Enterprise risk management (ERM) gives organizations a comprehensive framework for identifying, assessing, and mitigating risks across your entire business.
A properly implemented ERM program helps leadership make informed decisions and improve overall strategic decision making. At its core, ERM consists of five key components that work together to manage risk on an enterprise-wide level.
Internal Environment
The internal environment sets the tone for how risk is viewed and addressed within your organization.
It influences the culture of risk within your company and determines how ERM is structured and performs.
Some important aspects of the internal environment include the risk management philosophy, risk appetite, integrity & ethical values, and the governing body’s oversight role.
Senior management must establish a risk-aware culture and clearly communicate their tolerance for different types of risk. They should also ensure appropriate resources and training are provided to support the ERM process.
The internal environment lays the foundation for the other components of ERM to function effectively.
Setting Objectives
Setting objectives involves establishing organizational goals that support and align with the entity’s mission. It provides the context for identifying and assessing risks that could impact strategic, operations, reporting, and compliance objectives.
Goals should be specific, measurable, achievable, relevant, and time-bound.
Once objectives are defined, the organization can identify potential events that could prevent them from being achieved.
This helps focus risk identification on the most important risks that require ongoing monitoring and treatment.
Both strategic objectives and associated business objectives within different functions/divisions should be considered.
Event Identification
Once objectives are set, the next step is to identify potential future events that could positively or negatively impact their achievement. Event identification involves brainstorming risks within and across the organization to capture all possible sources of uncertainty.
Both internal and external factors should be considered, as risks can originate from various areas like political/regulatory changes, competition, supply chain issues, technology flaws, human resource matters, and environmental concerns.
Emerging risks and those further in the future also warrant attention.
The use of risk workshops/training, checklists, and risk ratings help structure the process. Completeness is key so no significant risks are overlooked.
Risk Assessment
Risk assessment involves analyzing identified risks according to their likelihood and potential impact. It establishes a common understanding of risk priorities based on quantitative or qualitative measures.
For each risk event, the probability of occurrence within a defined period is estimated. The potential consequences if the event occurs are also evaluated regarding criteria such as financial loss, safety issues, reputation harm, strategic setbacks etc.
The likelihood and impact ratings are then combined to produce an overall risk level on a standardized risk matrix.
This prioritizes risks for further evaluation and treatment. Risk assessment should also consider existing mitigating controls, risk interactions, and changes in the business/risk environment over time.
Risk Response
With risks prioritized, management can then develop strategies to modify risk levels to within the organization’s risk appetite.
Common risk responses include accepting, avoiding, reducing, and sharing risk through activities such as installing new controls, making process changes, adopting alternative technologies, purchasing insurance coverage, engaging in hedging etc.
Residual risk after treatment must be monitored to confirm it remains acceptable.
The strategies and action plans for high-priority risks are formally documented, assigned, tracked to completion, and tested for effectiveness.
On an ongoing basis, new risks are assessed while previously identified risks are reassessed as the operating environment changes.
These five ERM components build upon each other to establish a foundation for continuous risk management across the organization.
Successful ERM Implementation Involves:
Implementing ERM requires dedication, resources and strong commitment from senior management and the governing body.
Roles and responsibilities must be clearly defined along with training programs.
Tools like risk registers and scorecards help standardize the processes and reporting.
Benefits of an Enterprise Risk Management Program
The benefit of a coordinated, holistic approach to risk management is improved strategic decision making, more robust internal controls and greater assurance of objectives achievement.
Challenges do exist such as integrating disparate risk management activities, obtaining stakeholder buy-in and maintaining focus on both financial and non-financial risks.
But those organizations that establish a sustainable ERM program gain enhanced understanding and oversight of uncertainties that no single division could manage alone.
By addressing risks proactively rather than reactively, they build competitive advantage and long-term shareholder value.
So, you can see as we’ve laid out here, the five key components of internal environment, objective setting, event identification, risk assessment, and risk response form the foundation of an effective enterprise risk management framework.
When implemented jointly across an organization, they provide leadership a comprehensive view of risks threatening strategy and a standardized process to prioritize and treat uncertainty at both the entity and functional levels.
ERM establishes best practices for addressing both risks and opportunities in a coordinated manner tailored to an entity’s overall mission and risk tolerance.
