With risk assessment, analyze and prioritize identified risks to reduce potential impacts to an organization.
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What is a risk assessment? |
Benefits and challenges of risk assessment |
Steps to risk assessment |
Different methods of risk assessment |
Best practices for risk assessment |
Final words |
In August 2023, California and Nevada were slammed by Tropical Storm Hilary. Happily, there were no deaths. But the storm dumped record amounts of rain throughout areas that were mostly deserts. This disrupted people’s lives, government-provided services, and area businesses. It could have caused severe health and safety hazards and security risks for the government and businesses in the region. It’s a type of risk event that organizations of all kinds need to identify and be ready for—something extremely unusual, perhaps, but also potentially disastrous.
Preparing for disruptive events like Hilary is one of the main reasons why organizations of all kinds, whether public or private, need to establish risk assessment protocols. Risk assessment tools identify and categorize risks, analyze the likelihood and severity of each risk, and develop strategies to prevent, mitigate, or eliminate those risks. So, what strategies can organizations prepare themselves for dangers both predictable and not-so-predictable?
What is a risk assessment?
Risk assessment is the process of identifying, analyzing, and evaluating risks associated with a particular activity or project. It helps businesses and government agencies understand the potential risks they might face and how they might mitigate them.
It is an important tool for protecting the health and safety of the public and of customers, as well as for decision-making that can affect the financial health and sustainability of organizations and projects. Risk assessment is a major component of risk analysis, which is the process of identifying and analyzing all potential risks and issues that could result in events that are detrimental to a business or to the public. Risk assessment helps organizations to understand the nature and extent of any risks they might face, and with informed decision-making about risk management, including what level of risk organizations are willing and able to tolerate. It also helps them to uncover events that might seem unlikely—but which could suddenly and disastrously take place.
Why such assessments are crucial varies based on the nature of the organization. For businesses, risks can take various forms, including product failure, a shortage of key manufacturing components, and data breaches. During the pandemic period, many industries were hamstrung by a shortage of semiconductors, which have become more and more crucial for products as diverse as automobiles, home appliances, and manufacturing equipment. Supply chains in the fourth quarter of 2023—a period that includes the economically crucial holiday retail season—could be snarled once again, this time by the unprecedented and unpredicted drought affecting the Panama Canal.
Business risks are typically categorized as either enterprise risks or operational risks. Enterprise risks include strategic risks, which involve activities related to achieving business objectives. They also include financial risks such as debt levels, cash flow shortfalls, or investments that could harm the business’s bottom line. New technologies, notably generative AI chatbots such as ChatGPT, could disrupt many companies’ business models and open them up to possible compliance challenges. Insufficient cybersecurity can cause crucial company or customer data to fall into the hands of cybercriminals. There are legal risks such as lawsuits involving contracts or other business agreements. Then there are the risks associated with compliance–not meeting regulatory requirements.
Operational risks can come from various sources, including human error, third parties, cybersecurity threats such as ransomware attacks, external events such as political turmoil and natural disasters, and government regulations. If not properly managed, operational risk could result in financial losses, reputational damage, legal liability, or business disruption–or any combination of these. These risks usually involve internal business processes, systems, and people, though some external events (particularly if the organization has overseas operations) can also negatively affect an organization’s ability to maintain its operations on an even keel.
For government agencies, risks include safety management: hazardous incidents that endanger public health and safety. Natural disasters, such as the deadly fires that swept Maui this past summer, are obvious examples. (These risk events also can have a negative effect on certain businesses’ operations.) What’s not so obvious is that “unlikely” events like Tropical Storm Hilary and the Maui fires can occur—and potentially wreak significant havoc. However, by undertaking risk assessment, organizations can take steps to mitigate or avoid these risks and reduce the likelihood of negative consequences such as accidents, casualties, and financial losses.
For both enterprises and governments, risks that are particularly crucial targets for assessment are those relating to health and safety. Health and safety risk assessments are fundamentally essential parts of the missions of federal agencies such as OSHA and the EPA, of course. But businesses put themselves at peril if they don’t assess risks from the perspective of health and safety. Industries as diverse as agriculture, manufacturing, automotive, and energy (just to name some of the most salient) need to assess the possibilities of chemical spills, product failures, and (in some cases) natural disasters that can put employees and other stakeholders in danger.
Benefits and challenges of risk assessment
Establishing a risk assessment approach can help organizations identify, evaluate, and manage potential risks that can impact them and their stakeholders. The approach of risk assessment can help organizations allocate resources and identify potential areas of improvement. Using a risk assessment approach can save time and money by providing an automated system for evaluating potential risks.
