into a liquidity crisis that may, in some cases, trigger still more downgrades. It all becomes a spiral that can lead to a corporate meltdown.

Derivatives also create a daisy-chain risk that is akin to the risk run by insurers or reinsurers that lay off much of their business with others. In both cases, huge receivables from many counterparties tend to build up over time. (At Gen Re Securities, we still have $6.5 billion of receivables, though we’ve been in a liquidation mode for nearly a year.) A participant may see himself as prudent, believing his large credit exposures to be diversified and therefore not dangerous. Under certain circumstances, though, an exogenous event that causes the receivable from Company A to go bad will also affect those from Companies B through Z. History teaches us that a crisis often causes problems to correlate in a manner undreamed of in more tranquil times.

In banking, the recognition of a “linkage” problem was one of the reasons for the formation of the
Federal Reserve System. Before the Fed was established, the failure of weak banks would sometimes put sudden and unanticipated liquidity demands on previously-strong banks, causing them to fail in turn. The Fed now insulates the strong from the troubles of the weak. But there is no central bank assigned to the job of preventing the dominoes toppling in insurance or derivatives. In these industries, firms that are
fundamentally solid can become troubled simply because of the travails of other firms further down the chain. When a “chain reaction” threat exists within an industry, it pays to minimize links of any kind. That’s how we conduct our reinsurance business, and it’s one reason we are exiting derivatives.

Many people argue that derivatives reduce systemic problems, in that participants who can’t bear certain risks are able to transfer them to stronger hands. These people believe that derivatives act to stabilize the economy, facilitate trade, and eliminate bumps for individual participants. And, on a micro level, what they say is often true. Indeed, at Berkshire, I sometimes engage in large-scale derivatives transactions in order to facilitate certain investment strategies.

Charlie and I believe, however, that the macro picture is dangerous and getting more so. Large
amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other. The troubles of one could quickly infect the others.

On top of that, these dealers are owed huge amounts by non-dealer counterparties. Some of these counterparties, as I’ve mentioned, are linked in ways that could cause them to contemporaneously run into a problem because of a single event (such as the implosion of the telecom industry or the precipitous decline in the value of merchant power projects). Linkage, when it suddenly surfaces, can trigger serious systemic problems.

Indeed, in 1998, the leveraged and derivatives-heavy activities of a single hedge fund, Long-Term Capital Management, caused the Federal Reserve anxieties so severe that it hastily orchestrated a rescue effort. In later Congressional testimony, Fed officials acknowledged that, had they not intervened, the outstanding trades of LTCM – a firm unknown to the general public and employing only a few hundred people – could well have posed a serious threat to the stability of American markets. In other words, the Fed acted because its leaders were fearful of what might have happened to other financial institutions had the LTCM domino toppled. And this affair, though it paralyzed many parts of the fixed-income market forweeks, was far from a worst-case scenario.

One of the derivatives instruments that LTCM used was total-return swaps, contracts that facilitate 100% leverage in various markets, including stocks. For example, Party A to a contract, usually a bank, puts up all of the money for the purchase of a stock while Party B, without putting up any capital, agrees that at a future date it will receive any gain or pay any loss that the bank realizes.

Total-return swaps of this type make a joke of margin requirements. Beyond that, other types of
derivatives severely curtail the ability of regulators to curb leverage and generally get their arms around the risk profiles of banks, insurers and other financial institutions. Similarly, even experienced investors and analysts encounter major problems in analyzing the financial condition of firms that are heavily involved with derivatives contracts. When Charlie and I finish reading the long footnotes detailing the derivatives activitiesof major banks, the only thing we understand is that we don’t understand how much risk the institution isrunning.

The derivatives genie is now well out of the bottle, and these instruments will almost certainly
multiply in variety and number until some event makes their toxicity clear. Knowledge of how dangerousthey are has already permeated the electricity and gas businesses, in which the eruption of major troublescaused the use of derivatives to diminish dramatically. Elsewhere, however, the derivatives businesscontinues to expand unchecked. Central banks and governments have so far found no effective way tocontrol, or even monitor, the risks posed by these contracts.

Charlie and I believe Berkshire should be a fortress of financial strength – for the sake of our
owners, creditors, policyholders and employees. We try to be alert to any sort of megacatastrophe risk, andthat posture may make us unduly apprehensive about the burgeoning quantities of long-term derivativescontracts and the massive amount of uncollateralized receivables that are growing alongside. In our view,however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.

A week is a long time in the markets

Stelios Haji-Iannou remarked that " If you think risk management is expensive, try an accident".

Last week we started to count the cost of not having sufficent risk management is place in the derivatives' market. There is one estimate that this market is 11 times the value of the global GDP . No one knows how long or how painful it will be to extract the leverage out of that market or what the shape of the global financial industry will look like when it is finished.

Warren Buffet told us that derivatives were "weapons of mass destruction" back in 2002 when he reported on what he found when he unravelled General Re's derivative book. No one else comes close as a risk manager in the insurance business.

The Great Pandemic and the young

90 years ago this month 12,000 died of influenza in the USA. In October a further 195,000 died. American life expectancy dropped in 1918 by 12 years. Eventually 600,000 American citizien would die of the disease which singled out the young and fit and turned their immune systems against them. The estimates for world fatalities runs from 20-50 million. The truth is we just do not know how many and find it difficult to disentangle the effects of World War 1 with those of the pandemic.

Those authorities which swiftly recognised the nature of what they were dealing with, stemmed the mortality rate by limiting movement, by reducing contact between people and by promotingthe use of masks.

Others, such as the US army which had 13 million men register for the draft in September 1918, unwittingly exacerbated its effects.

Risk Managers should study the history of this great pandemic - if it was to occur again we would need to understand what did or didn't work in 1918, plus how we have moved on since those days, especially in terms of mobility and communication.

Young people take their health for granted, they think such a death couldn't happen to them. Sadly it did for my maternal grandmother in 1919, she was only 30 when she died of influenza leaving behind my mother , then a seven month old baby.

A head above the parapet

There is a risk in bearing bad news and perhaps an even greater risk in raising risk issues which do not chime with the CEO's world view.

Chris Lajtha of Adageo has sent me the following story from antiquity to illustrate the Risk Manager's Dilemma in the starkest terms:

When Darius, the Persian Emperor, decided to teach Alexander of Macedonia a lesson for invading his empire he assembled an enormous army designed to shock and awe with its size and opulence ( some ideas never go out of fashion).

