Risk Management

Definition of Risk
“Risk is the condition in which there is a possibility of an adverse deviation from
a desired outcome that is expected or hoped for”.
 Risk can be defined as the unforeseen element which may impede your
progress in achieving the objective.
 It can be defined as the effect of uncertainty on objectives.
 It is used to describe any situation where there is uncertainty about what
outcome (positive or negative) will come.
 If financial term it is often used to indicate possible variability in
outcomes around some expected values.
 Uncertainty- refer to a situation where the outcome is not certain or
unknown.
 Loss- it refers to the act or instance of losing the detriment or the disadvantage
resulting from losing.
 Perils- it refers to the cause of loss or the contingency that may cause the loss.
 Hazards- conditions that increase the severity of loss or the conditions affecting
perils.
 Physical hazards: Property conditions
 Intangible Hazards: Attitudes and culture.
 Definition
There is no universal accepted definition of risk. The term risk is variously defined as
:
a) The chance of loss
b) he possibility of loss
c) Uncertainty
d) The dispersion of actual from expected results
e) The probability of any outcome different from the on expected.

“ Risk is the condition in which there is the possibility of an adverse deviation from a
desired outcome will occur. Life is obviously risky.”
Types of Risk

1. Financial and non financial risks: it involves the simultaneous existence of three
important elements in the risky situation:
a. That someone is adversely affected by the happening of an event
b. The assets an income is likely to be exposed to the financial loss form the occurrence of
the events
c. The peril can cause the loss.
When the possibility of non financial loss does not exist, the condition is
being called as non financial in nature.
2. Individual and group risk: Individual/particular risks are confined to individual
identities or small group.Thefts, robbery, fire, etc.
A risk is said to be group or fundamental risk if it affects the economy or its
participants on a macro basis.These are impersonal in origin and consequences.
3. Pure and Speculative risks: pure risk situations are those where there is possibility of
loss or no loss. Speculative risks are those where there is possibility of gain as well as
loss. If you invest in stock market, you may either gain or lose on stocks.
4. Static and dynamic risks: Dynamic risk s are those resulting from the changes in the
economy or the environment . These risk factors mainly refer to macro economic
variables like inflation, income and output levels and technological changes. Contrary
to this, the static risks are more or less predictable and are not affected by the
economic changes.
5. Quantifiable and non quantifiable risks: the risk which can be measured like financial
risks are known as quantifiable while the situations which may result in repercussions
like tension or loss of peace are called as non quantifiable.
Risk Management
 Risk management is the identification, assessment, and
prioritization of risks followed by coordinated and economical
application of resources to minimize, monitor, and control the
probability and/or impact of unfortunate events or to maximize the
realization of opportunities.
 Risks can come from uncertainty in financial markets, project failures, legal
liabilities, credit risk, accidents, natural causes and disasters as well as deliberate
attacks from an adversary
Risk Management Process
Risk Management Process…

Risk management consists of several steps as follows:

A. Risk Identification/Assessment: it requires knowledge of the organization,
the market, legal, social, economic, political, climatic, financial strenght and
weakness, its vulnerability to unplanned losses , business mechanism by which it
operates. This stage provide foundation for risk management. The various mehods
are:
 Checklist Method
 Financial statement analysis
 Flowchart method
 Onsite inspection
 Statistical Records of losses.
B. Risk Identification: it can start with the source of problem or with the problem
itself.
 Source analysis: it may be internal or external to the system that is the target of RM.
 Problem Analysis: Risks are related to identified threats.

C. Risk assessment: Once risks has been identified, they must then be assessed as to
their potential severity of loss and to the probability of occurrence.
Potential risk treatment: once risks has been identified and assessed, all
techniques to manage risk fall into one or more of these four major categories:
 Avoidance (Eliminate)
 Reduction (Mitigate)
 Sharing (outsource or insure)
 Retention (accept and budget)
D. Risk Management plan and Implementation: Select appropriate control and
countermeasures to measure each risk. Risk mitigation has to be approved by the
appropriate level of Management.
E. Review and Evaluation of the plan.

There are essentially four ways to deal with each risk:

a. Reject the risk
b. Accept the risk
c. Transfer the risk.
d. Mitigate the Risk.
 Objectives of Risk Management

1. Achieve and maintain a reduced cost of risk (both insurance and self-
insurance) without placing the Institute in a position of risk
exposure that could have a significant impact on its financial security
and its Mission.
2. Evaluate and assess all risks of loss and need for insurance related to
the specific performance objective.
3. Modify or eliminate identifiable conditions and practices which may
cause loss whenever possible.
4. Purchased insurance coverage using the following guidelines:
- While a competitive atmosphere is desired, continuity of
relationship with insurance sources is advantageous and will be
maintained unless there is a significant reason for making a change.
- Selection is based on quality of protection, services provided, and cost.
 Methods Of Risk Management

