Clare Askew, originally from Sunderland in the UK, boarded a plane bound for Bali at Perth Airport on Sunday 22nd October. This was the city where she had lived and worked since emigrating to Australia many years ago. The Bali trip was very familiar to her. It had become almost a ritualised routine; she would frequently make the short flight as a break from her demanding routine as a psychiatric nurse. However, her happily anticipated return to old haunts in Denpasar was dramatically and horrifically curtailed.

Just as the plane established cruising speed soon after take-off, it began to plummet. The cabin crew were in a state of panic. Although they had just taken passengers on in Australia, all the desperate announcements coming over the address system were in Asian Languages. The only instruction delivered in all the chaos in English, as the oxygen masks were activated, was to ‘brace for impact’. “The panic was escalated because of the behavior of the staff, who were screaming and looked tearful and shocked,” said Clare. According to another passenger, the cabin crew were screaming “Emergency, Emergency” as the plane dropped over 20,000 feet in 11 minutes. Passengers were texting good-byes to their loved ones and saying farewell to those around them.

Improbably, I met Clare later that same day on the beach in Denpasar. Fearing that, after such a traumatic experience, she might never fly again unless she did something about it immediately, she courageously jumped on the next available flight to Bali. Now in possession of the facts, she explained that 25 minutes into the flight, the plane had become depressurised. To save their lives, the pilot had to drop as quickly as possible to 10,000 feet, the level where oxygen masks would no longer be needed. “We were already feeling woozy” she told us.

This incident and the contrast between the traumatic personal experiences of passengers and the official characterisation of this as a low risk event, dramatically illustrates the difference between objective and subjective risk. So far as the Airline was concerned, the pilot was faced with a technical issue for which there was an established protocol. The pilot responded with the appropriate procedure. No one was at risk. Everything had gone exactly to plan. From an objective and statistical point of view the base line probability of dying in a plane crash is 1:1,000,000, yet what Clare and her fellow passengers had been exposed to was far beyond any appetite that they had for risk. Even if they had been intrepid parachute jumpers, fire eaters or fearless roller coaster riders in their leisure time, their risk appetite would hardly have embraced 11 minutes in the antechamber of death. For the most anxious amongst us, that experience would have been life changing.

Apart perhaps from the failure to address English speaking passengers in their own language, this example is not presented in any way as a criticism. It is interesting because, in this incident, the distinction between an objective risk analysis approach is in such contrast with the subjective perspective and the extreme risk tolerance demands imposed on those passengers. Objective statistical methods of risk quantification and prediction are, at root, always based on counting incidents; how many plane crashes, how many people die, the frequency of tsunamis or volcanic eruptions and so on. All this is very necessary and invaluable information in terms of planning, organizational or national decision making, insurance, and other efforts to anticipate trends and maximize advantage or ameliorate, or compensate for any disasters we may face. On the other hand, risk as we experience it is personal and entirely subjective. One person’s exciting experience is another person’s worst nightmare. Where one sees only opportunity, another sees only danger. These individual differences in risk disposition will influence the perception of risk, a person’s reaction to risk and their readiness to take risks. These features will be a distinctive aspect of any individual’s personality. Rather than focusing on ’the risk out there’; any analysis of subjective risk is about the dispositions of the individuals involved and how these influence their decision making.

Consider the following road safety scenario. How dangerous a road is deemed to be will, one way or another, be calculated on the basis of accident numbers. If the result was, for example, 1 in 10,000 vehicle transits, this would be the basis for establishing the risk exposure for any driver using this road. Yet, clearly, there is also a link between driver characteristics and accidents. We know that more accidents involve teen age boys, that tired drivers cause accidents, that driving while using a phone will be a factor, that drinking habits could play a part, that experience, level of concentration, state of mind, impatience, competitiveness, distractibility will all potentially be important. Given all these ‘people’ factors, the probability of involvement in an accident cannot possibly be the same for all those individuals – as well as for the patient, careful, vigilant, defensive, cautious drivers. In fact, all these individual characteristics, on both sides, will have contributed to the current accident statistics.