Alexander did not have support from all Greeks and there were some Greek officers at the court of Darius. One of them, Charidemus, assessed the futility of Darius' approach

"Perhaps," he said, "you may not be pleased with my speaking to you plainly, but if I do not do it now, it will be too late hereafter. This great parade and pomp, and this enormous multitude of men, might be formidable to your Asiatic neighbors; but such sort of preparation will be of little avail against Alexander and his Greeks. Your army is resplendent with purple and gold. No one who had not seen it could conceive of its magnificence; but it will not be of any avail against the terrible energy of the Greeks. Their minds are bent on something very different from idle show. They are intent on securing the substantial excellence of their weapons, and on acquiring the discipline and the hardihood essential for the most efficient use of them. They will despise all your parade of purple and gold. They will not even value it as plunder. They glory in their ability to dispense with all the luxuries and conveniences of life. They live upon the coarsest food. At night they sleep upon the bare ground. By day they are always on the march. They brave hunger, cold, and every species of exposure with pride and pleasure, having the greatest contempt for any thing like softness and effeminacy of character. All this pomp and pageantry, with inefficient weapons, and inefficient men to wield them, will be of no avail against their invincible courage and energy; and the best disposition that you can make of all your gold, and silver, and other treasures, is to send it away and procure good soldiers with it, if indeed gold and silver will procure them."

The Greeks were used to direct speech as well as action, but Charidemus had not recognised how the Persians would react to such a blunt appraisal. Darius was so angry that he ordered him to be executed . "Very well," said Charidemus, "I can die. But my avenger is at hand. My advice is good, and Alexander will soon punish you for not regarding it."

Alexander and his men attacked and , as Charidemus predicted, they destroyed the enormous, unwieldly and polyglot army, forcing Darius to flee, leaving his wife and mother to be captured by Alexander, who treated them well.

Risks and type

Anne Fadiman is a wonderfully perceptive reader and she throws up lots of risks which attentive proof readers salivate over, some of which have serious consequences. In no particular order:

* misplaced apostrophes and spaces- my example would be man's laughter or manslaughter.
* misspellings as in the opening paragraph of Beverly Sills' memoirs -" When I was only three and still named Beverly Miriam Silverman I sang my first aria in pubic."
* key words missed out - here her example of the 1631 edition of the St James Bible which had the 7th commandment as "Thou shalt commit adultery."
* misplaced decimal point in a ship's mortgage in 1986 by a New York Law firm which cost their client $11 million.
* omitted hyphen by a NASA computer progammer from Mariner I's flight programme which sent the probe off course so badly that it had to be destroyed, thus wasting the $7 million investment.


However in writing this appreciation of her book "Ex Libris, Confessions of a Common Reader" I find myself at risk of offending her by describing it as a masterpiece, which has far too masculine an overtone for one so alert to gender issues in print, yet mistresspiece seems inappropriate and presumptuous and mispiece reads like the female equivalent of codpiece. So here we are, the only way around is to advise you to read her piece de resistance.

Impact on the public domain

Great risk management quote from Sir Edwin Nixon's obituary in the Telegraph today;

"Write nothing internally without considering its impact on the public domain."

Nixon became managing director of IBM UK in 1965 and retired as Chairman of its holding company in 1990, a remarkably long tenure, by today's standards. He also was Chairman of Amersham International from 1988-1996 overseeing notable growth.

In 1968 when I worked at Dexion, known for its slotted angle storage systems , Eddie Nixon was still proudly remembered after his four year stint as a Dexion management accountant, his first business post, as " the one who got away". He certainly managed his career risks extremely well and the obituary records that "although both approachable and good humoured, he was at the same time a perfectionist who liked things done well, and with style."

How does your CEO match up?

Holidays, fun and risk

Holidays away from home are fraught with risks. You are in an unfamiliar place, exposed to unfamiliar weather, eating unfamiliar food and without the restraints that normally you recognise. On top of all of this you have the absurd expectation that, because you are on holiday, nothing can go wrong. Truth is you don't want to think about details when you are on holiday.

I have seen a middle aged European holidaymaker agree to be strapped into a parachute harness and towed into the sky by a motor launch off a Phuket beach whilst a Thai lad, sitting on his shoulders, manipulated the parachute cords to steer him around the bay. To make matters worse the boat did not have a clear run to get up speed, but had to weave its way through the swimmers near the beach.

The issue was not did he have insurance - it would probably not have paid out if there had been an accident - but why did he not recognise the danger and the slapdash nature of the people who he was about to risk his life with. Maybe he was too laden with alcohol to take a sensible view, even more likely he thought it a good idea at the time and, his protective mantra was " nothing can go wrong, 'cos I'm on holiday." Nine times out of ten there was no problem, but those are only slightly better odds than Russian roulette.

The same lack of thought can happen on company away days, where risks are taken, often by the chief executive, with the whole management team, in the interests of bonding. There is usually no attempt to understand the risks and to get the team to find ways of mitigating them, there is just the focus on the goal of having a good time and there is sometimes an element of bullying . Directors who allow such thoughtless risk taking may find themselves faced with a corporate manslaughter charge if things go wrong. On holiday you're on your own.

Sounds familiar

Compare and contrast -

"It is clear that there has been a mispricing of risk.The Market did not understand the value or importance of liquidity and some banks did not fully understand some of the instruments they were dealing in."
Mervyn Davies, Chairman of Standard Chartered this week.

" A board that does not understand the strategy may not appreciate the risks, and if it does not appreciate the risks it will probably not ask the right questions to ensure the strategy is properly executed."
Justice Neville Owen in his summing up during the HIH bankruptcy case.

Careless Talk Costs Jobs

We have all enjoyed a good laugh at the Government's expense over their loss of computers and personal records. Yet I wonder how savvy we are when it comes to protecting sensitive information regarding our work.



Everyday on the commuter train you can hear detailed conversations of business contracts, disciplinary procedures and named individuals. Less obtrusive, but potentially even more damaging are those who work at their laptops on company documents with people standing or sitting next to them and well able to view what they are working on.



The same relaxed attitude is true of guests in restaurants and people talking or working on flights. I have seen documents across an aircraft aisle relating to a company which I was very familiar with, being worked on by a Japanese executive, which led me to believe that he was running his slide rule over them with a view to taking them over. A former Chairman of mine bragged of overhearing a conversation in a restaurant which led him to bid for the work under discussion and obtain it.



"Careless talk costs lives "was a watchphrase of World War2. We don't face such dire consequences but perhaps we need to revive it to read " Careless talk costs jobs" - starting with our own.

Too close for comfort

Well,well who would have thought it, the Transport Research Laboratory has found that 10,000 accidents in 2006 were caused by tailgaiting, the practice of driving right behind the car in front in an effort to intimidate them to move over or because you don't want anyone to cut in. Such car owners are known in the Welsh Valleys, I am reliably informed, as dog drivers - work it out.

