3. Meaning of Risk management
3/12/2024
By: Seble T.
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Risk management refers to the identification; measurement
and treatment of exposure to potential accidental losses
almost always in situations where the only possible outcomes are losses
or no change in the status
It is a general management function that seeks to assess and address
the causes and effects of uncertainty and risk on an organization
Risk management is a systematic process that identifies and evaluates
loss exposures faced by an organizations or individuals and selects the
most appropriate techniques for treating such exposures.
It is a scientific approach to deal with risks by anticipating possible
accidental losses and designing and implementing procedures that
minimize the occurrence of loss or the financial impact of the losses
that occur.
The purpose of risk management is to enable an organization to
progress towards its goals and objectives in the most direct, efficient,
and effective path. It is concerned with all risks.
4. Objectives of Risk Management
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By: Seble T.
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Risk management has many important objectives, which can
be classified as either
1. Pre loss Objectives
2. Post loss Objectives
Pre-loss objectives: A firm or organization has several risk
management objectives prior to the occurrence of a loss.
The most important include economy, the reduction of
anxiety, and meeting externally/legally imposed obligations.
Economy: The economy objective means that the firm should
prepare for potential losses in the most economical way.
This preparation involves an analysis of the cost of safety
programs, insurance premiums paid, and the costs associated
with different techniques for handling losses.
5. Objectives of Risk Management
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Reduction of Anxiety: Certain loss exposures can cause
greater worry and fear for the risk manager and key
executives.
For example, the threat of a terrible court case from a defective
product can cause greater anxiety than a small loss from a
minor fire. The risk manager, however, wants to minimize the
anxiety and fear associated with all loss exposures.
Meeting legal obligations: The final objective is to meet any
legal obligations.
For example, government regulations may require a firm to
install safety devices to protect workers from harm, to dispose
of harmful waste material properly and to label consumer
products appropriately
6. Objectives of Risk Management
2. Post- loss objectives: Likewise, a firm may have many risk
management objectives subsequent to the occurrence of the loss.
Important objectives after a loss occurs include survival, continued
operation, stability of earnings, continued growth, and social
responsibility.
Survival: The most important post loss objective is survival of the
firm. Survival means that after a loss occurs, the firm can resume at
least partial operations within some reasonable time period.
Continued Operation: The second post loss objective is to
continue operating.
For some, firms, the ability to operate after a loss is extremely
important.
For example, a public utility firm most continues to provide
service.
Banks, post offices, dairies, and other competitive firms must
continue to operate after a loss. Otherwise, business will be lost to
competitors.
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7. Objectives of Risk Management
Stability: The third post loss objective is stability of
earnings. Earnings per share can be maintained if the firm
continues to operate.
However, a firm may incur substantial additional expenses to
achieve this goal (such as operating at another location), and
perfect stability of earnings may not be attained.
Continued Growth: The fourth post loss objective is
continued growth of the firm. A company can grow by
developing new products and markets or by acquiring or
merging with other companies.
Social Responsibility: Finally, the objective of social
responsibility is to minimize the effects that a loss will have on
other persons and on society.
A sever loss can adversely affect employees, suppliers,
creditors and the community in general.
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8. The Risk Management Process
The risk management process involves the
following five steps:-
Step 1: Risk Identification
Step 2: Risk Measurement
Step 3: Select the appropriate techniques for treating
loss exposure, and
Step 4: Implementing and administering the program
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9. The Risk Management Process
Risk Identification: Risk identification is the
process by which an organization is able to learn
areas in which it is exposed to risk.
Risk identification is the process by which a business
systematically and continuously identifies pure risk
(property, personal and liability risk) exposures as
soon as or before they occur.
Risk identification is a very difficult process and it is
a continuous job for the risk manager because the
risk environment is dynamic.
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By: Seble T.
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10. 1. Risk identification techniques
The commonly used methods of risk identification
can be described as follows:
1. Loss Exposure Checklists: it can be used by both
business and by individuals.
