The Second Law of Thermodynamics and what it means to Risk Management

by Jeffrey Cavignac, CPCU, ARM, RPLU, CRIS, MLIS – President, Cavignac & Associates
A friend of mine related a conversation he had with his brother-in-law who happens to be an ER Doc. He asked him how they possibly maintained order in the chaotic environment of a Hospital Emergency Room. The Doctor pointed out that the main purpose of an ER was to treat traumatic medical events and bring calm to the injured as well as to the individuals and families involved. The doctor mentioned that managing these processes reminded him of the Law of Entropy. Well my friend hadn’t paid much attention in his Physics class so he asked for an explanation. Turns out the law of Entropy is expressed in the second law of thermodynamics. The law predicates that the natural state of all things from the tiniest atoms to the largest of galaxies is that of disorder. In layman’s terms, without appropriate systems or balances in place everything wants to fall into chaos. The Doc’s point was that an Emergency Room must be constantly monitored and have systems in place that prevent the facilities from falling into disorder every time an emergency is brought in to the hospital.

This is true of any process and Risk Management is an excellent example. To effectively manage risk, one needs to:

1. Evaluate what can go wrong (what are the risks)

2. Develop strategies to reduce the frequency and severity of those risks

3. Determine what part of the risk you may want to transfer (often to an insurer). You then need to make certain you

4. Monitor the risk and make adjustments.

In order to do this correctly you develop individual procedures and policies. But how many times have you addressed an issue within your company, communicated it to your staff, then assumed it was being done correctly, only to find out later that it wasn’t?

A good example is Project Intake. An engineering firm we represent has an excellent Project Intake Process they use to determine whether or not a certain project is go/no go. It asks questions about the client, the financing, project type (is it desired and appropriate for the firm), budget, schedule, etc. Project Managers are supposed to review the forms and if there are enough negative check marks, it is ramped up to senior management. Work has been tough to get in the last 5 years, firms have been scrambling, and when this happens, discipline tends to deteriorate. When the lawsuit came in the managing principal immediately wanted to see the Project Intake Checklist. This was a mixed-use retail/residential project (one the firm didn’t have much experience with) being developed by a company that had a history of suing their design professionals. The project was thinly capitalized and the schedule was unrealistic. How did this get through the Client Intake filter? What went wrong?

If you are like me, first you wonder if it is your staff’s lack of discipline. Maybe it’s your managers inability to manage? After all, I built the process and taught them how it works, why isn’t it working? I suppose this is a natural response and possibly there could be poor employees or ineffective management but more often than not I need to look back to determine if I have put in place the right systems to monitor the processes that I set up to begin with.

The old adage of “That which gets measured, gets done” holds true. You can’t simply develop systems and processes and forget about them. You have to also build procedures to measure and monitor those systems and processes. If there is no monitoring system in place you may not see the problem until it’s too late. All of the time and energy that your organization spent to develop the original systems will have been for naught.

Just like an emergency room must have systems in place to make certain traumatic injuries are handled correctly, your risk management program must also have monitoring processes to prevent it from falling in to its natural state…Chaos! What systems does your company have in place that will prevent the Law of Entropy from taking its toll on the risk management efforts of your company?