We’ve all heard it in the business industry: “no risk, no reward!” But we hear it for good reason—business efforts are never totally risk-free. Still, companies are constantly working on minimizing risk and maximizing their profit, which can really only be done through intentional, data-driven decisions. Finding new ways to predict and manage risk is a big part of an overall business strategy. 

The real question is how do business leaders and decision-makers measure, evaluate, and minimize risk? Industries like finance, transportation, manufacturing, and construction are finding more success by using a better and more reliable tool called a risk model.

A risk model is a mathematical technique, system, or method that predicts the risk elements of a business strategy. If done right, a risk model can provide functional data and quantitative estimates that help businesses make financial, strategic, and operational decisions. Some models also use qualitative elements, such as relying on subject matter experts to advise. 

Risk models can provide investment analyses, market insights, recurring patterns in your operations, and more. Simply put, a well-designed risk model allows you to input certain values, goals, or data and then makes clear and accurate predictions about your business projection.

What is Risk Modeling?

Risk modeling is the systematic and holistic approach to risk management, especially compared to more traditional methods, such as only buying insurance to protect your business. Risk modeling is about creating effective risk analyses, magnifying how efficient insurance can be, and taking a more comprehensive approach to risk research and solutions.

How Does Risk Modeling Work?

Risk management uses historical data/simulation, extreme value theory (EVT), market risk, as well as expertise elicitation to make reliable assumptions. Among assumptions, modeling also uses economic, statistical, and financial techniques to predict potential/maximum risk.

Some people like to break modeling into three main types: quantitative, qualitative, and a hybrid version. Quantitative modeling relies on statistical data and numerical evidence while quantitative relies more on expertise and potentially subjective knowledge. Most businesses will benefit from a combination of the two, which is where the hybrid model comes in.

Types of Risk

The application of risk modeling will also depend on your goals, the type of risk you're measuring, and your industry. There are several types of risk, but some common ones are strategic, operational, compliance, financial, security, credit, and reputational risk.

Some risk types have to do with the culture or procedures of a company, such as strategic risk or operational risk. Creating a culture of risk awareness and management helps minimize strategic risk. Others, such as financial risk, help measure the flow and use of money depending on market values, stocks, the history of sales or the company’s revenue, etc.

For example, let’s take the transportation industry. Even though the advancement of technology and IoT offers benefits for transportation, it also opens up more opportunities for supply chains and automation issues. A trucking company could use a risk model that analyzes the threats of their supply chain, whether that be security risk management or operational risk management. Different industries may focus on different categories depending on the risk level they face.

Model Risk

Sometimes, using a risk model is risky in and of itself. On the qualitative side, you never know when programming or technical malfunctions may occur. Qualitatively, risk models can always be mismanaged by human error.

Common Pitfalls You Should Know About

• Relying solely on the past won’t predict the future. As helpful as using historical data is, there’s no guarantee that the same system will work in future scenarios.
• Risk models don’t provide perfect insight. Risk models should be combined with other market research, benchmarks, and critical thinking that no computer or equation can manage.

• Subjective topics aren’t as reliable. Depending on the culture of your company, the priorities, the people in charge, plus the influence of people outside of your organization, risk models can fail due to misalignment or bias.

Misinterpreted or insufficient data. Model implementation isn’t always easy without expertise. Even if you are able to get the right kind of information, not everyone knows how to use or interpret data, which may make the model ineffective.

De-Risk Your Business

Systems like risk models are a great way to protect your business from unnecessary or predictable pitfalls. Remember, though, that risk modeling is only one piece of the puzzle. De-risking or risk management is more than a model: it’s a mindset. There are ongoing strategies, different controllable and uncontrollable factors, and industry-specific standards that all contribute to securing your company.

HNI services specialize in de-risking businesses so that you aren’t forced to rely on insurance in order to create secure opportunities. Contact us today to figure out what you need to de-risk your strategy and reclaim control over your business.