Risk Appetite

Introduction

The notion of risk appetite is used by many organisations as an attempt to diligently balance competing priorities with limited resources. Such statements represent an organisational expression of risks and rewards in the value system of the board and senior decision makers. However, there are serious methodological difficulties with this attempt to treat all risks as having the same underlying nature when, for example, market risks are quite different in nature to safety risks.

Market vs safety perspective

In the business community, risk appetite has often been expressed as meaning that an outstanding outcome can justify taking greater chances to achieve success. In policy terms, this means encouraging the organisation to select projects and programs with greater rewards for similar effort, which is to be applauded.

This interpretation of risk appetite is most relevant to the market risk paradigm. There remain some serious caveats to this approach. It is ordinarily unacceptable to adopt a course of action, which despite demonstrating an almost certain outstanding upside benefit, nevertheless has a low possibility of destroying the entire enterprise. A joint venture option is usually the way forward in such circumstances.

Safety has a different perspective. Often the consequences of failure are so high that there is simply no appetite for it.  The notion that anyone has an appetite for death and maiming is presently not acceptable in Australian society. The notion of danger money (increased pay due to the hazards associated with the work) has been firmly rejected. If a workplace is not safe then work must stop. Instead, provided the situation is not prohibitively dangerous, the requirement is for (safety) risk to be eliminated or reduced so far as is reasonably practicable (SFAIRP), a matter which can be forensically tested in court. This is a positive demonstration of safety due diligence.

The diagram below shows this difference graphically.

Diagram courtesy of Richard Robinson, R2A

From an overall business perspective a better term may be a risk tolerance statement or, keeping it generic across the different risk domains, a risk position statement. A risk position statement would be an articulation of the board’s understanding of the key risk issues for the business and their understanding of the management and optimisation of these risks. It would become a quality assurance document to ensure the board can transparently demonstrate risk management governance to stakeholders including the community, government and, if necessary, the courts.

Sources

The content on this page was based primarily on the following sources:

• Robinson Richard M and Gaye E Francis (2019). Engineering Due Diligence (11th Edition). R2A Pty Ltd, Consulting Engineers.