Spotlight: New Forms of Volatility

As the world becomes more uncertain, organizations are grappling with a combination of accelerating and changing known threats, such as climate change and pandemics, as well as new sources of volatility, such as complex supply chains, ESG, the rise of intangible assets and the widening health gap.

These developments create challenges at a corporate level – how do we understand and tackle these risks – as well as challenges for risk advisory firms and capital providers – how do we innovate for changing risk profiles and how can we provide comprehensive solutions that address risk mitigation, incident response and compensation for loss?

ESG, reputation, supply chain, cyber – these are enterprise-wide issues which, on the surface, have little in common. Yet a structured approach for addressing these risks reveals relevant shared characteristics.

Firstly, we generally regard these issues as opportunities as well as threats. So, at Aon, our goal is to take calculated risks rather than eliminate risk. For example, technology has played a central role in enabling business survival during the pandemic and contributing to economic growth post restrictions. However, this expanded dependency on technology has created “attack surfaces,” presenting more potential security vulnerabilities to bad actors. In another example, firms today leverage their IP like never before in strategic initiatives, such as capital raising and M&A, but this leaves them more exposed to IP infringement. A final example is ESG, where a firm's purpose, beliefs, and strategy can create long-term value and cement stakeholder engagement; however, breaches or a failure to deliver on that strategy can also introduce a host of new risks.

Secondly, these issues can quickly converge around a scenario. It is not difficult to foresee a situation where an organization could suffer a systemic cyber breach in its supply chain, which triggers a business interruption, ultimately damaging brand and reputation.

Thirdly, because these are enterprise issues and considered opportunities, they often interest a broader and more diverse set of stakeholders. Consider the role of CTOs in cyber risk, and procurement directors in supply chain risk. While the CEO is the ultimate custodian of an organization’s brand and reputation, marketing professionals are tasked with building reputation equity for the firm. This complex network of interested parties can make it more difficult to align these issues and treat them as risks.

Fourthly, we are dealing with different and often more limited data sets with these risks. Our tendency to rely on historic loss data as a measure of future exposure is far less achievable for the risk profile of new forms of volatility. However, alternative data sources can be used to develop a view of exposure - whether through the capacity or utilization of a key supplier or changes in public sentiment from key stakeholders - when measuring reputation risk.

Finally, we can adopt a similar framework to understand these risks better. And with this knowledge, we can develop more relevant solutions.

One Approach

At Aon we believe that improved insights, generated from data, analytics and advice, drive better decisions and deliver improved outcomes. Our clients have used scenario quantification and stress testing to capture a clearer view of their exposure to new forms of volatility, both individually and on a portfolio basis. Through better financial articulation of the risks, they can invest appropriately in mitigation and management controls and innovate around risk financing. The perspectives of key stakeholders and the use of non-conventional datasets are important in building credible scenarios.

Build Understanding

Use sources of thought leadership and credible data repositories – e.g., professional bodies and industry benchmarking – to build an improved understanding of the issues.

Assess Scenarios

Build assumption-based scenarios leveraging the enhanced data insights. Apply sensitivity testing and stress tests against relevant KPIs – EBITDA, liquidity, covenants, equity commitments, etc.

Optimize

Consider how best to apply resources to manage the risk. Depending on perceived financial exposure, consider the use of captives/cells as an incubator for future capital solutions.

Apply Solutions

Revisit the scenario over time to explore alternative solutions, as assessment of the risk improves.

Build Understanding

Use sources of thought leadership and credible data repositories – e.g., professional bodies, industry leaders, competition and customers – to build an improved understanding of the issues.

Assess Scenarios

Build assumption-based scenarios leveraging the enhanced data insights. Apply sensitivity testing and stress tests against relevant KPIs – EBITDA, liquidity, covenants, equity commitments etc.

Optimize

Consider how best to apply resources to manage the risk. Depending on perceived financial exposure, consider the use of captives/cells as an incubator for future capital solutions.

Apply Solutions

Revisit the scenario over time to explore alternative solutions, as assessment of the risk improves.

Results in Action

Through a process of scenario impact analysis designed and facilitated by Aon, a global conglomerate was able to size its exposure to cyber risk, resulting in a better integrated cyber risk management program and a more fit-for-purpose insurance policy, with limits of $400 million (up from the original estimate of $100 million)
With the support of Aon, an international consumer brands company based in Europe, developed a set of reputation risk scenarios through the lens of stakeholder sentiment and then quantified both the short and longer-term financial impacts associated with reputation damage and loss of attraction. The assessment significantly enhanced the process underpinning its viability disclosures, and a subsequent program analysis identified gaps in insurance coverage and an opportunity to consider bespoke cover aligned to reputation.
An Asian firm operating internationally developed a series of scenarios linked to climate change. Aon combined long-term temperature change data with catastrophe models, enabling the client to quantify their range of exposure. This enhanced insight helped the client to evaluate the long-term plan for its portfolio of investments, supported its loss control capital expenditure program and provided the analysis required for TCFD disclosures.
Aon developed contingent business interruption scenarios for a global life sciences firm, focusing on losing key suppliers connected to its flagship products. The range of estimated maximum losses was very high, so further probabilistic modelling helped the client reach an optimal decision on its insurance program design. The quality of the data, analytics and overall submission significantly improved the confidence of the underwriter and the capacity it was prepared to offer.

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