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Behavioural Risk Management: Is it time to reflect on how irrational we can be?

Are you an overly confident wheel spinner or a short-sighted detective? In a world in which we increasingly have access to data insights to support business and risk management decision-making, do we need to be more aware of our own behavioural flaws and cognitive biases, so that we're not the problem?


RiskSTOP Group’s Marketing & Communications Director, Johnny Thomson, explores the link between risk management and behavioural economics and offers up 4 strategies to help…

A wheel of fortune and a hand holding a dart in background, with a detective looking through a magnifying glass in the foreground

IN THE REALMS of business and risk management, understanding the numbers is just half the battle. Comprehending human behaviour is equally crucial. Behavioural risk management, an emerging field blending insights from behavioural economics with traditional risk management practices, addresses how irrational behaviours and cognitive biases can skew decision-making processes.


So what is ‘behavioural economics’?

Behavioural economics is a field bringing psychology and economics together to understand why people sometimes make irrational financial decisions.


We’ve all been there! Imagine you're in your local Tesco or Waitrose, planning to buy only a few essentials. A few minutes later you walk out with chocolate and snacks—things you didn't plan to buy. Behavioural economics studies why you were tempted to deviate from your plan, influenced by emotions, biases, and things like the store's layout or its marketing messages. It challenges the traditional economic assumption that everyone behaves rationally, showing that our choices are often swayed by various psychological factors, even when they might not be in our best financial interest.


If you expand this theory beyond the purely financial, you begin to understand that most decisions are impacted by irrational behaviours. Business and risk management are no exceptions.


Recognising our irrational biases

Imagine you're having fun at a fairground and you're facing two choices: Throw a dart to pop a balloon for a guaranteed small prize, or spin a giant wheel for a chance at a big jackpot. Most people would gravitate towards the wheel, enticed by the potential reward.


This scenario mirrors the ‘overconfidence bias’ in business, where decision-makers overestimate their knowledge or control over uncertain outcomes. It’s akin to spinning the wheel and hoping for the big win, overlooking the simple and more certain outcomes.


Another common player in our irrational ensemble is ‘confirmation bias’. Picture a detective fixated on one suspect, interpreting all evidence as pointing to guilt, while ignoring contradictory clues. In risk management, this bias surfaces when people favour information that supports their pre-existing beliefs, potentially leading to flawed risk assessments.


From theory to practice: 4 strategies to employ

To manage these biases effectively, organisations can employ four different strategies:


1. Structured decision-making processes:

Establish clear protocols that require justification for decisions and involve multiple perspectives. This method helps dilute the effect of individual biases by introducing diverse viewpoints, much like a jury deliberating a case from different angles.


2. Pre-mortem analysis:

Before finalising a decision, teams are encouraged to imagine that the project has failed spectacularly. They then work backwards to determine what might lead to this disaster. It’s akin to reading the last page of a mystery novel first, then piecing together the plot twists that led there.


3. Training and awareness:

Regular training sessions can help staff recognise and counteract their biases. It’s like having a handy little guidebook in another country, to help you understand local culture and navigate pitfalls more effectively.


4. Behavioural audits:

Regular audits can assess decision-making processes and identify bias patterns. Think of it like your car’s MOT test, but for your company’s decision-making machinery.


Making more sense of this complexity

To bring these concepts a little closer to home, let’s use the analogy of planning a family holiday, a task fraught with potential biases.


We could, for example, overestimate the enjoyment of camping in Scotland in November (overconfidence bias), or only look at sunny holiday snaps from the previous year, ignoring memories of midge bites and rain (confirmation bias).


Just as in business, taking a step back and assessing these decisions critically - perhaps by consulting all family members or considering past holiday mishaps - can lead to more robust plans.


At the same time, it’s important to understand that behavioural risk management does not seek to eliminate biases—as they are inherently human—but to understand and mitigate their impact on business and risk decisions. By recognising the quirky, often irrational ways we think and decide, organisations can better navigate the complexities of risk management. It's not about stripping away the human element, but refining it, much like honing a rough diamond to reveal its brilliance.


Through these strategies and analogies, we can see how behavioural risk management not only adds depth to traditional risk practices, but also makes them more effective, ensuring decisions are not just data-driven, but also distinctly human-aware.


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