Afraid of a little risk?

In monetary terms, the weather is one of the largest risk factors an organization will ever face. Weather influences nearly one third of the U.S. economy, which translates into $3.5 trillion annually, according to the Department of Commerce. U.K. firms lose £7.6 billion each year because of weather changes, according to weath-erXchange, a European weather risk management resource. Between 1994 and 2003, China and India accounted for 25 percent of global economic losses from natural catastrophes, according to a report given at an Organisation for Economic Co-operation and Development conference in November 2004.

Bob Hanscom,
Director of Loss Prevention,
Risk Management Foundation,
Cambridge, Mass., USA

→ Weather's effect on a project illustrates the challenge companies face when trying to identify and control risk: Like so many other risks, it can be a double-edged sword. “One person's sunny day is another guy's gloomy day; it depends on your business,” says Robert Holmes, director of marketing and origination at Overland Park, Kan., USA-based Guaran-teedWeather LLC.

Growing pressure from company shareholders to manage risk exposure effectively makes controlling risk management an increasingly important task. With a paradigm shift that recognizes and accepts both positive and negative risk, the project management community is developing more flexible risk management methods that are applicable in all levels of the project chain of command. At the same time, revolutionary new fields, such as nanotechnology, will demand new ways of dealing with risks that are yet unknown.

RISK MANAGEMENT AT NASA

NASA Long has been in the business of managing multiyear, multibillion-dollar projects under a media and political microscope. Here is NASA’s six-step method for risk management throughout the life of a project:

1 Identify the important current and future potential risks 2 I Develop step-by-step mitigation strategies with deadlines to meet each identified risk 3 I Meet regularly to monitor progress and add new risks, if applicable 4 Close identified risks when their mitigation strategies have been implemented successfully. Watch risks not yet closed. Activate other previously identified risks if predefined events or warnings occur 5 Develop action plans that allow for redirection of project elements, new sources or new technologies when warranted 6 Retain closed risks in the flow chart for future reference.

Source: “Continuous Risk Management,” Phil Sabelhaus, project manager, NASA’s Goddard Space Flight Center

While no one actually can change the weather, it is a good example of how an unknown and uncontrollable risk can, in fact, be managed in numerous fields.

GuaranteedWeather is one of a handful of companies throughout the world that design customized options—distant cousins of the options that carry the right to buy or sell stocks in equities markets—for just this purpose. Mr. Holmes says the global customers that use his company's weather options include utilities that need to hedge weather-related power consumption or construction firms seeking to minimize the dollar impact of weather-related work delays.

To meet their demands, GuaranteedWeather can build plenty of flexibility into a customized option. For example, options can be tailored to cover only weekends. Or so-called dual-trigger options can protect against both temperature and precipitation changes, Mr. Holmes says. Event planners might use a weekend option to ensure they're covered if rain or snow keep visitors at home. Farmers would benefit from dual trigger options because a good crop requires the right mix of rain and warmth.

Then there are “knock-in options, where if November, December and January are significantly cold, that knocks in the option for February and March,” he says. These options might be ideal for construction project managers who hope to compensate for delays and lost time because of unexpectedly cold weather November through January by altering their schedules and pushing work to winter's end. Or alternately, they could rely on the option to make up for the loss in the event the weather continues to be uncooperative in February and March.

A collar option can limit a company's downside, but in doing so, it also limits its upside. Depending on how the option is structured, a building project manager may get paid if there's too much rain to compensate for lost time; however, if the weather stays dry and the project finishes ahead of schedule and below budget, a portion of those savings might go to the company that provided the collar.

Many of GuaranteedWeather's clients come from Japan, where banks require such options to hedge their loan exposure to a project. By comparison, U.S. companies may purchase the options at their own urging to protect against contract late fees. When constructing and pricing its customized option products, GuaranteedWeather relies on a bountiful supply of meteorological data, although Mr. Holmes says the options aren't attempts to forecast the weather. “It's more a statistical and portfolio management issue,” he says.

Once health
practitioners
survive a
malpractice case
they just want
to put it behind
them, so a lot of
knowledge gets
lost. This could
change that.

—Bob Hanscom

Thus, the company operates similar to insurers that seek an optimal blend of exposure: If one option ends up unexpectedly costing the company, others can make up the difference. Mr. Holmes believes that, over time, weather options will grow in importance, representing another component of a risk manager's finance-centric tool kit, right along with interest rates, currency hedges or the fuel-cost hedges that airlines and utilities use to lock in prices.

Spread Risk Awareness

Meeting other risks demands the willing participation of everyone working on a project, and this requires a cultural change within the organization.

	Because nanotech is new there's not very much data around. You cannot learn from the past.
	Annabelle Hett, Head of Risk Perception System, Swiss Re, Zurich, Switzerland

→“In the past, risk management's been put in the back room,” says David Watson, head of the risk management software company Incom Pty Ltd, Roseville, Australia. “The risk manager is supposed to manage the risks while other managers focus on day-to-day details. But every manager is making decisions, and with every decision there's a risk. Therefore, the risk is best managed by the person who's most able to control it.”

To do this, the tools needed to identify and quantify risks and their respective consequences must be at everyone's disposal. Specifically, Mr. Watson's solution uses “the matrix method” which displays risks and their consequences via a matrix simple enough for anyone to build and understand. He says this standard grew from risk-abatement standards jointly enacted by the Australian and New Zealand governments.