Risk assessment also can allow organizations to stay current on the latest trends in risk management. Risk assessment is never once and done. It is an ongoing discipline, and an organization’s assessment approach should be reviewed regularly and updated whenever necessary.
One challenge of using a risk assessment approach is ensuring that the data being gathered is accurate and up to date. Another challenge is the costs associated with establishing and maintaining a risk assessment approach. Those expenses, which include dedicating significant employee time to the approach, are a key reason why many organizations drag their feet in setting up such an approach or doing so with the thoroughness that risk assessment requires. Keeping the approach updated—which includes identifying and incorporating new potential risks into the assessment—also has costs.
But the costs of not doing so can be even greater. Companies and government departments need to expect unexpected hazards. There is likely to be plenty.
Steps to risk assessment
Before establishing a risk assessment approach, the risk management team needs to understand the scope, the resources, the stakeholders, and the laws and regulations (such as those promulgated by OSHA and the U.S. EPA) that they may encounter by first starting the risk management process. The risk assessment approach is part of assessing and prioritizing risks within the risk management process.
We’ll discuss various methods for assessing risk later in this paper. For now, let’s look at the general steps an organization should follow when managing risks and how assessing risks should be done.
Identifying hazards
This step involves identifying any risk event that could cause harm or damage to people, property, or the environment in order to prevent the event or at least prepare for it. As we’ve noted, natural disasters are an obvious example of identified hazards. So are incidents where a plant or equipment releases hazardous chemicals into the land or air.
Assessing the risks
This is where the risk analysis process begins, thus so does risk assessment. Although there are many methods to analyze risks, many fall under qualitative or quantitative in which risk management teams must choose which method they should go with.
Qualitative methods involve collecting and analyzing non-numerical data to understand concepts, opinions, or experiences. These methods are primarily exploratory and are used to gain insights into underlying reasons and motivations. They are useful for developing theories when the area of study is not well understood. Techniques often used in qualitative research include interviews, focus groups, and observations. The data collected is typically text-based or visual, and the analysis is interpretive, aiming to find themes and patterns in the data.
Quantitative methods, on the other hand, involve collecting and analyzing numerical data that can be quantified and subjected to statistical procedures. These methods are used to test hypotheses, look at cause and effect, and make predictions. They are valuable in providing measurable and typically scalable results that can be generalized to larger populations. Common techniques include surveys with closed-ended questions, experiments, and correlational studies. The analysis involves mathematical modeling and statistical analysis to derive results from the data.
There are many more methods for assessing risks. We will go into examples later, but after choosing a method, the next step involves doing a risk evaluation of the likelihood and severity of harm that could result from each hazard. Who and what could be harmed? What kinds of harm could the event cause? How costly could the hazardous event be to the organization or to the public? Once determined, the risk management team must start prioritizing which risk factors could happen soon, which ones could cause a high potential impact on the organization the most, or a combination of both.
Prioritizing the risks
At this point, the risk analysis process essentially ends but the risk assessment approach continues. An organization’s risk assessment approach continues by prioritizing which risks need to be addressed first—and promptly. This could be based on impact, frequency, time to set up, customer fears, costs, and other scores.
Controlling the risks
Once the risks have been identified and assessed, the risk management team must establish the steps the organization would need to take to either eliminate or mitigate those risks. It also will need to look at the costs of these control measures to determine whether they exceed the value of prevention or mitigation. In some cases, an organization may decide that mitigation is more cost-effective than prevention.
Recording the findings
Documenting the results of the risk management process, including hazard identification and the control measures put in place for risk management, is essential communication for both employees and management. All stakeholders who might have decision-making responsibilities for a possible risk event need to know how to anticipate such an event, how to detect it, and how to respond if it occurs.
Reviewing the process
Finally, it’s necessary for the organization to periodically review the effectiveness of the control measures it has set up to ensure that risk management remains effective. That’s particularly true whenever the organization introduces new steps, equipment, technologies, processes, or other changes to its workflow, or whenever hazard identification uncovers new potential risks.
Different methods of risk assessment
There are numerous methods that an organization can use when undertaking a risk assessment. Here are the most widely used. Note that there is a distinction between potential risks and hypothetical risks. Simply stated, potential risks have a higher likelihood of happening than hypothetical ones, which are possibilities that might never happen at all. That noted, an organization should consider assessing both types. An unlikely risk could still become a very real event—and a very real problem for the organization.
Methods for assessing potential risks
Risk assessment matrix
A risk matrix is a visual tool used to assess the likelihood and severity of potential risks. It involves plotting risks on a matrix that assigns values to the risk occurring likelihood and its severity. This can help an organization’s “risk team” prioritize risks and determine appropriate risk mitigation strategies. It also can aid in determining the level of risk it is willing to tolerate.