So, can a road really be inherently dangerous? Obviously, zero drivers equals zero accidents. Isn’t it the behaviour of drivers that creates the statistics in the first place? Statistics don’t shape our behaviour, its the other way around; statistics come after the events. Putting it slightly differently, behaviour drives probabilities, probabilities don’t drive behaviour.

Two points in particular arise from the distinction between objective and subjective risk. The first concerns those managing people within any context where risk behavior and decision making are critical, whether on the shop floor, the office or the board room, they need to appreciate the subjective perspective on risk, its variability and its behavioural implications – the issues are equally important, but very different to those of objective risk assessment. Secondly, for policy makers, researchers, thought leaders or anyone attempting to understand and navigate the labyrinthine complexities of risk, it is necessary to get beyond the objectivity and comfort to be found in numbers and to be prepared to explore subjective risk and human factors. Numbers weald a reassuring but sometimes spurious and overwhelming authority. To many, the complexities of human personality and behavior are deemed to be even more intangible but in fact, because risk dispositions are rooted in personality differences that can be more clearly defined and more readily measured than is often the case with the risk itself. The realities of dealing with risk in our everyday lives as viewed through our subjective risk perceptions will impact on all our decisions and all our actions.

Predictive probability has been at the heart of modern insurance practices since the 17^th century. Much risk management also focuses on the probability and likely impact of potentially damaging outcomes. This is an objective statistical heritage that still holds sway over wider risk management practices. The impact on Health & Safety has often been to foster an authoritarian denial of individual differences and, particularly in high risk environments, the conceptualization of personal responsibility as ‘blind obedience’. Even though risk personality is measureable in ways that risk itself is not, these approaches persist in battling against the awkward realities of human nature, rather than recognizing it and working with it.

Risk management practices are changing and increasingly aim to foster greater self-awareness within a climate of mutual respect.  Employees learn where their risk dispositions assist the behaviours expected of them and where behavioural tendencies need to be reined in. This provides a basis for compliance that involves insight, staff development and an individual agenda for personal responsibility.  Get the attitude and behavior right and the statistics will take care of themselves.

 

GEOFF TRICKEY, October 2017

There has been a relentless change over recent years in the use of the words ‘risk’ and ‘danger’, presumably reflecting our preoccupations with the many and varied hazards that we all face daily. First reactions to the accelerating rise in our use of ‘Risk’ might be that we are all becoming increasingly neurotic about the vicissitudes of life. There is some support for this in the findings of behavioral economics which demonstrate that we place a higher value on something that we have (but might lose), than we do on something that we might gain. It seems that loss is more distressing than acquisition is rewarding. The longer we establish security in economic and physical terms, the more it seems that we become concerned about the prospect of losing it – and hence more ‘neurotic’ about risk. But this doesn’t explain why the term ‘danger’ has been in decline over the same period. The explanation for this has to be something to do with the way we use these words hasn’t it?

The word risk seems to have taken on a life of its own. We use it as if it were ‘a thing’ rather than an abstract idea. In fact, risk doesn’t exist at all outside of specific dangers, hazards, disappointments or pit-falls, yet it is often considered rather like an epidemic; something that can be confronted and defeated. We use the term ‘risk’ without necessarily feeling the need to be more specific. The reality is that there is potential risk in everything; everything we do, everything we plan, everything we dream. It is with us from conception, we deal with it every day in one or other of its manifestations (travel, infection, finance, games, engagement with others) and eventually, at the end of life’s journey, we will all succumb to it. The word ‘risk’ is huge in the territory that it covers – everything form hot tea to world war, from a headache to a global epidemic and much, much more. It seems we put it all in the same box and, fed by the media who love a good risk story if they can find one, we fret about it endlessly.

Although in fact a synonym, the word ‘Danger’ is very different. We don’t generalise about it so much.  It doesn’t work in the same ‘portmanteau’ way. The first response for most people would be ‘What danger?’ It is unusual to see a sign in the road saying simply ‘danger’, it would usually be clarified in some way, or at least be made clear by the situation. Whatever it is, we address it, work out what we should do, dispense with it immediately and then forget it.

