Defining risk?

There are many definitions available for the word’ Risk’ and the definition can be
narrow or as comprehensive as organisations/people may interpret it.

 Generally, risk is the deviation or variability of actual results from desired or

expected results
 It can be explained as the uncertainty or loss that occurs when an event takes
place because for a risk to occur/materialize, an event must occur.
 It is an unplanned event with unexpected consequences.
 It is a combination of the probability of an event and its consequences
 A condition where there is a possibility of an adverse deviation from a
desired outcome that is hoped for. (Deviation from the norm)
 An event with the ability to impact (inhibit, enhance, or cause doubt about)
the effectiveness and efficiency of the core process of an organisation
 The deviation/variability of actual results from the desired expected
results
In an organisational context, Risk is defined as anything that can impact the
fulfilment of corporate objectives and as such various organisations define risk in
their own ways and below are some such examples: -

Organization Definition of Risk

The Institute of Risk Management Risk is a combination of the

(IRM) probability of an event and its
consequences. Consequences range
from positive to negative
Orange Book from HM Treasury Risk refers to the uncertainty of
outcomes, within a range of exposures
arising from a combination of the
impact and the probability of potential
events
Institute of internal auditors The uncertainty of an event
occurring that could have an impact
on the achievement of objectives.
Here the risk is measured in terms of
consequences and likelihood.
ISO Guide 73 Effect of uncertainty on
objectives. Note that an effect may be
positive (opportunity), negative/loss
or deviation from expected
(uncertainty)
Risks/Quantification of Level of Risk
Risk is a combination of the likelihood (frequency) of an event occurring and the
extent or severity/impact of the e.g. financial loss it provides should the event
materialize/ occur. Two important concepts in the level of risk are;

 Frequency
 Severity

Frequency denotes the number of times that a risk occurs.

Severity refers to the magnitude/financial implications of the risk.

Examples below depict how the level of a risk exposure may be quantified:

 High frequency/low severity

 Low frequency/high severity

The Role of Risk in Decision Making

The principle in the business world is that if risk increases, the possible return
that is desired will also increase.
 Striking an optimal balance between risk and return is very important to
individuals and enterprises.
 Thus the concept of “no risk, no return” is widely accepted in the business
world. A consequence to that concept is “higher risk, higher return”.

Below is the illustration of how many people think about the trade-off between
risk and return. However, it is certainly not valid if risk is put into its proper
perspective.
Attitudes toward Risks

 Different people have different attitudes toward the risk-return tradeoff.

 People are risk averse when they shy away from risks and prefer to have as
much security and certainty as is reasonably affordable in order to lower their
discomfort level. They would be willing to pay extra to have the security of
knowing that unpleasant risks would be removed from their lives.
 So, why do people invest in the stock market where they confront the
possibility of losing everything?
 A risk seeker, on the other hand, is not simply the person who hopes to
maximize the value of retirement investments by investing the stock market. A
risk seeker is someone who will enter into an endeavor long as a positive long
run return on the money is possible, however unlikely.
 Risk neutral individuals will not pay extra to have the risk transferred to
someone else, nor will they pay to engage in a risky endeavor. To them,
money is money. They don’t pay for insurance, nor will they gamble.
Economists consider most widely held or publicly traded corporations as
making decisions in a risk-neutral.

The 3 Characteristics of a risk can either provides:

1. A Loss: - to mean that some danger or loss may be involved within that event
where it occurs (e.g. Loss due to accidental injury or death). Therefor care
must be taken to avoid that loss.
2. A Gain: - Some benefit or opportunity arises when that event occurs (e.g.
when ones invests in bonds, swaps, etc. when one engages in speculative
investment
3. Uncertainty: - the outcomes cannot be predicted when that event occurs
(e.g. People take risks in order to achieve some goal that they would
otherwise not have reached without taking a risk. (e.g. uncertainties on
 organisation’s distribution of its products due to market risks arising from
uncertainty in the environment they operate
Risk Management

Risk Management is the continuous, methodical process an organisation adopts to

identify and treat these risks exposures that surround the activities meant to ensure
that organisations achieve their set goals.
 Risk management is an increasingly important business driver and
stakeholders have become more concerned about risk.
 As businesses strive for the creation of value for their shareholders they
should understand what risks to take and those to avoid.
 As businesses grow, they are continuously exposed to greater, more complex
and diverse or dynamic risks
 Risk management protects and adds value to the organization and its
stakeholders through supporting the organization’s objectives through a
framework that enables organizational activities to take place in a consistent
and controlled manner.

