RISK MANAGEMENT PROCESS Learning Objectives » Define risk management » Explain the steps in risk management process 21 INTRODUCTION tain. Great risk is involved in the business expectations, estimates and ations to attain in conducting a he loss. It is the n against The future is largely unce! = pee ‘on the basis of assumptions, me ae is taken by individuals and business organis: Sean isk means some chance of loss may be occurred ais eae care has to be taken to avoid or minimise the los isis saat which plays an important role to provide protection ag Precise plan eae arising from a risky activity. Risk management provides a ie andle various types of contingencies. It includes all efforts pany to minimize the outcome of uncertain events or risks. Kia-2.2 2.2 DEFINITION OF RISK MANAGEMENT “Risk management may be defined as a managerial function the protection of the firms’ assets, earnings or Profits, legay i cern personal against financial losses that may result from fortuitous accidental happenings.” “The identification, analysis and economic control of tho; f i jae: se riekes that eaten the assets or earning capacity of an enterprise. can, Objectives of Risk Management To key objectives of Risk Management are : 1. To ensure that all the risks affecting the profitabili risks are identified, assessed and analysed. 2. To ensure that capitalization is adequate in terms of cumen, inherent in business activities and existing business enviros aa is form of capital and foreseeable profitability of business, a 3. To ensure that risk taking ability is allocated into areas according to selected policies and that risks tY and other mq different busine Properly priced, 4. To limit and mitigate fluctuations in the economic values organizations and a S. To ensure the overall efficiency, security and continuity of operations ag Risk management process involves the following five logical steps : Risk Identification Risk evaluation 2.3 STEPS IN RISK MANAGEMENT PROCESS Selection of Technique to Manage Risks. Implementation Review of Results 1. Risk Identification Risk identification is the first step in the process of risk manag Provides the foundation for risk management. Risk identification refét identify the loss producing events e.g. fire, flood, burglary. The important 8 of information relating to organization, market surrounding enV manufacturing processes, financial strengths and weaknesses,business mechanism pete may suffer a heavy loss in required for risk idenifcation, An or Some of the following important matnods ae to identify the risk at this a? A detailed checklist method used for riak identification, Financial statement Method Flowchart Method on-site Inspections interactions with other Contract Analysis statistical Records of losses 2. Risk Evaluation Bre of the important steps of risk management is risk evaluation. It evaluates the Frequency of losses ie. whether the losses occur regularly severity of losses te. the size of the losses. It may be small, medium or large. for example, minor losses occur frequently when goods in transit. Hence, these losses are of high frequency with low severity. On hae tea and severe losses due to explosions, floods and earthquake do not occur frequently. Risk evaluation plays a significant role to decide the sum insured under the policy and to decide whether to insure or not. d Implementing Risk Management Techniques. 3. Selecting an kk management process is to select the appropri The third step in the ris! techniques to manage the risks. Different types of methods are used such as ¢ method to manage the risk is to avoid it to be located on the land which is prone to the location to a safer area to avoid jate (a) Risk Avoidance. The simples altogether. If a manufacturing unit is earthquake then the firm may decide to shift the major risk of earthquake. Risks that can be eliminated without and adverse tfiect on the goals individuals or business probably should be avoided. mon Prevention and Reduetion, Different loss prevention andsloss oa methods may be used to eliminate or reduce the financial etn. Some of these techniques may assist to prevent the loss from , others may help to reduce the extent of loss, if it does occur: >. ee ganisations may prevent fire losses by strict enforcement o! se f ‘NoSmoking’ regulations. On the other hand installation of me Ten appliances helps to reduce the extent of damage when a etn business firm may reduce and prevent the fire losses thrown measures eh fy Utilisation of non-combustible materials in building construction Segregation of hazardous processes, Isolation of storage of hazardous products like petrol, cettulig from non-hazardous products and manufacturing units, and Use of standarlised electrical appliances. (c) Risk Retention. Under risk retention techniques, losses of — which occur frequently may be absorbed by the business Smog, normal operating expenses of the business. Minor damage lossea nai transit may be treated as normal loss and not insured. a A self insurance fund may be created by a large and financially acu to which periodic payments are credited and from which losses are paig 2 when they occur. ad Risk retention may also be possible by way of volun available under insurance schemes. tary excess or deducity (a) Risk Transfer. Risk transfer refers to transfer the risk creating acigy | The firm may available the services of a specialist sub-contractor by senting materials for processing if a particular process of manufacturing is up hazardous. Risk may also be transferred by contract. The owner may inser g condition in the contract that damage to the plant and third party liability mt be insured by the contractor in case of a contractor hires plant and equipment The risk may be transferred to insurance company. It is called the insurance method of risk transfer. 