How to develop a deep understanding of connected risk in order to mitigate successfully

Global risks (economic, environmental, geopolitical, societal and technological) are evolving rapidly and becoming highly interconnected, which can affect the production cycle of a multinational company dramatically. Risk managers are therefore challenged to respond in a forward-looking and holistic way to protect employees, assets and business continuity.

Today’s increasingly unpredictable geopolitical risks are deeply interconnected with the economic environment and if materialised, could have significant effects on businesses. A new report, Our World Transformed: Geopolitical Shocks and Risks 2017, produced by Zurich Insurance Group and the Atlantic Council, examines a number of possible future scenarios and their potential sociopolitical and economic consequences.

Areas of risk for multinationals are, for example, the increase of political violence risk around the world, the risk of the need to abandon assets or sovereign default risk for customers who are either lending or selling to government entities around the world, and cyber risks. All these risks can affect supply chains, international trade,and decisions about market entries or exits, as well as acquisitions.

The report looks at three risks with geopolitical consequences and interconnections – protectionism, energy crisis, and water and food scarcities. “While the threat of growing protectionism is a daily feature in the news, an energy crisis resulting from the worsening Middle East situation or the spread of water scarcity could also disrupt the world. Should any of these situations become full blown, the impacts would be nothing less than earth shattering for how the world governs or does business,” states the report.

David H Anderson, executive vice-president and managing director, Zurich Credit & Political Risk, says of the current risk environment: “The most sobering thing about the report is that these risks – protectionism, energy crisis and water scarcity – come at a particularly difficult time in the risk cycle. The low commodity price trough of the last few years has already put a strain on many countries, and we are seeing sovereign defaults in addition to record trade credit insurance losses.”

He adds: “This follows the significant political violence and forced abandonment paid claims of the 2011-2014 period for companies in countries like Libya, Yemen, and Ukraine. Meanwhile, the US and Europe are going through a tumultuous period, with uncertain outcomes. The complex, interconnected nature of all these risks will test risk managers and their insurers in the years ahead.”

So how can businesses develop a deep understanding of connected risk in order to mitigate successfully? Risk managers need to plan ahead, learn about possible business impact and work on contingency plans, scenario analyses and diversification of their exposure. Mr Anderson indicates that, particularly in the emerging markets, firms need to acknowledge that even the best forecasting is only of limited utility.

“Yes, you should subscribe to global economic and political risk news services and forecasters, but draw from multiple sources, and be humble about what you can really predict. Then develop a systematic map of the risks that the firm is willing to take, up to limited levels. Insurance can help with the rest,” he says.

Work on business continuity planning is key in order to build up resilience. It is vital to think out all the scenarios, what could happen with your production, your people and your stakeholders, according to different risks.

Some of the best practices companies can undertake to manage their geopolitical risk include diversification of their fixed assets and accounts receivable (bad debt) risk, and diversification of suppliers to avoid supply chain risks.

The report states that the response to geopolitical and environmental risks needs to start at the highest levels in companies: “As well as taking measures to manage and mitigate short-term disruptions, sustainable businesses will need to create frameworks that support longer-term enterprise resilience. Building an enterprise-resilience framework will help actively manage the downside, and upside, of geopolitical risks.”

The report concludes: “Companies with existing or prospective exposure in these areas are becoming more aware that they need a systematic way of assessing and mitigating the risk, and political risk insurance is one tool they can use to protect them from potentially catastrophic losses in a particular country or across multiple ones. With risks come opportunities, and companies that weigh both will be in a better position to weather the upcoming storms.”

Lastly, the report offers the following key takeaways:
– Geopolitical volatility will be a key driver of uncertainty during the next few years.
– Geopolitical risks are interrelated, so understanding the connections is a vital step in managing risk and avoiding surprises.
– Boards and risk managers must consider the potential impact of geopolitical risks on their financial and physical assets, operations including supply (value) chains, and people.
– Effective risk management requires companies to take into account the interdependencies between risks, and more than ever demands a truly holistic risk management approach.

Contributed by Zurich Commercial Insurance

Previous contributed articles by Zurich:

A spotlight on global solutions for employee benefits

More data on property risks means more informed decisions

Captive health checks for captive owners

A spotlight on global solutions for employee benefits