In contrast, the term ‘risk’ is somehow charged with negativity and foreboding. Is it that we have a collective habit of clumping all risk into one very scary bundle and then getting distressed about it? In fact the doom-laden media crank it up all the time. One recent example of this is the determination to express all health statistics in the form of increments of DEATH. Where once advice stopped at alerting us to the dangers and guiding us towards the healthy options, now it’s all predicated against dubious life expectancy estimates: drink coffee and live longer, eating or drinking today’s demonized consumable will reduce your life by X months or Y years. Worst possible scenario headlines such as, “Unhealthy lifestyle can knock 23 years off lifespan” and alerts about percentage reduction in risk without bothering to report how low the base line for the risk in question actually is; they’re all designed to alarm us.

My advice is to take back control. Forget the papers, tune out of the ‘today program’ at the first sign of doom and gloom (who needs that at the start of the day?). Don’t buy into the over generalized, alarmist notion of an ever-rising tide of RISK; just deal with specific challenges as they arise. Be determined to see the positive; as Eric Idle memorably advised “always look on the bright side of life”. My research tells me that it enhances the quality of life by a gazillion smile units!

 

Geoff Trickey, PCL, July 2017

To comply with regulation, financial intermediaries across the world are typically required to take ‘appetite for risk’ into account when assisting with a client’s investment decisions. Risk Appetite is a disarmingly accessible and intuitively meaningful term. But, as with most colloquialisms, pinning down a precise enough definition for operational purposes is not a simple matter. The level of specificity that is sufficient for casual discourse looks decidedly fragile in the context of accountable policy making within a strict regulatory framework. According to an early definition from the UK Financial Services Authority (FSA):

 

“Risk appetite is the amount of risk that one is prepared to accept, tolerate, or be exposed to at any point in time.” (2006).

 

A number of assumptions are inherent in this regulatory mission: firstly, that the clients themselves have a clear idea what their risk appetite is and can articulate it; and secondly, that their Financial Advisor will be able to interpret it in terms of product suitability.

 

Problems of communication

Risk measurement is never entirely objective, but underwriters, actuaries and quants seek objectivity in a world of numbers, statistics, mathematical models, and algorithms. In the world of finance, risk is calculated. As intermediaries, Financial Advisors (FAs) understand financial products in similar terms. This statistical approach is referred to as ‘objective risk assessment’.

Individuals, on the other hand, know a great deal about risk from their own life experience. Everyone deals with risk on a minute by minute basis, reacting heuristically and according to their own risk dispositions and there is often a mis-match between what they consider high risk and what the statistics suggest. Individuals perceive risk and react to it differently; we each have our own risk antennae. Dispositions like these are evident in everyday decision making; the way we cross the street, the way we plan our holidays, monitor our expenditure, behave at parties, manage our relationships, spend our leisure time, organise our work, react to unexpected events. There is a consistency amongst all this and, in broad terms, people are predictable in their approach to risk – it will be one of their most prominent characteristics. But this is a very different perspective on risk to the models and algorithms of the financial world. Nevertheless, it is clearly the basis of a person’s risk appetite.  We refer to this more intuitive approach as ‘subjective risk assessment’.

‘Objective risk’, then, is data driven and involves a combination of sophisticated statistics, model making and expert judgement.  ‘Subjective risk’ is risk as we actually feel it, experience it and act on it. Subjective risk is often questioned and criticised because it is at odds with the statistics and calculated probabilities, but this is what a person feels and experiences, this is their risk appetite. These worries and anxieties or seemingly unaccountable daring are in their nature; they cannot just be swept aside as ‘irrational’.

Financial professionals have responded to the regulatory requirement to assess Risk Appetite with a wide and varied range of questionnaires. Naturally enough, these were framed by the industry’s objective approach to risk. Customer engagement in the process is therefore very much on the terms of their advisor and the objective approach to risk that they are familiar with.

Financial Advisors cannot be expected to add coaching psychology to their skill set, but, if the goal is to match investments to the client’s risk appetite, they need an approach that facilitates a better balance between their own professional framework and the risk perceptions of their clients. To add to the complexity, few clients will be able to clearly articulate their own risk dispositions because they operate for the most part at an unconscious level, steered by the heuristic principles and intuitions that they have developed.

