By Hélène Galy, Willis Research Network Director, WTW
However, many businesses fail to evaluate the critical pathways in which severe operational or revenue disruption could push them towards insolvency. A clear grasp of these scenarios and an organisation’s risk tolerance, combined with sufficient cash reserves, provides a buffer against unexpected financial shocks, insolvency or default.
By setting just enough cash aside, while considering the opportunity cost of doing so, a company will have the liquidity to continue operations and meet financial obligations, even in the face of hyper-volatility where significant and unforeseen climate or geopolitical risks are more likely to occur. With robust cash reserves an organisation can, for example, quickly respond to a sudden increase in raw material costs without compromising financial stability.
Events like economic shocks, geopolitical disruptions and climate-related incidents can trigger one-off, unbudgeted losses. Financial analysis frameworks can be used to evaluate an organisation’s capacity to absorb such losses in excess of insurance in the context of its financial priorities, such as maintaining a budget, protecting credit ratings and preserving solvency.
Aligning reserve adequacy with defined risk tolerance thresholds provides a structured approach to evaluating an organisation’s financial resilience under stress by assessing the potential impact of those severe, low-probability loss events on financial performance.
We see more organisations managing hyper-volatility by building operational flexibility. Some practical examples an organisation might consider include:
Diversify revenue streams to spread across multiple products, services and markets to reduce dependence on any single source and mitigate the impact of sudden market changes or disruptions.Build supply chain redundancy to manage and mitigate the cascading effects of risks by having alternative options to continue operations in the face of disruption. With multiple suppliers and alternative production methods, a company can switch to a backup plan quicker than competitors if their primary supplier is compromised by climate, geopolitical or another driver of disruption.Digitalise to enhance operational flexibility. Cloud-based systems and remote work capabilities, for example, can help a company to continue operations despite the failure or destruction of physical infrastructure.
An organisational culture that values adaptability and innovation can prove vital for building financial resilience against hyper-volatility. When employees at all levels understand and prioritise the need to pivot and innovate, implementing and maintaining strategies that protect a company's financial health becomes easier. Continuous training, clear communication of an organisation’s risk management goals and known incentives for identifying risks proactively can help here.
Workshops on scenario planning put this in context and in practice: they leverage the problem-solving and critical thinking of employees beyond the risk functions, allowing them to better understand and then plan to respond to hyper-volatility.
By combining scenario testing, data and advanced analytics, an organisation can create hypothetical scenarios that capture the cascading effects of multiple risks, such as natural catastrophe events or geopolitical tensions, and then analyse how these scenarios would impact their supply chain and financial performance.
Consider the 2018 and 2023 wildfires in Hawaii, which had starkly different outcomes. The 2018 fire was contained with minimal damage, while stronger winds and the presence of non-native grass species exacerbated the 2023 fire, leading to significant losses. By testing scenarios that consider multiple and nuanced environmental and climate-related factors, you can better identify and then address potential vulnerabilities.
Using advanced analytics to translate stress-testing findings into financial metrics can illustrate how a severe climate event, such as a drought, could materially affect a company’s operations. Quantification of material impact helps make the business case appropriate resilience-building investments.
In a hyper-volatile environment, continuous learning and adaptation can prove essential. This is about reassessing an organisation’s risk management strategies regularly, using quantitative and qualitative methodologies and making adjustments as needed.
Staying informed about emerging risks and trends - combined with using advanced analytics to monitor real-time data on market conditions, such as fluctuations in commodity prices - means an organisation can adjust financial modelling and cost structures more effectively in real time.
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