It specifies numerous common potential sources of loss
from destruction of assets and from legal liability.
Loss exposure checklists are available from various
sources, such as insurers, agencies etc. the checklists
contain possible source of loss to the business firm from
the destruction of physical and intangible assets.
Sources of loss are categorized according to their
being predictable or unpredictable, controllable
or uncontrollable, direct or indirect, etc
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11. CONT….
Some loss exposure checklists are designed for specific
industries, such as manufacturers, retail stores,
educational institutions, or religious organizations.
2. The Financial Statement Method: proposed by
A.H. Criddle (1962).
Although it was intended for private
originations, the concepts of the financial
statements approach can be generalized in public
sector organizations as well.
By analyzing the balance sheet, operating
statements and supporting documents, the risk
manager can identify property, liability and human
exposures (losses) of the organizations. 3/12/2024
By: Seble T.
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12. Risk identification techniques
3. The Flow Chart Method: An organization’s exposure to
risk also can be identified by studying flow chart of
organization’s activities and operations.
Flow charts are representations of a sequential process.
Flow charts describe the operations of a firm can guide a
risk manager to associate risks with those operations.
4. Contract Analysis: Many of an organization’s exposures
to risk arise from contractual relationships with
other persons and organizations.
5. Interactions with other Departments: Frequent
interactions with other departments provide another source of
information on exposures of risk.
These interactions may include oral or written reports
from other departments on their own initiative or in
response to regular reporting system that keep the risk
manager informed of developments.
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13. Risk identification techniques
6. Interactions with Outside Suppliers
and Professional Organizations:
These outsiders may be, for
example, accountants, lawyers, risk
management consultants, actuaries,
or loss control specialists.
The objective would be to determine
or assess whether the outsiders have
identified exposures that otherwise
would be missed.
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14. Risk identification techniques
7. Statistical Records of Losses: When available, statistical records of
losses can be used to identify sources of risk.
These records may be available from risk management information
systems developed by consultants or in some cases, the risk manager.
These systems allow losses to be analyzed according to cause,
location amount and other issues to accident.
8. On Site Inspection: On site inspections are must for a risk manager.
By observing the firm’s facilities and the operations conducted
thereon the risk manager can learn much about the exposures faced
by firm.
Which method is the best?
There is a range of techniques available and no one technique
can be used in all situations.
No single method of risk identification is free of weakness , the
preferred is combination.
The choice is function in nature & size of the business
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By: Seble T.
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15. 2.Evaluating potential loss
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By: Seble T.
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Evaluating and measuring the impact of losses on
the firm involves an estimation of the potential
frequency and severity of loss.
Loss frequency – it refers to the probable number
of losses that may occur during some given time
period.
Loss severity – it refers to the probable size of the
losses that may occur during some given time period.
16. 3. Selecting appropriate techniques, or combination
of techniques for treating loss exposures
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By: Seble T.
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The major techniques for treating loss exposures are the following:
Risk control techniques – attempt to reduce the frequency and
severity of accidental losses. It includes:
avoidance
loss control
separation/ diversification
combination
Risk financing techniques – provides for funding of accidental
losses after they occur. It includes:
Retention/assumption
Self - insurance
Non-insurance transfers
Insurance
17. A. Risk control techniques
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1. Avoidance – it means that certain loss exposure is never acquired or
existing loss exposures is abandoned.
It avoids property, person or activity that could be a source of risk. One way to
control a particular risk is to avoid the property, person or activity giving rise to
possible loss.
Risk avoidance discontinues the source of risk. There are some characteristics of
avoidance. These are:
Avoidance may be impossible
It is an impractical approach
Avoiding a risk may create another risk
2.Loss control – it assumes that the firm will retain the property, person
or activity creating the risk but the firm will conduct its operation in the safest ways.
It is designed to reduce both the frequency and severity of loss.
