Enterprise Risk Management (ERM) vs Traditional Risk Management
Enterprise risk management (ERM) is a buzzword that has been doing rounds in the risk management field for the past few years. It is often used by managers in a context that implies that it is wider in scope than the traditional risk management function.
However, the number of risk management professionals who do not clearly know and understand the differences between traditional risk management and enterprise risk management is astounding. It is for this reason that this article will enumerate the major differences between the two approaches.
Insurable vs. Non-Insurable Risks
Traditional risk management mostly deals with risks where the exposure can be transferred to other parties in the form of an insurance contract. In some cases, where insurance contracts are not available, derivatives and structured finance products are used in order to meet this objective. However, enterprise risk management (ERM) is wider in scope. Here, the organization tries to deal with risks that are not insurable.
For instance, if there is an accident in the workplace and some employees suffer physical harm, then the financial loss arising from the harm can be covered by insurance. However, the accident also causes a loss to the reputation of the organization. This harm is not easy to quantify and hence cannot be insured.
The enterprise risk management (ERM) considers risks that would not be admissible in a traditional environment viz. damage to the companys social media presence, damage caused by vendor disruptions, damage caused by incorrect mergers and acquisitions, etc.
Single Dimension vs. Multiple Dimensions
Traditional risk management is only focused on one aspect of risks. This aspect is known as the probable impact. The probable impact is a product of the probability of a risk occurring along with the financial impact of the risk.
The enterprise risk management (ERM) framework is more holistic in nature. Instead of just trying to minimize the probable impact, it looks deeper to see how the risk affects the strategic goals of the organization. Some of the common questions asked by practitioners of enterprise risk management (ERM) are as follows:
- Will the risk be limited to one part of the organization or will it spread across various functions?
- What is the speed at which the risk will impact the various functions of the organization?
- Will the effects of the risk be short-lived or long-lasting?
Basically, enterprise risk management (ERM) helps look at risks from a broader perspective. Loss prevention is not the only key metric and other dimensions such as timing, information, and preparedness are also evaluated.
Department Level vs. Enterprise Level
In a traditional risk management environment, the risk is managed in a decentralized fashion. This generally means that every department discovers its own risks and makes a plan to mitigate them. These approaches may be right at the department level. However, when aggregated at the company level, these risks can often be inconsistent, contradictory, conflicting, and outright inefficient.
Risk management literature is full of cases wherein managers have inadvertently created risks in other parts of the organization while trying to minimize their own risk. Also, in many cases, resources are wasted when departments act in a silo.
A centralized risk management department is known to be more efficient and consumes much fewer resources. Another issue is that sometimes risks span different departments. In such cases, there is conflict regarding the ownership of these risks.
It is for this reason that enterprise risk management (ERM) takes a more centralized approach towards risk management. Here, decisions related to risk management are taken at the enterprise level. The purpose is not to work in the best interests of any department but of the organization as a whole.
Reactive vs. Proactive
Traditional risk management is often reactive in nature. This means that it is either reacting to an event that has taken place in the present or preventing an event that has taken place in the past. Traditional risk management relies on empirical data. However, a lot of risks are the result of newer technologies. Hence, they cannot be understood while looking in a rearview mirror.
New-age technologies create newer unseen risks and market shifts. This is whether the concept of enterprise risk management (ERM) comes into place. The emphasis is on trying to find out how the future will play out while keeping the current context in mind.
Standardization vs. Customization
The traditional risk management process is more or less standardized. Over the years, several frameworks and models have been developed. Implementing these frameworks is a fairly standard and common process and can be easily implemented. These processes cover most of the standard risks which an organization faces.
However, there are some non-standard risks being faced by organizations as well. This is why a more customized approach is necessary for enterprise risk management (ERM). The customized approach is not focused on compliances like the traditional approach. Instead, it is a more creative function that uses creativity as well as statistical skills in order to predict the possible risks.
The bottom line is that enterprise risk management (ERM) is a wider and more advanced version as compared to traditional risk management. The differences between them are significant. With the passage of time, more and more organizations are migrating towards the use of enterprise risk management (ERM).
