No company wants failures to occur in their operations, but even with all the preventive measures, failures occur from time to time and often have serious financial consequences.
You have to know how to manage the failures and losses that occur. Routine administrative tasks, such as gathering loss data across different business areas, documenting exceptions, calculating gross loss data, allocating appropriate capital and reporting risk exposure to senior management and the board of administrators require a lot of time and effort.
An efficient loss control mechanism that monitors losses across the company has become increasingly important.
The first step, and the main focus of this post, is to understand the loss event, how to classify it, and why it is important to record it.
What is an internal loss event?
Internal loss events can be viewed as real, potential and “near loss” events experienced by an organization:
- Real loss – an incident that has a negative financial impact on business;
- Potential loss – an incident that has been detected that may or may not result in financial losses;
- Near loss – an incident detected by means other than standard operating practices (even by luck) or by specific management actions that result in a zero or positive financial impact (it should be noted that a near loss can result in financial gains).
Sources of loss events can be understood in two ways:
- the result of a new risk for the organization, leading to a loss event;
- the result of a lack of control or control failure of an identified risk.
Why are they important?
Tracing internal loss event data is an essential part of risk management and contributes to risk assessment and monitoring. By consistently gathering loss event data, organizations can:
- measure risk exposure more accurately;
- justify the cost of new or improved controls and compare the effectiveness of controls;
- identify trends and lessons to learn over time;
- use loss data as a potential input for capital calculations.
Robust risk management requires a sufficient amount and quality of data for analysis to be meaningful and for decision making to be effective. Thus, data integrity is important in any loss event database.
How to classify a loss event?
Before classifying a loss event, limits should be defined that characterize a loss event as a real, potential or a near loss event. Loss events that exceed these limits should be registered and classified in an internal loss event database.
An important knowledge base
Losses resulting from a failure or lack of control and/or unforeseen events may be thought of as representing a vision of the past, while risk management should be forward-looking. However, events that have already occurred may recur and result in more significant impacts. To this end, seizing the opportunity to learn from hindsight can be helpful in forecasting and predicting.
When implemented effectively, the positive results of an internal loss event process are not just better informed responses to current risks, but also better informed management of future risks.