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MFS 4023 RISK MANAGEMENT

By : Salman Bin Lambak
Risk Reduction
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Types of Risk Reductions:-

1. Loss Prevention

2. Loss Control
Loss Prevention
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Loss prevention efforts are aimed at preventing the
occurrence or loss.

Example: Vehicles anti-theft device is installed to
prevent the vehicle being stolen
Loss Control
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Loss control efforts can be directed toward reducing
the severity of those losses that do occur.

Example: Water sprinkler is aimed to reduce the fire
damage to the building or content
Risk Reduction
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Basic Principles of Risk Reductions:-

1. Timing

2. Measure

Risk Reduction : Timing
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Risk control can be applied to act:-
1. Before the occurrence, to reduce the likelihood of
happening
2. During the occurrence, to reduce the severity
3. After the occurrence, to reduce severity and further
consequential impact i.e. contingency plan, first aid
provision

Risk Reduction : Measures / Mechanics
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Measure can be hard or soft:-
1. Hard (physical) measures that alter the risk by physical
means, e.g. water sprinkler, theft alarm, locks and bolts.
2. Soft (organizational and procedural) measures that are
aimed to ensure the people act in the appropriate way to
reduce the risk, e.g. risk committee, security patrol and
non-smoking room.

Risk Finance
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Risk finance is a form of risk treatment involving
contingent arrangements for the provision of funds to
meet or modify the financial consequences should
they occur.
Risk financing is not generally considered to be the provision of
funds to meet the cost of implementing risk treatment.




as defined by ISO/IEC Guide 73; see page 11 @ 17
Risk Finance : Transfer / Sharing
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Risk transfer / sharing is form of risk treatment
involving the agreed distribution of risk with other
parties.

It can be carried out through insurance or other
forms of contract.

The extent to which risk is distributed can depend on
the reliability and clarity of the sharing arrangements.
Types of Transfer
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Non Insurance Transfer
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It may be possible to transfer a risk to another party
in a contract.

For example, a landlord might make a condition of a
lease that the tenant be responsible for any damage to
the premises.
Insurance Transfer
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Insurance is the most widely used of all risk transfer
method.

It is a mechanism by which an organization can
exchange its uncertainty for greater certainty.

The details of insurance will be elaborated in next
chapter.
Insurance Transfer
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Like any other risk treatment method, insurance is
not perfect.

A residual risk will usually remain for the customer,
whereby:-
1. Some events may be excluded by policy conditions
2. A proportion of loss will be carried by the insured in the form
of deductible
3. The insurance company itself may become insolvent and fail
to pay the claim
ART (Alternatives Risk Transfers)
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ART is a name given to a range of instruments that
enable an organization to transfer financial risk to a
professional risk carrier other than by way of a
conventional insurance contract.
ART (Alternatives Risk Transfers)
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Instruments of ART:-
1. Derivatives:
It is a forward contract that will enable someone to buy or sell a
specified asset at a specified date in the future and at a specified
price.
Example is an earthquake. One such contract could be triggered
by an earthquake of a magnitude in excess of, say 7.1 on the
Richter scale occurring within the defined latitude and longitude,
and within a defined period.

ART (Alternatives Risk Transfers)
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Instruments of ART:-
2. Catastrophe bonds:
It is an investment bonds that provide a return to investors that is
based on insurance type events rather than financial market
development.

3. Catastrophe Risk Exchange (CATEX):
It is an electronic system for trading insurance risk. Licensed risk
bearers exchange or swap catastrophe exposures offered by other
subscribers.
For example, insurers and reinsurers may exchange a Japanese
earthquake risk for a Florida hurricane risk.

ART (Alternatives Risk Transfers)
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Instruments of ART:-
4. Loans:
Borrow funds after a catastrophe has occurred to help it meet the
extra costs that emerged.

5. Put Options:
It is sold by a financial institution to the organization. The effect is
that the option, or a contracted right to act, will become effective
following certain specified events. The damaged organization then
could use the contracted right to sell a pre-agreed level and type of
equity to the financial organization that provided the option.

ART (Alternatives Risk Transfers)
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Instruments of ART:-
6. Mutual:
Some industries find value in avoiding the insurance market by
creating a mutual company that can be used to share risks across
the sector. Examples include pools for the oil industry, marine
risks and others.

7. Combination of ART 1 - 6

Risk Finance : Risk Retention
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It means an acceptance of the potential benefit of
gain, or burden of loss, from a particular risk

Risk retention includes the acceptance of residual
risks
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The level of risk retained can depend on risk criteria
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1 Residual risk is the remaining after risk treatment. It can contain unidentified risk. The
residual risk can also be known as retained risk.

2 Risk criteria are based on organizational objectives, and external
and internal context
Risk Retention : Types
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1. Self Insure
2. Captive
Self Insure
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Self Insure was previously related to risks which are
not covered by insurance.

But now, the scope becomes wider which that the
individual or organization retains the risk on their
owns for many reasons.
Self Insure
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Reasons for self-insurance:-
1. Cost of insurance, be it short term or long run, exceed average
losses.
2. The organizational may also believe that the loss experience is
better than the average loss experience of other same nature.
3. The amount spent for insurance may more worth to be
invested.
Self Insure :- Types
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1. Handles as an expense
In this approach, the organization decides that no separate
funding is necessary. The losses, such as collision damage to
their motor vehicle, are handled as part of the running
expenses.

2. Loans
The organization may choose to rely on a loan if a loss occurs.
This saves of insurance premiums, but it has its drawbacks i.e.
the organization may be weakened by the loss.
Self Insure :- Types
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3. Contingency Fund
A special fund may be set up to pay for the loss, using all or part
of the money that would have been paid out as an insurance
premium. This has the attraction that the organization will
benefit from any investment income if the contingency never
occurs.

Captive
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A captive is an insurance company that has been set
up by the organization to insure its own risk, although
some may actually accept risk for profit from other
organizations.
Captive
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Captive perform a number of roles:-
1. They are a formalized method of self-insurance for high
frequency risk that can be carried by the company itself in a
tax efficient way.
2. They are also used as a financing instrument for very specific
low frequency / high severity risk.