Unit 1

Introduction to Risk Management

and Risk Identification

Presentation by
Dr. Basavaraj S.kudachimath
 Discussion Points
1. Risk-Risk and Uncertainty-
2. Types of Risk-
3. Burden of Risk-
4. Sources of Risk-
5. Methods of handling Risk-
6. Degree of Risk-
7. Management of Risk.
8. Risk Identification- Business Risk Exposures-
Individual Exposures-Exposures of Physical
Assets -Exposures of Financial Assets -Exposures
of Human Assets - Exposures to Legal Liability -
Exposure to Work-Related Injury. (Theory)
 What is Risk
A risk is ANYTHING that may affect the
achievement of an organization’s objectives. It
is the UNCERTAINTY that surrounds future
events and outcomes. It is the expression of
the likelihood and impact of an event with the
potential to influence the achievement of an
organization’s objectives.
 Risk Definitions
According to the dictionary,
Risk refers to the possibility that
something unpleasant or dangerous
might happen.
According to E.J. Vaughan
Risk is a condition in which there is
a possibility of an adverse deviation
from a desired outcome that is
expected or hoped for.
The degree of risk refers to the
likelihood of occurrence of an event.
It is a measure of accuracy with
which the outcome of a chance
event can be predicted
 In most of the risky situations, two elements are
commonly found:
1. The outcome is uncertain, i.e., there is a possibility that
one or other(s) may occur. Therefore, logically, there
are at least two possible outcomes for a given
situation.
2. Out of the possible outcomes, one is unfavorable or not
liked by the individual or the analyst.
 Risk Vs Uncertainty
All risks are uncertain but all uncertainities are not risks.
What is uncertainty?
Uncertainty refers to a situation where the outcome is
not certain or unknown. Uncertainty refers to a state of
mind characterized by doubt, based on the lack of
knowledge about what will or what will not happen in
the future
Uncertainty is said o exist in situations where
decision makers lack complete knowledge,
information or understanding concerning then
proposed decision and its possible
consequences
 Loss and Chance of Loss
A risk refers to a situation where there is the
possibility of a loss
What is a loss?
• Loss, in accounting sense, means that portion
of the expired cost for which no compensating
value has been received. (M.A.Arora)
• Loss refers to the Act or instance of losing the
detriment or a disadvantage resulting from
losing
 The chance of loss refers to a fraction or the
relative frequency of loss. The chance of loss in
insurance sense is the probability of loss.
• For example, assume there are 10,000 factories in
the insurance pool which may be affected due to
earthquake and on the basis of past experience, 5
have been affected,
then the probability of loss is 0.0005.
• The whole game of insurance business is based on
the probability of loss.
• If the insurer estimates correctly, he wins else
loses or is forced to close the business.
 Loss occurs due to
1. Perils: Perils refer to the immediate causes of loss.
Perils may be general or specific, e.g., fire may affect
assets like building, automobile, machinery,
equipment and also, humans. Collusion may cause
damage to the automobile resulting in a financial loss.
2. Hazards:Hazards are the conditions that increase the
severity of loss or the conditions affecting perils.
These are the conditions that create or increase the
severity of losses. Economic slowdown is a peril that
may cause a loss to the business, but it is also a hazard
that may cause a heart attack or mental shock to the
proprietor of the business.
 Hazards may be
1. Physical hazards
2.Intangible Hazard
a. Moral Hazard
b. Morale Hazard
c. Societal Hazard
1) Physical Hazards — Property Conditions —
consists of those physical properties that
increase the chance of loss from the various
perils.
For example, stocking crackers in a packed
commercial complex increases the peril of
fire.
2) Intangible Hazards — Attitudes and Culture —
Intangible hazards are more or less psychological in
nature. These can be further classified as follows:
(a) Moral Hazard — Fraud — These refer to the
increase in the possibility or severity of loss arising
from the intention to deceive or cheat. For example,
putting fire to a factory running in losses. With an
intention to make benefit out of exaggerated claims,
deliberately indulging into automobile collusion or
damaging it or tendency on part of the doctor to go for
unnecessary checks when they are not required, since
the loss will be reimbursed by the insurance company.
(b) Morale Hazard — Indifference — It is the
attitude of indifference to take care of the
property on the premise that the loss will be
indemnified by the insurance company. So, it is
the carelessness or indifference to a loss because
of the existence of insurance contract. For
example, smoking in an oil refinery, careless
driving, etc.
(c) Societal Hazards — Legal and Cultural —
These refer to the increase in the frequency and
severity of loss arising from legal doctrines or
societal customs and structure. For example, the
construction or the possibility of demolition of
buildings in unauthorized colonies.
 Types of Risks
1. Financial and Non financial risk
2. Individual and Group risk
3. Pure and Speculative risk
4. Static and Dynamic risk
