RISK

MANAGEMENT
 Objectives of the chapter
 Define what risk management is.
 Identify the characteristics of risk management.
 List the objectives of risk management.
 Understand risk management process.
Definition of Risk Management
It is the identification, measurement & treatment of

exposure to potential accidental losses where the only

possible outcomes are losses or no change in the
status.

It is a general management function that seeks

to assess & address the causes & effects of

uncertainty & risk causes on an organization
 Conti……
It is a technique of controlling and avoiding
threats to business organisation.
It involves determining, analysing and
mitigating harmful risk to an organisation’s
capital and earnings.
Moreover, is a practice which is required and
followed by every business irrelevant of their size
and nature.
It aims at recognizing the potential threats in
advance and takes all necessary steps to avoid
their adverse effects on business operations.
 Conti….
It is a continuous process & works throughout the
life of the project towards monitoring all risk factors.
It focuses on controlling all possible future
events by analysing various past information like the
probability of occurrence, historical data, lessons
learned etc.
It supports the organisation in the achievement
of their goals by ensuring that all activities are
running on their normal track.
It develops a safe and secure work environment
for all staff and customers and increases the stability
of business operations.
 Objectives of risk management
The objectives of risk management can be
broadly classified into two:
Pre-loss Objectives
Post-loss Objectives
(1) Pre-loss objectives
a. Prepare for potential losses in economic way

This involves :
 Analysis of safety program costs

 Insurance premiums

 The costs associated with the different

techniques of handling losses.
b. Reduction of anxiety
In a firm, certain loss exposures can cause greater worry

and fear for the risk manager, key executives and

unexpected stockholders of that firm.

Example: A threat of an lawsuit from a defective product

can cause greater anxiety than a possible small loss from
a minor fire.
The risk manager must minimize the anxiety and fear

associated with such loss exposures.

c. Meet any externally imposed obligations
The firm must meet certain obligations imposed on it

by the outsiders or risk manager must see that these

externally imposed obligations are met properly.
Example:
Government regulations may require a firm to install

safety devices to protect workers from harm.

A firm’s creditors may require that property pledged as

collateral for a loan must be insured.

(2) Post-loss Objectives
a. Survival of the firm
 It means that after a loss occurs, the firm can at
least resume partial operation within some
reasonable time period.
b. Continue operating
 For some firms, the ability to operate after a severe
loss is an extremely important objective.
 Especially, for public utility firms such as banks,
dairies, etc, they must continue to provide service.
Otherwise, they may lose their customers to
competitors.
c. Stability of earnings
Involves maintaining earnings per share after a

loss occurs.
This objective is closely related to the objective of

continued operations, because, earnings per share

can be maintained only if the firm continues to
operate.
d. Continued growth of the firm
A firm may grow by

 Developing new products and markets or

 Acquisitions and mergers.
Here, the risk manager must consider the impact that

a loss will have on the firm’s ability to grow.

e. Social responsibility
It involves taking responsibility to minimize the impact that
a loss has on other persons and on society.
 A severe loss can adversely affects

 Employees,
Customers,

Suppliers,

Creditors & Community in general.

