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Third Party Risk

Risk Treatment Strategies and when to use which

by Wen Sin Lim 29 Jan 2024

Navigating the complex landscape of risk management requires a keen understanding of various strategies aimed at mitigating potential pitfalls. Among the various approaches, four commonly known risk treatment strategies stand out: acceptance, avoidance, mitigation, and transfer.  

In this article, we embark on a journey into risk treatment, dissecting each strategy with a fine-toothed comb. Join us as we explore the intricacies of these risk management techniques, shedding light on their individual merits and demerits.  

Whether you're a seasoned risk management professional or just beginning your journey into this critical discipline, our in-depth analysis will empower you to make informed decisions and chart a course towards a more secure and resilient future. 

 

Risk Acceptance 

Risk acceptance occurs when an organisation decides not to take any specific action to alter a risk. This decision is usually undertaken when 

  • the likelihood and impact of the risk is low  
  • the opportunities or gains from taking certain actions justify the associated risks 
  • the effort and resources required to mitigate the risk are disproportionate to the level of threat posed 

In practice, the decision to accept a risk is often a calculated one, given that risk-taking is commonly understood as necessary to achieve certain business goals. The trick however lies in knowing which are the risks to take and which are the ones to avoid. 

Imagine a small software development start-up has identified a risk as that of a possible server outage resulting from irregular bouts of power outage in their area. However, seeing as the cost of implementing a backup power supply is high, and the likelihood of a power outage is relatively low, the start-up decides to accept the risk, acknowledging that it may incur short downtime if an outage occurs but not taking any preventive measures due to cost considerations. 

As evidenced, for risk acceptance to be a strategic choice, the decision cannot stem from a place of ignorance nor indifference. Rather, it necessitates an understanding and acknowledgement of the potential outcomes and a level of preparedness to manage any consequences resulting from it materialising. 

 

Risk Avoidance 

On the opposite end of the spectrum is risk avoidance, a strategy that seeks to remove the possibility of a risk occurring entirely. 

For example, a pharmaceutical company may decide not to proceed with the clinical trial for a new drug they have been developing for years after understanding from the researchers that consumption may lead to fatalities. effects. Such a choice, while undoubtedly costly, eliminates the possibility of harm to participants and any associated legal and reputational consequences.

This is not the same as ignoring a risk or failing to identify it. Instead, similar to the process leading up to risk acceptance, the decision to avoid taking a risk should only be made after careful evaluation, analysis, thought and planning. 

Since the goal here is to eliminate any potential negative impact, risk avoidance as a strategy is deliberately and completely steering clear of activities and engagements that pose an intolerably high risk. Sometimes, this means terminating an existing contract with a third-party; Other times, it involves withdrawing a product or service from a profitable market. A company may choose not to enter a volatile market despite there being a massive market due to political instability in the region which may incur greater costs than revenue.  

It is worth noting that the decision to avoid certain risks may come with unintended consequences, such as opening itself up other risks lie operational inefficiencies, competitive disadvantages, etc., hence why it might not be your go-to strategy. 

 

Risk Mitigation 

Risk mitigation is a strategy that focuses on reducing the likelihood and/or impact of risks.

Say a construction company were working on a high-rise building project in an earthquake-prone region. To mitigate the risk of structural damage and worker safety, they implement earthquake-resistant construction techniques, reinforce the building's foundation, and provide earthquake safety training for workers. These measures reduce the impact and likelihood of damage during an earthquake.

Risk mitigation as a strategy does not seek to eliminate risks in its entirety, nor to accept risks as they come. To date, it is the most prevalent strategy as it allows organisations to engage in high-risk (and potentially high-reward) endeavours in a controlled manner. 

As not every organisation has the necessary resources (like expertise, technology and finances) to effectively reduce the risks they face to an acceptable level, risk mitigation may not always be an option. However, where the benefits of reducing the risk outweigh the costs involved in the mitigation efforts, risk mitigation is the preferred strategy.  

Other acceptable instances include: 

  • risks identified fall within the organisation’s pre-defined risk appetite 
  • risk identified has a moderate to high likelihood of occurrence and its impact is significant but not catastrophic 
  • risk avoidance is deemed impractical or not possible

 

Risk Transfer 

As the name suggests, risk transfer entails reallocating the burden of risk to another party who is willing to assume that risk, typically in exchange for a fee.

One practical example of this is when an e-commerce company purchases cybersecurity insurance to protect against potential financial losses in case of a data breach due to its heavy reliance on its online payment system to process customer transactions. In the event of a data breach, the insurance policy transfers the financial responsibility for handling the breach, including customer compensation and legal costs, to the insurance provider. 

Adopting this strategy can lead to cost efficiency, as without the right resources, managing certain types of risks internally could be more expensive than transferring them. Moreover, by transferring risks – assuming the third-parties an organisation transfers risks to are reliable and financially stable – an organisation could potentially avoid sudden financial shocks, ensuring operational resilience. 

In contracts with suppliers and service providers, there is sometimes a clause that suggests that these third-parties could be held accountable for any product defects or service delays. 

An important consideration to have with this strategy is that transferring risk shifts only the financial burden of risks, but it does not necessarily transfer the underlying responsibility. Transferring risk involves sharing or shifting the financial consequences of a risk event to another party, while transferring liability specifically focuses on shifting the legal responsibility for those consequences.

Organisations often use both strategies to manage risks comprehensively, especially when dealing with complex and high-stakes risks. It is essential to carefully structure contracts and agreements to clearly define the scope of risk transfer or liability transfer and to ensure legal compliance. 

 

Which Risk Mitigation Strategy Should You Choose? 

Selecting the optimal risk treatment strategy requires a nuanced understanding of your organisation's specific risk landscape and appetite. Prioritising risks based on their relevance to your operations is crucial, as certain strategies are inherently more effective for specific risk types. 

 

Risk treatment strategies

 

Here we have provided a quick reference guide for how the decision to treat risks may be made but ultimately, the decision of whether to accept, avoid, mitigate or transfer a risk hinges upon the alignment of chosen strategies with your organisation's available resources. 

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