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- Risk Management - Introduction
- Benefits of Risk Management
- Principles of Risk Management
- Risk Management Process
- Risk Identification and Assessment
- Aspects of Risk Management
- Steps in Risk Management Process
- Approaches to Risk Management
- Risk Management Policy
- Commonly Used Measures of Risk
- Risk Management Plan
- Evaluation of Risk Management Plan
- Risk Treatment
- Role of HRD in Risk Management
- Enterprise Risk Management
- Implementing ERM
- Risk Management and Stock Market
- Outsourcing Risk Management Program
- Risk Management as a Profession
- Anticipating and Mitigating Organizational Risks in the Digital Age
- Challenges Facing the Australian Economy
- The Economic Costs of MeToo
- Automated Claims Processing
- Challenges in Global Insurance And International Claims
- Conflicts of Interest in the Insurance Business
- The Cost Structure in the Insurance Industry
- How Drones Will Impact the Insurance Industry?
- How Is Health Insurance Funded?
- How Self Driving Cars Impact Insurance?
- How Stock Market Volatility Affects Insurance Companies?
- Insurance Agents vs. Insurance Brokers
- The ABCs of Insurance Fraud in India
- Technological Advances in the Insurance Industry
- The Basics of Unemployment Insurance
- The Pros and Cons of Unemployment Assistance and Why it Matters in the Present Times
- The Role of Insurance In #MeToo Movement
- Why the Flood Insurance Market should be Privatized?
- Basics of Pet Insurance
- Cannabis Insurance
- Challenges Facing Cryptocurrency Insurance
- Evolution of Insurance Regulation
- Food Delivery Apps and Insurance
- How Does Captive Insurance Work?
- On-Demand Insurance
- Reinsurance vs. Double Insurance
- Solvency Regulations in the Insurance Industry
- Terrorism and Insurance
- The Basics of Microinsurance
- The Basics of Reinsurance
- Types of Captive Insurance Companies
- What is P2P Insurance?
- How Risks Affect Companies Providing Financial Services
- Risk Management Information System
- Disadvantages of Risk Management Information Systems
- The Known-Unknown Classification of Risk
- Operational Risk: Definition and Drivers
- How Regulations Have Affected Operational Risk?
- Identification of Operational Risks
- How to Identify Operational Risks
- Using Internal Loss Data to Mitigate Operational Risks
- External Loss Data in Operational Risk Management
- Risk Control Self Assessment (RCSA)
- Scenario Analysis in Risk Management
- Key Risk Indicators
- Basel Approaches in Operational Risk Management
- The Basel Risk Categories
- Cause Categories in Operational Risk Management
- Loss Distribution Approach
- The COSO Framework for Internal Control
- Mistakes to be Avoided While Building a Risk Management System
- Credit Rating Terminology
- Types of Exposures to Determine Credit Limit
- Types of Credit Events
- Active Credit Portfolio Risk Management
- Metrics to Measure Credit Risk
- Credit Derivatives: An Introduction
- Credit Linked Note
- How do Credit Default Swaps Work?
- Why are Credit Default Swaps Dangerous?
- Total Returns Swap
- What are Collateralized Debt Obligations and How do they Work?
- Collateralized Debt Obligations: Advantages and Disadvantages
- Mark To Market Accounting
- What are Recovery Rates? - Different Types of Recovery Rates
- Netting, Close Out, and Acceleration
- Expected Default Frequency (EDF)
- Expected Default Frequency: Advantages and Disadvantages
- Altmans Z Score Model
- Unexpected Loss and Economic Capital Buffer
- Stress Testing in Credit Risk Management
- Provisioning in Credit Risk Management
- How Corporate Governance Impacts Credit Risk
- Exit Strategies In Credit Risk Management
- What is Market Risk? - How its Measured and Sources of Market Risk
- Why is Market Risk Management Important?
- Introduction to Value At Risk (VaR)
- The Three Types of Value at Risk (VaR)
- Marginal, Incremental and Component Value at Risk (VAR)
- How Value at Risk (VaR) is Implemented?
- Backtesting Value at Risk (VaR)
- Advantages of Using Value at Risk (VaR) Model
- Disadvantages of Using the Value at Risk (VaR) Model
- How Margins Are Calculated Using Value at Risk (VaR)
- Market Risk Limits
- Tail Risk
- The Upside of Market Volatility
- Relationship between Volatility and Risk
- Importance of Data Quality in Risk Management
- Impact of Using Poor Quality Data and Metrics to Measure Data Quality
- Enterprise Risk Management (ERM) vs Traditional Risk Management
- Benefits of Enterprise Risk Management
- Corporate Risk Governance
- International Risk Governance Committee (IRGC) Framework
- Failure of Market Risk Management
- Mistakes to Avoid in Risk Management