December 5, 2006
Law Firms Ignore Their Biggest Risk
The December 4, 2006 Time Magazine includes an article dealing with the psychology of risk or "Why we worry about the things we shouldn’t and ignore the things we should."
It is well worth the read. It seems nature has left us to navigate this advanced world with a prehistoric brain. We are wired to respond to immediate threats rather than long term threats that may pose greater risk and danger. We are wired to respond to those things we dread—things that can cause pain and suffering.
The problem with this is that it leads to poor decisions. We elect to drive rather than choose the lower risk alternative of flying. We worry about mad cow disease, which has not killed one person in our country, but we continue to subject our bodies to practices that will lead to a fatal heart attack. We worry about lightning when more people die from falling out of bed. The article makes for interesting reading on a personal level, but it also has ramifications from a business risk standpoint. Misreading risks and ignoring those with higher certainty occurs in most law firms.
We worry about the gun-toting disgruntled client when a medical emergency is far more likely. We insure an important partner’s life but make no plans for the certainty of their eventual retirement. We purchase fire insurance but take inadequate steps to deal with data loss. We worry about malpractice claims and ignore the risk imposed by our aging partners.
One of the steps in strategic planning is to identify the risk faced by the business and then take steps to mitigate strategic risks—those with the biggest impact related to their likelihood of occurrence. To help our “old brains” put risk in proper perspective, planners should compute a Risk Index number for each item. A Risk Index is a computation based on likely occurrence and impact. For example, list the risk faced by the firm and assign to each a percentage of likelihood that the listed risk will occur within a given timeframe. For example purposes, let’s use 25 years.
Over the next 25 years, what is the likelihood of:
Destruction by fire
Sudden death or disability of key partner
Retirement of key partner
Server crash without recoverable backup
Major malpractice loss
Assign each a percent of likely occurrence in the next 25 years.
Destruction by fire = 05%
Sudden death or disability of key partner = 25%
Retirement of key partner = 100%
Server crash without recoverable backup= 100%
Major malpractice loss = 15%
Next, assign each an impact percentage and multiply the two to create a simple risk index.
Destruction by fire = 05% * 80% impact = 04 Index
Sudden death or disability of key partner = 25% * 60% impact = 15 Index
Retirement of key partner = 100% * 60% impact = 60 Index
Server crash without recoverable backup = 100% * 40% impact = 40 index
Major malpractice loss = 15% * 90% impact = 14 index
When one looks at risks faced by the firm in the above example using their Risk Index, the first concern of the law firm should be continuity planning. Their second concern should be taking additional steps to protect against loss of data. Yet at a strategic level, these two risks are often ignored in many firms. The two risks with the lowest Risk Index in our example are fire and a crippling malpractice loss. These are the two areas firms are most likely to have addressed at a partner level. It isn’t that those two risks shouldn’t be addressed; we just have a tendency to ignore risks of greater certainty. We do so because our brains are wired to react to some threats with fight or flight signals while ignoring other, more modern threats.
Identifying risks and viewing them from the standpoint of their risk index is one of the steps in a structured strategic planning process. Partners are not actuaries and are unlikely to precisely quantify likelihood or impact, but their collective judgment will be close enough to provide sound business insight into risks that need to be addressed from a strategic level. The law firm is a source of livelihood and wealth, and survivability should be the first objective of the business.
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Filed under Risk managment by Tom Collins