Are you ready for ETCOR?

Practitioners have been using the Total Cost of Risk as a key metric in the discipline for some time.

By Christopher E. Mandel

It has proven to be a reliable tool for fundamental measurement of the risk costs most common to the insurable risk realm. Some senior managers have been satisfied with it as a success metric and others have been unimpressed with its narrow focus. But what if you want to measure risk costs more comprehensively?

At a recent enterprise risk management conference, I was privileged to meet another speaker, Gary Bierc, CEO of The Kingson Group (soon to be the Baltimore-based rPM3 Solutions), who had the wisdom to create a more complete method of measuring risks costs, aka ETCOR (Enterprise Total Cost of Risk). He is also seeking and securing a patent on this concept. Few people have the drive or staying power to pursue a patent for seven years but Gary does.

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ARQ or Aggregate Risk Quantification is a patented enterprise risk management accounting method which in effect, is a new form of "risk accounting." It produces an ETCOR for any entity. Gary characterizes it as the "fifth financial statement." When set up within an entity's accounting environment, it pinpoints and extracts essential risk-based profit and loss information from the general ledger. When fully deployed, it measures, or accounts for and links the key components of successful strategic business risk performance management: strategic and operational objectives; performance results; and, risks that can impact those results. That's a game changer. Finally, this method achieves the much sought after nexus between risk and performance outcomes. This method has been designed to bridge this long-standing gap. When optimized, it has the potential to eliminate the distortion that often affects the interpretation of company results and strategy formulation.

This concept represents a way to measure enterprise risk management itself. It can enable the calculation of an explicit return on investment on enterprise risk management activities and resources. By understanding and being able to quantify the cost of these activities and compare them to the reduction in risk exposure, you would have a financial/accounting system-based way to validate the benefits of spending related to enterprise risk management. This has been a key deficiency in the risk discipline.

ARQ is also capable of helping identify opportunities for revenue and earnings improvement. It isolates the cost of managing company specific risk sources and ties these costs to actual performance. In essence, this new method illuminates and magnifies the "trade-offs" that exist between precious indirect and overhead spending and the actual results experienced (compared with performance targets). The result is the ability to make surgical cuts, when necessary, and deploy confident opportunity exploitation (the nimbleness to invest, even in tough times). Ultimately, ARQ promises to significantly help the decision-making process and improve earnings performance, enabling enterprise risk management to take its legitimate place at the decision-making table.

Early adopters of the ARQ methodology have seen strong stock price performance. Specifically, a clothing retailer which adopted this technique in 2007 demonstrated that the ARQ index showing decreasing cost of total enterprisewide risk mirrored the upward trajectory of its stock price over a three-year period.

CHRIS MANDEL is the president of Excellence in Risk Management, LLC, a long term risk management leader and former president of RIMS.

August 1, 2011

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