Thus, the risk manager’s role is to minimize the impact of
loss on other persons.
 Risk Management Process
The risk management process has five steps to be
implemented by the risk manager:
1. Risk identification
2. Risk measurement
3. Identifying the tools of risk management
4. Selection of risk tools
5. Risk implementation
 1. Risk identification
Is the process by which a business systematically &
continually identifies property, liability, and personnel
exposures as soon as or before they emerge.
The risk manager tries to locate the areas where
losses could happen due to a wide range of perils.
To identify all potential losses risk manager needs
A checklist of all the losses that could occur to
any business
A systematic approach to discover which of the
potential losses included in the checklist are faced
by his/her business.
Sources of information that can be used to
identify major and minor loss exposures.
Physical inspection of company plant &
machineries can identify major loss exposures.
Extensive risk analysis questionnaire
Flow charts that show production and delivery
processes can reveal production bottlenecks
where a loss can have severe financial
consequences to the firm.
Financial statements can be used to identify
the major assets that must be protected.
It is the responsibility of the risk manager to
identify several types of potential losses such as:
Property losses
Business income losses
Liability losses
Death or inability of key people
Job-related injuries or disease
Fraud, criminal acts and dishonesty of
employees
Employee benefits loss exposures
 2. Risk Measurement
Includes evaluating and measuring the impact of
losses on the firm which involves an estimation of
the potential frequency and severity of loss.
Loss frequency refers to the probable number of
losses that may occur during some given period of
time
Loss severity refers to the probable size of the
losses that may occur.
After estimating the frequency and severity of loss for
each type of loss exposure, the loss exposures can be
ranked according to their relative importance.
3. Tools of Risk Management
Identifying available tools of risk management such as
A.Avoidance
B.Retention
C.Loss control
D.Non-insurance transfers
E.Insurance
 A. Voidance
Area of risk management where the goal is to

eliminate risk and not just reduce it.

It often means the elimination of hazards or activities

that can increase the chance of a loss or claim.

Involves either choosing to not engage in an

operation or chooses to shut down an operation.

Means that a certain loss exposure is never acquired,

or an existing loss exposure is abandoned.

Examples
A pharmaceutical firm that produces a drug with
dangerous side effects may stop manufacturing that
drug.
To avoid Earthquake loss do not building a plant in
an earthquake prone area.
You don’t want to risk losing your savings in a
hazardous venture, so you pick one where there is
less risk.
You want to avoid the risks associated with the
ownership of property, so you do not purchase
property, but lease or rent instead.
 Advantages Disadvantages
It may not be possible to avoid
Chance of loss is reduced to
all losses.
zero, if the loss exposure is
not acquired i.e. the risk is E.g. A company cannot avoid the
not permitted to come into pre-mature death of a key
existence executive.
In addition, if an existing If risk avoidance were used
loss exposure is abandoned, extensively, the business would
the possibility of loss is be deprived of many
either eliminated or reduced opportunities for profit and
because the activity that probably would not be able to
could produce a loss has achieve its objectives.
been abandoned. E.g. The pharmaceutical company
can avoid losses arising from the
production of a particular drug.
But, without any drug
production, the firm will not be
in business.
 B. Retention
It means that the firm retains part or all of the losses
that result from a given loss exposure.
It can be effectively used when three conditions
exist.
1. No other method of treatment is available.
2. The worst possible loss is not serious.
3. Losses are highly predictable.
When a company chooses or is forced to retain a
certain risk, they will be responsible for paying any
losses from that risk out of pocket.
Risk retention can either be done voluntarily or be
forced.
 Advantages Disadvantages
 Save money in the long run if its The losses retained by the
actual losses are less than the loss firm may be greater than the
allowance in the insurer’s loss allowance in the
premium. insurance premium that is
 The services provided by the
saved by not purchasing the
insurer may be provided by the insurance.
firm at a lower cost.
Actually, expenses may be
 Since the risk exposure is retained,
there may be greater care for loss
higher as the firm may have
prevention. to hire outside experts such
 Cash flow may be increased since as safety engineers. Thus,
the firm can use the funds that insurers may be able to
normally would be held by the provide loss control services
insurer. less expensively.
Income taxes may also be
higher.
C. Loss control
Designed to reduce both the possibility that loss will

occur & severity of losses.

It deals with an exposure that the firm doesn’t abandon.

The purpose of loss control activities is to change the

characteristics of the exposure, so that it is more

acceptable to the firm.
Thus, the firm wishes to keep the exposure, but wants

to reduce the frequency and severity of losses.

