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Incomplete Risk Formulas Are Risky Business

Even a broken clock is right twice a day. But standard formulas for calculating risk leave out critical factors — such as vulnerability and submerged risks — that would more holistically and accurately assess risk. A new model addresses this.

Risk is everywhere, from business to the foundations of nature and society.

The fact that risk is inescapable means that evaluating it is not exactly a new concept, but it hasn’t always been done with the best methods or most useful tools. Casting bones and reading tea leaves produced mixed results. People with crystal globes cornered the market for a bit; followed by astrologers, Ouija boards and Magic Eight Balls.

None of these, however, could put an accurate dollar figure to the question, “What is the threat and what will the cost be if it happens?”

Eventually, an equation was developed that did try to encompass all this:

That is certainly better than a Ouija board, and many of today’s businesses — under threat from one type of risk or another — still use it.

But consider how much this formula leaves out. In Pompeii and Herculaneum, for example, some — seeing the volcanic Mount Vesuvius belching smoke — calculated the likelihood of a massive eruption and determined it was not great enough to merit precautions. The magnitude of probable damage if it should happen, on the other hand — as they could clearly calculate, and as what actually happened demonstrated — was death and destruction.

Others in these towns made a different assessment of likelihood and hightailed it out of there when the mountain rumbled. Yet the model above is wrong from top to bottom even if — for occasional threats — it may, like a broken clock, sometimes point to the right answer. It is wrong because it’s missing several critical factors that impact risk for good or ill.

The first of these is Vulnerability. The residents of nearby Naples were confronted with the same eruption at the same time, but the greater distance from Vesuvius made the level of vulnerability very slight.

A more useful model, then, would have been this:

Or, put more simply:

Using this methodology, the denizens of Pompeii living in underground tunnels and subterranean grottos might have found the risk very manageable, as their level of vulnerability would be low while both the threat and magnitude were high.

Those with homes and businesses at street level, on the other hand, might have realized both threat and vulnerability were high and skedaddled, or at least — in order to reduce the magnitude — sent their children and precious possessions off to family in Rome.

They could also have looked for submerged risks — secondary and tertiary risks that are unseen on the surface, but that must be teased out before a true picture of risk can be painted. This is a critical aspect of risk that almost every method and formula misses completely.

Finally, some threats are constant — making the notion of likelihood obsolete. For example, we know with certainty that the planet will be warmer. That is, the likelihood it will warm = 100 percent. In cases like this, where threat = 100 percent, including vulnerability is essential — as we see when people, governments and businesses take actions to reduce their vulnerability to the effects of the climate crisis, such as relocating away from the coast or building higher seawalls around their cities.

For a more thorough explanation of our risk model — and a bit about a tool we’ve built that automatically visualizes all of these risk factors — see our longer article, “A Better Way to Think About Risk.”