Risk – an event with the ability to impact (inhibit, Peril and Hazard

enhance or cause doubt about) the effectiveness and

Peril - cause of loss or damage
efficiency of the core processes of an organization
 common perils that cause loss to property
Elements of Risk
include fire, lightning, windstorm, hail, tornado,
 Loss exposure- any situation or circumstance in earthquake, flood, burglary, and theft.
which a loss is possible, regardless whether the loss
Hazard - condition that creates or increase the
actually occurs
frequency or severity of loss (kapabayaan, human
 Uncertainty of Loss categorize risk…
interference)
1. Objective risk- also called degree of risk, is
Four Major Types of Hazards:
defined as the relative variation of actual loss from
expected loss 1. Physical Hazard- a physical condition that
increases the frequency or severity of loss
2. Subjective Risk- perceived risk, is defined as
o example: rocky roads, defective wiring,
uncertainty based on a person’s mental condition or
weak building, foundation or poor
state of mind
maintenance, electronic device
NOTE: Objective risk is measurable while subjective risk 2. Moral Hazard – dishonesty or character defects
is not. As the number of exposures increases, an insurer in an individual that increase the frequency or
can predict its future loss experience more accurately severity of loss
because it can rely on the law of large numbers. o example: intentional
3. Attitudinal Hazard (Morale Hazard) -
carelessness or indifference to a loss, which
Chance of Loss - probability that an event that causes a increases the frequency or severity of a loss
loss will occur o example: leaving door unlock, changing
lane accident, texting while driving
Aspects of probability for a chance of loss:
4. Legal Hazard - characteristics of the legal
1. Objective Probability – refers to the long-run relative system or regulatory environment that increase
frequency of an event based on the assumptions of an the frequency or severity of losses
infinite number of observation and of no change in the o Example: law suits, regulatory actions of
underlying conditions (based upon recorded state insurance.
measurement and fundamental analysis).

 deductive reasoning - nagsisimula sa Basic Categories of Risk

observation and conclusion (example: tossing of
1. Pure and speculative risk
coin to gather data para mag-arrive sa
conclusion)  Pure risk - situation in which there are only
 inductive reasoning - begins in theory and will possibility of loss or no loss
support by scientific evidence (there is a basis  Speculative risk- situation in which either profit
and data) or loss is possible

2. Subjective probability- the individuals personal 2. Diversifiable and Non-Diversifiable risk

estimate of the chance of loss. Which can be influenced
 Diversifiable risk - affects only individuals or
by a wide variety of factors such as person’s age,
small groups and not the entire economy. It is a
gender, intelligence, education, and the use of alcohol
risk that can be reduced or eliminated by
or drugs.
diversification. It is also called nonsystematic
risk or particular risk.
 Non-diversifiable risk – affects the entire
economy or large number of persons or group
 within the economy. It is a risk that cannot be  Property risk – risk of having property damaged
eliminated or reduced by diversification. or destroyed from numerous causes
 Direct loss – financial loss that results from
3. Enterprise Risk – term that encompass all major risk
physical damage, destruction or theft of
faced by a business firm. Such risks include pure risk,
property.
speculative risk, strategic risk, operational risk, and
 Indirect loss or Consequential loss – a financial
financial risk.
loss that results indirectly from the occurrence
 Strategic risk- refers to uncertainty regarding of a direct physical damage or theft loss. These
the firm’s financial goals or objectives. are additional expenses that resulted from the
Example: expansion, putting up new branches, direct loss or can be defined as a consequential
new line loss.
 Operational risk – results from firm’s business  Liability risk- risk of paying substantial amount
operation due to damages done to others’ property
Example: competitors with same products but Example: being sued for injuring a person or
at lower price damaging properties
 Financial risk – refers to the uncertainty of loss
because of adverse changes in commodity
prices, interest rates, foreign exchange rates,
and the value of money. Treatment of financial
risks typically requires the use of complex
hedging techniques, financial derivatives,
futures contracts, options, and other financial
instruments.

Enterprise Risk Management combines into a single

unified treatment program all major risks faced by the
firm.

4. Systemic Risk – risk of collapse of an entire system or

entire market due to the failure of a single entity or
group of entities that can result in the breakdown of the
entire financial system.

