General overview on risk, its types and sources along with the risk management and enterprise risk management

2. Meaning of Risk, Peril and Hazards
• Risk is the potential of loss that is undesirable outcomes
arising out of uncertainty from a given action, activity or
inaction. Risk. It is the possibility of adverse results flowing
from any occurrence. The concept of risk in insurance refers
not only to uncertainty on economic matters but also on a life
of a person where the insured is promised to be compensated
for a loss in return for the payment of a much smaller but
certain expense called the premium.
• Peril is a source of loss or it is the cause of the risk/loss. (Fire,
accident, windstorm, flood, theft, etc).
• Hazards is the condition or situation that creates or increases
the likelihood or occurrence of peril.
• “Risk refers to relatively objective probabilities which can be
computed on the basis of past experience or some prior
principle.”
-------According to Haynes, Mote & Paul

3. Types of Hazards
• Physical hazard: Physical environment which could
increase or decrease the probability or severity of a
loss. It can be managed through risk-
improvement, insurance policy terms, and premium
rates.
• Moral hazard: Moral hazard are attitude and ethical
conduct of the insured which cannot be managed but
can be avoided by declining to insure the risk. Moral
hazards (most of which are avoidable), like dishonesty
(such as burning down the warehouse when your
company goes bankrupt to collect insurance money or
buying insurance on someone with yourself as
beneficiary and then killing them).

4. Based on Consequence
of Risk Event
• Speculative Risk(S)
• Pure Risk(P)
Based on Nature of
Event
• Fundamental Risk(F)
• Particular Risk(P)
Based on Nature of the
Environment
• Static Risks(S)
• Dynamic Risks(D)
SP-FP-SD

5. 1. Classification Based on Consequence of Risk
Event
A. Speculative Risks: Speculative risks are those
types of risks which may give loss or profit. There is only
the chance of loss or profit. For Example: Going into our
own business generates either loss or profit for us also if
we play card there is either the loss or profit we can get.
If we purchase shares there is either the chance we will
make profit or loss. In these situation, both profit or loss
are possible.
B. Pure Risks: Pure risks are those risks associated
with uncertainties which may cause loss. In pure risks
either a loss occurs or no loss occurs, there is no
possibility for gain. The uncertainties may be due to the
perils such as flood, fire, marine, theft, accident, etc.

6. 2. Classification Based on Nature of Event:
A. Fundament Risks: Fundamental risks are those
types of risks that affects the entire economy or large
number of persons or groups within the community or
nation. Inflation, war, earthquake etc are the risks
caused by conditions that is beyond the control of
individuals.
B. Particular Risks: Particular risks are those which
are caused by individual events and affect only the
particular individual instead of the entire community or
group. Burning of house, automobile accident etc are
the particular or specific risks that can be addressed
through the use of the insurance policies or risks
management or prevention techniques.

7. 3. Classification Based on Nature of Environment
A. Static Risks: Static risks refers to damage or loss to a
property or entity that is not caused by a stable economy
but by destructive human behavior or an unexpected natural
event like fire, earthquake, death, accident and sickness.
This risk can be covered by insurance. They have a regular
pattern of occurrence over time and can be reasonably
predicted.
B. Dynamic Risks: Dynamic risks are those risks that
arises as per the change in the economy and society. These
risks affect a large number of individuals but is considered as
less predictable since they do not occur with any precise
degree of regularity. Unemployment or war are the
examples of dynamic risks.

8. PURE RISKS
• Pure risks are those risks associated with uncertainties
which may cause loss. In pure risks either a loss occurs
or no loss occurs, there is no possibility for gain. The
uncertainties may be due to the perils such as flood,
fire, marine, theft, accident, etc. Most pure risks are
insurable.
• The pure risks can be classified as PPL:
a. Personal Risks(P)
b. Property Risks(P)
c. Liability Risks(L)

9. PURE RISKS
A. PERSONAL RISKS/INDIVIDUAL RISKS:
Personal risks are those types of risks that affects the income
earning capacity of an individual. Personal risks are risks that
directly affect an individual. They involve the possibility of loss or
reduction of income, of extra expenses, and the elimination of
financial assets. Death, disability, illness, accident,
unemployment etc are the examples of personal risks.

