be onjectives ner reading this chapter, you will be able to understand Risk Management ~ Conceptual Framework Risk Management ~ Definition, Process and Levels Risk Retention and Risk Transfer Risk Management by Corporations. and Individuals Managing Financial Risk Enterprise Risk Management Philosophy +. Risk Management Information Systems £0 wrong is that when a thing that cannot possibly Gong goes wrong, it usually turns out to be impossible to get’ at or repair — ‘Douglas Adams, ‘Ohortant, in that it can be used to protect against loss Tisky, activity, URE ‘ 1Risk Management — Definition and Process | inition Rip bute dogg tttement is an integrated process of delineating specific areas .or risk, i "lution © Comprehensive. plan, integrating the plan and conducting ongoing ‘ ; "anagement process involves the following logical steps.> aaa Ty, 7 \ L I. Iv. vs isk management exercise: The first ste ine fe objective. Risk management is widely i ine 2 risk management is to Se farmers, government bodies and e core at risky situations result in different kind of loss ae eee creaigwancirdiffering from loss from firm when risk sro an these riaks; they must have certain objectives, ‘produce ama po i risks; Sangha ral exposures: ‘The next step is to identify th Soe Rink managers must have the knowledge about the f P in the Defining the objectives of used by ven by eS. Logg managers st loss, © Potential loss e the firm, the Market in which it operates, the legal, social, economic and political environment in 0 the. bus: the organization. Pro death or disability, i which it operates the firm's financial background and als mechanism. Then the risk may cause a major loss for loss, liability loss, business income lose, unemployment, robbery, ete. are some of ¢ sources of flowcharts, financial statemen interaction with experts. ness the losses. This step involves security of losses. Logs frequency refer; shi may occur during some given size of the losses. example, if a pla al losg 1 i e than ees May be 2 20 lakhs. However, this event may occur once in more ae 50 years’ Bee risk manager ignores the event which occurs so infrequent Y. This, the point i r frequently or infrequé ntial losses should be evaluated, even if they occu oF Hntrenenay Poe ives and sele y Critical analysis of risk management feoaptrnitel palin nee one op eile. . cm them: ‘The next step in the risk management, process is to soloct | Be est tnpeopee technique for treating loss exposures. Y classinn’® as risk control and risk Sensing. anette Hak neg Implementation and review: ‘To have an cree thie Bae Pera, Tae ee ROSE ot the firm as well 0s the cogreht outing Te. 4 objectives, of the firm aT “wadition ts co i risk management obj t of loss XPOS ribes the detail espect to the treatment of loss exposuir’ smemual ‘oan bs developed This mgimew employess of the tot fa-a-verysusctulltool for!tral sO eas procedures to gir palette 5 ition 8 i informa’ includes important 1rhe risk manager should hav ee npketing, Production, tina, $ouperation with other financial departments like (7, the risk management pro, ae a gramme must be periodically revi termine whether the objectiy, . ly reviewed and evaluated ho ie ‘programmes must jectives are being attained. Risk management costs and sa be i a carefully monitored. Loss record: y es : . ecords must be periodically Samined t0 detect any changes in frequency and severity. 7 bo! gne_2 efore, be _brokendown_into_three elements, hich follo logical sequence: ch cornsdnde at step 1 ye ease step 2 2 Moderate 2 = — ‘ Unlikely * duce Conse Acceptable Reduc| quences, “Rare ~ Stir Major Critical Eien ‘Simple impact/Severity AE naeey Grass icone REIS the firm cann able some reago, oa to, penume the operations or nt least partial operations within onable time fi) eed 89 that the firm will sues eat ne aD Pahoa be t GD Congruence with missin and objectives: The ris “ned to the business Philosophy of the organization. the firms mainly seevicg | (i) Continued operation, Even if a loss occurs, the cee ed opecattllity pier should be able to continue their operation’ just continue to operat, Such as airlines, banks, bakeries and do © eve, titms a After etitors. to comp* ® loss. Otherwise business will be lost jecti ival of 4 ant post-loss objective is survi é ‘ot be totally shut down. The firm shoulg y, fi irm. ig aStability in earning: The next post-loss objective is stability in earni firm continues to operate, then there will be stability in the earning of the five, The firm will have to face substantial additional expenses to achieve this goal. The firm can shift their operation to another location. Continued growth: After the stability in earning, the company can show a continuous growth. It can develop new products and enter into new markets. They can acquire or merge with another company. The risk manager must consider the effect that a loss will have on the firm’s ability to grow. Optimizing social effects: The objective of social responsibility of risk management is to minimize the effects that a loss will have on other person and on society. A severe loss can adversely affect employees, suppliers, creditors and the community in general. For example, a severe loss that shut down a plant in small town for an extended period can cause considerable economic distress in the town. 4 Risk Financing Bs 1a) @ Bt nen the risk exposure for an organization exceeds the maximum limit that the anization can bear, it becomes necessary to either transfer or reduce risk. eer, there is cost involved in both of these exercises. If the method adopted is ce, the consequential impact on taxes and profits also becomes important. therefore, refers. to_the..manner.in.which..the.risk~control-measurese~« that have been implemented shall be financed. a lone ni Ants ; ; thas to be recognized that, in the long run, an organization will have to pay for its as shes own losses. primary objective of risk financing-is-to-spread-more-evenly-over-time | cost of risk in order to reduce the_financjal_; in and_po le_,insolyency.. which rindqm_cqncurrency of large losses may cause the secondary.objective is.tominimize risk costs.) Exentiaily, an organization can finance its risk cost in three ways: * Exante provision may be mad insurance or by building up.a.conting or losses, either through the