 Example: 2008 Financial Crisis, COVID 19

Pandemic Crisis, WW1 and WW2

Personal Risk- risks that directly affect an individual or

family. They involve the possibility of the loss or
reduction of earned income, extra expenses, and the
depletion of financial assets. Major personal risks that
can cause great economic insecurity include the
following:

1. Premature death
2. Inadequate retirement income
3. Poor health
4. Unemployment

Other personal risk

Risk Management is a “process that identifies loss
exposures faced by an organization and selects the
most appropriate techniques for treating such
exposures.”
Risk Management has several important objectives:
 Preloss Objectives – include the goals of
economy, reduction of anxiety, and meeting
legal obligation
 Post-loss Objectives – include survival of the
firm, continued operation, stability of earnings,
continued growth, and social responsibility.
Risk Management Responsibility
1. Assume responsibility for the governance of risk
by setting the direction of how risk should be
approached and addressed, to encompass:
o Opportunities and associated risks
when developing strategy; and
o Positive and negative effects on
achievement of objectives
2. Evaluate and agree the nature and extent of the
risks that the organization should be willing to
take and, in particular, approve:
o Risk appetite, namely the propensity to
take appropriate levels of risk; and
o Limit on the potential loss the
organization has the capacity to
tolerate
3. Exercise ongoing oversight of risk management
and, in particular, oversee that it results in the
following:
o Assessment of risks and opportunities
related to context and capitals;
o Assessment of the potential upside or
opportunity presented by risk;
o Assessment of the organization’s
dependence on resources;
o Design and implementation of
appropriate risk responses;
o Implementation of business continuity
arrangements; and
o Embedding of risk management in
business activities and culture.
The Risk Management Process
There are four steps in the risk management process:
1. Identify potential losses.
2. Measure and analyze the loss exposures.
3. Select the appropriate combination of
techniques for treating the loss exposures.
4. Implement and monitor the risk management
program
1) Identifying Loss Exposures
 Property loss exposures
 Liability loss exposures
 Business income loss exposures
 Human resources loss exposures
 Crime loss exposures
 Employee benefit loss exposures
 Foreign loss exposures
 Intangible property loss exposures
 Failure to comply with government laws and
regulations
Risk management information resources
1. Risk analysis questionnaires and
checklists
2. Physical inspection
3. Flowcharts
4. Financial statements
5. Historical loss data
6. Industry trends and market changes
7. Labor law data, taxes and other
government implementing rules
8. Global market data, etc.
2) Measure and Analyze Loss Exposures
 1. Estimate the frequency and severity of loss for
each type of loss exposure:
 Loss frequency refers to the probable
number of losses that may occur during
some given time period
 Loss severity refers to the probable size of
the losses that may occur
2. Ranking of various loss exposure according to
their relative importance.
Example: Potential bankruptcy exposure
 Physical inventory theft and robbery
exposure
 Customer information theft exposure
NOTE:
Loss severity is more important than loss
frequency:
□ The maximum possible loss is the worst loss
that could happen to the firm during its lifetime
□ The probable maximum loss is the worst loss
that is likely to happen
3) Select the Appropriate Combination of Techniques
for Treating the Loss Exposures
1. Risk control refers to techniques that reduce
the frequency and severity of losses
 Methods of risk control include:
o Avoidance - means a certain loss
exposure is never acquired, or an
existing loss exposure is abandoned
o Loss prevention - refers to measures
that reduce the frequency of a
particular loss
 e.g., installing safety features
on hazardous products
o Loss reduction - refers to measures that
reduce the severity of a loss after is
occurs
 e.g., installing an automatic
sprinkler system
o Duplication – means having back-up
copies of key records and important
parts
o Separation – refers to dividing assets
exposed to loss to minimize harm from
a single event
o Diversification – means reducing the
chance of loss by spreading loss
exposures across different parties,
securities, or transactions
2. Risk Financing refers to techniques that
provide for the funding of losses
Methods of risk financing include:
o Retention - Retention means that the
firm retains part or all of the losses
that can result from a given loss
 Retention is effectively used when:
 No other method of treatment
is available
 The worst possible loss is not
serious
 Losses are highly predictable
 A risk manager has several methods
for paying retained losses:
 Current net income: losses are
treated as current expenses
 Unfunded reserve: losses are
deducted from a bookkeeping
account
 Funded reserve: losses are
deducted from a liquid fund
 Credit line: funds are borrowed
to pay losses as they occur
 Captive insurer
4) Implementing and Administrating the Risk
Management Program
A risk management program must be properly
implemented and administered. This effort involves:
1. Preparation of a risk management policy
statement
2. Close cooperation with other individuals and
departments
3. Periodic review of the entire risk management
program
Factors affecting implementation of risk management
process: (COSTING)
a) Culture and values of the organization
b) Organizational structure of the business entity
c) Staff training in handling control risk
d) Trust among employees from management to
staff
e) Information technology of the firm
f) Nurtured communication within the
organization
 g) Governance and support of top management

Major Business Risk Management Treatment

1. Financial Risk Management – the identification,

analysis, and treatment of speculative financial
risks. Such risks include commodity price risk,
interest rate risk, and currency exchange rate
risk
2. Integrated Risk Program – a risk-treatment
technique that combines coverage for pure and
speculative risks within the same contract
3. Enterprise Risk Management – a comprehensive
risk management program that addresses all an
organization’s risks, including pure, speculative,
strategic, and operational risks.