The Psychology of Risk

The psychology of risk deals with the mental processing we undertake in perceiving, evaluating and responding to risks. This involves both cognitive and emotional processes with our decisions highly influenced by both cultural and social factors.

One key insight from the psychology of risk is that people do not always make rational or objective decisions when faced with assessing risks. Instead, our perceptions and judgments are influenced by a variety of factors, such as our past experiences, our emotions, our beliefs and values.

The psychology of risk is a multidisciplinary field that draws from, amongst others psychology, sociology and economics. Understanding the psychology of risk is important because it can help both individuals and organisations make better decisions about risk management, such as those related to health, safety, finances, and the environment.
Why are people generally bad at understanding and assessing risk? The primary reasons are mostly due to how our brains operate, how our brains conserve energy and our personal experiences.

Cognitive bias is a systematic thought process caused by the human brain’s tendency to simplify information processing through a filter of preferences and personal experience. This process is a coping mechanism that enables the brain to prioritise and process large amounts of information quickly. There are well over 150 different cognitive biases affecting our thinking and perception and the following are a few that relate closely to risk management.

Availability bias is a type of cognitive bias that helps us make fast, but sometimes quite incorrect assessments by relying on information that comes to mind quickly or is the most available to us. For example, people often overestimate the likelihood of rare but highly important events, such as plane crashes or shark attacks, while underestimating the risks of more mundane but potentially more harmful events, such as car accidents or heart disease. This phenomenon is thought to reflect the influence of media coverage and other sources of information on our perceptions of risk.

Another key factor influencing the psychology of risk is Perception bias and our tolerance for uncertainty and ambiguity. How people perceive risks can influence how they feel about them, and how they respond to them. People may be more likely to perceive risks as high if they are unfamiliar with them or if they believe they have little control over the situation. Additionally, cultural and social factors can play a role in shaping our attitudes toward risk, such as the influence of group norms or the perceived trustworthiness of the authorities communicating the risk. As an example, if someone is a supporter of a political candidate, they may only hear and remember the points that support their candidate’s position and overlook or forget the points made by the other candidate. This is because the person’s beliefs and expectations are influencing their perception of the information presented.

Influence bias is another cognitive bias that occurs when people are unduly influenced by others in their decision-making process. This bias can lead individuals to make decisions that are not in their best interest or that go against their values, beliefs, or preferences. For example, people are often more likely to follow the opinions or behaviours of those they perceive as authority figures, such as their bosses or experts, without critically evaluating the information provided or arguments presented. Similarly, herd or pack mentality can cause people to conform to the views of their peers or social groups, even if they do not agree with them.

Emotions such as fear, excitement and anxiety play an important factor in the psychology of risk. The Optimism bias refers to our tendency to overestimate the likelihood of experiencing positive events and underestimate the likelihood of experiencing negative events. An example of optimism bias is the belief someone has that they are unlikely to get a serious illness, even though they have several risk factors for the disease, such as a family history and poor lifestyle habits. This is the typical “it won’t happen to me” scenario, despite statistical evidence suggesting otherwise. Optimism bias can be helpful in some situations, as it can motivate for taking a risk, however, it can also lead people to make unrealistic plans or fail to adequately mitigate for potential negative outcomes.

A few more cognitive biases that can have an impact on risk management thinking:

• Confirmation bias – the tendency to seek out information that confirms your own existing beliefs and ignore information that contradicts them, can lead people to overlook important risks or fail to consider alternative viewpoints.
• Anchoring bias – this occurs when people rely too heavily on the first piece of information they receive when making decisions.
• Overconfidence bias – overestimating one’s own abilities and underestimating the likelihood of negative outcomes.
• Hindsight bias – the tendency to believe that events were more predictable after they have occurred. This can lead people to overestimate their ability to predict future events and underestimate the role of chance and uncertainty in risk management.

In conclusion, understanding the psychology of risk is important because it can help both individuals and organisations make better decisions about risk management. As risk managers, we need to have an understanding of the psychology of risk. How often have we heard from some senior executives that “We don’t need anyone telling us how to run our business and telling us what our risks are. We know how to run our business and we know what are risks are’. In order to mitigate against these cognitive biases we must consider the following:

• Ensuring that our organisation has a formal and effective risk management plan in place.
• Seeking out diverse sources of information, challenging individual assumptions and beliefs, and seeking out expert advice.
• Developing strategies for effective risk management, taking into consideration factors such as perception, emotion, cognition, and culture.
• Using a selection of different tools/methods for broadly assessing risks such as self-assessments, surveys, workshops and questionnaires.
• Having systems in place tracking key metrics such as key indicators, trends, near misses, incidents, predicative analysis, what ifs etc. Whilst risk management is part art and part science, things (including people) cannot be managed if they cannot be measured.
• Conducting regular independent audits of the risk management process including the auditing of processes, risks and controls.

A final example of a cognitive bias is asking a large group of people whether they consider themselves an above average driver. The results normally show around 75% claiming to be above average when we know that half need to be below average as not everyone can be above average. People have a tendency to overestimate their own abilities and this is known as the illusory superiority.

An excellent website for an explanation of cognitive biases is https://thedecisionlab.com/biases.

Warrick Asher
General Manager – Business Development, BarnOwl GRC.