The Ten Commandments of Risk Leadership

By Emily Li

The Stepping Stone, March 2024

Imagine a room buzzing with passionate discussion, where leadership gurus skilled in risk management dissect the hidden pitfalls of our own minds. This wasn't your average book club meeting—it was an electrifying dive into the world of cognitive biases and their impact on risk-based decisions.

On Dec. 6, 2023, the Joint Risk Management (JRM) and Leadership & Development (L&D) sections held the last meeting of the 2023 book club with a captivating live session on The Ten Commandments of Risk Leadership by Dr. Annette Hofmann. Joining the virtual space were around 20 members eager to engage with the author herself.

Dr. Hofmann, the director of the Lindner Center for Insurance and Risk Management at the University of Cincinnati, brought her wealth of experience in risk economics, insurance markets, and risk leadership to the table. During the engaging 90-minute session, she:

• Shared the captivating story behind her book, providing insights into the inspiration and research that fueled its creation.
• Offered a detailed breakdown of the 10 critical commandments outlined in her work, demystifying complex concepts and making them relatable to real-world scenarios.
• Fostered an open and dynamic dialogue, where participants actively shared their own experiences of encountering cognitive biases in their work and personal lives.

But this wasn't just a one-way street. The lively discussion saw members drawing thought-provoking connections to other relevant books and even challenging some of the ideas presented. It was a powerful exchange of perspectives, revealing the depth and diversity of risk leadership journeys within the group.

Risk Management versus Risk Leadership

Dr. Hofmann drew a critical distinction between risk leadership and risk management. While both fields tackle uncertainty, their approaches diverge. Risk management focuses on the technical aspects—"building defenses" against potential losses through planning, prevention, and data-driven modeling. But Dr. Hofmann emphasizes that this alone isn't enough.

Enter risk leadership. This goes beyond managing known risks; it's about navigating the unpredictable. Risk leaders embrace the chaos of uncertainty, recognizing the limitations of models and the biases that can skew even the most meticulous analysis. They are skilled communicators, visionaries, and decision-makers who can guide their organizations through turbulent times with resilience.

In essence, risk leadership isn't about minimizing losses; it's about thriving in an uncertain world. It requires a different lens, one that acknowledges human biases, embraces collaboration, and prioritizes agility over fixed models.

This distinction resonated with the book club members, sparking lively discussions about the interplay between risk management and risk leadership. Two insightful points were:

• Building a diverse team: Recognizing that both styles are crucial, book club participants emphasized the need for a balanced team within a risk function. Risk managers are the vital information providers, and risk leaders need that information to make smart, risk-based decisions. This synergy ensures both technical experience and strategic vision are effectively utilized.
• Evolution of a risk professional: The discussion also explored the natural career progression from risk management to risk leadership. Newcomers tend to be more technical and control-focused, but as they mature, they start asking the bigger questions: “so what?” and “what are the uncertainties?” This shift reflects the growing awareness of the limitations of data and the importance of considering human factors in risk assessment.

Dr. Hofmann's framework, with its emphasis on adaptability and human factors, resonated deeply with these observations. It offered a fresh perspective on how risk professionals can navigate the ever-changing landscape of risk, not just managing known threats, but thriving in an uncertain world.

The Perception of Risk

Dr. Hofmann further differentiated risk from uncertainty: "Risk is a situation where probabilities can be reliably estimated based on past data," she explained, "while uncertainty is where probabilities remain elusive, often due to unique or unprecedented events."

This distinction prompted participants to reflect on their own perspectives. They recognized the crucial shift in mindset for leaders. When facing risk, a statistical approach focused on probabilities thrives. But amidst uncertainty, where probabilities are unreliable, leaders should harness an intuitive mindset, embrace the unknown and navigate ambiguity with agility.

The discussion highlighted a frequent pitfall: mistaking uncertainty for risk. Often, we think we're dealing with risk, but the ground beneath our feet is much less stable. Recognizing this inherent randomness and embracing uncertainty will equip risk leaders with a more nuanced perspective to navigate the ever-changing landscape of risk.

Heuristic Tendencies and Biases

In her book, Dr. Hofmann listed various heuristic features and tendencies (including cognitive bias) that risk leaders should know and watch out for. Below are some that were discussed during the book club session:

• Ambiguity Aversion: This describes our human inclination to favor the familiar over the unknown, even when the known option is riskier. As one member aptly highlighted, this can manifest as excessive caution towards change, leading to missed opportunities. However, another reminded us that in certain situations, this "conservative" bias can be rational. Bold moves to optimize a well-oiled process might sometimes create more disruption than improvement, especially if the potential outcome and its likelihood are unclear.