4. Implementation Implementation is the fourth step in the process of risk management. Tht firm implements the selected techniques of risk management through tt different functional managers. The production manager may be concerned with fire loss prevention; The material manager may be responsible for packing of goods and their ® transportation Self-insurance fund may be managed by the finance manager. A separate insurance department may be established to purchase insurance product and for Tecovery of claims.122.5 peview the results ¢ last but least step in the process of risk management is the review of astjuced by implementing the various selected techniques. The firm the different loss prevention measures. Insurance policies offered urers may as be reviewed to transfer the risk of loss. The review be done at regu intervals. Many professionally managed firms do not rance policies without proper study of their risk exposures. ination of two or Th gults P / evaluate se ins option: of loss prevention and loss retention or €6 may be considered by firm to earn discounts in the premium. Expected Severity Technique Low Retention | Low Retention High ‘Transfer High Avoidance 2.41 RISK HANDLING TECHNIQUES Wisk is happening of an uncertain event which causes 4 loss. Following are the important techniques available to avoid the problem of risk : 1. Avoiding Risk. Some human activities are risky. They may increase the possibility of loss. So the best method to avoid the risk is not to undertake such type of activity. For example, if there is possibility of accident while driving a car, best method to avoid accident is, no to buy the car, a risk of damage by floods may be avoided by moving to another place. fae ek Reduction. Another important method of risk handling is risk eee: Rink reduction includes all those efforts which are made by company ie i reduce the risk creating events. There are number of ways to ers a eg. to avoid the fire by using fire proof materials, slogans moking like ‘no smoking’ etc. re of Risk, As risk is unavoidable to the full extent, therefore eating some = some risk. It is the best method to retain the risk with self by surable risks eee reserves or funds to meet such losses. The non- ¢ covered by maintaining funds at own level.are as under : 12.6 a 4. Transfer of Risks. Some of the methods of shifting non ie ey ur; Able tg (a) Hedging. One of the most important methods of shifting no risks (e.g. changes in prices) is hedging by means of future contrac nin shifting of the existing risk incurred in the Cash or Spot market by another contract in the future market. Utah ts. It ing enter; ng i ‘ty ‘Therefore, hedging transaction invvlves two-transaction simultan, ; c in the spot market and the other in the future market. ‘SURLY one (b) Sub-contracting. The general and original contractor may shifty, of his risk to other contractor by entering into sub-contract with them a work contracted for. It is mostly applicable in case of building industry, main contractor after getting a contract, enter into sub-contract with person for the supply of raw material, labour or even for the construction of D most 0 the parts of the building. Thus, original contractor shift most of his rig, to the sub- contractors. (@ Surety Bond. This is an arrangement under which third party steps iq the shoes of the person who has given surety bond, if the main person fais meet the liability. & (@ Limited Company. Company form of business has a large number of shareholders. Total risk of failure of a business is divided among a large number of members of the company. 5 5. Insurance. The unavoidable, insurable risks may be transferred to an insurance company by purchasing appropriate policy. Modern insurance system is capable of taking over the largest possible risks relating to persons, property | and liability. This is the most widely used device of risk avoidance. | A business may adopt all or any of the methods of risk avoidance in the light | of its organisational planning, organisational objectives and financial considerations. 2.12 REASONS FOR RISE OF RISK MANAGEMENT At present, there is a great increase in risk due to industrial revolution and industrial developments. The main reasons for rise in risk management are as follows : (i) Insurance in size, diversification, spread of activities of business has grown. eel ~ (ii) Complication of evaluating risk of each-and every aspect has incr12.7 increase in business relation with supplier, consumers, employees and (ii) govt. hazards have increased and changed in shape due to raw physical" process, products, machine etc. are coming into production. material, sed large investment have also increased the importance of iw Incre t protection and prevention. Business operations face many contingencies due to tough competition petween enterprise. W wi QUESTIONS TYPE QUESTIONS 1, Define Risk Management Process ? Briefly explain the major steps in Risk management Process. 2. Discuss the main steps involved in risk management process of the firm. . Define objectives of risk management. ‘4. Briefly explain the selection of appropriate techniques to manage the risks ? 5, Risk management is a (a) Personal function (o) Business function (c) Managerial function