Incom devised a software program called Risk Register based on this dual-nation standard. A risk's likelihood determines where it sits on the vertical axis, while the severity of the risk's consequences determines its position on the horizontal axis. Thus, if both the likelihood of the risk and its consequence are moderate, that risk would sit in the matrix's center. Alternately, if a risk is deemed very likely and its consequence is high, that risk would be positioned in the matrix's upper corner. A matrix can be five, seven, nine or more squares to the side, depending on the granularity desired.

Police departments and other emergency responders such as hospitals and municipalities use Incom's software. The city of Sydney installed a 400-user system that brought the tool to desktops throughout the city's administrative offices.

Doctors’ Dilemma

→One important risk aversion strategy is to ensure that mistakes made once are not repeated. Medicine is one area where risks need to be managed in real-time by individuals on the front lines, as medical errors can result in tragedy for victims and cripplingly high medical liability insurance premiums for physicians.

To help solve both problems, the Risk Management Foundation (RMF), a component of Harvard's medical institutions based in Cambridge, Mass., USA, built an online database of best practices aimed at reducing medical errors. These best practices are being used by physicians in the course of their daily work. The idea could serve as a model for an on-the-job best practices platform that project managers in other fields could employ.

“We've compiled a handbook called What Works, which is a set of practices and why we believe they're safe,” says Bob Hanscom, RMF’s director of loss prevention. While amassing all of the data is a considerable and ongoing task, it represents only half the battle for RMF.

A POSITIVE SPIN

“We've got to be able to give this information to the doctors and not ask them to take extra steps to get it; otherwise, it becomes like any other reference book and gathers dust,” Mr. Hanscom says.

RMF has worked with the Boston, Mass. USA-based healthcare delivery organization Partners HealthCare to incorporate its best practices into the lat-ter's electronic medical records system. As the system evolves, a physician might enter information about a patient's symptoms onto his or her tablet PC and diagnose based on the evidence. The system then creates second opinions based on the same evidence. Alternately, the system might provide the doctor with recommended, risk-mitigating best practices based on what transpired during a patient session.

What Works encourages doctors to volunteer information based on their experiences, creating a continually updated online body of knowledge. Mr. Hanscom says this helps physicians learn important lessons from the past. “Once health practitioners survive a malpractice case they just want to put it behind them, so a lot of knowledge gets lost,” he says. “This could change that.”

Small Matters

→ Sharing information to reduce risks proactively is exactly what Swiss Re, Zurich, Switzerland, recommends. Recently, the company published a comprehensive report on the risks of nanotechnology, a good example of the new, largely unknown technologies project managers and their organizations will be dealing with in the years ahead.

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In its report, Swiss Re highlights major risks it believes ought to concern insurers, such as what happens if a nano particle accidentally enters the body of a lab worker, how long might that microscopic particle remain in the person's body and what harm might it do while there. Annabelle Hett, head of Swiss Re's risk perception system and lead author of the paper, compares the risks posed by nanotech's unknowns to those that resulted from contact with asbestos, because the effects of exposure in the latter case were not known for years. This resulted in devastating consequences for the exposed individuals and often ruinous payouts on behalf of the insurer.

The way to manage such a risk to the satisfaction of insurers would be for stakeholders, such as scientists, regulators and large corporations, to develop a joint series of best practices that guide future research and development. Yet Ms. Hett says this compounds the problem in nanotechnology, as it is a revolutionary, not evolutionary, technology. “Because nanotech is new there's not very much data around. You cannot learn from the past,” she says.

“The beneficial properties of nano particles are exactly the reason for the risk concerns,” says Marcel Bürge head of Swiss Re's risk engineering services. “Researchers hope to exploit nano particles precisely because of their small size. But at the same time, the particles’ small size presents them with unknown risks.”

Risk's Silver Lining

→ Traditionally, organizations saw risk only in negative terms. But the Project Management Institute and others now embrace the idea that risk should be seen, instead, as any uncertainty that matters, because it can affect the objectives of a project in either a positive or negative way.

David Hillson, risk-management consultant and director of Hampshire, U.K.-based Risk Doctor & Partners, says this new understanding of risk can open up a world of new outcomes, as project managers can use the same methodology for identifying positive risk that they use for recognizing negative risks.

	If your risk process looks at upside as well as downside, capturing some of the upside will cancel out the effect of some of the downside.
	David Hillson, Risk-Management Consultant and Director, Risk Doctor & Partners, Hampshire, U.K.

“After defining objectives, the first step is risk identification,” he says. “Look for potential threats and potential opportunities. In the next step, risk assessment, decide what are the worst threats and the best opportunities. Finally, we develop appropriate responses to minimize or avoid threats and maximize or capture opportunities.”

Like good weather or a favorable change in interest rates, the unexpected use of an existing product is a positive risk that can be identified and planned for. The drug Viagra is, perhaps, the most famous example of this approach—originally developed as a treatment for heart disease, its effectiveness at treating erectile dysfunction was discovered later, Dr. Hillson says. If Pfizer, the drug's maker, hadn't had a strategy in place to capitalize on the unexpected outcome, it might have missed out on billions in potential revenue.

A dual-outcome risk strategy literally can dictate whether a project succeeds or fails. “If you imagine that you have a project plan and all you identify is threats which would cause you to fail, then the purpose of the risk process is to recover from those threats or prevent them, but it will never be 100 percent effective,” Dr. Hillson says. “There will always be unmanaged or unmanageable threats, so you will fail.”

“If your risk process looks at upside as well as downside, capturing some of the upside will cancel out the effect of some of the downside,” he says. “Your chances of reaching your objectives are hugely increased.” This is the best way to sell an organization on the benefits of seeing both sides of the risk coin. PM

Mark Ingebretsen is a Des Moines, Iowa, USA-based writer and columnist for the Wall Street Journal Online.