Introduction to RISK

CHAPTER 1
RISK IN INTERNATIONAL
BUSINESS

 STRATEGIC RISK
Strategic risk is defined as the risk
associated with future business plans
and strategies, including plans for
entering new business lines,
expanding existing services through
mergers and acquisitions, enhancing
infrastructure, etc
RISK IN INTERNATIONAL
BUSINESS CONT.
 OPERATIONAL RISK
Probability of loss occurring from the
internal inadequacy of a firm or a
breakdown in its controls, operations or
procedures.
 POLITICAL RISK
The possibility that political decisions or
social events in a country will negatively
affect the business climate. Eg:
Regulatory changes, Ruler change and
etc.
RISK IN INTERNATIONAL
BUSINESS CONT.
 COUNTRY RISK
Also known as political risk, refers to
potentially adverse effects on company
operations and profitability caused by
developments in the political, legal and
economic environment in a foreign
country.

Eg: Governments may control market

access to foreign firms or impose new
procedures on business transactions.
RISK IN INTERNATIONAL
BUSINESS CONT.
 TECHNOLOGICAL RISK
Our country do not have the advance technologies that
other countries have. Or otherwise whereby non developing
countries do not have the new technology that we have.

 ENVIRONMENTAL RISK
Actual or potential threat of adverse effects on living
organisms and environment by effluents, emissions, wastes,
resource depletion, etc., arising out of an organization's
activities.
RISK IN INTERNATIONAL
BUSINESS CONT.
 ECONOMIC RISK
One of collection of country risk. Either the
economic country is stable or unstable.
 FINANCIAL RISK
Similar with currency risk which refers to
the risk of adverse fluctuations in
exchange rate and it arises because
international transactions are often
conducted in more than one national
currency.
RISK IN INTERNATIONAL
BUSINESS CONT.
 TERRORISM RISK
An act that is intended to create fear
and targeted on civilians. One
example of political risk. It is unlawful
violence committed for various
reasons, including ransoms, to
overthrow the government or to
punish the terrorist.
 RISK MANAGEMENT

Is a systematic approach to
dealing with risks that threaten
the assets and earnings of a
business or enterprise.
RISK MANAGEMENT The Process
RISK MANAGEMENT The Process
Identify all pure loss exposures including:-
• physical damage to property;
• business interruption losses;
• liability lawsuits;
• losses arising from fraud, criminal acts and
dishonesty of employees;
• losses arising from the death or disability of
key employees.

Loss exposures can be identified from various

sources including questionnaires, financial
statements, flow charts and personal inspection
of facilities.
RISK MANAGEMENT The Process

After identifying potential losses, the next step is

to evaluate the potential losses of the firm.

Evaluation involves the estimation of the

frequency and severity of loss exposures and
ranking them according to their relative
importance.

Loss exposures with high loss potential will be

given priority in the risk management program.
 The Process
Financial criteria
RISK MANAGEMENT
that will consider
how the choice
will affect the
Select techniques:
 risk avoidance organization’s
 loss control Based profitability or
risk retention on rate of return.
risk transfer.
Non-financial
considerations
will include
humanitarian
aspects and legal
requirements.
RISK MANAGEMENT The Process

IMPLEMENT THE RISK

MANAGEMENT PROGRAMME
THAT HAS BEEN SELECT
RISK MANAGEMENT The Process

Once implemented, a risk

management programme
needs to be monitored to
ensure that it is achieving
the results expected and to
make changes to the
programme, if necessary.
METHODS OF HANDLING RISKS

Risk Avoidance

Loss Control Risk Transfer

Risk Retention
METHODS OF HANDLING RISKS Risk Avoidance
Risk avoidance involves avoiding the property,
person or activity, which produces the risk.

Examples:
i.A manufacturer who is worried about a
product liability lawsuit arising from one of his
products can avoid it by not manufacturing
that product.
ii.An individual who is worried about health
problems arising from lung cancer can avoid
them by not smoking.
METHODS OF HANDLING RISKS Loss Control
Loss control aims to reduce the total amount
of loss. The total amount of loss is influenced
by the frequency and severity of loss.

•Frequency of loss is the number of times a

loss producing event will occur over a given
period of time.
•Severity of loss is the cost or amount of loss,
in money terms, arising from loss- producing
events.
METHODS OF HANDLING RISKS Loss Control continued
Loss control measures handle risks by:

• Loss Prevention
Loss prevention refers to reducing the frequency
of loss, example: by the use of fire resistant
material in the construction of a building to help
prevent fire losses.