Loss control deals with an exposure that the firm doesn’t wish to abandon. It uses
both loss prevention and reduction program.
Loss prevention program – seeks to reduce or eliminate the chance of loss.
Loss reduction program – seeks to reduce the potential severity of the loss.
18. Cont.…
3/12/2024
By: Seble T.
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Loss Prevention is a classification of loss control that
are designed primarily to reduce loss frequency.
For example, measures that reduce truck
accidents include driver examinations, zero
tolerance for alcohol or drug abuse and strict
enforcement of safety rules.
For instance, a measures that reduce lawsuits from
defective products include installation of safety
features on hazardous products, placement of
warning labels on dangerous products, and
institution of quality control checks.
19. Cont.….
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By: Seble T.
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Severity reduction: Is refers to measure
that reduce the severity of a loss.
Consider an auto manufacturer having airbags
installed in the company fleet off automobiles.
This form is engaging in “severity reduction” (Loss
Reduction).
The air bags will not prevent accidents from
occurring, but they will reduce the probable
injuries that employees will suffer if an
accident does happen.
21. CONT……
3/12/2024
By: Seble T.
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3.Separation/diversification
involves the reduction of maximum probable loss
associated with some kinds of risks.
“Do not put all your eggs in one basket”
Separation of the firm’s exposures to loss instead of
concentrating them at one location.
Example, a firm may disperse its inventory in to different
warehouses than keeping it in one store. If fire destroys one
of the warehouses, the firm will save some of its inventories
placed in the other warehouses.
Through such separation, the firm is reducing the likely
severity of overall firm losses by reducing the size of the
exposure in any one location.
22. Cont…
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By: Seble T.
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4. Combination
Combination is a basic principle of insurance that follows
the law of large number.
Combination increases the number of exposure units
since it is a pooling process.
It reduces losses by making losses more predictable with
higher degree of accuracy.
Unlike separation which spreads a specified number of
exposure units, combination increases the number of
exposure units under the control of the firm.
Eg. Expand through internal growth, merger and
acquisition
23. B. Risk financing techniques
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By: Seble T.
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1.Retention/ assumption
It is a method of handling risks by the organization and the source of the fund
is the organization itself.
Retention may be passive or active, unconscious or conscious, and unplanned
or planned.
Retention is passive, unconscious and unplanned when the risk manager is not
aware that the exposure exists and doesn’t attempt to handle it.
Retention is active, conscious and planned when the risk manger considers
other methods of handling the risk and consciously decides not to transfer the
potential loss. Eg. Self – insurance
2.Self – insurance
It is a special form of planned retention by which part or all a given loss
exposure is retained by the firm.
It requires risk retention and there should be adequate financial arrangement
in advance to provide funds to pay for losses should they occur.
It is widely used in workers compensation insurance, used by employers to
provide group health, prescription of drug benefits to employees.
24. CONT….
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By: Seble T.
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3.Non-insurance transfers
Risk transfer involves in payments by one party (the
transferor) to another (the transferee or risk bearer) when the
transferee agrees to assume a risk that the transferor desires
to escape.
It is a method other than insurance by which Pure risk and its
potential financial consequences are transferred to another
party.
The most common forms of non insurance risk transfers are
hedging, hold-harmless agreements and incorporation.
4. Insurance
It represents a contractual transfer of risks. It is appropriate
for loss exposures that have low frequency and high severity.
25. Risk Management Matrix
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By: Seble T.
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Which method should be used?
In determining the appropriate method or methods
of for handling losses, a matrix can be used that
classifies loss exposures according to frequency and
severity.
Loss frequency
Loss severity
Low High
low retention Loss control and
retention
high insurance Avoidance
26. 4. Implementing and administering the
risk management program
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By: Seble T.
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It is the last step in the risk management process. To
be effective, the risk management must be
periodically reviewed and evaluated to determine if
the objectives are being attained.