10. MAJOR TYPES OF PERSONAL / INDIVIDUAL RISKS
• Premature Death
• Old Age
• Poor Health
• Unemployment
1.Earning
Risk
2.
Medical
Expenses
4.
Longevity
Risk
3.
Financial
Assets

11. PURE RISKS
A. PERSONAL RISKS
1. Earning Risk
Earning risks refers to the fluctuation in the earning which can
occur as a result of decline in the productivity of income earners.
Earning risks can occur due to the following reasons:
a. Premature Death- Death of the income earner that needs to pay the
mortgage loan, education of children
b. Old Age- Risk of insufficient income for the old age retirement since they
loose their normal amount of earning.
c. Poor Health- Includes the catastrophic medical bills and long term
disability that causes loss of the income saved which can create financial havoc in
the family.
d. Unemployment- Unemployment can be due to economic change,
seasonal factors, cyclic downsizing which can create the financial havoc in the
family.

12. PURE RISKS
A. PERSONAL RISKS
2. Medical Expenses: The risks of living long and facing
higher medical expenses due to illness, accident of an individual
or his/her family members.
3. Financial Assets: Risk related to market changes or poor
performance of an financial assets. EX: Shares, Option, Futures,
Currency.
4. Longevity Risk: The risk that the amount of money an
individual saves for retirement might not be enough to sustain
them, due to increased life expectancy.

13. PROPERTY RISKS
Property risks are those types of risk that results in a loss or damage to
property due to fire, theft, terrorism, war, flood, etc. The property risks can
be minimized through the property insurance policies by indemnifying the
insured for damage to covered property on one of the two bases:
a. Actual Cash Value(ACV) : Actual cash value is the amount equal to the
replacement cost minus depreciation of a damaged or stolen property at
the time of the loss. It is the actual value for which the property could be
sold, which is always less than what it would cost to replace it. Actual cash
value is the depreciated value of an item of property at the time of the loss.
b. Replacement Cost Value(RCV) : It is also called Re-instatement Value.
Replacement cost value is the amount it would cost to repair or replace a
lost, stolen or damaged item with one of the same material and quality as
the original — in today's market. It does not consider what you paid for the
item or how much it has depreciated in value since you purchased it.
Whenever you are purchasing a property insurance policy, you should
always ask whether coverage is for replacement cost or actual cash value.
Replacement cost coverage usually reimburses you for the full cost of
replacing the lost, stolen or damaged item, rather than simply reimbursing
you for the value of the item at the time of the claim. In this the Insured can
get NEW FOR OLD ones.

14. TYPES OF PROPERTY RISKS
1. Direct Risks: Direct risks are those risks when the property
is directly damaged, destroyed, or disappears on coming in
contact with the peril. Ex.: Building destroyed by fire or
vehicles stolen.
2. Indirect Risks: Indirect risks are those risks where the value
of property is lessened/depreciated as a result of direct
damage to some other property. Ex: The valuation of house
decreases when the house is caught on fire that causes
damages of the clothes or other furniture of the house but
the building although being safe is depreciated.
3. Net Income Risks: Net Income(Revenue-Expenses) risks is
the reduction in net income of the business when property is
damaged or destroyed. The loss may occur during the period
until such property is replaced or restored to its former
condition. Net income loss can arise on account of a decrease
in revenue or an increase in expenses.

15. LIABILITY RISKS
Liability risks are those types of risks that exposes an
individual to the third party. Ex: Accident while driving,
negligence by the professional, etc. Liability for causing harm
to others is the second major object of this risks.
Liability insurance is a part of the general insurance system
of risk financing to protect the purchaser (the "insured")
from the risks of liabilities imposed by lawsuits and similar
claims. It protects the insured in the event he or she if sued
for claims that come within the coverage of
the insurance policy.

16. TYPES OF LIABILITY RISKS
1. The first one is employer’s liability coverage which is covered by
the employee to get the protection on the work. It is enforced by the
law to get the proper coverage to the employee under the
employer’s liability policy to give the proper coverage.
2. The second one is public liability coverage, which covers by any
damage of public property. It is important to get the coverage based
on the types of coverage you required under the public liability
coverage.
3. The third one of product liability coverage, gives protection to the
manufacturers by way of the coverage. It is called the product liability
coverage and it will cover you against any damage or injury due to
products.
4. The fourth types of coverage are director’s and officers insurance
to give protection against any lawsuits against the officers or the
company to get the proper coverage.
5. The fifth one is professional coverage. It gives protection to the
professionals against any claims. It is necessary to get the
professional liability coverage.

