Topic 2.

Risk and Risk Management

Bus 200 Introduction to Risk Management and Insurance Jin Park

Overview

Terminology

Risk Perils, Hazards ERM, IRM

Risk Management process

Terminology

Risk

Deviation from expectation

Uncertainty concerning a loss

Worse than expected Better than expected

Pure vs Speculative Fundamental vs Particular Systematic vs Nonsystematic (Diversifiable) Objective vs Subjective

Uncertainty Loss (cf. Loss exposure)

Terminology

Pure Risk

Speculative Risk

Loss or no loss Fire Risk management & Insurance

Loss or gain No loss/gain Investment Finance

Enterprise Risk Management deals with managing both risks in a firm

Terminology

Perils

(Immediate) Causes of loss

Hazards

Physical hazards Moral hazards Morale hazards

Risk Management

Risk management

A systematic process for managing (pure) risks faced by an individual or organization. Pre-loss risk management

Should prepare for potential loss in the economical way possible

Survival of the organization Continuation of operation Stability of earnings

Post-loss risk management

Risk Management Process

Identify risks or exposures to loss Evaluate risks or exposures to loss Identify and select risk management techniques Implement and monitor

Identify Risks

Organization

Individual

Property Liability Business income Death or disability of key persons Job-related injuries or disease Fraud, dishonesty, crime International operation

Property Liability Premature death or disability Unemployment Sickness Liability

Identify Risks

Physical inspection Questionnaire Financial statement analysis Flowchart Contract analysis Statistical analysis of past losses

Risk management information system (RMIS)

Evaluate Risks

Risk management matrix

Frequency Severity
High

Frequency Low Low High

Severity

Evaluate Risks

Risk mapping
High

Frequency

Low Low Severity High

Identify and select RM techniques

Risk avoidance Risk retention (Risk assumption)

Risk reduction (control)

Self-insured Captive

Risk transfer

Loss prevention frequency Loss reduction severity Insurance Non-insurance

Example: Sprinkler, Hold-harmless agreement, ignorance, safety education, smoke alarm, deductible, warm-up, rent

Identify and select RM techniques

Risk mapping

Critical issue tolerance boundary or risktolerance boundary Prioritize risks

Implement and Monitor

Are techniques implemented correct? If not,

Insurance

Advantages

Disadvantages

Uncertainty is reduced Insurers can provide. their expertise such as loss control services. Insurance premium is tax-deductible. Insurance proceeds are tax-free.

Insurance premium may be a major cost. Moral and morale hazards may be created. Time and effort have to be spent. Insurance may not be renewed.

Others

CAT bonds Forward/Future Swaps Options Securitizations CDO, CMO, CBO, CLO

Enterprise risk management

Integrated risk management The process of planning, leading and controlling the activities of an organization to minimize the effects of risk on earnings and capital A holistic approach to risks faced by a firm

Requires a (strategic) risk management policy Needs support from the top level of a firm

Risk management has to be integrated among various players in a firm

The Three Faces of Risk Management

Although most companies have their bases covered should they meet with fire, theft or flood, such hazards represent Explains about ERM allows organizations to examine all the risks they face measure the potential impact of those risks on the long-term viability of the company take the appropriate steps to manage or mitigate those risks. "The goal is to ensure the continuity of the enterprise "This is an opportunity to get to know your risks better than your competitors. It can also leave you in a position to be able to take on more risk the type of risk that can help improve company performance."

An example of an electronics manufacturer

Top Cops

Explains about CRO Explains about ERM

"We're building the capability internally to identify all risks, analyze and quantify them, and then determine the optimum means of mitigating, absorbing, or transferring them. When that's done, we will decide on an ongoing basis which risks to keep and which to transfer. Then we can effect the transfer through our trading desks, financial markets, insurance carriers, integrated risk policies, OTC [over-thecounter] transactions, or a contractual transfer to another party entirely. other CROs are working closely with insurance brokers, accounting firms, and risk management consultants to lead the way,

Illinois Power

The Risk Register

a comprehensive risk-assessment system a formal process that identifies, quantifies and categorizes the risks facing Illinois Power, develops costeffective methods to control them and positions the company to achieve its stated goals

Illinois Power

Benefits of the Risk Register

aware of the catastrophic risks aware of the fact that its pre-loss risk management was not adequate developed a more efficient and effective post-loss risk management program built risk-related database

Illinois Power

IDENTIFYING THE RISKS regardless of insurability CONSIDERING CONTROL TECHNIQUES disregarding cost or appropriateness of any method SELECTING RISK CONTROLS subjected to a reasonableness test and a thorough economic evaluation IMPLEMENTATION MONITORING

UPS

Why small firms? Why not large firms? Why not pharmaceutical firms? Lessons

"Use more than one delivery company. "August is a good time for a strike, because there is not a lot of stuff being done."

Domino effects

???

Next- Loss Exposures

ETTI: Chapter 1, pp. 16 18 ETTI: Chapter 8, pp. 162 164, 170 172, 173 176 ETTI: Chapter 9, pp. 180 - 203 1. Business continuity planning: Preparing for the worst, KPMG Insiders, June 10, 2002 2. U.S. firms underestimate IT risks, Insurance Day, June 14, 2002 3. Prudent Man with a Plan, CFO Magazine, June 18, 2002. 4. Warning: A batman cape wont help you fly, New York Times, March 5, 1997. 5. Jury awards $12 million in voice-mail hang-up, Chicago Tribune, April 3, 2003. 6. $36 million awarded to heirs of 2 killed in freak accident, Chicago Tribune, date unknown.