Risk Mitigation: If You Predict Rain Build an Ark

Two critical aspects of any plan are risk identification and assessment, but if a team stops there and does not modify the plan to mitigate as much of the risk as possible then it’s pointless. Risk mitigation is what allows you to build a sustainable and enduring business.

Warren Buffet’s “Noah Rule”

Warren Buffet is famous for his chairman’s letters to the shareholders of Berkshire Hathaway. Here is an excerpt from his 2001 letter about why his insurance operations had terrible losses as a result of the 9-11 attacks.

What counts in this business is underwriting discipline. The winners are those that unfailingly stick to three key principles:

1. They accept only those risks that they are able to properly evaluate (staying within their circle of competence) and that, after they have evaluated all relevant factors including remote loss scenarios, carry the expectancy of profit. These insurers ignore market-share considerations and are sanguine about losing business to competitors that are offering foolish prices or policy conditions.
2. They limit the business they accept in a manner that guarantees they will suffer no aggregation of losses from a single event or from related events that will threaten their solvency. They ceaselessly search for possible correlation among seemingly-unrelated risks.
3. They avoid business involving moral risk: No matter what the rate, trying to write good contracts with bad people doesn’t work. While most policyholders and clients are honorable and ethical, doing business with the few exceptions is usually expensive, sometimes extraordinarily so.

The events of September 11^th made it clear that our implementation of rules 1 and 2 at General Re had been dangerously weak. In setting prices and also in evaluating aggregation risk, we had either overlooked or dismissed the possibility of large-scale terrorism losses. That was a relevant underwriting factor, and we ignored it. […]

Why, you might ask, didn’t I recognize the above facts before September 11^th? The answer, sadly, is that I did–but I didn’t convert thought into action. I violated the Noah rule: Predicting rain doesn’t count; building arks does. I consequently let Berkshire operate with a dangerous level of risk–at General Re in particular.”
Warren Buffet in his 2001 Letter to Shareholders of Berkshire Hathaway

Risk Mitigation Strategies

• Identify and Evaluate Risks.
  Developing prototypes that explore and identify the development risks in a new product, and pretotypes that help probe for market risks, are two risk mitigation strategies that should always be employed.  They allow you to evaluate the key risks in a new products.
• Don’t Let One Failure Wipe You Out
  Supporting multiple parallel approaches–or at least identifying in advance what alternate strategies should be employed if your primary approach fails–is an important step in immunizing you from any single point of failure.
• Avoid Moral Risk
  Working with honorable and ethical people–whether they are employees, partners, suppliers, or customers–minimizes the moral risk in entering a new market. If you don’t want your employees, or your customers, or the public to find out you have taken a certain course of action, then don’t take it.
• Allocate Resources and Training to Recovery and Rescue
  Dr. Atul Gawande has observed that teams that do an excellent job of risk mitigation cultivate expert judgment and teamwork, but also take responsibility for their choices by reserving resources that enable resilient improvisation and rescue. It’s not enough to prepare for failures and take steps to limit their damage, you have to persevere and attempt to “retrieve success from failure.”

Related Blog Posts

• Dr. Atul Gawande on Managing Complexity and Uncertainty
• Entrepreneurs Blend Passion and Prudent Risk Taking
• Discovery Kanban Helps You Manage Risks and Options In Your Product Roadmap
• Purpose, Patience, Politeness, and Prudent Risk Taking
• Seth Godin “Trust Is Even More Scarce Than Attention”
• Experiments vs. Commitments