Then there was the information that 90% of motorist were tailgated when they kept to the speed limit and only 50% when they drove without regard to it. It doesn't say how many of these are Central Lane Only Drivers (CLODs to the police) who add to a journeys' frustration.

The only three reliable risk management ploys I have come across with regard to tailgaiters are 1. to fit a switch to the dashboard to flash the brake lights without braking - one of my sales managers used this very effectively - smart man - he was also the only sales man in our electronic component company that Alan Sugar had time for 2. Follow the sensible advice of an American friend - drive so you have fast idiots in front, slow idiots behind 3.Have a number plate like my mother's - R2NEA -she has never been in a tailgate accident in 72 years of driving, but then she doesn't do motorways these days.

It's none of his business

Steve Jobs has been criticised for not being frank with his shareholders about his health. He has had one bout of cancer some years ago and the speculation is that he may be suffering a recurrence.

Any shareholder who buys Apple stock on the strength of Jobs being at the helm, must recognise that they are taking on an unusual set of risks. On the upside there is Jobs' extraordinary ability to develop new products which the world then realises that it wants extravagantly. On the downside there is the possibility, just like anyone, that he might not last out the year and the fear that he is irreplaceable.

There is no key man insurance big enough for Steve Jobs and the shareholders must accept that and not bleat about wanting to know the intimate details if he does not want to give them. You buy Apple stock for the ride and if it gets too scarey, jump off.

There's nowt so queer as folk

Looking at some of the news stories I am continually amazed at the low probability high impact stories which surface. It is, of course, the low probability which provides for the surprise element.

Talking of "surprise element" one of the stories was the tragic tale of the Polish visitor to England who relieved himself on the railway track. Not a problem in Poland where, if I remember rightly, the electricity cables are overhead. Sadly in the UK with the live rail right next to the usual track his mistake was fatal.

Then there were the three US crew who were found asleep on the job. Problem was that their job included access to nuclear weapon codes. Question I would like an answer to is" what were the conditions that made them all doze off?" Then it turned out we had not been in as much danger as it seemed as the codes they were guarding were out of date. Maybe we should go back to using geese, at least they don't sleep on the job.

Then there was the report that there have been 300,000 traffic accidents which have been caused, it was claimed, by SatNav, or rather by listening to SatNav and not using enough gumption. Imagine what a swarm of lemmings could do with SatNav - they might avoid going over the cliff. Unintended consequence.

The hammer and the aircraft carrier

An American aircraft carrier set sail from San Diego after a re-fit with a number of fitters still working on board. Three hours out one of the fitters reported that he had lost a hammer in an area which was potentially dangerous to the ship's operation and its safety.

The Captain immediately ordered the ship back to port, where after a fairly extensive search the hammer was found.

The punishment for the fitter? To be decorated for having the guts to own up to a mistake which could have badly damaged the ship. A good example of Think Risk, Smarter Decisions.

I don't think this is apocryphal, but I can't remember the original source. Let me know if you do.

Licensed to Hug

In the months after 9/11 I had a call from Frank Furedi, the Professor of Sociology at the University of Kent. He wanted to research the reaction to 9/11 and he needed to talk to risk managers and he needed funds. I arranged for AIRMIC to provide the risk managers and Lloyd's the funds. The result was Frank's report, which went out under the sponsorship of AIRMIC and Lloyd's called "Refusing to be Terrorised". Well worth reading.

Now he has just published with Jennie Bristow, a new report "Licensed to Hug"about vetting adults who work with children . Here is a brief section from his website http://www.frankfuredi.com/ on the subject- once again Frank is dealing with the fears of society and exposing how we are in the grip of idiots:

"The alleged protective effects of a system of vetting are largely illusory. Aside from the fallibility of record-keeping and technical systems, vetting takes into account only what somebody has done in the past. The most sophisticated system in the world cannot anticipate how individuals with a clean record might behave. Thus, the CRB provides little guidance about people’s behaviour in the future. It provides the impression of security, but not the substance. It is difficult to avoid the conclusion that the national vetting scheme represents an exercise in impression management rather than offering effective protection. Vetting measures also fuel suspicion about adults. In that sense, they are not just harmless rituals, but negatively influence the conduct of adult-child relationships.

Although proponents of the scheme contend that it is designed to prevent “worst-case scenarios”, the very institutionalisation of the scheme encourages worst-case-scenario assumptions to become the norm. One consequence of this process is that adults feel increasingly nervous around children, unwilling and unable to exercise their authority and play a positive role in children’s lives. Such intergenerational unease has not made children safer than in the past: if anything, it is creating the conditions for greater harm, as adults lose the nerve and will to look out for any child who is not their own. Perversely, it inadvertently encourages grown-ups to avoid their responsibility for assuring the well-being of children in their community. One of the principal consequences of the vetting of grown-ups is the legitimisation of the idea that it is not the responsibility of the older generation to take a direct interest in the lives of children. "

Click here to read the AIRMIC Press Release from 17th June 2002...

Floods, supply chains and cash flow

Floods are a particular problem for supply chain management. When all roads out are rendered impassable there is little comfort in having your factory on the top of a hill; staff can't make it to work, supplies can't be delivered or products shipped.

The impact is on the cash flow of the business. With no shipments there are no invoices and, if customers are also affected by floods then there may well be cancellations or contracts voided because of force majeure.

Bob O'Connor of A.M.Best spotlights the issue in his interview at the AIRMIC Conference with Dan Trueman of Kiln who are working to create insurance products to cover the revenue that the supply chain generates and respond to non-damage business interruptions. This is relevant to small companies as well as large, the sort our Business Continuity Management Online Course is designed to help. For more on that see http://www.riskrisk.com/

Risk Management is like a sheep dip

Risk Management is like a sheep dip. In order for it to be really effective the whole flock needs to be periodically immersed in the process.

57% of all reported fraud is inhouse

Here are some Statistics which raise some issues but should be kept in the context of the world's largest financial city:

* Reported fraud cost the UK £705 million in the last six months an increase of 74% of the same period a year ago.
* Of that £636 million was in the finance and insurance sectors.
*London and the South East account for £634 million of the total.
* Management fraud accounts for 46% of fraud reported.
* Other employee fraud is up from 2.5% of the total a year ago to 11%.
* When the employee fraud is added to the management fraud we get a total of 57% of all fraud is in house or £402 million.

I rang the company who provided these numbers, BDO Stoy Haward, to ensure that I had understood them and to understand what the difference was between management and employees - employees are people, according to BDO Stoy Haward, who are not managers.

The report only covered frauds in excess of £50,000 and I guess the insurance and banking sectors being tightly regulated are more likely to report than other sectors of the economy.

