RISK
Some text from MDIA slides

Accounting for RISK

Burgess COMMENTARY

Peter Burgess

MDIA-Pres-B-Accounting-for-RISK-140529.odp
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1 Accounting for RISK

Conventional accounting has a priority focus on the profit performance of the organization more than anything else.

Accounting for risk is not well handled in conventional accounting and the related reporting is inadequate.

In part, this has come about because of the growth or rules based accounting that have enabled dilution of many key accounting principles.

Much of the problem of risk has been handled by use of legal strategies … something that avoids risk while doing nothing to manage and diminish risk. Conventional accounting has a priority focus on the profit performance of the organization more than anything else.
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2 Accounting for RISK

Accounting for risk is not well handled in conventional accounting and the related reporting is inadequate.

In part, this has come about because of the growth or rules based accounting that have enabled dilution of many key accounting principles.

Much of the problem of risk has been handled by use of legal strategies … something that avoids risk while doing nothing to manage and diminish risk.

THIS IS A TRAIN-WRECK WAITING TO HAPPEN
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3 Accounting for RISK

MDIA does not ignore externalities, and in many ways risk is an externality.

MDIA brings ALL externalities into account.

MDIA values the future in a way that helps to make the long terms future as important as the immediate future.

MDIA specifically values opportunities and risks in the future so that they are part of the present accounting for 'state'.
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4 The case of the BP oil spill

In the months and years before the BP oil spill in the Gulf of Mexico, the corporate story was that deep drilling was safe and no accident like this could happen.

There is no question … an accident like this should not happen. Good engineering makes the likelihood of a catastrophic event extremely unlikely.

The reality, however, is that the corporate business model has profit at its center, and there is always pressure to reduce costs, do things more quickly and make more profit.

This increase the risk … and in some cases an event like this explosion and subsequent oil spill is the result.

The cost to BP for taking risks has proved to be in the range of $20 billion. This is big, even for a company the size of BP.
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5 The case of the GM ignition switch recalls

A rather modest cost saving of around $400,000 at GM many years ago has cost GM some $1.3 billion in the first quarter of 2014.

There are many lessons in this. Perhaps the most important is that reputation really matters.

Clearly safety is important, and saving a few pennies in the car cost that results in the safety being compromised is not good strategy.

Though the 'real' cost associated with the death of 13 people may be in the range of $50 million, an impact of on GM of around $1.3 billion is an order of magnitude bigger.

This is about the value of reputation. Reputation takes a long time to build. It is lost very quickly.
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6 The risk inherent in Climate Change

Scientists who have studied climate for years are expressing deep concern about the changes that are in progress.

The implication of this work is significant. It must be anticipated that there will be big changes, but it is less clear exactly what these changes will be.

Some of the potential changes in the weather patterns will likely result in significant disruption in many areas of the global economy … including the very essential food chain.

Sea level change will put at risk many low lying coastal areas around the world. Many areas will have to be abandoned. Huge and expensive new shoreline infrastructure will have to be built.
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7 The risk arising from Antibiotics in Meat

The discovery of antibiotics … initially penicillin, has been a game changer in human health.

Antibiotics have improved health outcomes in a very substantial way, but there are indications that more and more bacteria are showing resistance to antibiotics in the general medical setting.

Antibiotics are increasingly being used in the human food chain. What this means is that antibiotics are finding their way into almost everything we eat, with consequences that are likely to be problematic.

If widespread resistance to antibiotics becomes the norm, the cost in terms of human health will be huge. A quick calculation suggests that this might be in the range of some hundreds of trillions of dollars … a big number by any standards.

That is hundreds of trillions of dollars!
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8 The risk associated with Tobacco

The tobacco industry is a classic case of profit driving the business with nothing else mattering very much.

Scientists linked tobacco to cancer and other ailments a very long time ago. The tobacco industry did everything in its power to discredit these findings and continued to sell its products for maximum profit.

Some countries are constraining the practices of the tobacco companies … but the imperative for profit is still the controlling metric.

Tobacco companies continue their practices of aggressive advertising in developing countries, and in the these process increase their profits while doing lifelong harm to the health of their customers.
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9 The risk associated with Fracking

The risk associated with fracking should not be exaggerated, not should they be ignored.

Like many engineering processes, fracking can be done safely with no negative consequences.

Fracking can also be done in a sloppy manner and result in very damaging impacts that can be very expensive.

Many companies working in the fracking segment of the oil and gas industry are small companies with very limited financial resources.

If any of these companies has an 'event', they do not have either the financial resources nor adequate insurance cover to pay for the damage done.
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10 The risk associated with Unemployment

The risk associated with unemployment, underemployment and underpaid employment is substantial.

None of the widely used business and economic statistics take a risk like this into consideration at all … but it is a very considerable risk that should be handled.

According to conventional accounting and prevailing business models, decisions that make more profit are good, no matter what the consequences for society at large.

At some point, high unemployment, underemployment and underpaid employment will result in social instability. This can be catastrophic. It has happened in the past and could happen again.

The risk will be reduced when the basic business model is driven by metrics that include the people and planet dimensions rather than having just the singular focus on profit.
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11 What needs to change?

There are several changes that are needed.

(1) An estimate of the scale of the risk needs to be made. If an event happens, what is it going to cost to make things right.

(2) A second number is to estimate the likelihood of the event happening, and the time frame for such an event to be repeated.

A financial pool that is big enough to handle the cost estimated in section 1 has to be available.

Every entity involved with the operations that might give rise to the event must pay into the pool, on a basis that fairly reflects their role.

This is the basic concept of insurance of risk.
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12 What needs to change?

There must never be situations where the risks of any activity are carried by society while the profits arising from the activity accrue to the owners of the activity.

Where the cost of a risk event is going to be very large, it is critical that the risk pool is also very large.

Periodic contribution to the risk pool may be quite small if the frequency of a risk event is low.

The size of the risk pool must be big enough to handle the event if the event happens.

This does not seem to the the way the modern insurance community behaves, not those in charge of policy and oversight.
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13 Not 'for profit' insurance

There are issues with the 'for profit' insurance business model.

A well structured insurance business does not need to be financed by investors. It is the funds of the risk takers that are funds needed for the operations.

The stakeholders are simply the public and those that would otherwise be responsible for the costs of events that must be paid for.
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14 MDIA accounting for Risk

In order for reporting to be complete, there must be a clear expression of the scale of the risk in any activity.

There must also be an expression of the likely frequency of an event.

There must be a report of the size of the insurance pool available to meet claims.

Lastly there may be reporting of the amount of the periodic payments into the pool.


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