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Managing Director
Decision Empowerment Institute

Innovating to the Hagen Algorithm

Case studies are the prevalent way of mitigating risk holistically, but Hagen's approach offers root cause analysis.

One piece of folk wisdom cautions that "it's not what you know you don't know that gets you into trouble, it's what you know for sure that just ain't so."

Enter Brian Hagen, managing director of the Decision Empowerment Institute in Spotsylvania, Va., who brings engineering and economics to risk management.

Hagen's innovation is a method that allows expenditures on resolving problems, mitigating risks, or capturing opportunities to be completely comparable based on the best life cycle value for an organization.

"Everyone is looking for the best price to fix risk," said Michael Breggar, vice president of life sciences for the consulting firm Business & Decision. "That usually means changing a process or component, or laying off risk. But Hagen's magic tool box allows you to know how much it would cost not to fix the risk. And maybe that is an acceptable cost."

In short, Hagen asks, "Or else what?" The question seems like a juvenile taunt, but it is actually the leading edge of quantifying risk mitigation. Hagen's inspiration was to realize that few organizations are as rigorous in determining the value-added or the return-on-investment in risk mitigation, as they are in the same calculations for capital allocation, or marketing and sales expenditures.

From that revelation, he developed the mathematics and algorithms, then created a software application to enable its quick and efficient use in organizations. Evaluating the full range of costs for problems, risks, and opportunities--from doing nothing through complete elimination--the algorithms generate an "investment productivity curve" which then builds a business case for risk-management decisions. "Any boardroom can take it from there," Breggar said.

The prevalent method for holistic risk mitigation is to use case studies, but people familiar with Hagen's approach note that case studies can only provide snapshots, not root cause analysis. "Risk management is done, but not with enough rigor," Hagen said. "Boards want to know what they get in return for their risk-management costs. They think in terms of return on investment. This gives risk managers the tools to present to their executives and board in language those people understand."

"You can't begin to mitigate risk without understanding the root causes," said client Paul Seaback, vice president of supply chain for Medicis Pharmaceutical Co. "You have to go back upstream. Especially in areas like quality risk." That means comparing the cost of changing suppliers or investing in new equipment or buying insurance to cover a bad batch and its consequences.

Another common approach is to use a regulatory template, such as those provided by the Sarbanes-Oxley Act. That is often the technique used in companies in which the risk management function is housed in the legal department.

"Hagen's methods include regulatory costs and consequences," Breggar said, "but also the human resources and full-cycle costs of risk mitigation beyond any compliance issues."

"The whole industry has been struggling for years, and continues to struggle with how to quantify risk holistically," Seaback said. "At the end of the day, the decisions are still mostly qualified, not quantified. We can compare one premium to another or the cost of upgrading equipment, but everything else usually just comes down to a gut feeling. Even when you try to run the numbers, you don't know if you have generated a relevant set of figures."

Hagen reiterates that to quantify risk using his approach also helps risk managers to decide "whether to act or not on any particular exposure. Once you have the numbers, you can decide how to adjust your mitigation." In one pilot program, a process manufacturing company was ready to cease making one of its materials, because the supply-chain costs were too high. "We used that as a test case, because we knew the answer," a company official said. "After running the calculations for two or three weeks, the answer came back that we should continue to manufacture. We were even able to get hard data on the most economical supply-chain alternatives."

Risk managers said another benefit of Hagen's approach is that it enables their side of the house to speak the same language as their finance and management colleagues. That is especially important for companies when the risk management group is part of the treasury department reporting to a chief financial officer. "Having the data makes our conclusions and recommendations much more credible," Seaback said.

That said, Hagen has not created a soulless machine to replace human intellect. "He engenders trust," one risk manager said. "He came in and showed people the process and got answers from people that I had worked with for years and never gotten so much input from."

-- Gregory DL Morris

Manager
Vertice Seguros
Adjusting the Premium to the Risk

In Latin America, current methods that insurers use to measure the risk of domestic transport makes it almost impossible to know the real risk.

