Chapter Six

Risk and Insurance of Business Enterprises

Instructor Abraham A. (MSc)

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Risk and Insurance of Business Enterprise
6.1 What is Risk?
Risk is the possibility of suffering some form of loss or
damage as a result of decision making.
It is the chance of an unfavorable outcome associated with an
action.
Uncertainty is not knowing what will happen in the future.

The greater the uncertainty, the greater the risk.

 Con…
If there was no risk, there would be no return to the ability to
successfully manage it.
For each decision there is a risk-return trade-off.

Anytime there is a possibility of loss (risk), there should also

be an opportunity for profit.
Successful Entrepreneurs take calculated risks; they set their
own objectives at a level where there is a moderate risk of
failure.
 Con…

 Entrepreneurs must decide between different alternatives with

various levels of risk.
 They have internal locus of control, for they take responsibility for
their actions.
 They did not blame fate or some other external force.

 However, even with carefully planned road map there is risk here
comes the need for risk management and Insurance.
 Con…

 Risk management is the control of an individual’s or company’s

chances of failure through insurance measures.
 A sudden unexpected event can derail even the most detailed
plan unless you have anticipated and planned for catastrophic
events
 Hence, insurance products are useful in managing these risks.

 The entrepreneur should evaluate his life, disability,

liability/umbrella, and long-term care insurance
 Con…

• This difference leads to the classification of risks as either

speculative or pure risks.
• A speculative risk is a risk that accompanies the possibility of
earning a profit. Most business decisions, such as the decision to
market a new product, involve speculative risks. If the new
product succeeds in the marketplace, there are profits; if it fails,
there are losses.
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 Con…
• A pure risk is a risk that involves only the possibility of
loss, with no potential for gain. The possibility of damage
due to hurricane, fire, or automobile accident is a pure risk
because there is no gain if such damage does not occur.
Another pure risk is the risk of large medical bills resulting
from a serious illness. Again, if there is no illness, there is
no monetary gain.
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 Con…

Risk can be classified in a number of ways. Here it is

classified according to the CIMA Official Terminology

• Business or operational: relating to activities carried out

within an entity, arising from structure, systems, people,
products or processes.
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 Con…

• Country: associated with undertaking transactions with,

or holding assets in, a particular country. Risk might be
political, economic or stem from regulatory instability.
The latter might be caused by overseas taxation,
repatriation of profits, nationalization or currency
instability
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 Con…

• Financial: relating to the financial operations of an entity

and includes:
 Credit risk
 Currency risk
 Interest rate risk
 Liquidity( funding) risk

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 Con…

• Reputational: this is damage to an entity's reputation as a

result of failure to manage other risks.
• Strategic risk: these are risks stemming from the entity's
strategy and pose the greatest threat to the achievement of
the strategy.

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 6.2 The Process of Risk Management
The Enterprise Risk management (ERM )process
encompasses:
 Articulating risk strategies and promoting a positive risk
culture
 Designing a risk governance structure

 Comprehensive and robust risk identification,

assessment, and measurement
 Con…
 Formulating a spectrum of risk response options
 Implementing risk control policies and procedures
 Monitoring and reporting.
 Risk Management is the name given to a logical and systematic
method of identifying, analyzing, treating and monitoring the risks
involved in any activity or process.
 Risk Management is now an integral part of business planning.
 I) Identify the risks

Defining types of risk, for instance, ‘Strategic’ risks to the goals and
objectives of the organization.

• Identifying the stakeholders, (i.e.,who is involved or affected).

• Past events, future developments.

II) Analyze the risks

How likely is the risk event to happen? (Probability and

frequency?)

What would be the impact, cost or consequences of that event

occurring? (Economic, political, social?)
 III) Evaluate the risks

 Rank the risks according to management priorities, by risk category

and rated by likelihood and possible cost or consequence. What is the
likelihood of the risk event occurring? , determine inherent levels of
risk.

••Almost
Almost certain
certain ••Extreme
Extreme
••Likely What
What isis the
the ••Very
Likely consequence Very high
high
••Moderate consequence ifif ••Moderate
Moderate the
the risk
risk event
event Moderate
••Unlikely
Unlikely ••Low
Low
occurs?
occurs?
••Rare?
Rare? ••Negligible?
Negligible?
 IV) Treat the risks
Develop and implement a plan with specific counter-measures to
address the identified risks.

Consider:

• Priorities (Strategic and operational)

• Resources (human, financial and technical)

• Risk acceptance, (i.e., low risks)

 V) Monitor and review

• In identifying, prioritizing and treating risks, organizations make

assumptions and decisions based on situations that are subject to
change, (e.g., the business environment, trading patterns, or
government policies)
• Risk Management policies and decisions must be regularly reviewed
 Con…
• Risk Managers must monitor activities and processes to determine the
accuracy of planning assumptions and the effectiveness of the
measures taken to treat the risk.

• Methods can include data evaluation, audit, compliance measurement.

 Risk Response
1) Avoid
• you put a plan in place to make sure that it could never happen.
• You can’t do this with all risks, but it’s a handy approach to shutting
down trouble before it happens where you can
 2) Transfer

• Transferring a risk means shifting the responsibility for it on to

someone else.
• The best example of this is an insurance policy. When you buy an
insurance policy, you shift some of the impact of the risk on to the
insurance firm, and they would be liable if the risk did happen.
 3) Mitigate
• In this type of risk response strategy, you try to minimize either the
probability of the risks happening or the impact.
• For example, you find that a team member may leave for a certain duration
during the peak of your project.
• Therefore, to minimize the impact of his absence, you identify another
employee with similar qualifications from your organization and inform his
boss that you may need him for your project for a period of time.
 4) Accept

 This risk response strategy can be used with both kinds of

risks, Here you don’t take any action to manage the risk but
you do acknowledge it.
 You can accept the risk either by actively acknowledging it
or passively acknowledging it. In active acceptance, you
keep a separate contingency reserve to manage the risk if it
occurs,
 6.3 Introduction to Insurance of Business
Enterprises

• Insurance is a contract in which one party agrees to indemnify

(compensate) another party in the event of loss or damages
caused by risks specified in the contract, in exchange for the
payment of a certain amount known as the ―insurance
premium‖ to the first party. The premium could be arranged to
be paid as a lump sum amount or it could be paid as periodic
amount. 25
Table 6.1: Types of Insurance

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Figure 6-1 Insurable and Uninsurable Risk for Businesses and Individuals

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• Insurability of the Risk Insurers will accept responsibility
for risks that meet at least the following conditions:
 Losses must not be under the control of the insured.

 The insured hazard must be geographically widespread

 The probability of a loss should be predictable.

 Losses must be measurable.

 The policyholder must have an insurable interest.

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End of Chapter Six

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