2. DEFINITION
• As a systematic approach to
identifying, measuring and controlling
risks that can threaten assets and
earnings of oneself, a business or the
organization.
• The purpose of risk management is to
enable an organization to progress toward
its goal and objectives (mission) in the
most direct, efficient, and effective path
3. OBJECTIVES OF RISK
MANAGEMENT
• Objectives prior to a loss
• Objectives after a loss occurs
4. OBJECTIVES PRIOR TO A LOSS
• Reduce impact of loss
• Reduce fear and worry
• Required by law
5. OBJECTIVES AFTER A LOSS
OCCURS
• Survival of organization – organization still able
to continue operations
• Stability of earnings – business operations do not
have to stop and the organizations can
concentrate on their business activities as usual.
• Reduce impact of losses to organization and
society – when a loss occurs not only will the
organization suffer but the loss has to be
burdened by society as well. Employees may
have to be retrenched and some departments may
have to be closed down.
6. RISK MANAGEMENT PROCESS
1. Identifying potential losses
2. Evaluating potential losses
3. Examining alternative risk management
techniques
4. Implementing the risk management
program
5. Controlling/monitoring the program
7. IDENTIFYING POTENTIAL LOSSES
• Risk identification is the process by which an
organization is able to learn of the areas in which
it is exposed to risk.
• Identification techniques are designed to develop
information on sources of risk, hazards, risk
factors, perils and exposures to loss.
• It is everybody’s task to identify the loss
exposures in one organization.
8. IDENTIFYING POTENTIAL LOSSES
• Losses can be classify as:
– Direct damage (damage to building)
– Indirect damage (loss of profits due to
business interruption)
– Liability (court award to 3rd party since fire
was caused by negligence of the owner of
building)
– Loss of Key Employees (key employees such
as general manager/CEO/Researcher)
9. IDENTIFYING POTENTIAL LOSSES
• How to identify risk?
– Questionnaires
– Interviews
– Financial Statements
– Flow Charts
– Personal inspection / Observation
10. EVALUATING POTENTIAL LOSSES
– Risk measurement evaluates the likelihood of
loss and the value of loss in terms of
frequency and severity.
– The measurement process may take the form
of a qualitative assessment (using %)
– This step involves two important aspects of
loss exposures
• Frequency
• Severity
11. EVALUATING POTENTIAL LOSSES
– Risk measurement evaluates the likelihood of
loss and the value of loss in terms of
frequency and severity.
– The measurement process may take the form
of a qualitative assessment (using %)
– This step involves two important aspects of
loss exposures
• Frequency
• Severity
12. EVALUATING POTENTIAL LOSSES
– Identifying and determining the loss exposures
alone is not sufficient
– In evaluating the potential losses:
• Estimating the frequency and severity for each
type of loss exposure and ranked it according to
their relative importance. High loss exposure will
be given priority.
• Estimating relative frequency and severity of each
loss exposure as the selection of appropriate
technique will depend on this.
13. EVALUATING POTENTIAL LOSSES
• How can you determine and estimate the
impact of losses
– Frequency
• Referring to the number of times the loss occurs
– Severity
• Referring to the maximum size of loss exposures
14. EXAMINING THE METHODS OF
HANDLING THE LOSS EXPOSURES
• Two main ways to • Risk Financing
classify the risk – Retention/Assumption
management – Captive insurer
techniques
– Insurance
– Risk Control
• Risk avoidance
• Loss control
– Loss prevention
– Loss reduction
• Separation
• Contractual Transfer
15. RISK CONTROL
• Methods seek to alter an organization’s
exposure to risk.
• Risk control efforts help organization
avoid a risk, prevent loss, lessen the
amount of damage if a loss occurs or
reduce undesirable effects of risk on an
organization.
16. Risk Avoidance
• Risk is proactively avoided or abandoned after
rational consideration.
• If someone is afraid of risks, the best way to deal
with it is to avoid it completely.
• Example; a manufacturer may stop production of
a defective products to avoid a lawsuit.
