Navigating New Sources of Volatility in a World of Interconnected Risks
January 12, 2022
The last two years — and the instability caused by the COVID-19 pandemic, social unrest and the impact of climate change — have highlighted how risks facing businesses are becoming increasingly volatile and interconnected.
In 2021, beyond the pandemic, businesses also had to contend with growing cyber threats, business interruptions and supply chain disruptions. All ranked among the top 10 risks in Aon’s 2021 Global Risk Management Survey.
To thrive, businesses must take risks. At the same time, they must prepare to address the impacts of new and increased sources of volatility. To build the sorts of resilience necessary to face future crises, organizations must recognize the interconnected nature of many exposures and approach risk management in a holistic manner to mitigate their exposures. They also need more and better data, and the analytical capability to derive actionable intelligence from that information.
Of particular concern in the coming year are six “long-tail risks,” says Lambros Lambrou, chief executive officer of Commercial Risk Solutions at Aon. These are cyber security, damage to brand and reputation, complex supply chain risk, pandemic, intellectual property and climate transition.
“These interconnected risks are at the forefront of companies’ minds because of their complex nature and long-tail exposures,” Lambrou says. “Companies tend to understand these risks less well, either because they are new or because they are accelerating or changing in profile. This requires companies to take a fresh look at risk assessment and scenario quantification, and to rigorously test the validity of existing risk management and financing programs.”
The pandemic has had a double impact on organizations: forcing them to rapidly change business models while recognizing the interconnected nature of many risks.
“On top of navigating a course out of the pandemic, companies have had to rapidly adapt their decision-making amid a rapidly changing risk landscape, the evolution of a new kind of workforce, pressure to find ways to unlock the value of their organizations and new ways of doing business,” says Eduardo Dávila, CEO, EMEA at Aon.
The number and variety of risks that a modern business must face are increasing year-on-year. In this more volatile world, cyber risks have increased as businesses rely more on technology. Meanwhile, many businesses have also become reliant on far-flung supply chains, which were weakened by pandemic shutdowns. The impact of climate change has not only hit an organization’s operations, it has also forced changes to business models and markets, new competition and possible reputation and environmental, social and governance (ESG)-related risks.
“Our world is more volatile — economically, demographically and geopolitically — than ever before. Plus, our global economy is increasingly interdependent,” says Julie Page, CEO at Aon U.K. Ltd. “That situation creates great opportunities for businesses of all shapes and sizes. But it also generates incredible uncertainty. And risk with expanding connectivity.”
Growing Cyber Volatility
One example of interconnected risks and increased volatility came in the growth of cyber attacks. The cyber risk threat grew as businesses were forced to adopt remote work models to slow the spread of COVID-19.
The number of cyber crimes broke records in 2020, with ransomware attacks increasing 400 percent from the first quarter of 2018 to the fourth quarter of 2020, according to Aon’s 2021 Cyber Security Risk Report.
Looking at one crucial part of a company’s operations as an example, Paul Rangecroft, CEO of Wealth Solutions at Aon, cites the impact of that cyber risk volatility on pension plans.
“The data that you need to run a pension plan is basically a catalog of all the data you would hate to ever lose to a cyber criminal,” says Rangecroft.
Before the pandemic, plan sponsors had just started to focus beyond their own security walls and engage with service providers. This accelerated in April 2021 when the Department of Labor issued guidance for plan sponsors focused on looking more broadly at data protection.
“Of course, the pandemic forced service providers to send their people home, and to use their home Wi-Fi to work on plan accounts,” says Rangecroft. “The risks were already substantial, but this could compound the risk. We are now seeing a great deal of interest from plan sponsors in monitoring, assessing and mitigating cyber risks in potentially less secure environments.”
The Impact of Climate Change
More severe and more frequent extreme weather events reflect the growing volatility associated with climate change. The impact of a changing climate on tropical cyclones, wildfires and floods are notable examples of that increasing volatility.
The number of hurricanes experiencing rapid intensification has been increasing. Hurricane Ida in August 2021 was a case in point, strengthening rapidly over the Gulf of Mexico before making landfall as a Category 4 storm with windspeeds of more than 150 mph. The storm’s damage wasn’t limited to the Gulf Coast. The abundant moisture associated with Ida would later fuel historic rainfall and flooding in the northeast United States.
July 2021 saw record-setting floods in both western Europe and China. The tremendous rainfall that occurred in both cases was consistent with what researchers highlight as an expected result of warming in oceans and the atmosphere. Evidence is growing of the likelihood of more frequent or intense heavy rainfalls in some regions of the world, increasing possible flood risk.
The wildfire peril has become a growing threat in many areas of the world, but perhaps nowhere has seen a greater impact than California. Changing temperatures and precipitation levels, as well as a shift in the timing of the rainy season in California and the western U.S. has contributed to the growth of the wildfire risk. Rather than a “wildfire season,” the California Department of Forestry and Fire Protection now sees the wildfire risk extending year-round.
The risks associated with climate change don’t stand alone. They, too, are interconnected with other exposures such as pandemic, supply chain disruptions or geopolitical risks.
Taking a holistic, 360-degree approach to risk management that addresses long-tail risks and emerging threats is critical to successfully navigating new forms of volatility. Those efforts should be informed by data and the new approaches to analyzing the information.
Analytical models will need to become more predictive, not focusing solely on historical information. Organizations will have to combine data, powerful analytics and subject matter expertise to build new predictive models and solutions.
“Historically, we have learned and made decisions by analyzing data from loss events as they have occurred,” says Lambrou. “With the current absence of historical data for many emerging risks, the challenge will be to forward-think how to best develop solutions to properly prepare for and manage through them.”
“Especially now, every decision, big or small, has a huge significance,” says Page. “As we’ve seen throughout the last year, the consequences of decisions have never been greater.”
The Reality of Increasing Volatility
Increasing and emerging sources of volatility can have significant impacts on businesses, including loss of income and markets.
To thrive in this environment, then, businesses must understand how they might be affected, take steps to prepare themselves and use all the tools available to them to navigate that growing volatility.