RISK

MANAGEMENT
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 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.

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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
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 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.
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 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.

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 Objectives of risk management
The objectives of risk management can be
broadly classified into two:
Pre-loss Objectives
Post-loss Objectives

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(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.
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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.
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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.

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(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.
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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.
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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.

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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.

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 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

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 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.
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 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.

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 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

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 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.

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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

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 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.

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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 want to avoid the risks associated with the
ownership of property, so you do not purchase
property, but lease or rent instead.
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 Advantages Disadvantages
 It may not be possible to avoid all
Chance of loss is reduced to
losses.
zero, if the loss exposure is
E.g. A company cannot avoid the pre-
not acquired i.e. the risk is
mature death of a key executive.
not permitted to come into
 If risk avoidance were used
existence
extensively, the business would be
In addition, if an existing deprived of many opportunities
loss exposure is abandoned, for profit and probably would not
the possibility of loss is be able to achieve its objectives.
either eliminated or reduced E.g. The pharmaceutical company can
because the activity that avoid losses arising from the
could produce a loss has production of a particular drug.
been abandoned. But, without any drug
production, the firm will not be
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 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.
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 Advantages Disadvantages
 Save money in the long run if its  The losses retained by the firm
actual losses are less than the loss may be greater than the loss
allowance in the insurer’s allowance in the insurance
premium. premium that is saved by not
 The services provided by the purchasing the insurance.
insurer may be provided by the  Actually, expenses may be
firm at a lower cost. higher as the firm may have to
 Since the risk exposure is retained, hire outside experts such as
there may be greater care for loss safety engineers. Thus,
prevention. insurers may be able to provide
 Cash flow may be increased since loss control services less
the firm can use the funds that expensively.
normally would be held by the  Income taxes may also be
insurer.
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 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.

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 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.

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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.

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 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.

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 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 firm
The potential loss may be is still responsible for the
shifted to someone who is in claim.
a better position to  It may not always reduce
exercise loss control. insurance costs since an
insurer may not give credit
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 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.
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 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

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 Advantages Disadvantages
The firm will be indemnified The payment of premiums are a
after a loss occurs. Thus, the major cost. Considerable time
firm can continue to operate and effort must be spent in
Worry and fear are reduced for negotiating the insurance
the managers and employees, 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.
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 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 & Retention Damage for automobile

Shoplifting
Food spoilage

3. Low High Insurance Fire

Explosion
Flood etc
4. High High Avoidance If a person drunk & drive
a car

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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

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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.
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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.
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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

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 END OF THE CHAPTER

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