• However, some risks are unavoidable although
risk avoidance may be chosen as an option in
handling certain risks, the exposures of losses
cannot be eliminated entirely.
17. Loss Control
• Loss control is designed to reduce both the
frequency and severity of losses by
changing the characteristics of the
exposure so that it is more acceptable to
the firm. Divided into:
– Loss prevention
– Loss reduction
18. Loss Control
• Loss Prevention • Loss Reduction
– Seek to reduce the number – Designed to reduce or
of losses (frequency) of lower the severity of
losses losses, should it occur.
– Is used when the benefits – Since some risks are
outweigh the costs unavoidable, the other
involved. alternative is to reduce its
– Either imposed by law or impact.
imposed by companies and – Can be used in two
factories to fence circumstances: before a
dangerous machinery to loss, e.g. installation of fire
reduce the chances of alarm or after a loss e.g.
employees being injured. salvage efforts in the
restoration of a building
burnt down by fire.
19. Separation
• Involves the dispersal of the firm’s assets
in several locations instead of confining it
to one major area.
• This measure will reduce the impact of
losses should a major disaster occurs.
• Example, separation of head quarters and
assembly plant in automobile industry.
20. Contractual Transfer
• Risk transfer mechanism.
• Refers to the various methods other than
insurance by which a pure risk and its
potential financial consequences can be
transferred to other party.
21. Contractual Transfer
• Types of contractual transfer
– Incorporation
• The owner of the company transfers the risks to corporation
by registering the company.
– Leasing contracts
• An agreement where the owner or landlord transfers the risks
to the tenants
– Hedging
• An agreement to buy or sell a commodity at a certain price to
avoid losses due to price increase or decrease.
– Hold-harmless agreements
• An agreement between a retailer and a manufacturer whereby
the later agrees to bear losses due to the manufacturer of
defective products thus relieving the retailer of any liability.
22. Contractual Transfer
• Advantages • Disadvantages
– Can transfer potential – If the party to whom the
losses that are loss is transferred is unable
commercially to pay the loss the firm is
uninsurable still responsible
– Not necessarily cheaper
– Often cost less than
than insurance if discounts
insurance are taken into
– Potential loss shifted consideration
to a party who is in a – Ambiguity in contracts
better position to drafted may not hold in
exercise control court.
23. RISK FINANCING
• Methods involving generating funds to pay
for these losses
– Retention
– Self insurance and captive insurer
– Insurance
24. Retention
• Retention – the company will bear the
consequences of the loss
• Risk or loss exposed are normally assumed
or retained when their impact and
consequences are not too great or in cases
when or other methods seem feasible.
• In an organization, the ability to assume a
risk depends on one’s financial ability.
25. Self insurance & Captive Insurer
• Self insurance implies tat the organization sets up
a pool of fund to retain its loss exposures.
• Adequate financial agreement has to be made in
advance of the occurrence of losses.
• The number of loss exposures must be large
enough to ensure the mechanism of insurance to
be operative.
26. Self insurance & Captive Insurer
• A captive insurance company is an entity
to write insurance arrangement for its
parent company.
• The captive’s parent may be one company,
several companies or an entire industry.
28. Insurance
• Risk financing method of transferring the
financial consequences of potential
accidental losses from an insured firm or
family to an insurer
• Transferring the risks to another party
involves a contractual agreement whereby
the other party assumes the risks and is
liable for the loss in the event of loss.
29. Insurance
• In an insurance contract, the party exposed
to the risks (the proposer/insured) pays the
premium to the insurance company.
• In return, the insurance company agrees to
pay a stated sum on the happening of
certain risks specified in the contract.
30. TO DRAW UP AND IMPLEMENT THE
RISK MANAGEMENT PROGRAM
• Once a decision has been in the selection, the
management must select the best and most cost
effective risk management program
• The selection may based of two factors
– Financial criteria – whether it will affects the
organization’s profitability or rate of return.
– Non financial criteria – whether it affects the growth
of the organization, humanitarian aspects and legal
requirements.
