Why Government Takes Calculated Risks

Flood insurance? Bank deposit insurance? Pension guarantees? Home loan guarantees? No private sector business would take on some risks that the federal government agrees to bear on behalf of the broader society—at least not at an affordable price.

So government, by nature, oftentimes puts itself at financial or reputational risk on a regular basis. Risk is not necessarily bad. After all, avoiding risk might mean that the Federal Aviation Administration would ground all flights to prevent crashes. So, finding ways to manage risk is essential. In a new book, Managing Risk and Performance, Tom Stanton and Paul Posner observe that “the government agency often has a dual risk responsibility: not only to minimize risk to its programs but also to minimize risk to the broader economy and society.”

They say: “Indeed, one of government’s essential roles is to absorb risks so that the economy as a whole, as well as special categories of individuals and groups, may enjoy greater productivity and income. In protecting the private sector from undue risks, government often exacerbates its own fiscal and managerial risks.”

But unlike private sector risk managers, government often undertakes an even greater risk because it frequently acts through third parties rather than directly delivering services itself. NASA’s space shuttle Challenger was built by contractors, not government employees, but it assumed the risk of its disastrous explosion. Likewise, HealthCare.gov was built by contractors, but the government assumed the risk of its failure. And the Environmental Protection Agency often must rely on states to meet its goals, even when the same states disagree with EPA’s regulations, and the federal government faces risks that its partners will not follow through.

So what can public executives do to reduce risks that they largely cannot control because third parties are acting on their behalf? Stanton and Posner offer five strategies:

Choose the right “policy tool” upfront. Reducing or managing risk has to be top-of-mind when policy makers are developing a new policy or program in the first place. Different “policy tools”—grants, contracts, tax incentives, loans, subsidies, regulatory sanctions, etc.—work better in some circumstances than others. Picking the right policy tool upfront can have a big influence on success.

Ensure the design of the policy tool works. The authors note that some improperly designed programs are “crippled at birth.” For example, the student loan program was originally designed to be delivered by third-party lenders. Historically, that led to significant risks and high default rates, as well as high loan rates. The program was ultimately redesigned to be directly delivered by the federal government.

Select responsible third-party providers. Screening and preselecting providers of federally funded services based on past performance is the ideal, but some policy tools (e.g., tax expenditures) do not meet this standard. Stanton and Posner say: “Lacking a strong screening mechanism, agencies that administer these tools often seek to shift the priorities and values of established provider networks from within.” Which is not an easy task.

Exercise administrative oversight. This is the most traditional tool for ensuring accountability—and sometimes helps manage risk—but oftentimes oversight is hindsight not foresight. As a result, risks are not managed proactively but rather reactively. Traditionally, compliance reviews are conducted by auditors, but the real need of program managers is real-time, predictive information to preclude a particular risk—for example, excluding a doctor from participating in Medicare because of past bad performance, rather than trying to recover lost funding later.

Collect, analyze and report information in real time. Probably the most powerful way to reduce risk in programs delivered via third parties is to increase transparency and ensure program managers have easy-to-understand data analyses. The 2009 Recovery Act includes such provisions, and this “reportedly motivated recipients to focus on making good-faith efforts to succeed,” note the authors. The recently adopted Digital Accountability Transparency Act will ultimately extend this approach to all federal spending.

Stanton and Posner say these strategies are interdependent and emphasize that the underlying key element to reducing risk in federal programs delivered via third parties is effective communication. The five strategies they offer are all attempts to create the pathways for that conversation.

(Image via Jaromir Chalabala/Shutterstock.com)