What is clear is that in a recession some people become more likely to take the risk of committing fraud in order to fund a lifestyle, a credit card or a mortgage. This probably applies to minor fraud, shoplifting, burglary and mugging too. It will become worse if unemployment grows and there will doubtless be headlines to worry us when it does.

Just to cheer you up the report also mentions that the cases of fraud against the inland revenue is £22million which compares rather favourably with the same period last year when it was £336 million, unless, of course, they have left the records on the train.

Chance hardly affects the wise

"Chance hardly affects the wise; the really important and serious things are under control of their own deliberation and reason. No more pleasure could be derived from a lifetime of infinite span than from a life we know to be finite."

Cicero quotes ,with approval this remark of Epicurus , translated by Rapahel Woolf. Seems to me to be what all risk managers might aspire to.

However on the subject of the infinite Richard Donkin in Thursday's FT pointed out that Einstein once remarked "Two things are infinite: the universe and human stupidity: and I'm not so sure about the universe."

Are there lessons from the Sarin Gas attack?

Very low probability, high impact risks are difficult to identify, unless like the New Madrid fault they have been closely researched and some idea of their impact and probability has been estimated. Lloyd's, I was once told, consider the New Madrid Fault to be the greatest risk on their books and the probability of a 8.0 strength earthquake in that area occuring in the next 50 years is put at between 7 and 10% , as stated in the June 23rd 2005 issue of the magazine, Nature.

If it was to occur it might be trigger a number of similar quakes. In 1812 there were 4 earthquakes in2 months ranging from 7-8 on the Richter scale caused by the New Madrid fault which runs from just south of Indianapolis down to Memphis.

My most unlikely high impact, low probability event was the 1995 Sarin Gas attack when I was living in Tokyo and one of the Sarin canisters passed on a train within 100 meters of my apartment. No one in my family was affected, not even my brother visiting from England who with two other professors from Sheffield University was wandering around Kasumigaseki, the Whitehall area of Tokyo and main target for the attack , wondering why there were so few people! However 12 people died and several hundred were injured.

In reviewing what I might have done differently I can see no lessons to be learned for me as an individual, which is one of the problems with this type of random high impact event. The Tokyo authorities learnt some salutary lessons regarding the readiness of their hospitals to deal with an emergency and the police learnt that they should act more forcefully when there is evidence of terrorist activity ( there had been a similar Sarin attack seven months earlier and 7 people had died) . The New Madrid earthquake , being of higher probability will find the US Mid West better prepared than Tokyo that day in March 1995.

Martin Sullivan's journey

Not many of the CEOs who have lost or will lose their job this year will leave behind so many of their colleagues feeling bereft as does Martin Sullivan of AIG. After 35 years with the company he has made his mark as a very capable and humane leader. It was always a risk to take the reins of an organisation which had been so closely identified with its two previous leaders, but I cannot imagine that he regrets having had his hand on the tiller. For someone to work from the age of 17 for 35 years with the same company is not as common as it used to be. For that person to make it to the top of the world's largest insurer is a very great journey indeed.

For us in the UK there was especial pride in Martin's leading one of the Global 100 companies. When I introduced him at an AIRMIC breakfast forum in London two years ago I pointed out that only Lindsay Owen-Jones at L'Oreal, Howard Stringer at Sony and Martin had done that with a non UK company.

We wish him well for whatever he wants the future to hold.

Identity trashing

There is a lot of concern about identity theft. The BBC often reports on the sort of defensive procedures you need to adopt and credit cards providers offer to protect you in event of a loss.

There is far less concern about identity trashing on the internet, but a thoughtful piece in the weekend Financial Times by Christopher Caldwell sets out the risks of having your reputation damaged online.

First the internet is a very unforgiving medium. You get trashed on it once and it remains forever, regardless of what you do in the meantime. (Not completely new, of course, there is the story of the nobleman who broke wind when bowing to Elizabeth 1st and when he returned to court twenty years later the Queen said, " You are welcome ,my lord, we have quite forgot about the fart.")

Secondly a search will be able to find malevolent material and this could affect personal, business and employment relationships.

Thirdly there is far more protection for intellectual property than for privacy, especially in the USA, where it is hard to get redress.

Fourthly, the barrier to managing huge amounts of data on people has now been overcome by computing power and therefore people could be open to greater personal surveillance than ever before.

Caldwell points out the importance of the low evaluation by the public of these risks, "Privacy is the realm in which personal convictions ripen into public engagements - no privacy, no democracy. To judge from the amount of information shared online people are not yet terribly worried about privacy. That is another way of saying that they are not terribly worried about liberty."

David Davis who resigned his Parliamentary seat this week over the obtrusiveness of the State in survelliance matters and its assault on human rights in the name of security is tilting at an important windmill.

Sir Howard and the Toxic Products

Anthony Hilton in his City Comment column in the Evening Standard on Monday June 9th 2008 pointed out that the authorities were not unaware of what the bankers have been up to over the last few years and that Sir Howard Davies, when head of the FSA, delivered a speech in which "he clearly and explicitly warned about the invention of collaterised debt loan obligations and credit default swaps and described them as toxic."

He went on to say " Nor did you have to attend the dinner to hear the speech. His remarks were reported in this column".

In fact it wasn't a dinner it was the AIRMIC Lecture of January 29th 2002 at the RAC Club. Go to the link below for Roger Miller's report and the quotes on the second page in italics.

http://www.riskrisk.com/howard-davies-comments-feb02.pdf


Anthony Hilton points out that nothing the FSA could have done would have prevented the current turmoil, the bankers were uninclined to listen and quite capable of moving to more compliant regimes if the FSA had attempted to rein them in.

How we got Sir Howard to speak I will leave for another blog.

Zen and the Art of Risk Management

I have Geoff Tudor of the FUJI Club in Tokyo to thank for the following quotes, where he got them from I am not sure., they were entitled "Important Zen Teachings." I have selected the ones that relate to risk for your enlightenment.

"Never test the depth of the water with both feet."

"If at first you don't succeed, bomb disposal is probably not for you."

"Bungling,confusion,misplaced power"

Richard Overy in his remarkable book "Why the Allies won" describes how the Germans frittered their technical lead and their scarce resources away during World War 2 ;

"The German armed forces pursued technical excellence for its own sake..... The military domination of production had mixed effects. There is no dispute that Germany developed weapons of very high quality...but the pursuit of advanced weaponry came at a price. Instead of a core of proven designs produced on standard lines the German forces developed a bewildering array of projects. At one point in the war there were no fewer than 425 different aircraft models.

' Nobody could seriously believe that so much bungling, confusion, misplaced power, failure to recognise the truth and deviation from the reasonable could really exist.' complained a group of German engineers."

