You heard me right. Risk: Averse, Adverse, or Appetite? Which would you choose? Do we even have a choice? Read on …
We often hear that we live in a risk-averse society. By that, I mean that we don’t want to take risks, or that we’re too timid. I don’t think that’s the whole story.
In reality, we need to deal with several concepts. Let’s start by looking at risk:
- Appetite; and then
Risk Adverse versus Risk Averse
These terms are often used incorrectly, so here’s a useful comparison:
Many people are confused when faced with the choice between adverse and averse. While these two adjectives have many similarities, they are not used interchangeably.Merriam-Webster Dictionary
If you want to describe a negative reaction to something (such as a harmful side effect from medication) or dangerous meteorological conditions (such as a snowstorm), adverse is the correct choice. You would not say that you had an ‘averse’ reaction to medication or that there was ‘averse’ weather.
In short, adverse tends to be used to describe effects, conditions, and results; while averse refers to feelings and inclinations.”
A Formal Definition of Adverse
Again, the Merriam-Webster Dictionary sails to the rescue:
- 1: acting against or in a contrary direction:
- hindered by adverse winds
- 2a: opposed to one’s interests,
- an adverse verdict,
- heard testimony adverse to their position,
- especially: UNFAVORABLE,
- adverse criticism
- b: causing harm: HARMFUL, adverse drug effects
- 3: archaic: opposite in position”
This is all very well, but we need something that we can use, like a…
…Practical Definition of Risk Adverse
The Law Insider website provides a very useful definition of ‘Risk Adverse’.
It’s useful because it is so pertinent to safety. Let me explain. Often, we want to develop a product or service, but there are:
- Development risks – often called Project Management risks, as a development is often the focus of a project. Remember that the ISO 31000 defines risk as “the effect of uncertainty on objectives”. By definition, a project has specific objectives (e.g., budget, schedule, and quality).
- Procurement risks – when acquiring a new product or service and enterprise may also acquire development risks, for the new or upgraded thing. There are also risks associated with contractual acceptance, fielding the product, etc.
- In many industries and domains, regulatory approval may be needed. This may require qualification, certification, or accreditation (or a combination thereof).
- Commercialization risks include making a product commercially viable, positioning it in the market, and gaining user and/or public acceptance.
Each one of these topics is a massive subject, about which countless books have been written. Law Insider’s definition is very powerful!
So, risk aversion is about feelings and inclinations. This is such a familiar topic, that perhaps we don’t bother to explore it. Later on in this post, we will explore Risk Aversion by looking at Risk Perception.
Before we do that, let’s look at the opposite of Risk Aversion.
“Risk appetite is the level of risk that an organization is prepared to accept in pursuit of its objectives, before action is deemed necessary to reduce the risk. It represents a balance between the potential benefits of innovation and the threats, that change inevitably brings. The ISO 31000 risk management standard refers to risk appetite as the “Amount and type of risk that an organization is prepared to pursue, retain or take”. This concept helps guide an organization’s approach to risk and risk management.”Wikipedia
Risk appetite is a really interesting concept. The definition is that risk appetite is the level of risk that a person or organization is prepared to accept in pursuit of objectives.
Why is Risk Useful?
Risk is necessary because we need to take risks to do almost anything. Every time we breathe in, every time we eat or drink something, we’re taking a risk.
It’s the same for businesses, enterprises, and nations. If we keep on doing the same old thing again and again, eventually someone else will come along and outcompete us. Ironically, the risk is that we fail to adapt and cease to exist – Darwinian selection.
A great example of this is the Kodak corporation. For years Kodak dominated the photography market. However, they failed to see the promise of digital photography and didn’t take advantage of it. They were overtaken by rivals, and in the end, this mighty corporation went out of business.
So to ensure the survival of an entity, we must accept change, we must take risks. This seems to be true of populations, businesses – even software programs seem to illustrate this kind of evolutionary development .
Quantifying Risk and Appetite
In some areas of business, it’s easy to define risk appetite. Financial corporations can easily define how much loss they are prepared to accept. They can accept that a certain percentage of turnover or profit will be lost to fraud or error.
A more sophisticated business might quantify the benefit of taking risks. For example, lending more money might result in greater profits. If a business understands the relationship between risk and opportunity, it can exploit it.