• Loss Minimization
Loss minimization refers to reducing the severity
or amount of loss, example: by the installation of
an automatic fire sprinkler system to help reduce
the amount of fire losses when a fire occurs.
METHODS OF HANDLING RISKS Risks Retention

• Risk retention involves the retaining of risks

by an individual or organization.
• When risks are retained, the losses
incurred are borne by the party retaining
the risks. Risk retention may be planned or
unplanned. When risk retention is planned,
risks are retained deliberately.
• Unplanned risk retention involves the
retaining of risks unknowingly.
METHODS OF HANDLING RISKS Risks Transfer
Risk transfer involves the transferring of risks
to an organization or individual. When a risk
is transferred, the loss will be paid for by the
organization or individual to whom the risk is
transferred.

There are two ways of transferring risks.

i. Insurance contract
ii. Non insurance contract
METHODS OF HANDLING RISKS Risks Transfer continued
Insurance Contract
Example: A house owner can transfer the loss
incurred when his house is destroyed by fire by
entering into a fire insurance contract.

Non Insurance Contract

Example: A supermarket can transfer potential
liability arising from the sale of a defective product
by entering into an agreement whereby the
manufacturer agrees to compensate the
supermarket from any liability arising from the
defective product.
 INSURABLE RISK

The main characteristic of risk that can be

insured are based on financial value, large
number of similar risk, pure risks, No
Catastrophic Losses, Fortuitous Losses,
Insurable interest, Legal and Not Against
Public Policy and Reasonable Premium
 • Insurance is concerned with situations where
monetary compensation can be given following
INSURABLE RISK

a loss. Therefore, insurable risks should involve

losses that are capable of being financially
measured. The following are some examples
of such risks:
Risks Financial Management
Damage of property Cost of repairs
Injury to others Court awards
Death of a life assured The ability to pay the
premium in relation to the
sum assure d and his
financial standing
 There must be a large number of
INSURABLE RISK

similar risks before any one of the risks

is capable of being insured. There are
two reasons for this:
To enable the insurer to predict
losses more accurately.
If there are only few risks, the
principle of losses of a few to be borne
by many cannot be applied.
 • Insurance is concerned only with pure
INSURABLE RISK
risks because in a pure risk situation, one
will suffer a loss or incur no loss, thus
there is no possibility of profiting from a
pure risk.
• Speculative risks hold out the prospect of
loss, break-even or profit, and thus are
rarely insured. An insured in such a
situation would be less inclined to put in
efforts to bring about a gain because the
insurer will indemnify any loss.
INSURABLE RISK
• For a risk to be insurable, the loss
should not be so catastrophic (bersifat
bencana) in nature as to render it too
heavy to be borne by an insurer. A
catastrophic loss arises when a very
large number of risks incur losses at the
same time or when one risk results in a
huge loss. Examples of catastrophic
losses include losses arising from wars
and earthquakes
 • Another characteristic of insurable
INSURABLE RISK

risk is that the loss must be

fortuitous (secara kebetulan). A
fortuitous loss is one that is
accidental and unintentional.
Insurance cannot function properly
and efficiently if losses are
intentionally or fraudulently
(penipuan) brought about by the
insured.
 • Generally, a person who wishes to effect
INSURABLE RISK

insurance must have insurable interest

in the property, rights, interest, life, limb
or potential liability to be insured. The
existence of insurable interest in
contracts of insurance is one of the main
factors that differentiate insurance from
gambling.
 • The object of insurance must be
INSURABLE RISK

legal and not against public

policy. A ship engaged in
smuggling or a wager on a life is
not an insurable risk because
such a risk is of an illegal nature.
Fines and penalties imposed by
law are not insurable because it is
against public policy to provide
insurance for such events.
 • The final characteristic of an insurable risk is
INSURABLE RISK
that the premium must be reasonable in
relation to the potential loss. A risk that has a
very high probability of loss or near certainty
would involve a premium that may be
unreasonable from the prospective insured’s
point of view. On the other hand, the
insurance premium required to cover the risk
of fire on a ballpoint pen worth a few cents
may be quite unreasonable in relation to the
potential loss in view of the insurer’s claim
handling expenses.
INTRODUCTION TO
INSURANCE
• Definition- “transfer of risk”
• Law of large number
• Insurance and pooling
• Reason of pooling:
1.Few are spread over the entire group
2.Involve the grouping of a large number of exposure unit-
accurate prediction of future losses