Well today we have news that the National Audit Office has discovered 8 Chinook helicopters which have been so specially modified to the requirements of the British military establishment that they are unsuitable for use seven years after original delivery, despite them being badly needed, and the modifications to bring them back to service will double their original cost.

In trying to get certainty you often miss achieving your objective.

Peeing on the electric fence

"There are three kinds of men. The one that learns by reading. The few that learn by observation. The rest of them have to pee on the electric fence for themselves."

Will Rogers who wrote the above, died in a plane crash in 1935, and triggered the biggest outpouring of popular grief in the US between Lincoln and Kennedy. He deserves better acquaintance.

Think risk, smarter acquisitions

For any company contemplating an acquisition the following reality check from Justice Neville Owen is very pertinent.


"A Board which does not understand the strategy may not appreciate the risks, and if it does not appreciate the risks it will probably not ask the right questions to ensure the strategy is properly executed."

For two Boards contemplating a merger it is probably a deal breaker.

Two words connected

Shakespeare when we wrote Hamlet had frequent recourse (66 in fact) to hendiadys which is "the expression of an idea by two words connected by 'and' instead of one modifying the other". Examples such as 'law and order',house and home' are hendiadys as well as Shakespeare's own 'sound and fury' and "the book and volume of my brain".

James Shapiro in his book about Shakespeare "1599 " remarks that "when conjoined in this way the nouns begin to oscillate, seeming to qualify each other as much as the term individually modfies." They press on the audience's imagination, stretching the possible meanings and creating new connections.

I think it accounts for the discomfort and excitement that the phrase " risk and reward" provides.

Misleading percentages

"House sales to fall by 40%" is the headline used to attract attention by Yahoo to a report from the Chartered Surveyors.

This is serious, but it is also misleading. When you read on you find that house prices are expected to fall by 5%, whilst house sales plummet 40%.

The immediate downside risk is to the estate agents, the surveyors, and the removal companies.

But sales and prices are easily confused and most will think that the prices are to fall precipitously. They may, but that is not what the report expects.

Growler

Nigel Lucas, the Chairman of Risk Publishing Online, was an officer in the merchant marine years ago and tells me that , contrary to landlubbers' belief that all icebergs are 10% above the waterline there is another type which is totally submerged. This is called by sailors a " growler" presumably from the noise the hull makes on contact.

In risk management terms you either need sophisticated sonic detectors to pick it up or a look out on the prow of the ship.

Whatever the detection method "growler" is a great name for risks which you cannot identify until almost on top of them, but which lurk just under the radar! The people best able to detect them are at the sharp end of the business.

Brown on uncertainty

In our blog of September 11th 2007 we reckoned that Gordon Brown would not call an election at that time and that he might live to regret it.

What has become clearer with every mini crisis is that Brown is very risk averse and that his instinct is always to try to reduce uncertainty to the minimum. This approach worked as Chancellor because he was able to focus on a narrow set of criteria and he had Blair to force through decisions when he did not have enough data for his comfort. As Prime Minister he has to make decisions without enough certainty and he has to accept that sometimes the decisions will go awry.


He is a good example of a manager playing to his strengths even when they are not appropriate for the situation. It is unlikely that he will be able to change and the electorate is starting to see the mismatch.

Off the record

The National Archive at Kew , guardian amongst other things of the Domesday Book, has a deserved reputation for protecting the national records. It has tight control on all access to its material as theft is one of the major risks it faces.

What has recently come to light, aired on a BBC radio show, is that someone has been adding material to the archive without permission, creating false records which have then been used, it is thought, to support sensationalist claims in books relating to World War 2 events. Over 20 false records have been identified and new controls are now in place to stop this happening again.

Once there is doubt about the records then the damage to the reputation of the National Archive is very signficant because researchers do not know whether the document they are quoting is authentic or not.

The Fantods of Risk: Essays on Risk Management

The Fantods of Risk: Essays on Risk Management
By H.Felix Kloman, published by Xlibris. Available from http://www.xlibris.com/ or Amazon http://www.amazon.com/ for $20

Roger Miller,a previous Executive Director of AIRMIC and no slouch with the apposite phrase, once described Felix Kloman to me as having a“luminous mind”.

The range and reading of that mind are on display in Kloman’s latest collection of essays on risk management,esoterically entitled “the Fantods of Risk”. Fantods are either a state of extreme nervousness(the fidgets) or a sudden outpouring of rage ( a fit).

Kloman ,I guess, is more likely to take to his keyboard in a fit ,one perhaps brought on by extreme nervousness as he contemplates the risks facing us and our general incomprehension. He has the seriousness of an Old Testament Prophet, laying down the law ( he likes lists),citing other scriptures including the saintly Peter Bernstein and the blessed John Adams, both known to members for their presentations at the AIRMIC Conference. Kloman is remarkable amongst the IRM membership for being struck dumb when giving their Lecture, an event which he describes in the book, graciously thanking the crisis management of the IRM and the hosts Willis.

He has read very widely and across many disciplines. He is one of the few writers on Risk Management from an insurance background who has become an active member of GARP, the Global Association of Risk Professionals, the financial risk managers who have recently been weighed in the balances and found wanting in their knowledge of risk. He chastises the improvident and the impertinent- including AIRMIC on two occasions in this book for the Partnership agreements which Kloman considers an outrageous conflict of interest – I disagree with him, but I can see why he might get a touch of the fantods when considering the situation from Maine or Connecticut, where he is in residence.

We need more prophets like Kloman, more such writers and thinkers ( not always the same thing of course) and his essays are always illuminating, as Roger said he found the man. They are full of wonderful insights, irritations, the odd haiku, a dash of Monty Python and serious analysis . He makes the study of risk an essential and central activity ,not some obscure calling. He has striven mightily to have the word “risk” accepted as having an upside as well as a downside. It makes you realise that if you look hard enough, within a prophet you may often find a poet.


.

Traders,Testosterone and Risk

Research by Dr Coates and Dr Herbert at Cambridge,reported in April 19th Economist, shows that on the days when traders' testosterone levels are high they are more successful. It is not that testosterone rises because they are successful, but that the higher levels are followed by success.

On the other hand when it came to stress, uncertainty was a much bigger driver than failure.

As you might imagine we are only talking male traders here.

There is separate evidence, not in the Economist article, from Spanish scientists, Martinez-Sanchis,Aragon and Salvador of an interaction between testosterone and cocaine on the central nervous system. What is unclear is whether traders could gain success by enhanced testosterone levels due to cocaine intake. The danger is that those desperate for success some will consider this link a given. It is not.

