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Introduction To Risk & Risk Management-1

The document discusses risk management and risk. It defines risk as uncertainty about loss and discusses types of risk like pure risk. The objectives of risk management are outlined as meeting pre-loss goals like reducing costs and post-loss goals like ensuring survival. The key steps in risk management process are identified as evaluating exposures, analyzing risks, selecting techniques, and monitoring the program. Risk management techniques include risk control, risk financing and insurance.

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Mehul Bharwad
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0% found this document useful (0 votes)
33 views

Introduction To Risk & Risk Management-1

The document discusses risk management and risk. It defines risk as uncertainty about loss and discusses types of risk like pure risk. The objectives of risk management are outlined as meeting pre-loss goals like reducing costs and post-loss goals like ensuring survival. The key steps in risk management process are identified as evaluating exposures, analyzing risks, selecting techniques, and monitoring the program. Risk management techniques include risk control, risk financing and insurance.

Uploaded by

Mehul Bharwad
Copyright
© Attribution Non-Commercial (BY-NC)
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Download as PPT, PDF, TXT or read online on Scribd
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RISK MANAGEMENT

Lecture 1

Introduction to Risk
& Risk Management-1
Learning Objectives
 What is Risk?
 Types of Risk
 Chance of loss
 Peril & Hazard
 Categories of Risk
 How to handle risks?
 What is Risk Management?
 Objectives of Risk Management
Learning Objectives
 Steps in Risk Management Process
 Benefits of Risk Management
What is Risk?
 No single definition.
 Risk is defined as uncertainty concerning the
occurrence of a loss.
 In finance, risk is defined as variability of
returns.
 Measure of financial risk:
 Standard Deviation
Is risk bad?
 No, risk is not bad.
 Risk-return framework.
 No gain without pain.
 One cannot expect higher return unless one
exposes oneself to higher level of risks.
 Investors differ in their risk bearing capacity.
 Risk averse
 Risk neutral
 Risk seeker
Types of Risk
 Objective Risk (Degree of Risk)
 Relative variation of actual loss from expected
loss.
 It varies inversely with square root of number of
cases under observation.
 Law of large numbers: As number of exposures
increases the actual loss will approach the
expected loss.
 Measures: Standard deviation, coefficient of
variation
Types of Risk
 Subjective Risk
 Uncertainty based on a person’s mental condition
or state of mind.
 High subjective risk leads to more conservative
behavior.
 Low subjective risk leads to less conservative
behavior.
Chance of loss
 Defined as probability that an event that
causes a loss will occur.
 Objective Probability:
 Long run relative frequency of an event.
 Can be determined by deductive or inductive
reasoning.
 Subjective Probability:
 Individuals personal estimate of chance of loss.
 Depends on age, gender, education, etc.
Chance of loss vs. Objective
Risk
 Chance of loss is defined as probability that
an event that causes a loss will occur.
 Objective Risk is the relative variation of
actual loss from expected loss.
Peril & Hazard
 Peril is defined as the cause of loss.
Examples: Fire, earthquake, flood, etc.
 Hazard is a condition that creates or
increases the chance of loss.
 Physical hazard
 Moral hazard
 Morale hazard
 Legal hazard
Categories of Risk
 Pure Risk: situation in which possibilities are
loss and no loss.
 Speculative Risk: either profit or loss is
possible.
 Differences:
 Law of large numbers can be easily applied to
pure risks.
 Insurers typically insure pure risks.
 Society may benefit from speculative risks.
Categories of Risk
 Fundamental Risk: affects entire economy or
large sections of it. Examples: War, inflation,
etc.
 Particular Risk: affects individuals.
 Enterprise Risk: encompasses all major risks
faced by a firm.
 Pure, speculative, strategic, operational &
financial risks.
Categories of Risk
 Systematic Risk: Risk that cannot be
