Made to Measure
At Stevens Institute of Technology, leaders have implemented risk-based financial metrics. Their strategy for ensuring that all threats are gauged: identify, measure, and report.
By Randy Greene, Chuck Shaw, and Ron Salluzzo
The University Risk Management and Insurance Association now represents approximately 540 institutions—nearly double the number a decade ago. Risk management functions play an increasingly important role in universities, as institutions aspire to help everyone on campus become more aware of potential problems before those dangers become a reality. These risk and compliance functions are as critical in small and medium-sized organizations as in larger, multicampus research organizations.
The dynamic that has taken place at Stevens Institute of Technology, Hoboken, New Jersey, focuses on understanding enterprise-level risks; correlating those risks to their potential impact on institutional strategy; and then measuring, monitoring, and reporting those risks to the board. We collectively serve as members of the university's board and senior leadership team and have recognized that one of the most important parts of our enterprise risk management (ERM) program has related to our ability to complete not only the ERM tasks, but to communicate the key components of the program to our board, as well as campuswide.
One challenge any university faces is the balance between the amount of information to share with boards and the form that information should take. We have found that there are two reasons boards are often relatively uninformed about the business of the institution: (1) senior leaders tell the board everything they know, without filtering the information for importance, or (2) senior leaders tell the board very little. In either case, the absorption of knowledge by the board is about the same.
We make every effort to strike the right balance and deliver the appropriate level of information to support the board's stewardship responsibilities, believing that boards are most effective when they are focused on strategic issues rather than on the everyday operations of the institution.
In our respective roles, we clearly recognize the need for campuswide awareness of the importance of identifying, monitoring, and reporting such risks—and even more so at the board level. In determining the best way to prepare for this kind of strategic governance, we also consider the following factors.
Board members who generally work in the for-profit arena often struggle to understand the business of higher education. Lacking an understanding of the industry and institutional risks, such members will default to what they believe to be critical. For example, at Stevens we realized that trustees and executive management needed a better understanding of what is meant by “operating cash,” which is a relatively straightforward concept in the for-profit world. While colleges and universities do pool their operating cash over time—as do for-profit organizations—for higher education, cash may not be entirely fungible. That is, external sources (such as donors who place restrictions on resources), internal designations that specify certain expenditures, or policies that result in operating funds generated from retention of department surpluses all have an impact on budget options; there must be enough cash to satisfy donor constraints and internal resource-allocation decisions.
Since both the environment and the institution are constantly changing, historical solutions likely do not apply to current issues. To meet the challenges of a growth strategy in a demanding, dynamic, and evolving engineering and technology industry, we needed to focus on key elements that allow the organization to increase agility and flexibility.
The 2008 financial crisis caused a liquidity concern, and from a stewardship perspective the management of cash balances and lines of credit has increased in importance. At Stevens we're taking a holistic view of the short- and medium-term sources and uses of university resources and have added a liquidity measure to the metrics we use to manage our finances. The measure we have adopted comes from Strategic Financial Analysis in Higher Education, Seventh Edition (KPMG, Prager Sealy and Co., and Attain, 2010).
The information we developed regarding liquidity sources and uses, counterparty exposure, demands for cash, and any operational changes across the institution that can alter our liquidity position have been completed on a comprehensive basis. We've established a target liquidity measure of 1:1—defined sources and defined uses—and the plan to achieve that level influences both our operating and capital decisions. As an example, if we have an opportunity to purchase fixed assets from existing resources, in addition to assessing the impact on ratios—such as the primary reserve and viability ratios (expendable net assets becoming non-expendable)—we think about the impact of the use of cash, over the short and longer term.
More broadly, over the past several years Stevens experienced significant growth. In the middle of this expansion, the 2008 economic downturn was a unforeseen event that placed an increased emphasis on the careful management of financial metrics. In response, we created a board and senior management-led enterprise risk management program. ERM processes have a better chance of being effective when the institution engages the board and staff in a meaningful way to ensure that everyone understands the key financial issues the institution faces. Such engagement also facilitates participation in creating or implementing strategic solutions.
ERM at Stevens focused on three priorities:
- Identify key institution-level risks.
- Monitor those risks by designing and tracking specific metrics.
- Vest responsibility in the board and its committees to report on and manage the process, taking appropriate action when necessary.
The goals of this program are (1) an improved understanding of the financial drivers of the enterprise, (2) better communications within the board and senior leadership of the key risks that the university faces and the management of those risks, and (3) improved board committee activities based on better understanding of the metrics that affect the work at the committee level.
Guiding ERM Framework Development
To accomplish these goals, we knew we needed to directly involve the board as well as key members of staff campuswide.
Board engagement. We engaged the board in this process by asking three questions regarding communication, measurement, and monitoring:
- What do board members expect the institution to tell them and why?
- What data does the board want to see and how often?
- What actions should the board take based on the data, and what does the board do about situations in which results don't match expectations?
Campuswide involvement. Beyond the board's role, we created a structure (see Figure 1) that would give everyone at Stevens a common understanding of ERM, their particular risk responsibilities, and the way ERM would affect their overall roles. Staff support for this initiative is provided by an internal structure that includes:
- A risk and compliance steering committee composed of the senior officers of Stevens and chaired by the provost.
- A risk and safety task force.
- A university-compliance working group.
- Chief risk officer and compliance office positions.
- A department of environmental health and safety.
- An expanded internal audit function.
- The audit committee's endorsement of the ERM initiative.
Digging Into the Details
We developed 10 enterprise-level risks, all of which we selected because of their high strategic impact, and we ranked the likelihood of occurrence of each as high, medium, or low. Each risk was selected based on the current circumstances at Stevens, and we expect modifications over time as circumstances change.