The challenge

This is precisely the challenge addressed by Risk Type. This is a framework based on consensual neurology and personality psychology research and it provides a very accessible and easily communicated model that is informative for clients and their advisors.

First and foremost, financial advising helps clients to make good, responsible decisions in the face of uncertainty – decisions in which the client knows the score, both in objective risk terms, and in terms of a grounded and perceptive understanding of their own risk dispositions. Our understanding of decision making is at the core of the Risk Type model.

There are two neurological processes at work in decision making:

 

“Decision-making draws on both the analytical and the emotional systems in the brain”

From “INNOVATION Managing risk, not avoiding it”

Annual Report of the Government Chief Scientific Adviser 2014.

 

On the emotional side, every individual falls somewhere between the fearful, pessimistic, apprehensive end of the scale, and the confident, optimistic, imperturbable end. The analytic or rational dimension is about a need for understanding, coherence and certainty. At one end of the scale, people are controlled, conventional, prudent, systematic and deeply discomforted by uncertainty. At the other end, are those attracted to novelty and excitement challenge convention and are open minded, adventurous and unconcerned about details. Again, everyone will fall somewhere between these two extremes.

Psychometric measures, based on the analytic and emotional parameters, confirm that they are independent of each other (Diagram A). Arranged orthogonally, they define the ‘compass points’ for a continuous 360^o spectrum of risk dispositions.

Many people will be placed close to an extreme on both scales and the additional four intermediate  Risk Types (diagram B) represent people that are influenced by both the neighboring Risk Types. For example, the Wary Risk Type at the top has two reasons to be risk averse; they are fearful (Intense) and they are troubled by uncertainty (Prudent). Similarly, at the bottom of the compass, the Adventurous Risk Type has two reasons to be risk taking; they are both excitement seeking (Carefree) and they are fearless (Composed).

For practical convenience, then, the 360^o gradation of risk dispositions can be segmented into 8 distinct Risk Types reflecting the range of possible combinations of emotionality and rationality. This is the ‘shape’ of subjective risk, or human factor risk. It differentiates people in ways that they recognize, that their colleagues and partners recognize and that provides accurate description of teams, professions and organizations. You are no more likely to encounter one Risk Type than any other because in the wider population, there are very evenly represented. However, within different professions and organizations, the balance of Risk Types can be very distinctive. Risk Type is a remarkably good differentiator and, as the following examples show, it has real life consequences.

Essentially, risk appetite is a consequence of individual differences in personality. For some, risk taking is simply a consequence of being relaxed and easy going and not taking enough care; for others it is their need for excitement that gets them into trouble, or perhaps not adhering to rules, not bothering to plan ahead or research decisions, being impulsive or spontaneous, or just because they like to do things differently. Alternatively, for some, risk taking is more about missed opportunities. They miss the boat because they are inflexible, excessively anxious or troubled by uncertainty; too rule bound to see other possibilities or because they fear failure.

The diagram above gives an indication of the scope and utility of Risk Type and the specific focus for each. Risk Type Compass reports describe the risk appetite of clients comprehensively and in terms that are immediately meaningful. The language articulates a clear and coherent framework from which to consider “the amount of risk that one is prepared to accept, tolerate, or be exposed to at any point in time” (FSA, 2006). Clients appreciate the insights that are brought into focus by this process. They are offered an account that is consistent with personal experience. The model is also very easily assimilated into FA practice. Intermediaries quickly become familiar with the typology and are able to facilitate clients in their decision making. Armed with the self-knowledge afforded by their Risk Type assessment, clients become more than ‘bit part actors’ in the process and are able to contribute and play a full part in the discussions that are clearly all about them.

The FA’s task has often assumed a style of customer education, simplifying the complexities of the market for the benefit of the financially naïve. The typical ‘how would you feel if…’ scenario questions that are so prevalent are not a helpful way to develop client insight. This approach stems from the presumption that the task is to initiate the client in the ways of finance. That is partly true but it is not the crux of the matter. There can be no meaningful discussion without establishing a consensual understanding about the client’s risk dispositions and their implications.  This is surely necessary for both parties if they are going to play their respective parts fully? This is a mutually beneficial process that establishes a purposeful and professional basis for fruitful collaborative relationships.

 

Geoff Trickey, 2018