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RISK should not be ignored. Risk should not be discounted in the same way that future profits may be discounted, and risk should not be gamed so that it is handled by society at large rather than the responsible parties. This is becoming more and more important as existential threats like climate change, sea level rise and social unrest emerge.

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  1. 1. File: TVA-p3-RISK-examples-lessons-151022.odp Peter Burgess (c) All rights reserved RISK LESSONS LEARNED … OR NOT! TRUE VALUE ACCOUNTING
  2. 2. CONTEXT This slideset is a Work-in-Progress and will be updated from time to time. It is part of a series that aims to describe the extremely complex socio-enviro-economic system that we live in, and how better metrics will make this system work better. TRUE VALUE ACCOUNTING
  3. 3. The BP oil spill … TRUE VALUE ACCOUNTING
  4. 4. In the months and years before the BP oil spill in the Gulf of Mexico, the corporate story was that deep water drilling was safe and no accident like this could happen. An accident of this magnitude should not have happened. Good engineering makes a catastrophic event like this extremely unlikely. The reality, however, is that the corporate business model has profit at its center, and there is always pressure to reduce costs, do things more quickly and make more profit. This increases risk … and in some cases this is the result. The cost to BP for taking risks has proved to be in the range of $20 billion. This is big, even for a company the size of BP. TRUE VALUE ACCOUNTING
  5. 5. The Risk of Fracking … TRUE VALUE ACCOUNTING
  6. 6. The risks associated with fracking should not be exaggerated, nor should they be ignored. Like many engineering processes, fracking can be done safely with no negative consequences. Fracking can also be done in a sloppy manner and result in very damaging impacts that can be very expensive. Many companies working in the fracking segment of the oil and gas industry are small companies with very limited financial resources. If any of these companies has an 'event', they do not have either the financial resources nor adequate insurance cover to pay for the damage done. Society at large then has to pay! TRUE VALUE ACCOUNTING
  7. 7. The GM ignition switch … TRUE VALUE ACCOUNTING
  8. 8. A modest cost saving of around $400,000 at GM many years ago cost GM some $1.3 billion in the first quarter of 2014. The big lesson from this is that reputation really matters. Clearly safety is important, and saving a few pennies in the car cost that results in safety being compromised is not good strategy. Though the 'real' cost associated with the death of 13 people may be in the range of $50 million, a cost to GM of around $1.3 billion is an order of magnitude bigger. This is about the value of reputation. Reputation takes a long time to build. It is lost very quickly. TRUE VALUE ACCOUNTING
  9. 9. Climate Change Risk TRUE VALUE ACCOUNTING
  10. 10. Eminent scientists who have studied climate for years are concerned about the changes that are in progress. It must be anticipated that there will be big changes, but it is less clear exactly what these changes will be. Changes in the weather patterns will likely result in significant disruption in many areas of the global economy … including essential food chains. Sea level change will put at risk many low lying coastal areas around the world. Many areas will have to be abandoned. Huge new shoreline infrastructure will have to be built. At some point in the next hundred years hundreds of trillions of dollars will have to be spent! TRUE VALUE ACCOUNTING
  11. 11. Antibiotics in Meat … TRUE VALUE ACCOUNTING
  12. 12. The discovery of antibiotics was a game changer for human health. Now, antibiotic resistance is emerging. There are indications that more and more deadly bacteria are showing resistance to antibiotics in the human health setting. Antibiotics are now being used on a massive scale in the food chain, meaning that antibiotics are finding their way into almost everything we eat, with potentially dangerous consequences. If widespread resistance to antibiotics becomes the norm, the cost in terms of human health will be huge. A quick calculation suggests that this might be in the range of some hundreds of trillions of dollars … a big number by any standards. That is hundreds of trillions of dollars! TRUE VALUE ACCOUNTING
  13. 13. Tobacco … TRUE VALUE ACCOUNTING
  14. 14. The tobacco industry is a classic case of profits driving the business with nothing else mattering very much. Scientists linked tobacco to cancer and other ailments a very long time ago. The tobacco industry did everything in its power to discredit these findings and continued to sell its products for maximum profit. Some countries are constraining the practices of the tobacco companies, but the imperative for profit still dominates. Tobacco companies continue their practices of aggressive advertising especially in developing countries, and in the process increase their profits while doing lifelong harm to the health of their customers. TRUE VALUE ACCOUNTING
