Risk Assessment and Treatment:

Risk Management

Risk management is the process of measuring, or assessing, risk and developing strategies to manage it. Strategies include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, and accepting some or all of the consequences of a particular risk. Traditional risk management focuses on risks stemming from physical or legal causes (e.g. natural disasters or fires, accidents, death, and lawsuits).

Explanation

In ideal risk management, a prioritizing process is followed whereby the risks with the greatest loss and the greatest probability of occurring are handled first, and risks with lower probability of occurrence and lower loss are handled later. In practice the process can be very difficult, and balancing between risks with a high probability of occurrence but lower loss vs. a risk with high loss but lower probability of occurrence can often be mishandled.

Intangible risk management identifies a new type of risk (A risk that has a 100% probability of occurring but is ignored by the organization due to a lack of identification ability). For example, knowledge risk occurs when deficient knowledge is applied. Relationship risk occurs when collaboration ineffectiveness occurs. Process-engagement risk occurs when operational ineffectiveness occurs. These risks directly reduce the productivity of knowledge workers, decrease cost effectiveness, profitability, service, quality, reputation, brand value, and earnings quality. Intangible risk management allows risk management to create immediate value from the identification and reduction of risks that reduce productivity.

Risk management also faces difficulties allocating resources. This is the idea of opportunity cost. Resources spent on risk management could have been spent on more profitable activities. Again, ideal risk management minimizes spending while maximizing the reduction of the negative effects of risks.

GLBA risk assessments should cover all IT risk management functions including security, outsourcing, and business continuity. Senior management should ensure IT-related risk identification and assessment efforts at the enterprise-wide level are coordinated and consistent throughout the organization. A strong, high-level, risk assessment process provides the foundation for more detailed assessments within the functional risk management areas. An effective IT risk assessment process will improve policy and internal controls decisions across the organization.

Senior management can use risk assessment data to make informed risk management decisions based on a full understanding of the operational risks. Small institutions with less complex systems may have a more simplified risk assessment process. Regardless of the complexity, the process should be formal and should adapt to changes in the IT environment. Examiners should measure the effectiveness of the process by evaluating management’s understanding and awareness of risk, the adequacy of formal risk assessments, and the effectiveness of the resulting policies and internal controls.

Steps in the Risk Management Process

Establish the Context

Establishing the context involves:

1. Planning the remainder of the process.
2. Mapping out the scope of the exercise, the identity and objectives of stakeholders, and the basis upon which risks will be evaluated.
3. Defining a framework for the process and an agenda for identification.
4. Developing an analysis of risk involved in the process.
   

Identification and Ongoing Data Collection

Understanding the institution's environment is the first step in any risk assessment process. Senior management should incorporate information on IT issues such as resource limitations, threats, priorities, and key controls from several sources.

In developing a formal risk assessment, management should collect and compile information regarding the organization’s information technology environment from several locations including:

• IT systems inventories are critical to understanding and monitoring the tactical operations of the institution’s information technology as well as to identifying the access and storage points for confidential customer and corporate information.
• IT strategic plans provide insight into the organization’s planning process. Review and analysis of the strategic plans as part of the risk assessment process may spotlight developing risk exposures or other deficiencies that limit the institution’s ability to implement strategic priorities.
• Business recovery and continuity plans prioritize the availability of various business lines to the institution and often encompass restoration and provision of control, customer service, and support. The plans can offer insight into the organization’s critical operating systems and the control environment.
• Due diligence and monitoring of service providers can present valuable information on the servicer control environment. The information is necessary for a complete risk assessment of institution’s information technology environment.
• Call center issue tracking reports can often indicate potential performance or control issues if the problem reports are aggregated and analyzed for repetitive or common issues.
• Department self-assessments on IT-related controls can provide early identification of policy noncompliance or weaknesses in controls.
• IT audit findings provide insight into the veracity and responsiveness of the institution’s staff and management, commitment to policy compliance and internal controls.
  

After establishing the context, the next step in the process of managing risk is to identify potential risks. Risks are about events that, when triggered, cause problems. Hence, risk identification can start with the source of problems, or with the problem itself.