1. Risk Financing : it refers to the manner in which the risk control

measures that have been implemented shall be financed. The primary
objective of risk financing is to spread more evenly over time cost of
risks in order to reduce the financial strain and possible insolvency
which random concurrency of large losses may cause. Essentially an
organization can finance its risk costs in three ways:
a) Losses may be charged as they occur to current operating costs.
b) Ex-ante provision may be made for losses, either through purchase of
insurance or by building up a contingency found to which the losses
may be charged.
c) When losses occur they may be financed with loans, which are repaid
over the next few months or year.
2. Risk Transfer: it implies that the exposed party transfers whole or
part of the losses consequential to risk exposure to another party for a
cost. Some of the techniques of risk tranfer are:
a. Insurance: it is a contractual transfer of risk. The insurance company
agree to indemnify the losses arising out of occurrence pre determined
and charges some cost for this act, called as premium.
b. Non insurance transfers
 Hold harmless agreements or indemnify agreements are the
contractual relationships specifying that all the losses shall be borne by
the designated party.
 Incorporation in another method, where sole trader and partnership
firms can convert themselves into companies and reduce the liability
on them.
 Hedging can be used to transfer speculative risk.
 Diversification across business or geographical locations.
3. Risk Control: Risk can be controlled either by avoidance
or by controlling losses. Loss control can be exercised in two
ways:
 One way is to enhance and monitor the level of precautions
taken to minimize the losses due to exposures.
 Another is to control and minimize the risk operations,
internal risk control technique include diversification and or
investments in getting information of loss exposure so as to
control them
Select Appropriate Risk Management Technique/Strategies
Risk level RM Techniques
High Risk •Avoidance
•Risk Transfer (Contractual)
•Self-Retention

Medium risk •Avoidance (if unacceptable risks)

and •Risk Control
High-Medium Risk •Loss Reduction
•Risk Transfer (Contractual, Insurance policy)
•Duplication of Resources
•Segregation of Exposures

Low Risk •Self Retention

•Loss Reduction
Risk Management for Individuals and corporations

Individual risk management refers to the identification of

pure risk faced by an Individual or family and to the selection
of most appropriate technique for treating such risk. In order
to reduce risk elements certain basic steps has been followed
under individual risk management process:
(1). Identification of Potential Losses: it arises due to following
risks:
a. Personal risk
 Risk arising due to loss of earned income to the family
because of premature death of family head.
 Insufficient income and financial assets during retirements.
 Loss of earned income from unemployment.
b. Property risk
 Direct physical damage to a home and personal property
because of fire, lightning, flood, earthquakes or other case.
 Theft of valuable property like money, securities and antiques.
 Theft of car, motor cycle or direct physical damage.
C. Liability risk
 Legal liabilities arising out of defamation of character and
similar exposures.
 Legal liability arising out of negligent operation of a car,
motorcycle, boat
 Legal liability arising of business or professional activities.
(2) Evaluation of Potential losses: estimating the frequency and severity of
potential losses is the most appropriate technique which is used to deal with the risk.
Ex: the chance that your home is will be totally destroyed by natural calamity- like
thunder, storm, flood etc is relatively small , but the severity of losses can be
catastrophic. Such loss should be insured.
(3) Selecting the appropriate techniques for handling losses:
 Loss control: it is a method by which frequency and security of losses are
controlled. Ex: Car theft can be prevented by locking the car, wearing helmet can
reduce the severity of head injury
 Avoidance: Apart from controlling losses other substitute for preventing losses to
occur is avoidance. Ex: you can avoid risk by not travelling on a lonely road and not
to drive the vehicle with poor brakes.
 Retention: it means the amount of losses that you can bear it all some loss occurs.
 Non insurance transfer: it an instrument by which a pure risk risk is transferred
to a party other than the insurer.
 Insurance: it is the cheapest mode generally used by individuals for risk
management.
(4) Review the program periodically to find out any deviations, if the deviations
are significant, it requires a modification or complete renewal of whole model.
Corporate risk management
 Risk Management by business firm differs substantially from risk
aversion by individuals.
 Diversification is one of the strategy persued by the business firm
to tackle risk by spread into number of businesses.
 Corporate risk management in a classical sense, has been viewed
in terms of cost management primarily focusing on financial risks
in the narrow sense. In holistic view risk management can be
viewed as a means to improve efficiency of other activities of the
firm.
 The International Standards Organization has even attempted to
standardize the process of organizational risk management,
defining it as "the effect of uncertainty on objectives."
Corporate risk Management Process
 To analyze the risk profile of the firm and the changes
brought by the fluctuations in the factors that influence the
cash flows relating to assets and liabilities.
 To restructure the factors depending on the nature of the risk
and organizational strategies to manage them.
 To develop a model, dynamic in nature which keeps a
continuous watch on actual risk undertaken, relative to that
targeted.
 Comparison of actual with targets calls for corrective action
and application of suitable risk transformation products.
Types of risk managing firms
Business firm on the basis of risk perceptions can be classified as
follows:
a) Risk controllers are the firms which use risk management for
purely internal control purpose.
b) Efficient enhancers are firms that use their risk control tools to
operate their business more efficiently. They focus more on
strategic issues relating to risk management rather than tactical
or implementation issues.
c) Risk transformers are optimistic and view the risk management
as a business opportunity and the main focus area is on design of
new financial products for risk management.