Risk Management

• Risk management is a scientific approach to

the problem of dealing with the pure risks
facing individuals and organizations.

• It evolved from corporate insurance

management, which focused on the risk of
accidental loss to assets and income of the
organization

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 History of Modern Risk Management

• The general trend in use of the term "risk

management" began in the early 1950's.
• One of the early references to risk management
in literature appeared a 1956 article in Harvard
Business Review by Russel Gallagher.
• Gallagher proposed that someone within the
organization should be responsible for
"managing" the organization's pure risks:

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 Development of Risk Management

Evolution from corporate insurance buying

1929 Corporate insurance buyers met informally
in Boston to discuss mutual problems
1931 American Management Association
established its Insurance Division
1932 Insurance Buyers of New York formed
1950 National Association of Insurance Buyers
Formed.

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 Development of Risk Management

• Emergence of risk management was a

revolution that signaled a dramatic shift in
philosophy.
• It occurred when the attitude toward insurance
changed and insurance lost its traditional
status as the standard approach for dealing
with risk.
• The question is why the change occurred when
it did.

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 The Shift in Philosophy

The insurance manager’s function was to buy

insurance
• while these buyers attempted to get the most
coverage for the insurance dollar, they could
hardly be criticized for buying insurance.
After all, that was their job.
• Something other than mere evolution
triggered the shift.

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 Causes of the Shift in Philosophy

What caused the change in attitude toward

insurance and shift to a risk management
philosophy?
• The shift to a risk management philosopy
coincided with a reappraisal of curriculum in
business colleges in the U.S in 1950s and 60s.
• The most significant changes in business
curriculum were the introduction of operations
research and management science.
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 Business College Curriculum

• Operations research and management science

originated in World War II and developed
through engineering applications in post-war
military and aerospace programs.

• Management science’s emphasis on cost-

benefit analysis, expected value, and a
scientific approach to decision-making under
uncertainty led to a shift from descriptive
courses to normative decision theory.
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 Insurance Faculty and the Shift
Not surprisingly, insurance faculty were among
the first to embrace decision theory.
• Many were trained in actuarial science
• Most had an inventory of interesting
questions relating to decision making under
uncertainty.
• They not only questioned the central role that
had been granted to insurance, but developed
the theoretical justification for the challenge.

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 Insurance Buyers and the Shift

• Some insurance buyers intuitively (and

independently) reached the same conclusions
about the supremacy of insurance in dealing
with risk as academics who applied the new
decision models.

• Many concepts of modern risk management

that originated in academic halls were taken
over and applied in the corporate world.

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 The Origins of Risk Management

• Risk management grew out of a merger of

engineering applications in the military and
aerospace programs , financial theory, and
insurance.

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 Risk Management Defined

Risk management is a scientific approach to

dealing with pure risks by anticipating possible
accidental losses and designing and
implementing procedures that minimize the
occurrence of loss or the financial impact of the
losses that do occur.

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 The Nature of Risk Management

1. Scientific approach to dealing with pure risks

2. Broader than insurance management

3. Differs from insurance management in

philosophy

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 Scientific Approach

• Risk management depends on rules (laws)

derived from the general knowledge of
experience, through deduction, and from
precepts drawn fromother disciplines,
especially decision theory.

• Although risk management is not a science in

the same sense as the physical sciences, this
does not preclude its use of the scientific
method.
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 Distinguishing Characteristics

Narrower than general management

• General management is responsible to all risk

facing the organization: speculative and pure

• Responsibility for pure risk is delegated to the

risk manager.

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 Distinguishing Characteristics

Broader than insurance management

• Because it evolved from insurance
management, risk management is concerned
primarily with insurable risk.
• The risk manager’s responsibility is broader
however, and includes both insurable and
uninsurable pure risks.

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 Risk Management Tools

Risk Control
• Avoidance
• Reduction

Risk Financing
• Retention
• Transfer

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 Henri Fayol and Risk Management

Henri Fayol, famous French management

authority divided all industrial activities into six
broad functions:
1. Technical activities (production)
2. Commercial activities (marketing)
3. Financial activities
4. Security activities
5. Accounting activities
6. Managerial activities

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 The Risk Management Process

1. Determination of objectives
2. Identification of risks
3. Evaluation of risks
4. Consideration of alternatives - selection of
the tool
5. Implementing the decision
6. Evaluation and review

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 Evaluation of Risks

Critical Severe financial impact (e.g.,

losses that could result in
bankruptcy)
Important Moderate financial impact
(e.g., losses that would require
resort to credit)
Unimportant Modest financial impact (e.g.,
losses that could be met from
existing assets or cash flow).
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 Misconceptions About RiskManagement

Two misconceptions have developed concerning

risk management.

• The first is that the risk management concept

is applicable principally to large
organizations.

• The second is that the risk management

approach seeks to minimize the role of
insurance.

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 The Risk Manager’s Job

• Not every corporate employee who deals with

insurance functions is a risk manager.
• The term risk manager can be used in a
functional sense to mean anyone who performs
the risk management function.
• As used in the text, it refers to an individual
employed by the organization who is
responsible for the organization’s risk
management function.

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Responsibilities & Duties of the Risk Manager

1. Assist in Developing Risk Management Policy

2. Risk Identification and Measurement
3. Selecting Risk Financing Alternatives
4. Negotiate Insurance Coverage
5. Managing Claims
6. Internal Administration
7. Communicating with Other Managers
8. Accounting
9. Administer Risk Functions
10. Loss Prevention
11. Managing Employee Benefits

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 Background for Risk Management

• Because risk management encompasses many

fields, it is virtually impossible for anyone to be
an expert in everything related to risk
management.
• Consequently, risk managers tended to be
• specialists in one phase of risk management
(e.g., insurance or loss prevention) or
• generalists without expertise in any of the
sub-disciplines of risk management.

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 Background for Risk Management

With the advent and growth of professional studies

in risk management, the view has changed.
• The emphasis in the study of risk management
is on management in the decision making sense.

• Persons trained in risk management are

uniquely equipped for organizing, planning,
leading and controlling the risk management
functions of the organization.
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 Position in the Organization

• Most risk managers have a financial

orientation, reporting to a vice president-
finance, treasurer, or comptroller

• There is a growing school of thought that says

the risk manager should be in a less
specialized department, reporting to an
executive VP or to the president to illustrate the
company-wide scope of risk management
activities.

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 TITLE IN THE ORGANIZATION

According to a 1995 survey conducted by Logic

Associates for RIMS,

48% of respondents reported their title was

Risk Manager,

45% said their title was Director of Risk

Management, and

6% reported the title Assistant Treasurer.

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 The Nonprofessional Risk Manager

• The nonprofessional risk manager should

understand & appreciate the principles of risk
management.
• Must know enough about risk management to
recognize whether his advisers are any good.
• Must know enough about risk management and
insurance to know when help is needed and
must be able to determine if help is any good.

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 Risk Management and the Individual

• To achieve maximum protection against static

losses, the individual must select from among
the risk management tools of retention,
reduction and transfer.

• Although the primary emphasis in the course is

on commercial risk management and insurance
buying, the basic principles discussed apply
equally well to the individual and family unit.

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 Outside Risk Management Services

• Risk Management Consultants

• Insurance Agents and Brokers

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