purchase of -y_found.to-which-losses-can-be-charged; * When losses next few mo: , they may be financed with loans, which are repaid over the hs or years. Se Rick financing includes the following alternatives: 22 Risk Retention Risk retention implies that the losses arising due to a risk exposure shall be retained “' assumed by the party or the organization. Risk retention is generally a deliberate “sion for business organizations inherited with the following characteristics: () The consequential losses are small. Losses are shown as operating expenses or can be funded with retained profits.Figure 2.1 shows that risk i irst fo drants are low in ter, i isk in the first four qua 1 i id eens These risks must, therefore, be retained. In an insur; ant i may be following ways of retaining risk. Self-insurance ™S of Probab ance Sense, the, Benefits of Self-insurance (a) Saves transaction (6) Accuracy of predi (ce) Investment 9) x invest large chunk of funds in ‘Urns arising t| ‘erefrom is not reflected in the rat charged by the ‘surers, the cost reduction becomes obvious for the insured. (d) Minimization of disputes. Self-managed funds enhances Satisfaction to the ‘Insured ang Teduces the conflicts in claims settlement. Also, there 48a direct ineentive to reduce and control the risk of loss. Captive Insurance Gietive insurance companies Tye esent a special case of risk ‘retention, insurance company is an enti Purpose is to pro method is that th which would oth, Captive ity created and controlled ae aaa Whos Main vide insurance to its So era oat eras costs hind thie © parent ee company. Also, the inene erwise be charged by ad to advantages ; companies claim Bectatime as oxpenses, which may captives or froup eqns of differential cash flows. These captives may ei ished by the parent @enerany fits 8 A pure captive is an insurance company estaniistrance cover to itself ne HS supe insurance business) organization te provide ten tor! HES oF affiliated organizations. a group of companies fh Group captives are those formed by ding j, ive risks. In US terminology: tence tive and collect anies.” ntrol their respective nce 60! ‘lao Kom ae "reoe neebesos iu Se aretives behind Captives Mol" jptimized Toss prevention benefits: The benefits enduring from loss prevention (o) OPP available directly to the insured. ; conomies of scale: Groups with several subsidiaries can enjoy the benefit of () eefectly tailored insurance products made available to cover risks. | al lity of insurance: Captives provide to cover, risk exposures for Nich covers are otherwise not available in the market. pen stability of earnings: The captives reduce the chances of adverse imp: Siaden fluctuations in profits on the firm. : vets 1 and tax advantages: Obviously, as said earlier, captives reduce cost of ris « foancing and provide gains in the regime of differential taxes. ( @d 23 Risk ‘Transfer yes . impli transfers whole or part of the losses : sfer implies that the exposed party : ie ental to risk exposure to another party for a cost. The insurance contracts | a amentally involve risk transfers. : i tractual transfer of risk. The insurance company se ee danny “the losses arising out of an occurrence pre-determined and Sarged some cost for this act, called as premium. The insurance method of Hak transfer is most appropriate when the severity of losses is very high. Since the important constraint, i.e., the cost of transfer prevails, the suitability of this method depends upon the size of the organization and affordability. Apart from the insurance device, there are other techniques by which the risk may be transferred. () Noninsurance transfers: Out of the various methods of non-insurance. risk transfers, the most common are: - (i) Hold-harmless_agreementsor--indemnityagreements_are_the contractual relationships specifying that all losses shall be borne by the designated party, e.g., a landlord contracting that all losses shall be borne by the 2 tenant. These agreements by themselves do not ‘reduce original risk.4 The is form and jurisdiction of hold-harmless ‘agreements varies from contract to d ontract. ae f (li) {ecorporation is another method by which, Proprietorship firm or partnership firm can TauPanies and reduce the liability on them. To quote, the liability of a shares ore firm is unlimited compared to that of a company limited by — the liability of the members is limi ital’ cinebated ability 6 limited to the extent of capital ee ea for example, the . sole’ convert themselves intoi lative risk. The Popul; ae ing cap, be used to transfer specul: i ‘ar catego, mo fie ae used in hedging are derivative contracts, "of (iv) Diversification across business or geographic locatio; ‘aMons justified oF cow 1 with synergies or economies of scale can also Significantly reduce leg aggregate. isk, in in ii ion is also emerging as anoth, (v) Investment in information is alsg g er useful handling risk. By UsITg Sophisticated information systems any 80d of programmes, organizations can reduce level of Perceived uncer Tesearg} thereby be able to handle the risk in a better way, ainty an, 2.4 Levels of Risk Management ¢ Yaad ow The risk management Preferable to perform an or task, the time and follows: Process operates on, three levels, in-depth application i 1, Time-critical Tt primara, ‘ing to identify risks, hazards and Aevelops const ive when done in a Sroup. Examples of qe inning of upcoming operations, review of standard operating, maintenance, or training procedures, and damage. control © disaster response Planning. : 3. Strategic le the pla This is the deliberate process with more thorough of dagiih aes ; assessment involving research of available oe associated with the formal testing, or long-term tracking of me Lal oxperts)” Tels nsda iow operation (normally with assistance from in a operation or system, or ong iY the hazards and their associated risks in (eam a i ications ;, 1 Whi, trategic applications jn." Which, the hazards are not well understood.(Examples of stra! ch : long-term planning of complex operat! introduction of aera Mate, the 8, y rricula, high ,; 1 CUETIEE isk 4, Tals tics and ete tegic risk managemer, “cig and operational, development of. ean or repainystrat ent Shoug construction and major sys‘ em, OVE ity risks. be used on high priority or high visibility