MITIGATION AND CONTROL

MITIGATION AND CONTROL
After the risk exposure has been assessed, the next step is to consider
how one deals with it. Continuing with our street-crossing example,
one possibility would be to avoid the risk entirely and not cross the street at all (a wise strategy if the road in question were, say, Interstate 94 at rush hour). Alternatively, if we decide to proceed, the question might be the following: do we jaywalk and cross the street now, or
Risk and Risk Management 13
stroll down to the traffic signal and wait for the green light? Each of these alternatives represents an economic decision, weighing the cost of the strategy against the potential benefits.
Generically, mitigating a risk exposure entails the identification of tactics either to reduce the probability of a bad outcome, or to reduce the magnitude of a loss, should a bad outcome occur. The former types of activities, referred to as loss prevention measures, would include the cross-at-the-intersection option discussed above, or, in a more mundane
industrial setting, the inspection of electrical wiring to reduce the probability of an electrical fire. Indeed, most of the risk mitigation strategies that come easily to mind are designed to keep us out of trouble
in the first place—don’t put the gasoline can next to the furnace, don’t smoke in bed, lock your doors before you retire for the night. Loss reduction, on the other hand, describes the class of risk mitigation activities designed to reduce the magnitude of a loss, should one occur. The standard example here would be the installation of sprinklers in a warehouse, which doesn’t reduce the probability of a fire starting but, rather, mitigates the damages that result from the fire.
The explosion of boiler number six at the River Rouge powerhouse occurred during a maintenance shutdown. As far as can be determined, a valve unintentionally left open allowed natural gas to flow into the boiler, which was quickly ignited by the electrostatic scrubbers located in the boiler’s chimney.
In retrospect, it appears that the tragedy stemmed from a lack of attention paid to issues of risk mitigation during routine episodes of maintenance. Not only was the act of shutting down the boilers rare, but apparently there were no written procedures or checklists to guide the process. Employees who had not been trained in shutting off the boilers and who had last received an equipment manual in 1997, had to shut off over 30 (unlabeled) natural gas valves throughout the powerhouse
complex. They missed one, and the rest is history.
We make trade-offs in our personal and business lives between the burden of risk exposure and the cost of risk mitigation. Financing the costs associated with a bad outcome becomes the question. In personal settings, the risk financing strategy generally adopted is that of risk shifting to a third party, usually an insurance company (think about the collision and liability insurance on your car, homeowner’s insurance, or the warranty on a new appliance). The problem with this type of risk
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transfer, though, is that it creates what is known in economics as a “moral hazard.”
A colleague of mine kept a sailboat moored off the end of his dock on Long Island Sound. One day, during casual conversation, I asked about his strategy for dealing with storms and the like—as a boat owner myself, I was aware (risk identification and quantification) of the effects of heavy wave action on a boat banging against a dock. He responded that he wasn’t worried because he had insurance and he never took the boat out of the water until the end of the season. The problem here, of course, is that if one is fully insured against a loss, then one has no incentive to take (privately costly) actions to reduce one’s risk exposure. Insurance companies, not surprisingly, have figured
this out.
When my teen-aged son finally made enough money to purchase a car, it turned out that the machine of his dreams was a 1994 Camaro Z28, with a 5.7 liter V-8 engine and 270 horsepower. You might think that no insurer in their right mind would write coverage in a situation like this, but you would be wrong. An automobile insurer in Michigan was willing to provide liability coverage at a finite premium. But, there was a catch—no coverage for collision damage.3 Effectively, he has a 100 percent deductible if he wraps the car around a tree.
This retained risk has “incentivized” my son to drive carefully. This is generally the trade-off that you will find in your personal and professional risk financing decisions—increased investment in risk elimination reduces the premiums you pay per dollar of coverage, but the down side is that you are exposed to more risk.