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Afraid to make risky business decisions?

Two HP Labs researchers want to offer you insurance


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It’s not that we want to make people more risk seeking. It's that we want them to be risk neutral.

By Simon Firth, Nov. 2005

Experts say it threatens the CIA, the US military, corporations and governments around the world.

In a recent speech to the Joint Services Conference on Professional Ethics, Lt. Colonel William Bell of the US Army called it "possibly the greatest danger facing us today. It undermines everything that our Army is supposed to value and stand for."

What is this menace? It’s the fear of taking risks.

It’s not something you'd expect to find in the gung-ho military or in supposedly buccaneering industries like high tech. But the problem is very real in both, says Bernardo Huberman, Senior HP fellow and director of the Information Dynamics Lab at HP Labs.

Decision insurance

Whenever an organization gets to be larger than just a handful of employees, Huberman explains, its executives often become risk averse – even when the riskier of two possible actions could considerably benefit their organization.

"Most organizations consider taking risks as an essential part of their success," he notes. "Yet few have policies to encourage risk-taking by managers and employees."

During the past year Huberman and Labs colleague Tad Hogg have studied this problem and developed a novel idea for solving it – what they're calling "decision insurance."

An offshoot of their lab's ongoing research into market mechanisms for pricing utility computing and the dynamics of electronic communities, decision insurance could be a model for how to get executives to do what corporations want and need them to do – make smarter decisions about the risks they are asked to take.

How organizations become risk-averse

It's not hard to see how the problem of risk-averse decision-making arises.

In the military, says Huberman, "if you're concerned about promotions in your career, the important thing is not to have a single blemish on your record."

Similarly, he says, sales managers are often faced with the choice of pursuing an old account or spending time on a risky, but potentially profitable, new line of business.

This happens in part because individual employees' interests may not always be aligned with those of their organization, adds researcher Hogg.

"If you're an individual salesperson," he suggests, "your bonus usually depends on whether your particular sales happen or not. But from the company’s perspective, one particular sale is not as important as the total sales for the quarter or the year."

In such cases, explains Hogg, an employee is being rewarded for an outcome (closing a particular sale) and not for the decision behind it (which, if different, might have opened up a new market for the company).

Encouraging risk-taking

One way to make people focus on decisions rather than outcomes is to allow them to feel free to fail – in other words, to take more risks.

"It’s not that we want to make people more risk seeking," cautions Huberman. "It's that we want them to be risk neutral. Then they will be able to evaluate potential opportunities in a rational and objective way."

But how should you do that? Well, why not offer insurance against making a wrong (i.e. unprofitable) decision?

Insurance pool

In a proposal outlined in a recent paper Huberman and Hogg recommend grouping decision-making executives into a pool, just as insurance companies pool drivers or home owners.

Each group member would pay a regular premium into the insurance pool, which would be used to compensate anyone whose bonus, perhaps, was lessened because of decisions that didn't pay off.

"This shifts the risk from you to the organization," Huberman says. "It encourages you to be less risk averse, and it aligns your interests with those of the company."

Eliminating "moral hazard"

There's an obvious problem with this idea, though. If I have such insurance, what's to stop me from making a series of not just risky but bad decisions? However much I blundered, I'd still be covered, right?

This is a common issue with any insurance – known as the problem of Moral Hazard. How Huberman and Hogg solve this problem for decision insurance is one of the most innovative things about their idea.

With house or auto insurance, laws prevent Moral Hazard from being a problem. It's illegal to burn down your house, for example, and then claim the insurance.

Peer network feedback

In the case of decision insurance, says Huberman, the answer is to tap the peer network of an insured employee. Every member of an organization has a group of people, "who create a consensus as to whether or not you’re doing your job," he says. "This is why people worry about their reputations.”

These people, along with your manager, are in a best position to know how serious you are about your work and what your track record is, says Huberman.

To make sure the group is a true reflection of an employee's peers and not just a selection of their friends (or twisted by another party to include only their enemies) Huberman and Hogg tapped into some of their lab’s work on the dynamics of electronic communities.

Finding true peer groups

In a widely publicized experiment, they found that by simply analyzing the ‘To’ and ‘From’ headings of internal e-mails, it's possible to establish the group of people with whom anyone most often interacts.

Often, that group has very little to do with a person's organizational position. "You might belong to Lab X, but have most of your peers in Lab Y," says Huberman. "And your manager might not even know that."

An established peer group can offer insight into the quality of a member's decisions, independent of whether those decisions paid off in terms of outcome (e.g., money made, military battles won, legislation passed or customers served).

Putting the company's interests first

By doing this you are now rewarding effort rather than outcomes, adds Hogg.

"The easiest thing to compensate for is outcomes," he says. "But what an organization would really like to figure out is, are you making good decisions based on the information you have? A mechanism like this can encourage people to put the company's interests first when they’re making their decisions."

In some ways this model is like profit sharing, where some part of all employees' compensation is based upon the company's overall profits in a given period.

In very large organizations, the connection between what any individual does and the company's profit is often extremely weak.

"With the decision insurance," explains Hogg, "you can choose the appropriate group size. So among a group of sales people, for example, any individual can have a big impact on that group –and thus on their bonus as well. This way, when you are deciding between a more or a less risky project, you understand what the result will be for either your insurance payout or profit-sharing payout."

Setting insurance premiums

Hogg imagines that such insurance might be a mandatory part of a particular group's compensation package, or it could be something that people have the option to buy – it would depend on how risk averse they were as a group in the first place.

In the latter case though, what if the only people who take the insurance are the 'losers' in a group? This is another well-known problem in traditional insurance, called Adverse Selection.

Although the example used in the researchers' paper assumes that all individuals are the same, Hogg says he expects that the insurance mechanism would evolve so that premiums could be adjusted based in individuals' track records. In extreme cases, when people are really bad at their job, they might not be offered insurance at all.

Realistic proposition

Given the proprietary information that decision-insurance adjusters would need to set realistic rates, it's most likely that such mechanisms could only be set up within individual companies.

But that also makes this kind of insurance a realistic proposition.

Hogg and Huberman were inspired to think along these lines by the work of influential Yale economist Robert Shiller, who has argued that even in economies such as America's and Europe's, people are generally underinsured. Shiller would like to see people offered career insurance, for example.

Proposal attracting interest

The idea is exciting interest. Huberman recently presented the group's work to the business school at the Federal Institute of Technology in Zurich, Switzerland, and at an international conference on risk in Toledo, Spain.

“Many of the executives that come to these seminars complain about the same problem," Huberman reports. "Their subordinates are too risk averse, especially in Europe."

Will HP ever adopt such insurance? Huberman and Hogg aren't sure.

"The role of research is to create options for the company," notes Huberman, "and this, certainly, is an option."

Simon Firth is a writer and television producer living in Silicon Valley.

Related links

» Taking risk away from risk taking: decision insurance in organizations
» Information Dynamics Lab

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Bernardo Huberman and Tad Hogg
From left: Bernardo Huberman, Senior HP Fellow and director of the Information Dynamics Lab and researcher Tad Hogg


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