• Source analysis Risk sources may be internal or external to the system that is the target of risk management. Examples of risk sources are: stakeholders of a project, employees of a company or the weather over an airport.
• Problem analysis Risks are related to identified threats. For example: the threat of losing money, the threat of abuse of privacy information or the threat of accidents and casualties. The threats may exist with various entities, most important with shareholder, customers and legislative bodies such as the government.
  

When either source or problem is known, the events that a source may trigger or the events that can lead to a problem can be investigated. For example: stakeholders withdrawing during a project may endanger funding of the project; privacy information may be stolen by employees even within a closed network; lightning striking a Boeing 747 during takeoff may make all people on-board immediate casualties.

The chosen method of identifying risks may depend on culture, industry practice and compliance. The identification methods are formed by templates or the development of templates for identifying source, problem or event. Common risk identification methods are:

• Objectives-based risk identification Organizations and project teams have objectives. Any event that may endanger achieving an objective partly or completely is identified as risk. Objective-based risk identification is at the basis of COSO's Enterprise Risk Management - Integrated Framework
• Scenario-based risk identification In scenario analysis different scenarios are created. The scenarios may be the alternative ways to achieve an objective, or an analysis of the interaction of forces in, for example, a market or battle.
• Taxonomy-based risk identification The taxonomy in taxonomy-based risk identification is a breakdown of possible risk sources. Based on the taxonomy and knowledge of best practices, a questionnaire is compiled. The answers to the questions reveal risks. Taxonomy-based risk identification in software industry can be found in CMU/SEI-93-TR-6.
• Common-risk Checking In several industries lists with known risks are available. Each risk in the list can be checked for application to a particular situation. An example of known risks in the software industry is the Common Vulnerability and Exposures list found at http://cve.mitre.org.

Assessment and Analysis

Management should use the data collected on IT assets and risks to analyze the potential impact of the risks on the institution. The analysis should identify various events or threats that could negatively affect the institution strategically or operationally. Management should evaluate the likelihood of various events and rank the possible impact.

Once risks have been identified, they must then be assessed as to their potential severity of loss and to the probability of occurrence. These quantities can be either simple to measure, in the case of the value of a lost building, or impossible to know for sure in the case of the probability of an unlikely event occurring. Therefore, in the assessment process it is critical to make the best educated guesses possible in order to properly prioritize the implementation of the risk management plan.

Some examples of events that could affect the institution include the following:

• Security breaches - Security breaches that can affect the institution include external and internal security breaches, programming fraud, computer viruses, or denial of service attacks.
• System failures - Common causes of system failures include network failure, interdependency risk, interface failure, hardware failure, software failure, or internal telecommunication failure.
• External events - Institutions are also exposed to external threats including weather-related events, earthquakes, terrorism, cyber attacks, cut utility lines or wide spread power outages that bring about system or facility failures.
• Technology investment mistakes - Mistakes in technology investment including strategic platform or supplier risk, inappropriate definition of business requirements, incompatibility with existing systems, or obsolescence of software may constrain profitability or growth.
• Systems development and implementation problems - Common system development and implementation problems include inadequate project management, cost and or time overruns, programming errors (internal/external), failure to integrate and/or migrate successfully from existing systems, or failure of system to meet business requirements.
• Capacity shortages - Shortages in capacity result from lack of adequate capacity planning, including the lack of accurate forecasts of growth.
  

Once the institution has identified the universe of risks, management should estimate the probability of occurrence as well as the financial, reputation, or other impact to the organization. Organizational impacts are highly variable and not always easy to quantify, but include such considerations as lost revenue, flawed business decisions, data recovery and reconstruction expense, costs of litigation and potential judgments, loss of market share, and increases to premiums or denials of insurance coverage. Typically, risk analysis ranks the results based on the relationship between cost and probability.

Prioritization

Once management understands the institution's technology environment and analyzes the risk, it should rank the risks and prioritize its response. The probability of occurrence and the magnitude of impact provide the foundation for reducing risk exposures or establishing mitigating controls for safe, sound, and efficient IT operations appropriate to the complexity of the organization. The overall risk assessment results should be a major factor in decision making in most IT management responsibility areas including:

• Technology budgeting, investment, and deployment decisions
• Contingency planning
• Policies and procedures
• Internal controls
• Staffing and expertise
• Insurance
• IT performance benchmarks
• Service levels for internal and outsourced IT services
• Policy enforcement and compliance

Risk Scoring System

A successful risk-based IT audit program can be based on an effective scoring system. In establishing a scoring system, the board of directors and management should ensure the system is understandable, considers all relevant risk factors, and, to the extent possible, avoids subjectivity.