A 13 year old deserves respect - be very afraid

You may have missed this. It is a remarkable addition to the library of poorly calculated statistics. Great story - look on 13 year olds with more respect . I found this on the Straits Times Site:

April 16, 2008

German boy, 13, corrects Nasa's asteroid figures
BERLIN - A 13-year-old German schoolboy corrected Nasa's estimates on the chances of an asteroid colliding with Earth, a German newspaper reported on Tuesday, after spotting the boffins had miscalculated.
Nico Marquardt used telescopic findings from the Institute of Astrophysics in Potsdam (AIP) to calculate that there was a 1 in 450 chance that the Apophis asteroid will collide with Earth, the Potsdamer Neuerster Nachrichten reported.
Nasa had previously estimated the chances at only 1 in 45,000 but told its sister organisation, the European Space Agency (ESA), that the young whizzkid had got it right.
The schoolboy took into consideration the risk of Apophis running into one or more of the 40,000 satellites orbiting Earth during its path close to the planet on April 13 2029.
Those satellites travel at 3.07km a second, at up to 35,880km above earth - and the Apophis asteroid will pass by earth at a distance of 32,500km.
If the asteroid strikes a satellite in 2029, that will change its trajectory making it hit earth on its next orbit in 2036.
Both Nasa and Nico agree that if the asteroid does collide with earth, it will create a ball of iron and iridium 320m wide and weighing 200 billion tonnes, which will crash into the Atlantic Ocean.
The shockwaves from that would create huge tsunami waves, destroying both coastlines and inland areas, whilst creating a thick cloud of dust that would darken the skies indefinitely.
The 13-year old made his discovery as part of a regional science competition for which he submitted a project entitled: Apophis - The Killer Astroid.

"Not without risk"

William Shakespeare's family motto " Not without Right" was part of his coat of arms which caused some controversy when it was granted on the grounds that an actor could not be a gentleman.

Ben Jonson seemed to think so too and one of his more scabrous characters in a play was a newly minted gentleman whose coat of arms was a boar's head with the hilarious motto " Not without mustard."

But " Not without right" is a cagey, modest motto , a motto for dangerous times. You only have to go to Tower Hill in London and look at the memorial plaques surrounding the old scaffold's location - Thomas More ,Thomas Cromwell, Archbishop Laud and many others- to remember just how precarious life was at court and that the higher you rose the greater the downside risk.

As Sir Walter Raleigh is supposed to have etched with his signet ring on a glass pane

"Fane would I climb,
Yet fear I to fall "

Only to have Queen Elizabeth Ist add her comment underneath to complete the poem

"If thy heart fails thee
Climb then not at all."

Perhaps the Elizabethans' motto should have been " Not without risk" or should we claim it for ourselves?

Accidents and Options

Imagine you are the owner of a company and you have an important guest on your premises. Naturally you supervise all the arrangements to ensure that everything is managed well and any risks to your guest are controlled with great care.

However, despite all your best efforts and those of your staff a terrible accident befalls the guest. You then discover that one of your staff was not fit for duty and his errors and your decisions have contributed to the accident.

Do you

1.accept that the fault lies with the decisions made by you and the culture of the company which you have set up and recognise that the guest's family may believe you culpably negligent and the authorites think that there is a corporate manslaughter case to answer with a very clear guiding mind( you) identified?

or
2. claim it was someone else's fault and cover up any traces of the unsuitability of your staff for having care of the guest?

If you chose 1. you run the risk of being prosecuted and sent to gaol , paying out huge damages and possibly losing your licence to run the business if it is one where the general public are involved.

If you chose 2. you should vigorously pursue other parties as being the cause of the accident and you may, even though your claims might be conclusively proved to be false, get away with deflecting the criticism of your organisation and your decisions

The authorities should make sure that 2 is not an option, at present it seems it is.

The Bottom Line at BA

Some are born in crisis, some achieve crisis and some have crisis thrust upon them.

Churchill was born in crisis when he took over as Prime Minister in 1940. Many chief executives are thrust into crisis through a disaster, think of those trying to carry on after 9/11 . Then there are those who through their own management style, or the culture of the company manage to achieve crisis because they do not pay enough attention.

Willie Walsh the CEO at BA has achieved crisis for his company. The opening of Terminal 5 was a well heralded event. The issues that had to be addressed were well understood and yet not enough attention was paid to them, because not only has a lot of baggage been lost and passengers severely inconvenienced but flights are having to be cancelled on a daily basis. It has been humiliating for the staff, the company and the wider community.

Walsh is a numbers' guy, he has not demonstrated any people skills in public that I am aware of and I would guess that his drive to ensure the bottom line is healthy is at the bottom of this mess. More time for training, fewer flights to start with so that the system and staff could be better able to cope, these would have been ruled out, in the fond hope that it will be all right on the night. In business continuity terms BA has been found wanting and their incompetence has affected many others - in future the best decision will be not to fly BA for if you do it could impact your business badly.

Will BA shareholders demand Walsh resigns because of the damage done to reputation and therefore the money earning capacity of the company? Probably not, they won't make the connection between reputation and share price and the culture that brought about the Terminal 5 fiasco, but they should.

A Risk Management culture for the long term

I should declare two interests. First my wife has less than 200 shares in the company and second from 1982 to 1990 I was General Manager of Spirax-Sarco's Japan Branch.

Spirax-Sarco was first amongst equals in low pressure steam controls in 1982, with strong competition from German, Japanese and American competitors. Now 25 years later it is the undisputed world leader. During those 25 years it has made but two major acquisitions - the first was to buy its orginal parent Sarco Inc in the USA and secondly to buy the Watson-Bredel company with its range of peristaltic pumps. Its major divestment was to sell off the Drayton radiator valve company in order to concentrate on its core business. Over the period it has more than trebled its sales to £417 miliion and quadrupled its profits. Most of the growth has been internally generated as it expanded into new markets - it has its own or associated companies in 33 markets - and through new products, most of which have been developed in the last 15 years, all focused on managing steam systems.

It has been led by a series of outstanding executives, including the founder Lionel Northcroft and on April 1st 2008 a new CEO takes over, the third engineer drawn from outside the company (he joined in 2003), whilst there have been two accountants who have come up from within.

The foundations of its success has been its application knowledge which , from my experience in Japan was clearly a completely novel way to sell for the Japanese users of steam systems. The knowledge was provided free of charge to help customers design better systems in order to deliver improved product quality for whatever was using steam for process and reduce energy costs. The Spirax correspondence course on steam system design has been take by over 1 million students - it is available free of charge in almost every major language.

What does all this have to do with risk management?

Plenty.

First the company has been disciplined and has not made rash acquisitions. It has stuck to the knitting, would that British Leyland had.