diversified. Also called market risk.
 Non-systematic Risk: Risk that can be
eliminated by diversification. Also called
Unique/Specific risk.
Types of Pure Risk
 Personal Risk:
 Premature death.
 Insufficient income after retirement.
 Poor health or disability.
 Unemployment.
 Property Risk: Direct or Indirect.
 Liability Risk
Burden of risk on society
 Larger emergency fund
 Loss of certain goods or services.
 Worry and fear
Methods of handling risk
 Avoidance
 Loss Control
 Loss prevention
 Loss reduction
 Retention
 Active retention: Individual is aware of risk and deliberately plans
to retain it.
 Passive retention: Ignorance, indifference.
 Non-insurance Transfers
 Transfer of risks by contracts.
 Hedging price risks.
 Limited liability company.
 Insurance
What is Risk Management?
 Does it mean ‘reduction of risk’?
 Risk Management (RM) is a process that
identifies loss exposure faced by a firm and
selects the most appropriate techniques for
treating such exposures.
 Points to note:
 It is a dynamic process.
 Does not talk about risk reduction.
Objectives of Risk Management
 Pre-loss objectives:
 Economy: Firm should prepare for potential losses in most
economical manner.
 Reduction of anxiety.
 Meeting legal obligations.
 Post loss objectives:
 Survival
 Continued operations
 Stability of earnings
 Growth
 Social responsibility
Application
 Why doesn’t Government of India insure its
assets?
 Large number & value of assets. Itself becomes
an insurer.
 Worst case scenario does not threaten its
survival.
Steps in RM process
 Identify loss exposures.
 Analyze the loss exposures.
 Select appropriate technique for treating the
loss exposures.
 Implement and monitor the risk management
program.
Steps in RM process-1
 Identify loss exposures.
 Property loss: buildings, plants, inventory, etc.
 Liability loss: defective products, pollution, law
suits, etc.
 Business income loss.
 Human resources loss: death of key employees,
injuries, etc.
 Crime loss: theft, fraud, cyber crimes, etc.
Steps in RM process-1
 Identify loss exposures.
 Employee benefit loss: failure to comply with govt.
regulations, etc.
 Foreign loss: currency risks, kidnapping,
nationalization, etc.
 Reputation.
 Sources: inspections, financial statements,
historical loss data, analysis of operations,
etc.
Steps in RM process-2
 Analyze the loss exposures.
 Estimation of frequency and severity.
 Loss frequency: probable number of losses in a given
time frame.
 Loss severity: probable size of loss.
 Maximum possible loss: worst loss that could
happen.
 Maximum probable loss: worst loss that is likely to
happen.
Steps in RM process-3
 Selecting the appropriate technique.
 Risk Control: techniques that reduce frequency
and severity of losses.
 Avoidance: means a loss exposure is not acquired or
existing loss exposure is abandoned.
 Loss prevention: measures that reduce frequency of a
particular loss.
 Loss reduction: measures that reduce severity of a
loss after it occurs.
Steps in RM process-3
 Selecting the appropriate technique.
 Risk Financing: techniques that provide for
funding of losses:
 Retention: active or passive.
 Can be used if no other method is available, losses are
highly predictable, worst possible loss is not serious.
 Advantages: save money, lower expenses, encourage
loss prevention, increase cash flow.
 Disadvantages: possible higher losses, higher
expenses, higher taxes.
Steps in RM process-3
 Selecting the appropriate technique.
 Non-insurance transfers: pure risk & its potential
financial consequences are transferred to another
party. Examples: leases, hold-harmless agreements.
 Insurance: appropriate for loss exposures that have a
low probability but high severity.
 Advantages: indemnification, reduction of uncertainty, tax
deductible, risk management services provided by insurers.
 Disadvantages: cost of premiums, time & effort in
negotiating insurance, less incentive to follow loss-control
program.
Steps in RM process-4
 Implement and monitor the RM program.
 Policy statement.
 Cooperation with other departments.
 Periodic review and Evaluation.
Benefits of RM
 Pre-loss and post-loss objectives are more
easily attainable.
 Cost of risk is reduced.
 Benefits to society.

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