Major risk factors commonly used in scoring systems include the following:

• The adequacy of internal controls
• The nature of transactions (for example, the number and dollar volumes and the complexity)
• The age of the system or application
• The nature of the operating environment (for example, changes in volume, degree of system and reporting centralization, sensitivity of resident or processed data, the impact on critical business processes, potential financial impact, planned conversions, and economic and regulatory environment)
• The physical and logical security of information, equipment, and premises
• The adequacy of operating management oversight and monitoring
• Previous regulatory and audit results and management’s responsiveness in addressing issues
• Human resources, including the experience of management and staff, turnover, technical competence, management’s succession plan, and the degree of delegation
• Senior management oversight
  

Auditors should develop written guidelines on the use of risk assessment tools and risk factors and review these guidelines with the audit committee or the board of directors. The sophistication and formality of guidelines will vary for individual institutions depending on their size, complexity, scope of activities, geographic diversity, and various technologies used. The institution can rely on standard industry practice or on its own experiences to define risk scoring. Auditors should use the guidelines to grade or assess major risk areas and to define the range of scores or assessments (e.g., groupings such as low, medium, and high risk or a numerical sequence such as 1 through 5).

The written risk assessment guidelines should specify the following elements:

• A maximum length for audit cycles based on the risk scores. (For example, some institutions set audit cycles at 12 months or less for high-risk areas, 24 months or less for medium-risk areas, and up to 36 months for low-risk areas. Audit cycles should not be open-ended.);
• The timing of risk assessments for each department or activity. (Normally risks are assessed annually, but more frequent assessments may be needed if the institution experiences rapid growth or significant change in operation or activities.);
• Documentation requirements to support scoring decisions; and
• Guidelines for overriding risk assessments in special cases and the circumstances under which they can be overridden. (For example, the guidelines should define who can override assessments, and how the override is approved, reported and documented.)
  

Numerous industry groups offer resources where institutions can obtain matrices, models, or additional information on risk assessments. Among these groups are: ISACA, American Bankers Association (ABA), American Institute of Certified Public Accountants (AICPA), and IIA. Day-to-day management of the risk-based audit program rests with the internal audit manager, who monitors the audit scope and risk assessments to ensure that audit coverage remains adequate. The internal audit manager also prepares reports showing the risk rating, planned scope, and audit cycle for each area. The audit manager should confirm the risk assessment system’s reliability at least annually or whenever significant changes occur within a department or function. Operating department managers and auditors should work together in evaluating the risk in all departments and functions by reviewing risk assessments to determine their reasonableness.

Auditors should periodically review the results of internal control processes and analyze financial or operational data for any impact on a risk assessment or scoring. Accordingly, operating management should be required to keep auditors up to date on all major changes in departments or functions, such as the introduction of a new product, implementation of a new system, application conversions, or significant changes in organization or staff.

The fundamental difficulty in risk assessment is determining the rate of occurrence since statistical information is not available on all kinds of past incidents. Furthermore, evaluating the severity of the consequences (impact) is often quite difficult for immaterial assets. Asset valuation is another question that needs to be addressed. Thus, best educated opinions and available statistics are the primary sources of information. Nevertheless, risk assessment should produce such information for the management of the organization that the primary risks are easy to understand and that the risk management decisions may be prioritized. Thus, there have been several theories and attempts to quantify risks.

HORSE FACTS: Numerous different risk formula exist, but perhaps the most widely accepted formula for risk quantification is: (Rate of occurrence multiplied by the impact of the event equals risk)

Later research has shown that the financial benefits of risk management are less dependent on the formula used but are more dependent on the frequency and how risk assessment is performed.

In business it is imperative to be able to present the findings of risk assessments in financial terms.

Potential Risk Treatments

Once risks have been identified and assessed, all techniques to manage the risk fall into one or more of these four major categories:

• Tolerate (aka retention)
• Treat (aka mitigation)
• Terminate (aka elimination)
• Transfer (aka buying insurance)
  

HORSE FACTS: Remember as 4 T's!

Ideal use of these strategies may not be possible. Some of them may involve trade-offs that are not acceptable to the organization or person making the risk management decisions.

