Friday, November 19, 2010

Looking at the Bigger Picture -- Forecasting on an Enterprise-Wide Basis

I've been a consulting actuary for more than 25 years now. As I think back at some of the work that I have done and supervised, I realize how flawed some of it has been -- not the work itself, but the nature of the work that we were asked to do. We've been asked to do work in a vacuum, but independent of other parts of our client, its benefits program in total, or its human resources program in total. So, while we may have done an excellent job, the assignment may not have had the value to our client that it could have had we been engaged "properly."

I'm not saying that this was necessarily anyone's fault. Perhaps we were the retirement consultants and weren't being engaged for any other HR work. Perhaps the individual engaging us didn't have purview beyond the retirement plans. In any event, however, I'm taking a guess that I've had clients who looked at bad-case or worst-case scenarios that I presented to them and combined them with other bad-case or worst case scenarios in doing planning.

To illustrate, let me use a (hopefully) absurd hypothetical. Suppose the worst-case for a company's energy division occurs when temperatures are moderate, but the worst case for their agriculture division is when temperatures are extreme. Conversely, the best case for the energy division is extreme temperatures and the best case for the agriculture division is moderate temperatures. So, in total, the enterprise has hedged its risks well.

However, in our hypothetical, each division is left to its own devices to manage its own risks. So, the energy division spends money to "insure" against moderate temperatures and the agriculture division spends money to  "insure" against extreme temperatures. Each division has spent money to manage risks that were already managed on an enterprise-wide basis. Of course, this never happens in real-life, does it? WRONG! It happens all the time. I've seen it.

It's often difficult for all but the top executives in an organization to evaluate risks and "insurance" needs on an enterprise-wide basis. On the other hand, within the human resources function, for example, isn't the entire department its own sub-enterprise? So, as an example, might it not be a good idea to look at the effect of a 1% decrease in underlying interest rates on the entire HR function rather than just on the pension plan? Perhaps in a lot of those scenarios, as interest rates fall, so does inflation and wage increases. So, while pension plan costs might be increasing, compensation costs might be decreasing. In total, HR may be doing a fine job of managing its costs, but if the pension manager is asked to manage pension costs and the compensation manager separately is asked to manage compensation costs, each could be spending resources managing a risk that within the total HR department is already appropriately managed.

I'll comment more on this in the future, but for the time being, I just wanted to give some food for thought. For mid-level managers, the corollary to this is that the better you can view things on an enterprise-wide basis, the faster you will escape that mid level and get to a high level.

Think about it ...

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