How inclusion and diversity plays a critical role in risk management

In this edition of our A Year in the Life of the Strategic CRO series, Mallika tells of the benefits of a diverse risk management team as well as some of the drivers of those benefits.

Those responsible for enterprise risk management (ERM) know that diversification is a key tenet of managing any portfolio of risks. Consider the measures risk professionals take, based on the roles they play in risk mitigation:

• Risk managers take special care to appropriately allocate their investment portfolios to manage volatility.
• Underwriters carefully review geographic concentrations to ensure we are not overexposed to specific types of catastrophe risks.
• Insurers offer several different lines of insurance to maintain overall profitability through ups and downs in individual markets.

As an industry we are striving for diversification throughout every aspect of our business portfolios, so it stands to reason that we benefit from diversity within our risk management teams as well.

Proven benefits of diverse teams

There is a proven financial benefit to more diverse leadership teams. A Catalyst study of Fortune 500 companies showed that companies with a higher representation of women on their boards of directors outperformed their peers 53% in return on equity and 42% in return on sales.

More and more studies are confirming these financial benefits of gender and racial or ethnic diversity in boards and executive leadership teams.

Just like risk and opportunity, diversity is multi-dimensional and intersectional, so there are many ways for you to achieve diversity in your team, including by:

• Age
• Gender
• Race or ethnicity
• Sexual orientation
• Educational or industry background
• Veteran status
• Company tenure
• Risk committee tenure

Hormones and risk

What if I told you that your financial risk strategy is overly optimistic, that your risk appetite in practice is higher than on paper, that your strategy favors short-term and purely monetary gains over long-term or indirect gains? If your team in charge of financial risk-taking decisions is primarily men, this could be the case.

In Testosterone, Cortisol and Financial Risk-Taking, Joe Herbert of the University of Cambridge’s Department of Clinical Neurosciences examined how hormone levels in men and women impacted their risk-related decisions. His review of several studies showed connections between higher levels of testosterone and mispricing and “over-optimism about future changes in asset values.”

The studies showed that this link appears to hold true even for experienced financial traders, not just the average Joe. Herbert suggests there may also be impacts from the “winner effect” in which a successful risk-taking endeavor leads to elevated testosterone levels, causing people to take on higher levels of risk right after the recent win. This could be one explanation for “bubbles” in the financial markets.

Women, who typically have lower levels of testosterone than men, may not be as susceptible to the “winner effect,” and may anchor more toward long-term trends. In addition to the hormonal relationship to risk-taking, there may be cultural norms that impact how men and women perceive risk and reward. In Western cultures, women have typically been conditioned by society to associate less with the reward of money and may value other factors or outcomes of risk-taking higher than monetary reward.

A word of caution and some good news

Now, we certainly should not take this to mean that men are not effective risk-takers, but we can use these concepts as support for forming a diverse risk management team that can overcome groupthink, balance multiple perspectives and consider a broader array of opportunities and outcomes.

The good news is that there is still time to diversify your ERM team! Just like you should periodically review your risk management plan to determine whether changes should be made, you should also periodically reassess your team. The people that fulfill various responsibilities in your ERM program will need to change over time to optimize your outcomes.

4 ways to build create a diverse ERM team

1. Make regular and gradual changes. Regularly re-evaluate your risk management leadership team. For each role, ensure that you are considering multiple candidates, including diverse candidates in your interview slate and diverse colleagues in your interviewing team. Ask for outside opinions or recommendations on who might be a good fit for each role. Simply increasing diversity within your search process will help you see results over time.
2. Consider a bottom-up approach. Depending on your organization, you may find it difficult to populate your ERM leadership roles with a diverse group of colleagues at the right level of seniority.
   In this situation, start looking one or two levels down and grooming the next round of ERM leaders. Ensure diversity in middle-management roles for each of your individual areas of risk, and work to develop these managers into more senior roles. Expose diverse candidates to the ERM process earlier, allowing them to take on more responsibility, where appropriate, and establish feedback channels through which these employees can voice their opinions and viewpoints on the organization’s ERM approach. This will be an important skill for them in their leadership roles and is crucial to an inclusive team environment.
3. Look outside your ERM team. We have noted how risk management teams can become more successful by interacting with colleagues outside of their teams, such as planning and budgeting and other operational teams. Consider whether colleagues from those teams could benefit your ERM program as part of your leadership team. Companies have had success with implementation of a rotation program for employees just below the management level, which can expose them to a variety of business areas, including risk management. This creates a constant flow in your talent pipeline from which to fill risk management roles.
4. Look outside your organization. When an internal search fails to identify qualified diverse candidates for your risk management team, don’t just give up. Search outside of the organization, or even outside of your industry, for diverse candidates who could fit the role.

For example, an insurance company looking for diverse ERM professionals may have luck finding more candidates with ERM experience from the banking industry or other financial sectors. Or perhaps you insure manufacturing risks and might be able to find diversity among manufacturing executives to fill your risk management leadership team. This gives you the bonus effect of identifying diverse candidates who also have a different industry perspective, which may help your organization to identify new risks and opportunities or prioritize your current portfolio of risks differently.

Employ these tactics to diversify your team — just like you’ve diversified your risk portfolio — and you’ll ensure the long-term success of your risk management strategy.

Previously in the A Year in the Life of the Strategic CRO series: Bringing risk appetite into strategy