Risk Avoidance

Includes not performing an activity that could carry risk. An example would be not buying a property or business in order to not take on the liability that comes with it. Another would be not flying in order to not take the risk that the airplane were to be hijacked. Avoidance may seem the answer to all risks, but avoiding risks also means losing out on the potential gain that accepting (retaining) the risk may have allowed. Not entering a business to avoid the risk of loss also avoids the possibility of earning profits.

Risk Reduction

Involves methods that reduce the severity of the loss. Examples include sprinklers designed to put out a fire to reduce the risk of loss by fire. This method may cause a greater loss by water damage and therefore may not be suitable. Halon fire suppression systems may mitigate that risk, but the cost may be prohibitive as a strategy.

Modern software development methodologies reduce risk by developing and delivering software incrementally. Early methodologies suffered from the fact that they only delivered software in the final phase of development; any problems encountered in earlier phases meant costly rework and often jeopardized the whole project. By developing in iterations, software projects can limit effort wasted to a single iteration.

Risk Retention

Involves accepting the loss when it occurs. True self insurance falls in this category. Risk retention is a viable strategy for small risks where the cost of insuring against the risk would be greater over time than the total losses sustained.

All risks that are not avoided or transferred are retained by default.

This includes risks that are so large or catastrophic that they either cannot be insured against or the premiums would be infeasible. War is an example since most property and risks are not insured against war, so the loss attributed by war is retained by the insured. Also any amounts of potential loss (risk) over the amount insured is retained risk. This may also be acceptable if the chance of a very large loss is small or if the cost to insure for greater coverage amounts is so great it would hinder the goals of the organization too much.

Risk Transfer

Means causing another party to accept the risk, typically by contract or by hedging. Insurance is one type of risk transfer that uses contracts. Other times it may involve contract language that transfers a risk to another party without the payment of an insurance premium. Liability among construction or other contractors is very often transferred this way. On the other hand, taking offsetting positions in derivatives is typically how firms use hedging to financially manage risk.

Some ways of managing risk fall into multiple categories. Risk retention pools are technically retaining the risk for the group, but spreading it over the whole group involves transfer among individual members of the group. This is different from traditional insurance, in that no premium is exchanged between members of the group up front, but instead losses are assessed to all members of the group.

Creating the Plan

Decide on the combination of methods to be used for each risk. Each risk management decision should be recorded and approved by the appropriate level of management. For example, a risk concerning the image of the organization should have top management decision behind it whereas IT management would have the authority to decide on computer virus risks.

The risk management plan should propose applicable and effective security controls for managing the risks. For example, an observed high risk of computer viruses could be mitigated by acquiring and implementing anti virus software. A good risk management plan should contain a schedule for control implementation and responsible persons for those actions.

Implementation

Follow all of the planned methods for mitigating the effect of the risks. Purchase insurance policies for the risks that have been decided to be transferred to an insurer, avoid all risks that can be avoided without sacrificing the entity's goals, reduce others, and retain the rest.

Review and Evaluation of the Plan

Initial risk management plans will never be perfect. Practice, experience, and actual loss results will necessitate changes in the plan and contribute information to allow possible different decisions to be made in dealing with the risks being faced.

Risk analysis results and management plans should be updated periodically. There are two primary reasons for this:

1. to evaluate whether the previously selected security controls are still applicable and effective
2. to evaluate the possible risk level changes in the business environment. For example, information risks are a good example of rapidly changing business environment

Limitations

If risks are improperly assessed and prioritized, time can be wasted in dealing with risk of losses that are not likely to occur. Spending too much time assessing and managing unlikely risks can divert resources that could be used more profitably. Unlikely events do occur but if the risk is unlikely enough to occur it may be better to simply retain the risk and deal with the result if the loss does in fact occur.

Prioritizing too highly the risk management processes could keep an organization from ever completing a project or even getting started. This is especially true if other work is suspended until the risk management process is considered complete.

It is also important to keep in mind the distinction between risk and uncertainty. Risk can be measured by impacts x probability.

Enterprise Risk Management

In enterprise risk management, a risk is defined as a possible event or circumstance that can have negative influences on the Enterprise in question. Its impact can be on the very existence, the resources (human and capital), the products and services, or the customers of the enterprise, as well as external impacts on society, markets, or the environment.