Measures that reduce loss frequency
Quality control checks,
Driver examination,
Strict enforcement of safety rules and
Improvement in product design.
Measures that reduce loss severity
Installation of an automatic sprinkler or burglar
alarm system,
Early treatment of injuries and
Rehabilitation of injured workers.
D. Non-Insurance transfers
Is the transfer of risk from one person or entity to
another by way of something other than a policy of
insurance.
Are methods other than insurance by which a pure
risk and its potential financial consequences are
transferred to another party.
It is also sometimes known as a contractual risk
transfer.
 Examples
1. A company’s contract with a construction firm to
build a new plant can specify that the construction
firm is responsible for any damage to the plant
which it is being built.
2. A firm’s computer lease can specify that
maintenance, repairs and any physical damage loss
to the computer are the responsibility of the
computer firm.
3. A publishing firm may insert a hold-harmless
clause in a contract, by which the author and not
the publisher is held legally liable if anybody sued
the publisher.
 Advantages Disadvantages
The risk manager can The transfer of potential loss
transfer some potential would become impossible, if
losses that are not the contract language is
commercially insurable. ambiguous.
Non-Insurance transfers If the party to whom the
often cost less than potential loss is transferred is
insurance. unable to pay the loss, the
The potential loss may be firm is still responsible for the
shifted to someone who is in claim.
a better position to exercise It may not always reduce
loss control. insurance costs since an
insurer may not give credit for
the transfers.
 E. Insurance
Insurance is a contract, represented by a policy, in
which an individual or entity receives financial
protection or reimbursement against losses from an
insurance company.
Insurance companies collect small payments from
a large group of customers every month
(premiums)
Insurance is appropriate for loss exposures that
have a low probability of loss but the severity of loss
is high.
Five key areas to be emphasized when insurance
is used to treat certain loss exposures:
1. Selection of insurance coverage
2. Selection of an insurer
3. Negotiation of terms
4.Dissemination of information concerning
insurance coverage
5. Periodic review of the insurance program
 Advantages Disadvantages
The firm will be indemnified The payment of premiums are a
after a loss occurs. Thus, the major cost.
firm can continue to operate Considerable time and effort
Worry and fear are reduced for must be spent in negotiating
the managers and employees, the insurance coverage.
which should improve their The risk manager may take less
productivity. care to loss-control program
Insurers can provide valuable since he has insured. But, such
risk management services a lax attitude toward loss
Insurance premiums are control could increase the
income-tax deductible as a number of non-insured losses
business expense. as well.
 4. Selection of Risk Management Tools
Types of Loss Loss Appropriate risk Examples
Loss Frequency Severity management tools
1. Low Low Retention Theft of secretary’s
notepad

2 High Low Loss control & Damage for

Retention automobile
Shoplifting
Food spoilage

3. Low High Insurance Fire

Explosion
Flood etc
4. High High Avoidance If a person drunk &
drive a car
5. Risk implementation & Administration
Is implementation and administration of the risk
management program.
It involves three important components;
1. Risk management policy statement

2. Co-operation with other departments

3. Periodic review and evaluation

Risk management policy statement
Is a tool used by companies to identify and
respond to risks in a way that minimizes their
impact.
A risk management policy serves two main
purposes:
 To identify, reduce and prevent undesirable incidents or
outcomes
 To review past incidents and implement changes to
prevent or reduce future incidents.
It outlines the risk management objectives of the
firm, as well as company policy with respect to the
treatment of loss exposures.
Co-operation with other departments
The Accounting Department can adopt Internal
Accounting Controls to reduce employees fraud and
theft of cash.
The Finance Department can provide information
showing how losses can disrupt profits and cash
flow.
The Marketing Department can prevent liability
suits by ensuring accurate packaging.
The Production Department has to ensure quality
control and effective safety programs in the plant
can reduce injuries and accidents.
Periodic review & evaluation
The risk management program must be
periodically reviewed and evaluated to see
whether the objectives are being attained or not.
Especially, the following must be carefully
monitored:
Risk management costs,
Safety programs and
Loss preventive programs
END OF THE CHAPTER