NACD Report: "Adaptive Governance: Board Oversight of Disruptive Risks"

Members at a board of directors meeting

December 10, 2018 |

Members at a board of directors meeting has written a number of articles referencing material drawn from information provided by the National Association of Corporate Directors (NACD). We also continue to follow and read NACD white papers and press releases. The latest NACD monograph, titled Adaptive Governance: Board Oversight of Disruptive Risks, should be required reading for all captive insurer boards of directors. The following summarizes some of the recommendations found in the NACD paper and how they are germane to the captive insurance industry.

In the report's cover letter, the cochairs of the NACD Blue Ribbon Commission, which authored the report, make the following observation.

It is more important than ever before for board members and executives to anticipate changes that could affect those four elements of long-term value creation—performance, strategy, risk management, and purpose—especially developments that could undermine the validity of key assumptions on which the organization's strategy and operating model are based. Yet traditional enterprise risk management (ERM) processes may not be well enough designed to address these types of risks; by necessity, many ERM activities focus on determining the impact and the likelihood of a range of identifiable potential risks in order to help prioritize the allocation of scarce resources. [Citing Keith Baxter, "Avoiding Black Swans," De-Risk blog.] And boardroom discussions often rely heavily on reports about past performance and results, which may offer limited insight into the unconventional or unexpected.

Notice that the letter references enterprise risk management (ERM). For many captive insurers, ERM is an evolving concept. While many large single-parent captives will have an active ERM process, group captives, especially those composed of smaller businesses, nonprofits, or municipal entities, are still getting up to speed. To even suggest the board needs to move beyond the ERM concept to implementing adaptive governance will probably be viewed as a large overreach.

However, the cochairs continue as follows.

In an operating environment frequently characterized by the acronym VUCA (volatility, uncertainty, complexity, and ambiguity), boards need to help their organizations do a better job of assessing disruptive risks—those risks that, whether internally or externally driven, could have a significant economic, operational, and/or reputational impact—and to help them be better prepared to respond when they occur. We believe this task is not an optional undertaking for directors: it is a critical imperative for the boards of for-profit as well as nonprofit organizations, and for both private and public companies. 

We could not agree more. Complacency and/or the fear that this is all just too difficult to master for captive insurers is not a viable option. Sooner or later your captive will face one of these disruptive risks, and your ability to overcome the problem will be directly related to how seriously you took your role as a director and undertook the heavy lifting that was required.

Those who decide to download the entire report from NACD will notice a familiar graphic, "Sources of Disruptive Risk," on page 9 of the report. The graph used is from a white paper titled The Emerging Risks Quandary: Anticipating Threats Hidden in Plain Sight from Marsh & McLennan's Global Risk Center. It is built on the same template has referenced in the past that we have called generative governance.

Regardless of the nomenclature employed—adaptive governance, generative governance, or just plain futuring, the need remains the same: to build captive boards that are comfortable operating in an environment with a fair degree of ambiguity and uncertainty and where tangible feedback on the results of these efforts may never develop.

The NACD report proposes four bullet points, summarized below, to define "adaptive governance."

  • Directors should establish and conduct a boardroom culture that includes "open discussion, constructive challenge, and active self-reflection," according to the report. When directors are unwilling to "rock the boat," they are likely to miss the opportunity to foresee disruptive risks, the report said.

  • Diversity in directors' background, skills, perspectives, and experiences is essential if a board is to keep up with rapid changes in the business environment, the report warns. Also required is directors' commitment to "staying current with industry, technology, and societal and other trends that will have a significant impact on the organization's strategy, competitive position, and risk profile," according to the report.

  • Board agendas should include plenty of time for considering the future and how disruptive risks may affect "long-term strategy and value creation," according to the report, and also limit the amount of time spent dwelling on "past performance or 'box-checking' activities."

  • Directors should actively guide the company to improve its resiliency so it can respond profitably to disruptions that can't be predicted or defended against, the report said.

Next time your captive board meets, take a look at these four concepts and compare them against what you are doing in your meetings. The first step down this path is arguably the hardest and requires the board to acknowledge what it doesn't know and isn't doing. Either that or you can sit back and assume everything is fine and you are doing a wonderful job with your captive's governance.

December 10, 2018