In addition, every probable risk can have a pre-formulated plan to deal with its possible consequences (to ensure contingency if the risk becomes a liability).

From the information above and the average cost per employee over time, or cost accrual ratio, a project manager can estimate:

• The cost associated with the risk if it arises, estimated by multiplying employee costs per unit time by the estimated time lost (cost impact, C where C = cost accrual ratio * S).
• The probable increase in time associated with a risk (schedule variance due to risk, Rs where Rs = P * S):
  • Sorting on this value puts the highest risks to the schedule first. This is intended to cause the greatest risks to the project to be attempted first so that risk is minimized as quickly as possible.
  • This is slightly misleading as schedule variances with a large P and small S and vice versa are not equivalent. (The risk of the RMS Titanic sinking vs. the passengers' meals being served at slightly the wrong time).
• The probable increase in cost associated with a risk (cost variance due to risk, Rc where Rc = P*C = P*CAR*S = P*S*CAR)
  • Sorting on this value puts the highest risks to the budget first.
  • See concerns about schedule variance as this is a function of it, as illustrated in the equation above.

Risk Management Activities

Risk management includes the following activities:

• Planning how risk management will be held in the particular project. Plan should include risk management tasks, responsibilities, activities and budget.
• Assigning a risk officer - a team member other than a project manager who is responsible for foreseeing potential project problems. Typical characteristic of risk officer is a healthy skepticism.
• Maintaining live project risk database. Each risk should have the following attributes: opening date, title, short description, probability and importance. Optionally a risk may have an assigned person responsible for its resolution and a date by which the risk must be resolved.
• Creating anonymous risk reporting channel. Each team member should have possibility to report risk that he foresees in the project.
• Preparing mitigation plans for risks that are chosen to be mitigated. The purpose of the mitigation plan is to describe how this particular risk will be handled; what, when, by who and how will be done to avoid it or minimize consequences if it becomes a liability.
• Summarizing planned and faced risks, effectiveness of mitigation activities and effort spend for the risk management.

Risk Management and Business Continuity

Risk management is simply a practice of systematically selecting cost effective approaches for minimising the effect of threat realization to the organization. All risks can never be fully avoided or mitigated simply because of financial and practical limitations. Therefore all organizations have to accept some level of residual risks.

Whereas risk management tends to be pre-emptive, business continuity planning (BCP) was invented to deal with the consequences of realised residual risks. The necessity to have BCP in place arises because even very unlikely events will occur if given enough time. Risk management and BCP are often mistakenly seen as rivals or overlapping practices. In fact these processes are so tightly tied together that such separation seems artificial. For example, the risk management process creates important inputs for the BCP (assets, impact assessments, cost estimates etc). Risk management also proposes applicable controls for the observed risks. Therefore, risk management covers several areas that are vital for the BCP process. However, the BCP process goes beyond risk management's pre-emptive approach and moves on from the assumption that the disaster will realise at some point.

It is vital to identify from a prioritized perspective what components of your business are most important for the continuation of your business. How much down time can a business sustain before permanent damage to reputation or revenue puts a business into bankruptcy? A Disaster Recovery Requirements Analysis should be performed to answer these mission critical questions before a catastrophe strikes. Prudent proactive planning will always be a good business decision.

--Mdpeters 08:42, 15 February 2007 (EST)

Further Reading

• Risk Management Magazine
• The RMA Journal®
• U.S. EPA's General Risk Management Program Guidance (April 2004)

Associations

• Association of Insurance and Risk Managers (AIRMIC)
• The Risk and Insurance Management Society, Inc. (RIMS)
• European Federation of Risk Management Associations (FERMA)
• Latin American Association of Risk and Insurance Managers(ALARYS)
• International Federation of Risk and Insurance Management Associations (IFRIMA)
• International Risk Governance Council
• The Global Association of Risk Professionals (GARP)
• The Professional Risk Managers' International Association (PRMIA)
• The American Society for Healthcare Risk Management (ASHRM)
• The Institute of Risk Management (IRM)
• University Risk Management & Insurance Association (URMIA)
• The Institute of Risk Management South Africa (IRMSA)
• Audit Director Roundtable (ADR) covering risk in internal auditing
• The Risk Management Association (RMA)