The singer Shakira is no longer the most flexible, powerful, and desirable innovation to come out of Colombia: rather the nod goes to AsisCarga, the first risk simulator based on marine insurance programs in Latin America that can support the companies that are investing and using land transportation in the continent.

Jose A. Ricuarte, a manager with Vertice Seguros in Bogota, Colombia, designed the simulator to measure the risk prior to delivery, and to adjust the premium based on the level of risk.

Although Latin America is one of the fastest growing regions in the world, owners, underwriters, and brokers in the region acknowledge that the current methods that insurers use to measure the risk of domestic transport makes it impossible to know the real risks.

In response, Ricuarte developed AsisCarga, using his own model. "We have a lot of experience with the Latin America roads, but we also have a mathematical risk model that we run each time that a truck starts a trip. We define the risk level of each shipment based on statistical information,'' Ricuarte said. "The model is fed every day, depending on the status of the roads. We are talking not only in terms of security. Remember that for the last year, the catastrophic risk like floods, landslides, in general the risks of nature caused millions in losses. The cargo risks transport in Latin America are so dynamic, change all the time.''

"The major brokers who operate in the region focus on the big picture, but I don't think they have the time to focus on new things," said Claudia Vargas, vice president at Chubb Colombia. "Jose Antonio saw what was happening on the ground, what the shippers needed, and developed this answer himself. He has worked with freight forwarders and truck companies who needed something like this."

There are almost a quarter of a million freight forwarders in Colombia, Ecuador, and Peru, according to sources in the region. "We track the risk factors," Ricuarte said. "We use six initially to measure the level of risk. The first is the customer or the owner of the goods, because not all companies/corporations have the same way to manage the cargo risks. Some merchandise is more exposed than others, even carrying the same goods by the same route. That varies with the owner, and we always try to identify them to use special strategies.''

"This has been a hugely helpful program," said one manager at a freight forwarder. "It was very difficult to understand the risk of land transport. This program allows me to compile all the risks and better know how to mitigate them. I have shown the program to colleagues in places like China and in Southeast Asia because I think they face the same kinds of problems."

Setting political correctness aside, Ricuarte's starting points were the unique challenges faced by regional freight operators, including the poor condition of some roads, traffic congestion, the absence of any meaningful tracking system, the difficulty in checking references or safety records for drivers, high rates of theft in some areas, and a lack of standardized security or operating procedures.

Ricuarte's innovation was to address those conditions as risks that could be quantified or at least evaluated, and that unique risk management processing could be brought to bear.

"Jose Antonio's idea was to have a marine open policy with all the solutions available at the same time," Vargas said. "This did not seem possible with so many freight forwarders, and commodity categories."

Bringing the rigor of risk management to the market was the true innovation, said Juan C. Salcedo, marine director at Liberty Colombia. "In effect he has created a new channel. We can guess and write business on unknown risks, just based on our experience, or we can use this process and write to a risk we understand." Owners and underwriters say that absolute losses have declined, as the measurement and tracking bring perils into focus. The claims process also has been simplified because there is a data trail.

Insurance companies say they like the application for underwriting in particular.

"The process is very fast because of the large data base," Salcedo said. "It has also made our negotiations with the client very easy. The client gets a rapid response with a quote. Before we would have to study and consider each quote. Then the client would argue. Now we say here are the statistics for that commodity on that route, so this is the premium. We have done more business with our same clients, and we have brought in new clients."

The biggest prize may be yet to come: with the flowering of free-trade agreements around the region, it is expected that there will be both an increase in freight traffic, but also an increase in companies from the U.S. and Europe wanting to invest in the region.

That investment can't happen unless freight companies, and their brokers and insurance firms can measure the cargo transportation risk. If global coverage stops at the wharf, development does, too.

There is also a great deal of local pride in the fact that this approach was developed using the knowledge of regional operators and input from brokers and underwriters already in the market.

-- Gregory DL Morris

Senior Managing Director of Product Development
Aon Benfield

Managing Director
Aon Benfield

Mapping the Impact of Risk

The team of Paul Budde and Kristi Wilts is a force nature has to reckon with.