Quantitative assessments
This method uses mathematical models and statistical methods to assess risk. This method can be used to analyze complex systems and assess the likelihood and severity of potential risks.
Qualitative assessments
This approach analyzes risk based on subjective or “narrative” evidence, which can include expert opinion, experience, and judgment. This method can be useful when quantitative data isn’t available or when assessing risks associated with new or untested technologies.
Methods for assessing hypothetical risks
What-if analysis
This method involves asking a series of “what if” questions to identify and evaluate potential risks and their consequences—particularly potential risks that might not be immediately apparent. This method often looks for possible deviations from the design, construction, modification, or operating intent. What-if analysis can be helpful in detecting potential risks associated with new projects or initiatives.
Scenario analysis
Scenario risk analysis involves creating hypothetical scenarios that could potentially occur and then assessing the risks associated with each scenario. This can help stakeholders identify potential vulnerabilities and prepare contingency plans to mitigate those risks.
Methods for assessing system risks
Fault tree analysis
Fault tree analysis (FTA) is a top-down approach to identifying the causes of a hazard or system failure. It involves creating a diagram that maps out all the possible paths leading to the failure or hazard, and then analyzing each path to identify potential causes and contributing factors. The factors typically include combinations of hardware failures, software failures, and human errors, with stakeholders in the risk analysis asking, “How might this happen?” FTA can be used to assess risks associated with complex systems, such as nuclear power plants and aviation components.
Failure modes and effects analysis
Failure modes and effects analysis (FMEA) is a way to identify and evaluate all potential failures, such as errors or defects, in a manufacturing or assembly process, or a product or service. FMEA begins early in the product or system design process. It involves breaking down a system or process into smaller components and then analyzing each component to identify potential failures and their effects. Organizations using this method prioritize risks according to how serious their consequences are, how frequently they occur, how easily they can be detected, and how serious their effects are likely to be. FMEA is commonly used in industries such as automotive manufacturing, aerospace, and healthcare.
Hazard and operability analysis
A risk assessment method like FMEA is hazard and operability analysis (HAZOP). Like FMEA, HAZOP involves breaking down a system or process into smaller components, and scrutinizing each component for potential hazards and operability problems. Used primarily by chemical and materials processing companies, HAZOP can help with hazard identification in a system as well as operability problems that could lead to a process breakdown or dangerous product malfunction.
Best practices for risk assessment
Risk assessment is a critical component of risk management, helping organizations identify, evaluate, and prioritize risks. Here are five best practices for an effective risk assessment approach:
Establish a Clear Framework
- Define the scope and objectives of the risk assessment clearly.
- Establish criteria for evaluating risk, including the likelihood of occurrence and the potential impact.
- Ensure that the framework aligns with the organization’s overall risk management strategy.
Involve the Right Stakeholders
- Engage a diverse group of stakeholders from various parts of the organization to provide different perspectives on potential risks.
- The inclusion of stakeholders not only brings in varied insights but also ensures broader acceptance and commitment to implementing risk mitigation strategies.
Use a Combination of Qualitative and Quantitative Methods
- Qualitative methods, such as expert interviews and SWOT analysis, are useful for identifying risks and gaining insights into their implications.
- Quantitative methods, such as statistical analysis and modeling, help in quantifying risks and estimating their impact.
- Combining both approaches provides a more comprehensive understanding of risks.
Regularly Update and Review
- Risk assessment is not a one-time activity. Regular reviews and updates are necessary to account for new risks and changes in existing risks.
- Establish a schedule for periodic reassessment and update the risk management plan accordingly.
Documentation and Reporting
- Document all findings, methodologies, and decisions made during the risk assessment process.
- Prepare clear and concise reports that summarize the risks, their potential impacts, and proposed mitigation strategies.
- Ensure that the documentation is accessible for audit purposes and for informing future assessments.
Implementing these best practices can enhance the effectiveness of the risk assessment approach, leading to better risk management and decision-making within an organization.
Final words
In conclusion, risk assessment serves as a fundamental tool for organizations across all sectors to assess and prioritize potential risks effectively. By implementing a structured risk assessment approach, organizations can proactively prepare for both predictable and unexpected events, thereby minimizing potential damages and ensuring operational continuity.
The integration of both qualitative and quantitative methods enriches the analysis, providing a balanced perspective on risk severity and likelihood. Regular updates, stakeholder involvement, and thorough documentation further enhance the robustness of the risk management strategy. Ultimately, a well-executed risk assessment not only safeguards the organization against potential threats but also supports strategic decision-making, contributing to the long-term resilience and success of the organization.