  15. 15. Unemployment … TRUE VALUE ACCOUNTING
  16. 16. There are risks arising from unemployment, underemployment and underpaid employment. None of the widely used business and economic performance metrics take this risk into account at all … but it is substantial should not be ignored. With prevailing business models and conventional accounting, decisions that result in more profit are good, no matter what the consequences for society at large. At some point, high unemployment, underemployment and underpaid employment will result in social instability. This may be catastrophic. It has happened in the past and could happen again. TRUE VALUE ACCOUNTING
  17. 17. What needs to change … TRUE VALUE ACCOUNTING
  18. 18. The idea that risk can be discounted to a present value in much the same way as future profit flows are discounted should be discarded. A risk has these elements: (1) If an event happens, what is the cost to make things right; (2) What is the likelihood of the event happening, and in what time frame; (3) Who is responsible for creating and mitigating the risk; (4) Who is responsible for paying to make things right, and where does the funding for this come from. TRUE VALUE ACCOUNTING
  19. 19. The risks associated with any activity should accrue to the owners of the activity in the same way as the benefits from the activity. They should not be born society at large. Where the cost of making good after a risk event is going to be very large, then the risk pool must also be very large. Periodic contribution to the risk pool may be quite small if the frequency of a risk event is low. The size and liquidity of the risk pool must be big enough to handle the make good costs if the event happens. Is this the way that modern risk management and insurance operates? TRUE VALUE ACCOUNTING
  20. 20. Conventional accounting has a singular focus on the profit performance of the organization and ignores everything outside the reporting boundary (the externaities). Risk is not well handled in conventional accounting and the related reporting is inadequate. Accounting rules that ignore reality and the essential principles of accounting are enabling reporting that ignores the impacts of risk. To a significant extent the problem of risk has been handled by use of legal strategies that shifts risk outside the reporting envelope while doing little to diminish risk. THIS IS A TRAIN-WRECK WAITING TO HAPPEN TRUE VALUE ACCOUNTING
  21. 21. True Value Accounting brings externalities into account, including risk wherever it arises. Maximizing for profit alone almost always results in increased risk. A true valuation of the future requires that the long term future is not heavily discounted and significantly changes the profit performance calculus. Opportunities and risks in the future should be taken into account in the present valuation of 'state'. TRUE VALUE ACCOUNTING
  22. 22. In order for reporting to be complete, there must be a clear expression of the scale of the risk in any activity, an expression of the likely frequency of an event, the size of the insurance pool required and the size of the insurance pool available. There must be reporting of the amount of the periodic payments required to maintain the insurance pool, and the amount of the periodic payments actually being made. TRUE VALUE ACCOUNTING
  23. 23. What is the right structure for the insurance industry? How should it be capitalized. Should it have a conventional for profit structure or should it be a 'mutual' model? A well structured insurance industry need not be financed by investors, but funded by the risk takers who will be responsible for making good after and event. The public at large should be protected against risks being created by enterprise and should not be responsible for funding the make good costs of events that have been caused by others. Does modern law do this? TRUE VALUE ACCOUNTING
  24. 24. REMINDER This slideset is A WORK-IN-PROGRESS. It will be upgraded periodically. It is part of a series of more than 100 slidesets. Navigation to these is available here: FEEDBACK is welcome. Please email to Peter Burgess … … with a catchy phrase in the subject line so that it gets attention, and please identify the specific slideset(s) involved. TRUE VALUE ACCOUNTING
  25. 25. The ideas in this slideset would benefit from more specific expertise in risk management and insurance. If you have such expertise and would like to help place contact me. TRUE VALUE ACCOUNTING
  26. 26. THANK YOU Some links and contact information: Email Peter Burgess … Peter Burgess LinkedIn profile Link to website Link to navigation to other resources: TRUE VALUE ACCOUNTING