Three distinct dimensions of risk management

 Generating and utilizing opportunities in situations where a business has

distinct advantages in accomplishing beneficial results with improved chances
of success (upside management)
 Introducing controls to prevent or restrain losses as a result of the constraints
posed by the operating environment of the business (downside
management)
 Exercising methods and techniques to reduce the variance between
anticipated financial outcomes and actual results (uncertainty management)

The above indicates that risk can have an upside(gain/opportunity) a downside

and an uncertainty nature.

Lack of risk management

• The correlation between poor business performance and correspondingly
poor governance and risk management has been identified by many
commentators.
• There is a negative impact on companies’ long term investment performance
due to lack of robust risk management and good governance

Objectives of risk management

  Achieve and maintain a reduced cost of risk (both insurance and self-
insurance) without placing the Institute in a position of risk exposure that
could have a significant impact on its financial security and its Mission.
 Evaluate and assess all risks of loss and need for insurance related to the
specific performance objective.
 Modify or eliminate identifiable conditions and practices which may cause loss
whenever possible.
Purchased insurance coverage is always advisable for risk outside the organizations’
tolerance levels. In selecting that insurance organizations use these possible
guidelines:
• While a competitive atmosphere is desired, continuity of relationship with
insurance sources is advantageous and will be maintained unless there is a
significant reason for making a change.
• Selection is based on quality of protection, services provided, and cost.

Risk management in business can improve the company’s brand by letting

employees, customers and other businesses know that the company is responsible
and resourceful. Furthermore, risk management plans give companies a chance to
gather important information that may be useful for other purposes as well.

Three Ways Risk Management Plans Improve Companies

Risk management plans improve your company’s health, integrity and resilience in
many ways. Here are three ways a solid risk management plan will bolster an
Enterprise.

1. A Risk Management Plan Makes for Consistent and Efficient Operations

In the process of risk management planning, companies often discover risks that
would cause their business to operate inconsistently or inefficiently.

For example, if a company discovers that is relies on a specific part to produce a key
product and that the part in question has always been obtained from the same
source, the company has discovered a risk. If the source suddenly dries up, the
company cannot operate efficiently.

To manage this risk, the company needs to find alternative sources for the part to
use as a backup.

2. A Risk Management Plan Leads to More Satisfied Customers

Risk management planning opens in a new window or helps a company to improve
nearly all aspect of its business operations, from the development of products and
services to the company’s finances. All of these improvements allow the company to
operate more effectively, which in turn improves customer satisfaction.

3. A Risk Management Plan Gives You a Healthier Bottom Line

As a business engages in the risk management process of planning, it will discover a
significant amount of information that may reveal operational inefficiencies,
opportunities to save money and opportunities to avoid or deal with risks that could
compromise the company’s finances. Identifying and resolving each of these issues
will improve the company’s bottom line

Risk management consists of three distinct dimensions:

a. Generating and utilizing opportunities in situations where a business

has distinct advantages in accomplishing beneficial results with
improved chances of success (upside management)
b. Introducing controls to prevent or restrain losses as a result of the
constraints posed by the operating environment of the business
(downside management)
c. Exercising methods and techniques to reduce the variance between
anticipated financial outcomes and actual results (uncertainty
management)
The above indicates that risk can have an upside(gain/opportunity) a downside and
an uncertainty nature.

Managing risk under uncertainty

Risk and uncertainty:

 Uncertainty arises from a person's imperfect state of knowledge about future

events.
 Perceived uncertainty: depends on information that person can use to
evaluate the likelihood of outcomes and the ability to evaluate this information
 Uncertainty consists of the following two elements:
o uncertainty whether an event will take place
o if the event does occur what the outcome thereof will be

The definition of risk as the deviation of an actual outcome from the expected
result or outcome implies the following:
 Uncertainty surrounds the outcome of the event. The decision maker is
uncertain about the outcome, and the actual outcome may therefore
deviate from the expected outcome. If the outcome was certain and
only one outcome was possible, there would be no uncertainty and no
deviation from the expected result and therefore no risk for the decision
maker.
 The degree of uncertainty surrounding the event determines the level
of risk. The more uncertain the decision maker is, firstly, about whether
the event will take place, and secondly, of what the outcome will be,
the greater the Risk (possible deviation of the actual from the expected
result).
 The degree of risk can therefore be interpreted in terms of the
frequency with which an event will occur and the probability that it
will display a particular outcome/impact which could be positive or
negative towards the strategic goal the organisation had intended to
achieve. This event represents the deviation from the expected
outcome.
 The degree of risk is calculated as the frequency with which an event,
namely the deviation from the expected outcome, occurs and the
probability that it will display this particular outcome.