5. Quantifiable and non quantifiable risks.
1. Financial and Non financial Risk
When the loss happened due to risk is measured in
terms of financial units , it is called as financial risk.
The risk has three important elements to consider it as
financial risk
(a) that someone is adversely affected by the happening
of an event,
(b) The assets or income is likely to be exposed to a
financial loss from the occurrence of the event and
(c) the peril can cause the loss.
For example, loss occurred in case of damage of
property or theft of property or loss of business. This is
financial risk since risk resultant can be measured in
financial terms.
• When the possibility of a financial loss does
not exist, the situation can be referred to as
non-financial in nature. Financial risks are
more particular in nature. For example, risk in
the selection of career, risk in the choice of
course of study, etc. They may or may not have
any financial implications. These types of risk
are difficult to measure. As far as insurance is
concerned, risk is involved with an element of
financial loss.
 2. Individual and Group risk
Risk associated with an individual person such
as theft, fire to individual property create loss
to individual person only.
The risk associated with the group of
individuals affected by macro environment
changes is creating loss to the mass. Example:
Flood, Earthquake etc.
 3. Pure and Speculative Risks
Pure risk situations are those where there is a
possibility of loss or no loss. There is no gain to the
individual or the organization. For example, a car can
meet with an accident or it may not meet with an
accident. If an insurance policy is bought for the
purpose, then if accident does not occur, there is no
gain to the insured. Contrarily, if the accident occurs,
the insurance company will indemnify the loss.
Speculative risks are those where there is possibility of
gain as well as loss. The element of gain is inherent or
structured in such a situation. For example — if you
invest in a stock market, you may either gain or lose on
stocks.
 Differences between Pure and Speculative risks
• (a) Pure risks are generally insurable while the
speculative ones are not.
• (b) The conceptual framework of the risk pooling
can be applied to pure risks, while in most of the
cases of speculative risks it is not possible.
However, there may be some situation where the
law of mathematical expectation might be useful.
• (c) Speculative risk carry some inherent
advantages to the economy or the society at large
while pure risks like uninsured catastrophes may
be highly damaging.
 Types of Pure Risks
1. Personal Risk:
a. Risk of Premature death
b. Risk of insufficient income during retirement
c. Risk of poor health
d. Risk of unemployment
2. Property Risk
a. Direct loss ( Physical damage to property)
b. Indirect Loss ( Financial loss riging from physical
damage)
3. Liability Risk: Risk arising out of legal impact. If injury
happens to propert or life due to mistake of somebody the
person who made the mistake is personally held
responsible for the loss. Example Accident nad damage to
vehicle
 4. Dynamic and Static Risks
• Dynamic risks are those resulting
from the changes in the economy or the
environment. For example economic
variables like inflation, income level,
price level, technology changes etc. are
dynamic risks. Since the dynamic risk
emanates from the economic
environment, these are very difficult to
anticipate and quantify. Dynamic risk
involves losses mainly concerned with
financial losses. These risks affect the
public and society. These risks are the
best indicators of progress of the
society, because they are the results of
adjustment in misallocation of
resources.
 Static Risks
Static risks are more or less predictable and are
not affected by the economic conditions. Static
risk involves losses resulting from the
destruction of an asset or changes in its
possession as a result of dishonesty or human
failure. Such financial losses arise, even if there
are no changes in the economic environment.
These losses are not useful for the society. These
arise with a degree of regularity over time and as
a result, are generally predictable. Example for
static risk includes possibility of loss in a
business: unemployment after undergoing a
professional qualification, loss due to act of
others, etc.
5. Quantifiable and Non-quantifiable Risks

The risk which can be measured like financial

risks are known to be quantifiable while the
situations which may result in repercussions
like tension or loss of peace are called as non-
quantifiable.
Sources of Business Risk are also called
Enterprise risks
Burden of Risk on Society
Avoidance of Risk
 Loss Control
If you cannot avoid risk the, then loss can be
controlled arising out of risks. The loss
controls are of two ways.
1. Loss prevention: Example avoiding risk of
road accident by training the driving skill.
2. Loss Reduction: Keeping fire extinguishers in
the premises to reduce the loss due to fire.
 Retention Method
It is managing the risk by taking partial
financial support like keeping aside some
money out of income for repair and
replacement of asset. Example: Depreciation,
Saving for future etc.
Non Insurance Risk Transfer
Agreements
 Insurance
Insurance contracts can be entered with
insurance company to get compensation for
losses
Degree of Risk