- Effectiveness and efficiency of financial operations.
- Facilities renewal and optimization.
- Adequacy of human capital.
- Conflicts of interest.
- Disruption of operations.
- Fundraising sufficiency.
- Health and safety.
- Regulatory compliance.
- Sponsored research (related mainly to volume uncertainty).
- Student success.
Within each of the identified vulnerabilities is a hierarchy of other elements: a series of sub-risks, with selected metrics we use to monitor the risk level; and a scoring system, which estimates the strategic impact and likelihood of each risk's occurrence.
At Stevens, the likelihood of our first five high-priority risks occurring and strategies for mitigating the risk are illustrated in Figure 1.
Make the Connection
The critical factor of this program is linking these metrics with the institutional assessment of risk, and requesting committees of the board to consider these measures as part of their normal deliberations. We have agreed to use certain metrics that allow us to monitor the institutional exposure on each of the identified areas of vulnerability and to understand whether a particular risk is increasing or decreasing in likelihood. As part of our planning processes, these metrics are built into the measurements used to assess success of the strategic plan.
We have augmented our metrics with key performance indicators in specific areas. One important component has been to limit the number of metrics to those that are critical. This is an area where less is more, if the program is to maintain an enterprise characteristic.
The information for the first 5 of our 10 identified risks answer four high-level questions:
- Are resources sufficient and flexible enough to support the mission?
- Are resources, including debt, managed strategically to advance the mission?
- Do asset performance and management support the strategic direction?
- Do operating results indicate the institution is living within available resources?
We believe that answers to these questions—considered in the context of the institution's liquidity—provide the board with sufficient detail to understand the financial condition and operating performance of the institution in a way that guides effective and timely decision making.
The answers to the questions also translate into the Composite Financial Index, or CFI, for the institution. This is a single measure of financial health and allows an institution to translate the answers to the four questions into an understanding of institutional financial health.
CFI as a Critical Financial Measurement Tool
Figure 2, “Composite Financial Index Schema,” visually illustrates the verbal descriptions in Figure 1, and shows their relationship to the Composite Financial Index, which is used by many institutions to determine current financial health of the enterprise and highlight areas of concern or weakness. The CFI is described in detail in Strategic Financial Analysis in Higher Education, Seventh Edition. This single index—which can range from negative scores to a high of 10—is the composite of the four ratios that relate to the four top-level questions noted earlier. The index is a powerful measure of overall performance that allows quantification of the affordability of the institution's initiatives as described in the strategic plan, which assists the board in its decision-making processes.
The numbered notations in the lower part of Figure 2 (–4 to +8) indicate the actions that institutions with those particular indexes might take to increase their CFI or remain at their current strength of performance.
Figure 3, “Cumulative Values for Stevens Institute's Peer Institutions,” presents the computation of the CFI for a sampling of institutions of Stevens's size and type. These calculations show that overall the peers have a CFI of 3.39 as of FY10.
Given that the highest possible CFI is 10, a score of 3.39 indicates that the institutions' leaders collectively should focus on reengineering their institutions. Time should be spent thinking about how the institutions will compete in the future. These ratios and values are crucial in informing discussions at the senior leadership and board levels.
Currently, the CFI for Stevens is somewhat lower than that of the peer group. This gap represents a competitive disadvantage for Stevens. This information has helped us frame the actions that we believe will help close the gap, as well as understand the longer-term impact of a decision with financial implications. For example, the university is working on its strategic plan for increasing market competitiveness.
In addition to ensuring the programmatic growth of the institution, the process is committed to creating results that will improve the financial position of the institution. Financial progress is measured in terms of Stevens Institute's improvements as well as in terms of our relative position against a selective and small group of peers. We have established certain goals in areas such as fundraising, and will eventually expand the plan to include virtually all areas of the institution.
The ratio map from Strategic Financial Analysis displays the various financial metrics as they appear in Figure 4, “Does the Institution Have Sufficient Liquidity?” These ratios, while relatively few in number, achieve the goal of providing a robust understanding of the institution's financial health.
We believe that identifying a few measures is better than trying to monitor a large number, assuming the measures are the correct ones. Note that the map starts with liquidity, and then moves on to establish the four high-level questions that the Composite Financial Index helps to answer. The subsidiary ratios that are presented below each of the high-level ratios are intended to provide more insight and depth to the understanding of the institutional financial position. As an example, the viability ratio provides insight to overall debt capacity, and the ratios that follow—debt burden, debt service coverage, and interest burden—provide insight into the affordability of the current debt levels.
The board and finance committee have primary responsibility for monitoring the ratios leading to the CFI. These subsidiary ratios are all within the province of the various committees of the board. In each committee these are coupled with other key metrics, to create a well-rounded view of the committee's area of responsibility.
The key to this program is the active engagement of the board, but with specific purpose. This is a continuing process and is never quite complete because as the institution evolves, the program evolves.
Our next steps include looking at the risks implied by the strategic plan currently under development, pricing the ERM plan, establishing financial targets, and monitoring the results as we move forward. Our ability to communicate our financial position and operating results in a concise fashion with predetermined standards of performance is key to our governing process.
RANDY GREENE is chief financial officer; CHUCK SHAW is chief risk and compliance officer; and RON SALLUZZO is chair of the audit committee, Stevens Institute of Technology, Hoboken, New Jersey. Salluzzo is also a partner with Attain LLC in the Higher Education and Academic Medical Center Practice and a coauthor of Strategic Financial Analysis in Higher Education, Seventh Edition.