• Reference Bias: Our risk perception is often anchored by individual reference points, influenced by factors like wealth, risk tolerance, and past experiences. Dr. Hofmann emphasizes that these reference points, and the biases they may harbor (like anchoring), significantly impact how we assess risk. As one member astutely noted, this aligns with the industry definition of risk as deviation from expected outcomes. Without a firm grasp of realistic expectations, any risk management effort flounders, potentially becoming worse than useless. A member also provided a chilling example of a company relying on skewed risk metrics based on unrealistic expectations, highlighting the criticality of setting the appropriate reference points.

• Loss Aversion: We generally feel losses more acutely than gains of the same magnitude. Dr. Hofmann illustrated this with the "limited availability" marketing tactic, which taps into our fear of missing out. Interestingly, the discussion revealed that a measured dose of loss aversion might be beneficial in strategic decision-making, especially in the highly regulated insurance industry where "protection" is paramount.

• Confirmation Bias and Anchoring: These two go hand-in-hand. Confirmation bias drives us to seek information that confirms our existing beliefs, while anchoring makes us overly reliant on the first piece of information presented. The book club offered fascinating real-world examples: companies clinging to "consistently wrong" yet optimistic financial projections due to anchoring and overconfidence; and companies selectively using a consulting firm's suggestions to validate their preconceived notions. These scenarios expose the dangers of ignoring contradicting data and clinging to faulty first impressions.

• Framing: It's not just the data itself, but how it's presented, that can sway our risk perception. Attendees passionately discussed the importance of unbiased information presentation, especially when supporting critical decisions. As one member pointed out, using a diverse range of risk metrics paints a more holistic picture of a company's risk exposure, rather than relying on a single, potentially skewed view. Recognizing this framing effect is key to making objective assessments.

• Groupthink and Peer Effects: Group environments can breed "think alike" mentality, fueled by peer pressure and a desire for consensus. One member pointed out how this compromises the effectiveness of "committee approval" as a control mechanism. The discussion then explored strategies to mitigate peer pressure and enhance independent thinking within groups, such as appointing rotating devil’s advocates, encouraging junior members to speak first, and formally approving detailed meeting minutes.

The Ten Commandments

Dr. Hofmann, after peeling back the layers of cognitive biases, offers ten potent antidotes. These "commandments" are not rigid laws, but practical reminders to steer clear of common pitfalls. Rooted in both the book and insightful book club discussions, here are the key takeaways.

• Quantify, even when confident: Don't rely on gut feeling—measure even familiar risks.
• Shift your reference point: Your risk perception is relative. Adjust your perspective to consider different value frameworks.
• Lead the information flow: Negotiate effectively by anchoring the discussion with your acceptable range.
• Beware the loss aversion trap: Losses bite twice as hard as gains. Avoid letting fear drive suboptimal decisions.
• Challenge the status quo: Don't let familiarity blind you to potential improvements.
• Embrace healthy pessimism: Underestimating risks often leads to better outcomes.
• Diversify and collaborate: Build teams with diverse perspectives and well-defined communication practices.
• Emotions can hijack logic: High-impact, low-probability events trigger strong emotions, which can cloud your judgment.
• Humility in prediction: Don't overestimate your forecasting abilities. Considering the opposite scenario can reveal blind spots.
• Don't trust your intuition: When predictions are crucial, actively explore alternative possibilities.

Notes at the End

This glimpse into our 90-minute book club discussion barely scratches the surface of the rich exchange we had nor the heuristic pitfalls that Hofmann highlighted in her book. This discussion serves as a stark reminder that the path to sound risk leadership is paved with constant self-reflection and a healthy dose of skepticism. By consistently questioning our own biases and refining our risk philosophies, we equip ourselves to navigate uncertainty with agility and make decisions that stand the test of time.

Ready for More?

The SOA Book Club Has You Covered!

The SOA Book Club has an exciting lineup planned for 2024, offering opportunities to delve deeper into diverse and relevant topics. Mark your calendars for these upcoming sessions:

• March 8: Celebrate International Women's Day with a session on Good Guys: How Men Can be Better Allies for Women in the Workplace by David Smith. Hosts: Olga Jacobs and Dave Dillon.
• May 31: Join us for a deep dive into David Miller's The Influential Actuary. A free digital copy of the book is available at https://www.actexlearning.com/exams/p/the-influential-actuary. Hosts: Hellen Hou and David Miller.
• July 26: Wrap up first half of 2024 with a session on The Ideal Team Player by Patrick Lencioni. Hosts: Cody Miles and Shirley Wu.

Stay tuned for further announcements and don't miss out! Sign up for the SOA Book Club email list to get the latest updates and even express your interest in volunteering with the program.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the editors, or the respective authors’ employers.

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Emily Li, FSA, CERA, FRM, MAAA, is a manager at Deloitte, LLP. She can be reached at mengrli@deloitte.com or via LinkedIn.