You are on page 1of 60

Introduction to Risk Management

Basic areas: defining risk management objectives of risk management the risk management process personal risk management program

Meaning of Risk Management

Definition of Risk Management

A systematic process for:

-the identification and evaluation of pure loss exposures faced by an organization or individual
-and for the selection and administration of the most appropriate technique for treating such exposures.

Not the Same as Insurance Management

Risk management is a broader concept.

Insurance is one of several methods the risk manager can use to treat loss exposures.
Risk management provides for the periodic evaluation of all techniques for meeting losses, not just insurance.

Types of Pure Risks

1- Personal Risks 2- Property Risks

3- Liability Risks

Major personal risks include the following:

Death or total disability of one or both parents and the subsequent loss of tuition support possible injury while skiing or surfing catastrophic medical bills and loss of income if Jennifer becomes seriously ill or totally disabled involuntary loss of part-time job and a subsequent reduction in total income

Major property risks include the following:


Physical damage to personal property because of a fire, tornado, or other cause Theft of personal property Physical damage or theft of the sports car Theft of the trumpet which could jeopardize her position in the college band

Major liability risks include the following:


Driving an automobile while under the influence of alcohol Legal liability arising out of injury to another skier or surfer Legal liability arising out of activities as a student that accidentally cause property damage or bodily injury to others

Objectives of Risk Management

A risk management policy statement offers several advantages. Such a policy statement is necessary in order to have effective administration of the risk management program.
The policy statement states the risk management objectives of the firm and company policy with respect to treatment of the loss exposures.

In addition, a risk management statement has the advantage of educating top-level executives in the firm about the risk management process.

Also, the written policy statement enables the risk manager to have greater authority throughout the firm.
Finally, the policy statement provides a standard for judging the risk manager's performance.

Pre-loss Objectives:

Economy goal Reduction of anxiety Meet any legal obligations

Post-loss Objectives:

-Survival of the firm

-Continued operation -Stability of earnings


-Continued growth -Social responsibility

Risk Management Process

Steps in the Risk Management Process

Identifying Potential Losses

Types of potential losses:

Property loss exposures Liability loss exposures Business income loss exposures Human resources loss exposures Crime loss exposures Employee benefits loss exposures Foreign loss exposures

Major loss exposures and techniques for handling the loss exposure include the following:

Physical damage to a bus in an accident (can be handled by a commercial auto policy, by retention of part of all of the loss exposure, and by loss control activities to reduce the possibility of an accident)

Suits arising out of injuries to children in a bus accident (can be handled by a commercial auto policy, by loss control such as a defensive driving course, and by avoiding hiring drivers with poor driving records)

Suits arising out of bodily injury or property damage to other motorists or pedestrians

(can be handled by a commercial auto policy, by loss control such as a defensive driving course, and by avoiding hiring drivers with poor driving records)

Physical damage losses to the three garages from natural disasters or other perils

(can be handled by a commercial property insurance policy and by retention of part of the exposure by a sizable deductible)

Loss of business income if the firm is unable to operate (can be handled by business income insurance that covers the loss of business income and extra expenses that continue during the shutdown period and by loss control activities to reduce the possibility of a loss)

Workers compensation claims if a bus driver or other employees are injured in a work-related accident (can be handled by workers compensation insurance and by selfinsurance)

Death or disability of a key executive


(can be handled by loss control, such as an annual physical exam, and by having other employees trained to take over the duties of the key executive)

Tools for recognizing loss exposures:

Risk analysis questionnaires Physical inspection Flow charts Financial statements Historical loss data

Evaluating Potential Losses

Two concepts:

- Loss frequency - Loss severity

This is important so that the various loss exposures can be ranked according to their relative importance.

In addition, the relative frequency and severity of each loss exposure must be estimated so that the risk manager can select the most appropriate technique, or combination of techniques, for treating the loss exposure.

Guidelines for measuring severity:

Maximum possible loss Maximum probable loss

The maximum possible loss is the worst loss that could possibly happen to the firm during its lifetime.

The maximum probable loss is the worst loss that is likely to happen.

Selecting the Appropriate Technique

Risk control

Risk control refers to techniques that reduce the frequency and severity of accidental losses.

Avoidance Loss control

Risk financing

Risk financing refers to techniques that reduce the frequency and severity of accidental losses.

-Retention
(can be used if no other method of treatment is available, the worst possible loss is not serious, and losses are highly predictable)

Sources of funds to pay losses if retention is used in a risk management program include the following:

Pay losses out of current cash flow. Establish a funded reserve. Borrow from a bank by arranging a credit line in advance of a loss. The company may be able to join a trade association that owns a captive insurer.

-Non-insurance transfers
(contracts, leases, and hold-harmless agreements)

-Commercial insurance
Factors to be considered a. selection of insurance coverages b. selection of an insurer or insurers c. negotiation of terms of the insurance contract d. dissemination of information to others in the firm concerning the insurance coverages e. periodic review and evaluation of the insurance program

The major advantages of commercial insurance include: - indemnification after a loss occurs, - reduction in uncertainty, - availability of valuable risk management services, -and the income-tax deductibility of the premiums.

The major disadvantages of commercial insurance include: -the cost of insurance, -time and effort that must be spent in negotiating for insurance, -and a possible lax attitude toward loss control.

Implementing the Program

Policy statement

Cooperation with other departments

Periodic review

Personal Risk Management