Rationalization always holds the risk of running a race to the bottom, or at least settling for the lowest common denominator as two systems or organizations are integrated.

Paul Budde, senior managing director for product development with Aon Benfield, was given the task of leading a small team to integrate the exposure management systems of Aon and Benfield, when Aon decided to purchase Benfield, a well-known analytics shop in the reinsurance marketplace. The end result was to be called ImpactOnDemand.

"Benfield had Exposure View, which has strong mapping functions, and Aon had Cat Portal, which was a data warehouse, heavy on business intelligence," Budde said. "Both tried to do similar things from different perspectives. The Eureka moment for us was taking the strengths of both and not just sticking them together but using those strengths as the basis for a complete, integrated redesign."

That initiative took a bit of courage, because it drove against the tendency common in behavioral psychology called the persistence of interim solutions. "There was some pressure to just stick the two things together," Budde said. "It would have been quicker, and there were plenty of other things we could have been working on. But once we decided that a complete redesign was best in the long run, we got very good support up to the corporate level."

"Paul's expertise in actuarial mathematics and modeling enabled him to see an opportunity to turn the project into an underwriting tool," said Dan Dick, executive managing director, at Aon Benfield, "and then Kristi working in the field saw a role for it as a claims management tool."

Budde realized early that current mapping speed and performance capabilities were not sufficient. Clients wanted faster, more flexible, more powerful applications than were commercially available. Working with in-house software designers and code writers, Budde developed first a mapping and tiling operation.
The tool is integrated with the National Oceanic and Atmospheric Administration (NOAA) for live tornado, hail and thunderstorm activity, as well as with EuroTempest to provide in-depth analysis of European windstorms.

Insurers can upload their most current portfolios for viewing and analysis at any time, and are able to plot as many as a million risk locations.

"All other programs require the broker to upload the data," Dick said. "That is fine under ordinary circumstances, but what if a hurricane is bearing down? ImpactOnDemand allows clients to load their own data. We saw the value of this in the tornadoes in Joplin, Mo. This was a totally new way of thinking about data access and display. It has already been a very rough year for tornadoes and hail, but we have been able to overhaul our claims and underwriting capabilities on the fly with this."

Once the original initiative started to take on a life of its own, its development gathered momentum, Budde's team realized the tool would have to have a flexible but rigorous permissions system with tiered access and authority.

One hallmark of innovation is not just the original thinking and execution that goes into the initiative, but how much further innovation it engenders in others. Once the tiered hierarchy structure was in place, it also enabled a theoretical function. Users can take projected storm paths and run potential damage scenarios safely isolated from actual loss information.

ImpactOnDemand is a web-based application, which means that users can access their data globally through a secure connection with a proprietary public and private key encryption scheme. The platform requires no installation or local storage capacity.

With that flexibility, Managing Director Krisi Wilts took the system into the field for training and testing. "She quickly came back with a next-generation idea for smart-phone applications that could be used by adjusters live in the field," Dick said.

There is no limit on the number of locations that can be uploaded, viewed and analyzed with ImpactOnDemand. Users can view and track exposures worldwide via its global mapping capabilities and portfolio analysis tools, and receive real-time information on catastrophes including earthquakes, hurricanes, wildfires, tornado and hail events, and even volc
anic eruptions.

The tool is integrated with pre- and post-event identification of exposures by CRESTA zone for named storms, as well as identification of exposures by CRESTA zone using the EuroTempest live five-day, peak-gust speed forecasts and recorded observational data. It is also integrated with Tropical Storm Risk for live tropical cyclone event analysis.

Colleagues say Budde and Wilts are an ideal inside-outside complement. He holds a doctorate in mathematics from the University of California at Berkeley, and was a 2008 Reinsurance Power BrokerŪ. She has field experience in both marketing and claims adjusting, as well as training.

Based on input from the field, the next generation after the next generation could be moving out into other types of coverage beyond property and casualty. "The ability to visualize data is the key," said Patrick Sheridan, responsible for corporate risk management at the Westfield Group. "With the business analytics in place, there is likely a great deal of capability beyond current lines."

-- Gregory DL Morris