17. SOURCES OF RISKS
• The sources of risks are divided into:
External
Sources
Economic
Factors(E)
Natural
Factor(N)
Political
Factors(P)
Internal
Sources
Operational
Factors(O)
Human
Factors(H)
Technological
Factors(T)
Physical
Factors(P)
PEN HOTP/POTH

18. External Sources of Risks
External sources of risks are the forces or sources belonging to
the external environment affecting the particular business
enterprise. Some external sources are:
1. Economic Factors: Economic factors of risks are the
sources that results from the change in the market
conditions. They may be in the form of changes in demand for
the product, price fluctuations, changes in income and the
trade cycles. They are also called dynamic risks which is less
predictable because they do not appear at regular intervals.
Ex: Due to the market fluctuation or trade cycle a well known
product may either lose its demand or gain larger market
share.
2. Natural Factors: The natural factors are the unforeseen
natural calamities over which an entrepreneur has very little
or no control. They may occur at any time and any place
which causes loss of life and property to the firm or damages
the goods. The natural factors mostly includes the events like
earthquake, flood, cyclone, lightening, tsunami, etc which is
beyond the control of human.

19. External Sources of Risks
3. Political Factors: The political risks are the risks that is caused
due to the political situation and condition of the country or the
region which influence on the functioning of business in the long
and short term. The political risks results from the political changes
in country, communal violence or riots in the country, civil wars,
changes in government policies and regulations also adversely
affect the business enterprise. Ex: Changes in the industrial policy
and trade policy during the budget amendments hampers the
business enterprise by increasing or decreasing the profit.

20. Internal Sources of Risks
Internal sources of risks are the risks associated with the
internal working environment of the business enterprise.
1. Operational Factors: This is the risk associated with
the monetary losses resulting from inadequate or failed
internal processes, human error or from external events. To
mitigate this risk companies must either improve internal
organizational structure or outsource the management of
this risk. Ex: System or technology failure, inadequate record
keeping, lack of supervision and control, fraud, etc.
2. Human Factors: Human factors are those factors which
results from strikes and lock-outs by trade unions,
negligence by employees, accident or death in the industry,
incompetence of the manager along with the failure of
suppliers to supply the materials or goods on time or default
in payment by debtors etc adversely affect the business.

21. Internal Sources of Risks
3. Technological Factors: These are the risks due to
the changes in the techniques of production or
distribution which results in technological obsolescence
and other risks. Ex: Advancement in technological leads to
the decrease in the production capacity of the company
using the tradition method of production which leads to
loosing the market share along with inferior quality of
product in comparison to technological advanced
company.
4. Physical Factors: These are the factors which result in
loss or damage to the property of the firm. They include
the failure of machinery and equipment used in business,
fire or theft in the industry, damages of goods in transit.

22. RISK MANAGEMENT
• Risk management is the acceptance of responsibility for
recognizing, identifying and controlling the exposure to
loss or injury which are created by the activities of
university. It is a process whereby the risk with greatest
loss and greatest probability of occurrence are handled
first and the risk with low probability are handled in
descending order. Risk management is closely identified
with the types of instruments that can be used to manage
risk.
• “Risk management is the process by which various risk
exposures are identified, measured and controlled. It is
the systematic applications of principles, approach and
process to the tasks of identifying and assessing the risk
and planning the responses.

23. Process of Risk Management
1) Establishing the Context(Framework)
a) Identification of risk
b) Framing the risk framework
c) Identification of agenda
d) Developing an analysis of risk
2) Risk Identification
a) Source analysis(from where the risk comes)
b) Problem analysis(what the problem is)
i. Problem based risk
ii. Scenario based risk
iii. Taxonomy based risk
iv. Common risk checking
v. Risk Charting
3) Risk Analysis/assessment
4) Potential risk treatment
i. Risk avoidance
ii. Risk reduction
iii.Risk sharing
iv.Risk retention

24. Methods of Risk Management
I. Identify the threats
II. Access the degree of critical assets to specific threats
III. Identify the risk(Highest level of threats)
IV. Identify the ways to reduce the risk
V. Identify the risk reduction measurement based on strategies.

25. Objectives of Risk Management
• It ensure the management of risk is consistent and
supports the achievement of strategies and corporate
objectives.
• Provide high quality customer service.
• Minimizes the human cost of risks
• Minimize the financial and other negative consequences
of loss and claims.
• Helps initiating the action to prevent or reduce the
adverse effect of risk.

