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Alternative Strategies - A year away from the City - March

Patrick HealyThe topic for this month’s instalment suggested itself very naturally and it brings me closer to the disciplines that I have used in my work in recent years than most of the previous articles.

Risk management is a much abused term and apparent failures in risk management have been identified as causative factors in the recent (and ongoing) financial crisis.  I would suggest that it is probably fairer to say that the risk management issues arose from the excessive faith placed in it as a science but also from the generally unacknowledged fact that there are very large areas where current risk management techniques simply cannot provide clear answers.

The terms in which much risk language was couched were part of the problem. For example the phrases ‘a one in a hundred year event’ or ‘likely to occur once every thousand years’ contain an implied term.  Broadly speaking this term is ‘on the basis that the patterns that underlie historical trends continue to operate in the same manner in future and that the data we are using is reasonably accurate and complete in terms of our attempt to model the events we are trying to forecast’.  This is obviously quite a mouthful and this may be part of the explanation as to why it did not make it onto many of the PowerPoint slides used for presentations to the boards of banks.

The events which prompted this discussion of risk management were the outcome of a failure of my own to properly evaluate risk.

The general approach to deciding whether a certain risk is acceptable results from an evaluation of two main aspects of a risk; the probability of that feared event happening and the effects of the feared outcome actually occurring.  In banking terms this is usually expressed in financial terms and this is summarised as ‘likelihood’ and ‘impact’ as in ‘the likelihood of half our loans proving to be irrecoverable and the impact of a billion dollar write-off’.  In my recent case the phrase would read ‘the likelihood of me being stung by an Irukandji and the impact of having to be airlifted to hospital and spending two days in intensive care’.

As with many of the recent risk management failures my mistake was based in part on a misunderstanding of the environment in which I was operating but also on poor data used in the original risk evaluation.

A word of explanation first on the Irukandji.

The Irukandji is not, as you might have thought, a rare and delicious type of sushi but in fact a tiny transparent jellyfish, about the size of a fingernail, that trails a few centimetres of almost invisible stinging tentacles.  The most notable characteristic of this otherwise undistinguished little blob is that it is believed to be the most venomous creature in the world.

With some authority I can confirm the description of the symptoms of being stung by an Irukandji as described in Wikipedia; “excruciating muscle cramps in the arms and legs, severe pain in the back and kidneys, a burning sensation of the skin and face, headaches, nausea, restlessness, sweating, vomiting, high heart rate and blood pressure”.

My risk management failure, as with many of the financial sector problems, resulted from the fact that several assumptions that were fundamental to my analysis being proved to be wrong.  These assumptions themselves also closely parallel those used in much of the risk management in the banking sector. Essentially these were that:

  • risk conditions were unchanged from what had been in place before,
  • the data sources I had were reliable, and;
  • the risk mitigation measures I had in place were adequate.

The anticipated risk conditions were based on the guidebooks I had and discussions with travel agents, the boat crew and the dive team.

The guidebooks noted the various hazards of diving on and around the Great Barrier Reef; rip tides, sharks and, indeed, jellyfish.  The information on jellyfish concentrated on the Box Jellyfish, which is reasonably visible and mainly concentrated near the shore.  The guidebooks had not been updated for an upsurge this year in the number of Irukandji, which is effectively invisible and also occurs away from the shore.  This represented a significant change in risk conditions.

Photograph by Lucy Reeve.

The travel agents, boat crew and dive team had all mentioned ‘marine stingers’ in passing, generally noting that attacks were very rare and that protection was to be had from wearing a wetsuit.  There was an unseen bias in this information in that all of these people had a strong economic interest in encouraging me to go diving.  In reality there had been ten cases in the area in the previous month that had required divers to be airlifted out to hospital.  One of these cases related to a diver on the boat that I was diving from and took place in the week before my incident.  This particular fact was not disclosed until after I had been hospitalised.

Photograph by Lucy Reeve.

My protection consisted of a full-length wetsuit.  The only exposed areas of skin were my hands and my face and neck to the extent that they were not covered by my mask and regulator.  I was stung just under my right ear.

The parallels with the financial crisis fortunately seem to end at this point in that after my stay in hospital I made a pretty rapid recovery.  I have even been diving since (in the less hazard filled waters of New Zealand).

The necessity of providing a reminder of the limitations of risk management in the current environment is probably not great but it probably is still worth making a mental note that if a risk manager tells you that they can definitively measure the risks of your business it may be worthwhile to ask them what assumptions lie behind their calculations.

Patrick Healy was the Group Head of Risk Reporting for Man Group plc
© Patrick Healy

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