How to Determine Risk Scores: Internal and External Risks

As key indicators of any Enterprise Risk Management System, risk scores can help you identify and respond to the most pressing concerns affecting the health of your organization. In this blog post, you'll learn what they are, how they're calculated, and how to use them most effectively.

Accurate and up-to-date risk scoring is a key component of any successful enterprise risk management system.

When calibrated effectively, risk scores can help you identify and respond to risks in an appropriate fashion. Ultimately, they help support your company’s growth, reduce inefficiencies, and prevent reputational damage.

But how exactly are risk scores determined? Let’s take a closer look.

In this post we discuss:

1. Internal Risk Scores
2. External Risk Scores
3. How to Determine a Risk Score
4. The Importance of Risk Scoring
5. How LogicGate Can Help

What Are Internal Risk Scores?

Just like it sounds, an internal risk score is an assessment of any risk factor that comes from within the company. Though they can be just as damaging as external risks, internal risks are often the most difficult to identify because they rely heavily upon the company's culture of risk.

As you may have experienced, mid-level management is often more aware of potential internal risks, but have trouble securing support from upper management to put adequate mitigation processes in place.

Common Internal Risks:

• Human error, such as unintentional data leaks, union strikes, or ineffective management
• Inadequate organizational structure and reporting responsibilities
• Asset loss, including damage or destruction of company property or unforeseen costs of doing business

What are External Risk Scores?

External risk scores are assessments of anything and everything that could threaten your business from outside the company. These risks vary greatly and in some cases have few (if any) warning signs. It’s important to identify potential external risks so your organization has processes in place to react to and mitigate damage as soon as possible.

Common External Risks:

• Natural Disasters—everything from hurricanes and flooding to droughts and earthquakes
• Economic Change, including recessions and industry disruption
• Political Factors: changes in governmental policies and regulations
• Cyber Attacks, such as data theft by hackers, ransomware attacks, and the like
• Many more

How Do You Determine a Risk Score?

In order to accurately calculate risk scores, two components must be taken into consideration: risk identification and risk analysis.

1. Identify Risks

Identifying potential risks is paramount to a successful project. Risk identification should not only be performed at the earliest stages of project development, it should also be reassessed throughout the project life cycle.

Risk identification should be a key topic in status and reporting meetings. Sure, there will be some that are obvious to the team at large. These known risks are still worth identifying and discussing.

Making risk identification a focus, though, can allow organizations to uncover more nuanced risks.

2. Run A Risk Analysis

Once a risk has been identified, analysis helps you understand the threat it poses to your project or organization. This step explores the risk’s potential qualitative and quantitative impacts — which will help in creating processes to mitigate negative consequences. In other words, risk analysis is about calculating probability and likely outcomes.

3. Calculate Risk Score

The risk score is the result of your analysis, calculated by multiplying the Risk Impact Rating by Risk Probability. It’s the quantifiable number that allows key personnel to quickly and confidently make decisions regarding risks.

The following are a few guidelines for calculating risk.

Risk = probability of event x magnitude of loss

Probability of Occurrence

• High probability (80 % ≤ x ≤ 100%)
• Medium-high probability (60 % ≤ x < 80%)
• Medium-Low probability (30 % ≤ x < 60%)
• Low probability (0 % < x < 30%)

Risk Impact

• High to Catastrophic (Rating A – 100)
• Medium to Critical (Rating B – 50)
• Low to Marginal (Rating C – 10)

Why Is Knowing Your Risk Score Important?

Accurate risk scores allow your organization to design an appropriate risk-response system, complete with processes and procedures to address any incident. Risk scores not only help to lower the probability of adverse incidents occurring, they can also help to limit the damage in the event something negative does occur.

This leads to lower costs, greater likelihood of successful project outcomes, and increased customer satisfaction. Continuously assessing your level of risk and scoring both internal and external risks allows your organization to plan responses appropriately should one pass the threshold of your risk appetite.

Go Deeper with Key Risk Indicators

Key risk indicators (KRIs) are leading metrics that give organizations an early warning of potential risk events. Similar to risk scoring, they use external or internal data sources to estimate the likelihood that a risk could occur, how quickly it could occur, and the impact if it does.

KRIs are important metrics, as they act as tripwires for potential risk. They help you get ahead of risk to catch issues before they occur. If connected under a single platform, like LogicGate's Risk Cloud®, you can sync your risk data together and improve organizational communication around risk, and provide better visibility to all stakeholders.

Tie Risk To Financial Impact with Risk Quantification

Risk quantification allows you to determine the cost of a risk materializing. Being able to quantify the financials around risk gives risk leaders the tools to get organizational buy-in for the initiatives they need to kick off to properly monitor, manage, and mitigate risks.

It is the process of calculating the potential loss frequency and severity of a particular risk and translating it into financial terms. That sounds simple enough, but it's not always easy to do.

It requires a nuanced understanding of your risk landscape, a deep evaluation of people, processes, and controls, and most importantly, the ability to model quantitative analyses of risk.

For cyber risk, this is accomplished in using the Open FAIR model. It is a rigorous, quantitative approach that involves running thousands of simulations to determine the estimated financial impact (minimum and maximum) that each risk cloud carries if it occurs.

The FAIR model runs Monte Carlo simulations, which are built from repeated, random sampling aimed at producing estimates of the value of loss a risk could carry.

Monte Carlo simulations return two outputs:

• A loss exceedance curve that shows the percentage of the simulations that met or exceeded a given amount of loss in one year
• A table showing the probable frequencies and magnitudes of the loss events

How LogicGate Can Level Up Your Risk Scoring

LogicGate’s Enterprise Risk Management solution in Risk Cloud® is an agile and robust platform specifically tailored to your business.

Specifically, Risk Cloud Quantify® enhances traditional risk quantification and scoring techniques with Monte Carlo simulations and supports the Open FAIR model. You can proactively predict, manage, and mitigate risk with true financial context.

Imagine how much easier decision-making becomes in risk management when you're able to consistently use an ROI-driven approach to communicate strategy in dollars and cents.

If you're ready to start your risk quantification journey, request a demo of Risk Cloud Quantify today.