26. Pros of Risk Management
• It encourages to analyze the available and
predicted risks.
• It help the firm to manage itself better by
clarifying and being better prepared of risk.
• Helps to prioritize org. investment and
reduces the internal disputes

27. Risk Management Tools
There are five major tools/methods of risks handling.
They are:
1. Risk Control
a. Risk Avoidance
b. Risk Reduction
2. Risk Financing
a. Risk Retention
b. Risk Transfer(Non-Insurance transfer)
i. Contract
ii. Hedging
3. Loss Control
4. Insurance

28. Risk Management Tools
1. Risk Control
a. Risk Avoidance: It is the elimination of risk. The
risk of a vulnerable disease can be avoided by not
having sex, or risk of divorce by not marrying, the
risk of car accident by driving the car safely and
following the traffic rules.
b. Risk Reduction: It is the process of reduction or
mitigation of risk caused from certain hazards. In
this the hazards that can be the source of risks is
mitigated by taking certain measures or actions.
Ex: The risk of fire/theft in storehouse can be
reduced by installing the fire extinguishers or CCTV
Camera.

29. Risk Management Tools
2. Risk Financing
a. Risk Retention: It is another tools of risk management where the
risk of known or unknown nature is retained by the risk takers
knowingly or unknowingly or considers it less risky or doesn’t have
idea of the risk. Smoking Cigarettes, Speeding of vehicles etc are the
examples of risk retention.
b. Risk Transfer: It is the most widely preferred risk management tools
where the risks is managed by transferring to the non-insurance
holder.
 Contract: Risk can also be transferred though contract by
purchasing the warranty period of the goods or items where the
risks transfers from the buyer to the manufacturer of the items.
 Hedging: It is the another risk management tools mostly used in
the stock market where the price varies on the regular basis. In
this the price/rate is fixed between the parties on the signing
date of agreement and remains fixed for the future date.

30. Risk Management Tools
3. Loss Control
• Loss Control is also known as loss prevention or loss
reduction which reduces the probability of risk that
minimizes the loss. Loss prevention involves
identifying the factors causing loss, assessing the
factors/loss and eliminating/minimizing the factors
effect. Speeding and drink driving increases the
accidents. Not driving after drinking is the method
of prevention of loss from being occurred while
driving slowly after drinking reduces the magnitude
of the loss caused.

31. Risk Management Tools
4. INSURANCE
• It is the most widely used tools by people,
businesses and organizations where the pure risks is
transferred to insurance company by paying a
certain amount of premium in exchange for the
possible loss. An insurance company can pay the
loss because it pools the premium collected and
invests to the same to pay the few who will have
the significant losses. There is the two parties
involved, one who pays premium called insured and
the insurance company called insurer.

32. RISK Evaluation Tools/Risk Identification
1. Risk Mapping:
• Risk Mapping is systematically mapping the risks faced by the company. It is listing of
all the relevant risks that might affect the company, where each single risk is placed in
a two-dimensional space: Frequency and severity. The location of the risks in this
space allows top management to reach a decision regarding which risks should be
assumed and which risks should be hedged. The higher a risk ranks for these
qualities, the more threatening it is to your organization.
• Risk management begins with building a list of all risks your organization
faces. Depending on your industry, this number could range from a handful to
hundreds.
• Risk mapping is beneficial because it requires you to assess each risk and its causes
and consequences individually. It also allows you to look at your risk environment as a
whole and understand how frequencies and severities compare.
• The most severe and frequent risks, your primary risks, are critical and would hinder
your ability to conduct business. Risks that are severe but unlikely, your "detect and
monitor" (D&M) risks, are those that need to be watched but don’t require heavy
mitigation strategies. Risks that are highly likely but insignificant, your monitor risks,
will not impact your ability to continue operations. Finally, the risks that are low in
both frequency and severity, your low control risks, can be revisited on a yearly basis
to ensure the risk remains low.

34. 2. Risk Assessment Matrix:
 A risk assessment matrix is a Risk management tool that allows a single
page quick view of the probable risks evaluated in terms of the likelihood
or probability of the risk and the severity of the consequences.
 It is made in the form of a simple table where the risks are grouped
based on their likelihood and the extent of damages or the kind of
consequences that the risks can result in.
 Making a risk management matrix is the second step in the process of
risk management, and it follows the first step of filling up to determine
the potential risks.
 The preparation of risk assessment is a more elaborating task and
involves determining risks, gathering risk data, determining the
probability and the impact levels of the risks, understanding
consequences, assigning priorities and developing risk prevention
strategies.
 On the other hand, a risk assessment matrix just provides the project
team with a quick view of the risks and the priority with which each of
these risks needs to be handled.
RISK Evaluation Tools/Risk Identification

