Existential risk and boards with Celia Huber

The COVID-19 pandemic has shown many organizations that they are insufficiently prepared for crises that could undermine their existence. McKinsey spoke with Celia Huber, a senior partner who leads the firm’s North American Board Services practice area, about the role boards can play in ensuring preparedness for such crises.

McKinsey: Why is existential risk on boardroom agendas and why is it important to insurers?

Celia Huber: In our annual survey of approximately 1,500 corporate directors, we found that boards are dissatisfied with their performance on risk management. Very few report excellent risk management over the past year, and only 40% say their organizations are prepared for the next big crisis.

Traditional thinking is to estimate the value at risk multiplied by the probability of the event, but existential risks such as oil spills that could derail the whole business should be treated as if they could happen without adjustment according to their probability.

The pandemic was an example of an extraordinary crisis, which we define as a high-consequence, low-probability event that can cause long-term economic impact, significant reputational damage and leadership changes. It’s not about looking for “black swans”, but about identifying events that would have significant ramifications for the heart of your organization. If you provide cybersecurity, for example, a cyberattack will be central to your value proposition. We are now seeing major issues around supply chains, and the inability to obtain critical inputs for your products or services could pose potentially existential risks.

Traditional thinking is to estimate the value at risk multiplied by the probability of the event, but existential risks such as oil spills that could derail the whole business should be treated as if they could happen without adjustment according to their probability.


Corporate boards also need to consider scenarios in which multiple crises occur at the same time – this is what COVID-19 represented. We had a health crisis, a financial crisis and a social crisis. The risk of multiple crises is also apparent in the public sector. I live in California, where the combination of the pandemic and our wildfire season has resulted in a lack of staff to deploy for things like vaccination clinics.

Insurers play a unique role in society by providing financial stability and pooling property, health and mortality risks. Customers depend on the reliability of insurers to deliver on that promise and, secondarily, to protect their information. Existential risks affect insurers in two ways. First, the underlying risk they insure may change and affect their ability to pay, for example when there is a significant increase in disability or mortality company-wide or an increase in risk forest fire. Second, in their own operations, insurers need to be aware of risks such as cybersecurity threats to their customers’ data or their ability to pay claims.

McKinsey: How should boards approach risk assessment and magnitude?

Celia Huber: While management ponders the most likely and least severe risks, boards should sift through these low-probability “predictable surprises” and identify a few of those with significant consequences to test against the model. operational and fundamental values. An effective approach is what we call a premortem, showing how the organization would be affected by the risks that the World Economic Forum and other expert groups have identified. And it is important to think about the first order of consequences, the second and the third.

Risk appetite, both financial and operational, is very important to define.


I worked with the board of directors of an insurance company that started by identifying 25 trends that created risks for the organization, such as labor shortages, inflation, recession and government regulations. We tried to make these trends granular so that we could play on worsening risk, and among those 25 we identified a subset that we felt was existential – they would change the future of the business.

McKinsey: How should the board approach mitigating these tail risks?

Celia Huber: You need to ensure that management invests in resilience holistically, implementing measures to protect the organization during an incident and to preserve its ability to invest as it emerges from the crisis. For example, I work with life insurers and retirement product providers for whom the general low interest rate environment is a threat to their business model. For them, a resilience mindset means asking: How long can we weather the storm and do we think interest rates will ever change? One company drew a line in the sand: “We will stay in this business until this point. After this point, we will change the products we offer because we can no longer manage the risk. Risk appetite, both financial and operational, is very important to define. Boards that do it well not only force themselves to think about what could happen, should happen, and is likely to happen, but they deliberately choose one of the outlier scenarios and drill into it so they can push their thinking .

In terms of mitigation, I would be remiss not to mention the obvious leverage of insurance. It can be expensive, but it’s better to have coverage than to cover losses entirely from your own equity. Another element concerns operational risk. What is the cost of a chemical spill that forces you to shut down your plant and pollutes surrounding communities? There is insurance to mitigate this, but you can also make safety or equipment changes and improve processes. If you think about earthquake risk and how to mitigate it, insurance can be too expensive, so businesses need to consider operational changes that allow them to withstand, say, a magnitude 5 earthquake, but can not go so far as to prepare for an earthquake of magnitude 8.

***

Celia Huber is a senior partner in McKinsey’s Bay Area office.

To learn more about corporate governance and board effectiveness, see:

  1. State Street’s Ron O’Hanley on business resilience and ESG
  2. The Post-Pandemic Board Agenda: Redefining Business Resilience
  3. How to accelerate diversity on boards of directors
  4. How advice can help digital transformations
  5. Inside the Strategy Room Podcast: The Board’s Role in Preparing for Extraordinary Risks

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