Second it has managed the succession of its leaders very effectively and has ensured that no one can hijack the direction of the company, not for Spirax the fate of GEC.

Thirdly it has used its knowledge to successfully develop markets such as Korea and China so that now Asia accounts for twice the profit from North America and closer to home Continental Europe twice the profit from the UK. This spread of markets has allowed it to manage exchange risks and market downturns in various economies and to deliver an increase in dividends per share for each of the last 15 years.

Fourth, because of its dividend performance and strong management record it has 50% of its shares held by 10 different investment funds, many of which have had the shares for over 20 years. This has given the management stability, but they have earned it.

Fifth being involved with energy saving whilst climate change moves up the agenda, something recognised by Spirax at least 20 years ago, creates a culture, shared by the staff globally , of a company ( I use that in both meanings of the word) addressing to the best of its ability one of the key problems of the world community. Spirax does not lose many people to its competitors.

A fall from a roof top

One Chinese definition of "schadenfreude" is " it is pleasant to see an old friend fall from a roof top."

I disagree. Having yesterday attended the funeral of a friend, who had fallen from his roof just before last Christmas whilst clearing the gutters of leaves ,I can say that there is nothing pleasant at all, just general shock and sadness that a very fit and popular man should be cut down in the prime of life.

Much more to the point is the realisation of how the low probability, high impact events can cause such disastrous consequences. Of course you may say that going up onto the roof is inherently dangerous and therefore the probability was not so low, but my friend, who had lived in the house for 30 years and had doubtless gone on to the roof every year to deal with the leaves, had not considered it a risky venture, confident as he was in his knowledge of the roof, which was not very high and of his own excellent balance and agility. He was a man, who having retired early from a large accountancy practice, had not the slightest interest in risk taking either financial or physical.

Because he did not see the risk as severe he went onto the roof unprepared - no harness, no one to stand at the bottom of the ladder and, most importantly, for it would have saved his life - no hard hat. I don't blame him, I have done the same many times, but I won't in future, for I have been made aware in a most terrible way of the perils of taking risk lightly at home, where we automatically assume that nothing bad can befall us. I tell this story in the hope that those who read it will think more positively of hard hats and wear them when appropriate.

Now if the Chinese had said " it is pleasant to see an arrogant hypocrite fall from the roof top" then I would have taken the roof top to be the metaphorical one which Mr. Spitzer fell off and joined in the clouds of schadenfreude wafting down Wall Street. But an arrogant hypocrite by definition does not equal a friend.

Risk Management can never be perfect

The title of this blog comes from Alan Greenspan's article in today's Financial Times. He is referring, in particular, to the exercised state of the financial markets. He points out that the risk management models do not adequately account for human nature, in one of its manifestations he referred to "irrational exuberance" when he was Chairman of the Fed. Now he considers that "paradoxically,to the extent risk management succeeds in indentifying such episodes,it can prolong and enlarge the period of euphoria."

By which I guess he means that people rely on risk management methodology too much and that, only when it is proven inadequate, such as now, does fear replace euphoria and greed.

Timing is all

Keynes said "In the long run we are all dead." He also observed " wordly wisdom teaches it is better to fail conventionally than it is to succeed unconventionally."

It is that second quote that is mentioned in today's Telegraph obituary of Tony Dye , the Phillips and Drew Fund Manager. Dye was a contrarian who in 1996 considered the FTSE 100 overvalued at 4000 and took a sizeable part of his clients' money out of the market. In March 2000 when the index stood at 6400 he was fired , yet within a month of his leaving the stock market turned. Many of those fund managers who had followed the herd kept their jobs.

Dye's story indicates the importance of timing in risk management. If he had made the switch out of equities in January 2000 he would have been hailed as one of the greatest fund managers of all time. He was right that the market would fall, but completely out on his timing, partly because he underestimated the power of Alan Greenspan to support irrational exuberance whilst at the same time fulminating against it.

There is nothing intrinsically wrong with going with the herd although it is always worth remembering that the Gadarene swine thought the going was good for the first part of the way . Warren Buffett always reckons it is best to fearful when others are greedy and greedy when others are fearful and as for timing, Bernard Baruch said "I have made my fortune by buying too late and selling too early".

Major sound bites

"A free and open society is worth a certain amount of risk," so said John Major, last Conservative Prime Minister, at the Guildhall last night where he was the guest speaker at the Chartered Insurance Institute's dinner and in snappingly good form.

He also pointed out that " if we are to control the liberty of individuals we need more uncertainty than that (by which he meant the current threat levels)".

He went on to inveigh against identity cards and dna databases and to point out that governments, of any party, with large majorities did not have to take as much care with legislation and so many poorly drafted got passed which would be better scrutinised by both sides if the government's majority was small. He admitted to there being" Too much legislation- I accept a degree of mea culpa".

" Simplicities in politics so often backfire,"was his phrase which conjured up all the unintended consequences of knee jerk reactions by politicians to tabloid headlines.

Amongst the guests were his old colleagues,such as Lord Heseltine and Lord David Hunt, the President of the CII. Most interesting was the presence of Charles Clarke, the ex Home Secretary. I wonder where he stands now on identity cards and why politicans out of office make so much sense.

Hoist by your own robot

The history of warfare is full of stories of people turning their enemies' weapons against them with disastrous results.Today's report from AFP that armed robots could be reprogrammed by terrorists to attack us should come as no surprise.

Prior to an address to the Royal United Services Institute, Sheffield University Professor Noel Sharkey is reported as saying " Military leaders are quite clear that they want autonomous robots as soon as possible, because they are more cost effective and give a risk-free war......The use of such devices by terrorists should be a serious concern."

It seems stating the obvious that if the robots can be turned against you then you do not have risk-free war.

"Terminator" style machines will eventually be developed. Will they make better , more precise decisions than troops on the ground who get confused, angry and scared? Probably. Will we feel safer, more secure, more willing to find a peaceful solution? Probably not.

The unintended consequences of Berwick-on-Tweed

If, as the latest straw poll suggests, the inhabitants of Berwick-on-Tweed were to seek to join Scotland after 500 years of being English then the Scots should think through the unintended consequences for Scotland’s claims to the Shetland Islands. After all these islands were pawned in 1469 by the King of Norway and Denmark for a Scottish loan, so they have only been in Scottish hands 13 years longer than Berwick-on-Tweed has been English. There was a right of redemption in payment of 210 kgs of gold , which seems a rather reasonable sum for the oil rich Norwegians to find for 566 square miles, even at the present price of gold.