36. Enterprise Risk Management(ERM)
• Enterprise Risk Management(ERM) is the process of
planning, organizing, leading and controlling the activities of
an organization in order to minimize the effect of risk of an
organization’s capital and earnings. It is a systematic,
integrated approach to managing all risks facing an
organization.
• ERM is a process effected by entities, board of directors,
mgmt. and other personnel applied in strategy setting across
the enterprise designed to identify potential events that may
affect the entity and manage risk to be within risk appetite to
provide reasonable assurance regarding the entities
objectives.
• ERM is the discipline, by which an organization in any
industry assesses, controls, exploits, finances and monitors
risks from all sources for the purpose of increasing the
organization’s short and long term value to its stakeholders.

37. Nature/Features of ERM
• Ongoing Process
• Application in strategy setting
• Applied across the enterprise(Every level and
unit and Entity)
• Helps in identifying potential events.
• Effected by people at every level of an
organization.

38. Risk in ERM
• Credit Risk
• Market Risk
• Underwriting Risk
• Operational Risk
• Strategic Risk

39. Components of ERM
• Internal Environment
• Objective setting
• Event identification
• Risk Assessment
• Risk Response
• Control Activities
• Information and Communication
• Monitoring

40. Risk Measuring Tools
1. Risk Adjusted Performance Measures(RAPM):
It is a profitability measures that jointly takes into consideration of
the margin or profit produced by business and its capital at
Risk(CaR).
It is the calculation of risk adjusted returns of transactions, trading
units and business.
It means the performance of a security or investment relative to its
risk. It measures returns against the risk taken.
RAPM= (Return-Expected Loss)/ Economic Capital

41. Risk Measuring Tools
2. Value at Risk(VaR):
It is a threshold value such that the probability that the mark-to-
market loss on the portfolio over the given time horizon exceeds this
value is the given probability level. It measures the risk of loss on a
specific portfolio of financial assets. It is the tool for measuring the
market risk.
It is a tools to measure bank’s risk exposure. It is extensively used in
banks and has been strongly supported by banking regulators. It is
the measure of volatility of firm’s banking or trading book. A portfolio
containing assets that have a high level of volatility has a higher risk
than one containing assets with a lower level of volatility.
It is the maximum loss that can occur with X% Confidence over a
holding period of n days. Eg; If a daily VaR is stated as £ 1,00,000 to a
95% confidence level, this means that during the day there is only a
5% chance that the loss the next day will be greater than £ 1,00,000

42. Scope of Risk Adjusted Performance
Measures(RAPM)
1. Capital Management(CM):
• Helps to determine capital required to support business activity.
• Establish efficiency of capital utilization
• Helps to allocate capital based on returns generated on capital.
2. Return Management(RM):
• Focuses on dissection of return relative to the risk of business
segments
• Helps to analyze the performance at multiple level
3. Performance Linked Compensation Strategies(PLCS):
• Focuses on use of risk adjusted return on capital as a means for
establishing accurate mechanism to align employees performance
and compensation of shareholders returns.
4. Risk Budgeting(RB):
• Covers the use of RAPM techniques to allocate risk and assume risk
efficiently within investment portfolios.

43. Measures to Evaluate Risk Adjusted
Performance Measures(RAPM)
1. Sharpe Ratio:
It is the average of the excess return divided by the volatility of the excess return.
It is mostly used in investment industry which measures the consistency of the
performance of a portfolio in excess of the risk free rate in risk adjusted terms.
Sharpe Ratio=(Rp-rf)/S.D, Where Rp is portfolio return and rf is risk free return
2. Information Ratio:
It measures the performance of a portfolio relative to a benchmark(minimum
acceptable return) instead of the risk free rate in risk-adjusted terms.
Information Ratio=(RP-rb)/S.D, whereas rb is benchmark or minimum return
3. Sortino Ratio:
It is the refined version of sharpe ratio which is defined as the average of the
active return divided by the downside risk. It measures whether the portfolio’s
return in excess of specified benchmark was sufficient to cover the downside
risk(volatility of negative active return) inherent in the investment.
Sortino Ration=(RP-rb)/Downside risk S.D.

44. Approaches to Computing Value at Risk
(VaR)
1. Historical Simulation
2. Model Building Approach
3. Linear Model
4. Quadratic Model
5. Monte Carlo Simulation