Showing posts with label rules of thumb. Show all posts
Showing posts with label rules of thumb. Show all posts

May 30, 2009

Paradox of Cautiousness

Actuary, Accountant, Supervisor or Consultant, life is full of paradoxes....

Let's examine a very interesting statement made by the respected President of the Dutch Supervisor DNB, Dr. A.H.E.M. Wellink, in a recent interview on Dutch television (2009;Pauw & Witteman, in Dutch):

"If the (economic) growth fall is between minus 1 and minus 2, and I think it is minus 2, I would express myself in a very subtle and nuanced way, by saying:
"I think it's closer to minus 2 than minus 1". And then, if you listen well, you would know it's actually minus 2.
To be sure, we - me and my (supervisory) colleagues - say it in a more
cautious way ..."

What can we conclude from this short prodigious statement?

Communication fuzz
What first becomes clear in this statement is that responsible board members of (local) supervisors, due to media attention and unrealistic expectations, are forced to communicate in euphemisms or coded idiom.

As a consequence, professionals as well as the public, can only have a best guess at what the real message could be, with communication fuzz as a result.

President Wellink should be allowed to simply state that what he actually means, in this case:
"I think the economic growth will be around minus 2 percent"

Diferent meaning
Second problem with trying to communicate in a 'cautious' way, is that the word 'cautious' has a different meaning for different stakeholders.

For example: an investment will have a different risk profile for the investor, the asset management company, the company's shareholder or the supervisor. Each of these stakeholders will therefore have their own definition of the word 'cautious'.

As a consequence, last but not least, it is the question whether it's 'cautious' if you state the negative growth higher (less negative) than what you really think it is. Most people in the public domain will probably qualify this statement as incautious.

Life of supervisory board members is not easy. They are confronted with a persistent paradox, the Paradox of Cautiousness.

If board members report 'early warnings' they are treated as 'messengers of bad news', accused of market interference or irresponsible actions and launching self fulfilling prophecies. On top of this they may get fired or even be held responsible for the negative financial impact of their statements.

On the other hand, if they don't report their findings public and try to solve the problems in a diplomatic way behind close doors, they may get accused afterwards for not having warned in an earlier phase.

Life is full of risks, not only financial risks, but also the risk of the consequences of (non) communication.

As actuaries, we're often in the same difficult situation as President Wellink. We also have to act cautious, realize our 'cautious' advise regarding the Pension Fund, could implicate an 'incautious' advice for the sponsor or the participants of the pension fund.

Not only actuaries, but also accountants, investors or - in short - everyone who has an advisory or controlling function, have to deal with this 'Paradox of Cautiousness'.

Risk Escalation Management & POP
In most cases the Paradox of Cautiousness can be avoided by proactive Risk management.

If (recalculation of) your Risk Management Models or Scenario's indicate a significant change of risk in the (near) future, immediately take action, propose measures and demand adequate decisions. Don't postpone your actions in order to be sure of the observed changes nor on the advice of friendly 'experienced' stakeholders that tell you with a smile there'll be no problem at all and you're overreacting.

Once you're in the phase where incidentally ad-hoc repair management by the board has failed and serious structural repair management scenario's have to be put on the table, you're too late!

You'll have past the so called point of no return - in this case - the Point of Paradox (POP), you're caught in

The Paradox of Cautiousness

If you put your warnings and proposals in this phase on the table, stakeholders will tell you they felt caught by your actions. Soon board members and other stakeholders will blame you for not having warned them earlier and will question your accountability. Before you realize what's going on, you're in phase three: Crisis management, your head is on the block.

Rules of Thumb
From Wellink's simple example, we may conclude several rules of thumb about being cautious:
  • Dimension cautioness
    Never state that you are cautious in general, always dimension cautiousness with regard to the different stakeholders and the type and size of risks.

  • Early stage warning
    In line with "good governance" always try to warn in an early stage, before the Point of Paradox (POP) when things are (about) to move in the wrong direction, but are still manageable. Warn in a transparent way, open and visible to all stakeholders. Arrange a board level discussion and make sure you've got a completely free hand in what and how you put your findings and vision on the table.

  • External Advice
    Make sure that you're allowed (and have budget) to hire external consult whenever you think this is necessary. In case of discussions or decisions that may have substantial financial impact, don't doubt, but hire external legal or financial consult to assist you and to validate your findings.

  • Contract & Access
    Make sure your contract includes conditions that prevent your employer from firing you during your report findings period and make sure you have (formal) access to any (supervisory) board member when you think this is opportune.

After this heavy stuff, let's conclude with a nice parable...

Parable of the Cautious Actuary
There was a very cautious actuary,
who never laughed or cried.
He never risked, he never lost,
he never won nor tried.
And when he one day passed away,
his insurance was denied,
For since he never really lived,
they claimed he never died.
- Unknown -