Too Big to Fail
A few years ago we saw the downside of that thinking. Organizations thought they were too big to fail or too clever – they couldn’t go wrong. Some high-profile failures lead to a domino effect, whereby many institutions effectively collapsed. This was the Global Financial Crisis.
As a result, the regulation of lenders was tightened up. Banks and similar bodies were forced to keep higher reserves of cash and assets in order to survive miscalculations of risk.
How Much Risk is Enough?
So, how can we determine an appropriate risk appetite, without over-reaching ourselves?
This is a particularly difficult judgment when considering safety. Now we are not trading $ for $, we are trading dollars for injury and even death. This is a much more difficult ethical problem. There are various ways of making this judgment, for example in Australia we can refer to Safe Work Australia’s guidance.
In this article, we will consider what leads us to a distorted perception of risk.
Some researchers claim that there are three factors that cause us to look at risk and misunderstand it.
“Psychometric research identified a broad domain of characteristics that may be condensed into three high order factors: 1) the degree to which a risk is understood, 2) the degree to which it evokes a feeling of dread, and 3) the number of people exposed to the risk. A dread risk elicits visceral feelings of terror, uncontrollable, catastrophe, inequality, and uncontrolled. An unknown risk is new and unknown to science. The more a person dreads an activity, the higher its perceived risk and the more that person wants the risk reduced.”Wikipedia
I have observed that people are ready to take more risks when they think they are in control. For example, we’re more willing to take risks when driving, rather than in trains or planes where someone else is in control.
It’s interesting to recall that our risk of death per journey is the same in a car as it is in a plane. Moreover, we are three times more likely to be injured in a car crash than in an air crash. Yet, people worry about flying, but they don’t think about the car journey to get to the airport.
Therefore, if we are to think rationally about risk, we must address those three factors of risk perception – and control.
Three Risk Perception Factors
First, we must understand risk. Risk assessment helps us to do this and can help us make objective decisions.
Second, we must recognize feelings of dread, for example, fear of radiation. We must strive to understand the mechanisms that give rise to risks so that we can understand how to treat or control them. This should give us confidence, which will counteract dread.
(Also, we might explicitly identify the benefits of the risky activity. This should help us to deal with dread rationally.)
Third, we must estimate the number of people exposed to the risk. Accidents with multiple casualties cause Societal Concern and get a lot of media attention, whereas the constant background of individual casualties in car accidents goes largely unreported.
Let’s Look at Control
We often have the illusion that we are in control, and that this will prevent accidents.
The night I had my most serious car accident, I was hit by a drug/ drunk driver. I had not lost control of my vehicle and I had done nothing wrong. However, when the other car turned into my path, I could not avoid the collision.
We need to give people a realistic view of how much they really control.
If we can give people control, without real adverse effects, then so much the better. Either that or take away control completely and make sure that users know this.
Many fatalities have resulted from users misunderstanding how much control they had – for example over ‘self-driving’ cars.
All these factors are challenging to deal with. Moreover, there are a number of agents using social media to stoke and exploit public outrage. This is done for various purposes, which may have nothing to do with actual levels of risk (i.e. it not be a genuine societal concern).
Perhaps we can learn from those who manage outrage for enterprises that need it?
They work to actively and regularly present a rational view of risks and benefits. This is intended to counter the sensationalist reporting that will arise from time to time. Think of it as a regular vaccine of rationality against periodic outbreaks of emotional outrage.
Risk: Averse, Adverse, or Appetite?Conclusion
Of course, there are no guaranteed solutions or magic answers to these questions.
We will always have a subjective and visceral reaction to danger. This is a good thing, essential even. It’s a very important survival skill, and we should be afraid of things that can hurt us.
Yet, to live without risk at all is simply not possible – we will all die of something. Will we achieve something meaningful before that dread day comes?
To do anything requires us to take risks. As individuals, as a society, we need to take risks to enjoy the benefits that result. “Great empires are not maintained by timidity” as a Roman historian once said.
As in so many things, we are looking for a balance.
How much risk-aversion do you need to survive, versus how much risk appetite to thrive?
(For more on risk management, see the FAQ.)
 Les Hatton & Greg Warr, Conservation of Information in Proteins, Software, Music, Texts, the Universe and Chocolate Boxes, Heiland Lecture, Colorado School of Mines, 06 Mar 2018.