The financial attractions for the Shetlanders of joining Norway might be even greater than those enthusing the burghers of Berwick-on-Tweed. They would not only be able to expect amongst the highest living standards in Europe, the end to direct EU interference in their lives, but they could also make off with whatever oil reserves are left in their section of the North Sea.

Downhill Risk

Last week in the Daily Telegraph there was the obituary of a Richard Burton who died on January 6th 2008. Not the one who married Elizabeth Taylor twice, but the one who survived 65% burns in a racing car accident , married five times and employed Sarah Ferguson before she became Duchess of York. As my father would have said "He was quite a boy." He was also the direct descendant of Robert Burton who wrote "The Anatomy of Melancholy." Melancholy does not seem to have been a problem, rather an excess of joie de vivre.

One wonderful snippet went as follows " Burton married often and was a fount of knowledge on the art of making love; for example, he insisted that when doing so on a mountainside it was important to be facing downhill."

In the interest of think risk, smarter decisions I leave it to my readers to think through the possible consequences of Burton's downhill tryst.

Walking away is a decision

Sometimes the best decision is not to get involved further. Bidding at an auction is a good example. You need to be very clear about what your top bid is and when you get there you need to be disciplined to walk away otherwise you get caught up in the desire for the object and the competition with the other bidders. That way lies penury. Saito san, when President of Daishowa Paper paid massively over the odds for his Van Gogh portrait of Doctor Gachet, at the time a world record for any picture, just to show that he could. No wonder the Japanese paper industry has a reputation for over investment and poor returns. They used to get away with it because their major shareholders, the banks, were unable to walk away beacuse they were all bound together with cross shareholdings.



Luqman Arnold of Olivant last week demonstrated how it shold be done when he withdrew from the Northern Rock auction citing the impossibility of meeting the government's critieria and also delivering a satisfactory return for his shareholders. He will have enhanced his reputation as a thoughtful investor .

Embracing diversity

"The underlying struggle is between worlds of plenty and worlds of want; between the modern and the ancient; between those who embrace our teeming, colliding, irksome diversity, whilst still insisting on a set of values that binds us together, and those who would seek, under whatever flag or slogan or sacred text, a certainty and simplification that justifies cruelty towards those not like us."

Blessed be the embracers for they shall take risks.

The quote is from Barack Obama's book " Dreams From My Father".

Retail is detail

A well known clothing retailer offers free delivery for all items when the combined spend online exceeds £30. In the recent sales a customer who bought salegoods online plus other non-sale items was disappointed when he was told several days later that, due to demand, the sales items could not be supplied and irritated extremely when that meant that the combined total of the goods to be delivered was now below £30 and therefore liable to a delivery charge of £3.50.
Eventually the customer's cries of indignation prevailed and the goods were delivered free of charge, but not before their trust in buying online from the retailer had been badly shaken.


Several questions come to mind

* why couldn't the system immediately advise that the sales items were out of stock, thus avoiding all the subsequent problems?
* why couldn't the computer system pick up the anomaly of a customer losing a benefit because of non- availability, so that it could be looked at and if need be, overridden?
* why wasn't this sort of glitch identified when the system was being set up?


Trust on the internet is key for buyers. Lose that trust and the customers not only never come back they will pass the word to others of their poor experience. The downside of online shopping is much bigger than most people imagine.

The Dangers of Change

There is a rather interesting article on the 'Crackunit' blog run by Iain Tait. The short article lightly pokes fun at the current air of security paranoia.
Read the full article here - http://www.crackunit.com/2008/01/28/the-dangers-of-change/

Sign of the times

Are signs good risk management or have they proliferated to such an extent that their impact has been lessened? Would removal of signs assist in some situations and if so what would they be?

Are signs more effective in some cultures than others? It was remarked by British engineers working at my company’s factory in Japan that a sign on the door saying "Danger,Do Not Open" was scrupulously observed by the Japanese, where in the UK it would be seen as a challenge to open.

That said the Japanese engineers at Tokaimura , whose management was criminally negligent when organising the movement of radioactive material, clearly had no training as to the danger and no signs would have helped them, the safety culture was non-existent. It is having a workforce that thinks and discusses about downside risk that creates a good safety culture.

Signs are for strangers, like the one the farmer is taking away. If you know your business in great detail you don't need signs.

In place of a sign, how about reviewing the Tokaimura accident and asking what lessons can be learned? Here it is, culled from various sources.


Tokaimura Accident
On September 30th 1999 the most serious nuclear radiation accident in Japan’s history to date occurred at Tokaimura northeast of Tokyo . The accident occurred at JCO’s plant, a subsidiary of Sumitomo Metal Mining Co.

Wikipedia notes
The direct cause of the criticality accident was workers putting uranyl nitrate solution containing about 16.6 kg of uranium, which exceeded the critical mass, into a precipitation tank. The tank was not designed to dissolve this type of solution and was not configured to prevent eventual criticality. Three workers were exposed to (neutron) radiation doses in excess of allowable limits, and two of these workers died; a further 119 received lesser doses of 1 mSv or greater.[1]
Dozens of emergency workers and nearby residents were hospitalised and hundreds of thousands of others were forced to remain indoors for 24 hours.

The New York Times asked

Why were workers mixing vastly excessive amounts of enriched uranium manually rather than with the plant's sophisticated machines that were meant to insure precise measurements?

Why was no alarm sounded at the fuel enrichment plant after an accident that produced 10,000 to 20,000 times normal radiation levels in the immediate area?

Why was the plant itself not clearly marked as a nuclear production site and equipped with a battery of anti-radiation and security measures, even though it is situated in the midst of a residential area?

The Tokaimura uranium refining plant did not have any markings identifying the site as dangerous, its staff lacked proper protective shields, it had no alarm system, and it had never been equipped with a safety manual.

BBC said Hideki Motoki, operator of the JCO Company, admitted using illegal standards for uranium processing for the past four years. Among several known violations, the firm changed its procedures manual without government approval in order to speed up processing and allowed workers to transport uranium in stainless steel containers similar to buckets instead of relying on high-tech equipment. It has also been reported that the workers never received proper training.

Japan Times. "JCO Chief Admits Workers were Poorly Trained."The head of JCO Co.'s uranium processing plant, Kenzo Koshijima, admitted that the firm had never educated its workers regarding criticality or its effects and that portions of the procedures in a manual were skipped "for the sake of efficiency."

Koshijima explained that his workers used stainless steel buckets to melt highly enriched uranium because using the melting tower--required by standard procedure--left residue that in turn raised questions as to the purity of the end product. He added, "It was also true that doing things manually was more effective in getting the job done at times."

This was a small company where they got lazy despite the extreme danger of what they were handling and they stopped thinking and reinforcing the imperative need to manage the risk and to adhere to the strict standards of the industry.