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RISK AND INSURANCE

RISK MANAGEMENT

DEFINITION
As a systematic approach to
identifying, measuring and controlling
risks that can threaten assets and
earnings of oneself, a business or the
organization.
The purpose of risk management is to
enable an organization to progress toward
its goal and objectives (mission) in the
most direct, efficient, and effective path

OBJECTIVES OF RISK
MANAGEMENT
Objectives prior to a loss
Objectives after a loss occurs

OBJECTIVES PRIOR TO A LOSS


Reduce impact of loss
Reduce fear and worry
Required by law

OBJECTIVES AFTER A LOSS


OCCURS
Survival of organization organization still able to
continue operations
Stability of earnings business operations do not
have to stop and the organizations can concentrate
on their business activities as usual.
Reduce impact of losses to organization and society
when a loss occurs not only will the organization
suffer but the loss has to be burdened by society as
well. Employees may have to be retrenched and
some departments may have to be closed down.

RISK MANAGEMENT PROCESS


1. Identifying potential losses
2. Evaluating potential losses
3. Examining alternative risk management
techniques
4. Implementing the risk management
program
5. Controlling/monitoring the program

IDENTIFYING POTENTIAL LOSSES


Risk identification is the process by which an
organization is able to learn of the areas in which
it is exposed to risk.
Identification techniques are designed to develop
information on sources of risk, hazards, risk
factors, perils and exposures to loss.
It is everybodys task to identify the loss
exposures in one organization.

IDENTIFYING POTENTIAL LOSSES


Losses can be classify as:
Direct damage (damage to building)
Indirect damage (loss of profits due to
business interruption)
Liability (court award to 3rd party since fire
was caused by negligence of the owner of
building)
Loss of Key Employees (key employees such
as general manager/CEO/Researcher)

IDENTIFYING POTENTIAL LOSSES


How to identify risk?

Questionnaires
Interviews
Financial Statements
Flow Charts
Personal inspection / Observation

EVALUATING POTENTIAL LOSSES


Risk measurement evaluates the likelihood of
loss and the value of loss in terms of
frequency and severity.
The measurement process may take the form
of a qualitative assessment (using %)
This step involves two important aspects of
loss exposures
Frequency
Severity

EVALUATING POTENTIAL LOSSES


Risk measurement evaluates the likelihood of
loss and the value of loss in terms of
frequency and severity.
The measurement process may take the form
of a qualitative assessment (using %)
This step involves two important aspects of
loss exposures
Frequency
Severity

EVALUATING POTENTIAL LOSSES


Identifying and determining the loss exposures
alone is not sufficient
In evaluating the potential losses:
Estimating the frequency and severity for each
type of loss exposure and ranked it according to
their relative importance. High loss exposure will
be given priority.
Estimating relative frequency and severity of each
loss exposure as the selection of appropriate
technique will depend on this.

EVALUATING POTENTIAL LOSSES


How can you determine and estimate the
impact of losses
Frequency
Referring to the number of times the loss occurs

Severity
Referring to the maximum size of loss exposures

EXAMINING THE METHODS OF


HANDLING THE LOSS EXPOSURES
Two main ways to
classify the risk
management
techniques
Risk Control
Risk avoidance
Loss control
Loss prevention
Loss reduction

Separation
Contractual Transfer

Risk Financing
Retention/Assumption
Captive insurer
Insurance

RISK CONTROL
Methods seek to alter an organizations
exposure to risk.
Risk control efforts help organization
avoid a risk, prevent loss, lessen the
amount of damage if a loss occurs or
reduce undesirable effects of risk on an
organization.

Risk Avoidance
Risk is proactively avoided or abandoned after
rational consideration.
If someone is afraid of risks, the best way to deal
with it is to avoid it completely.
Example; a manufacturer may stop production of a
defective products to avoid a lawsuit.
However, some risks are unavoidable although risk
avoidance may be chosen as an option in handling
certain risks, the exposures of losses cannot be
eliminated entirely.

Loss Control
Loss control is designed to reduce both the
frequency and severity of losses by
changing the characteristics of the
exposure so that it is more acceptable to
the firm. Divided into:
Loss prevention
Loss reduction

Loss Control
Loss Prevention
Seek to reduce the number
of losses (frequency) of
losses
Is used when the benefits
outweigh the costs
involved.
Either imposed by law or
imposed by companies and
factories to fence
dangerous machinery to
reduce the chances of
employees being injured.

Loss Reduction
Designed to reduce or lower
the severity of losses, should
it occur.
Since some risks are
unavoidable, the other
alternative is to reduce its
impact.
Can be used in two
circumstances: before a loss,
e.g. installation of fire alarm
or after a loss e.g. salvage
efforts in the restoration of a
building burnt down by fire.

Separation
Involves the dispersal of the firms assets
in several locations instead of confining it
to one major area.
This measure will reduce the impact of
losses should a major disaster occurs.
Example, separation of head quarters and
assembly plant in automobile industry.

Contractual Transfer
Risk transfer mechanism.
Refers to the various methods other than
insurance by which a pure risk and its
potential financial consequences can be
transferred to other party.

Contractual Transfer
Types of contractual transfer
Incorporation
The owner of the company transfers the risks to corporation by
registering the company.

Leasing contracts
An agreement where the owner or landlord transfers the risks
to the tenants

Hedging
An agreement to buy or sell a commodity at a certain price to
avoid losses due to price increase or decrease.

Hold-harmless agreements
An agreement between a retailer and a manufacturer whereby
the later agrees to bear losses due to the manufacturer of
defective products thus relieving the retailer of any liability.

Contractual Transfer
Advantages
Can transfer potential
losses that are
commercially
uninsurable
Often cost less than
insurance
Potential loss shifted
to a party who is in a
better position to
exercise control

Disadvantages
If the party to whom the
loss is transferred is unable
to pay the loss the firm is
still responsible
Not necessarily cheaper
than insurance if discounts
are taken into
consideration
Ambiguity in contracts
drafted may not hold in
court.

RISK FINANCING
Methods involving generating funds to pay
for these losses
Retention
Self insurance and captive insurer
Insurance

Retention
Retention the company will bear the
consequences of the loss
Risk or loss exposed are normally assumed
or retained when their impact and
consequences are not too great or in cases
when or other methods seem feasible.
In an organization, the ability to assume a
risk depends on ones financial ability.

Self insurance & Captive Insurer


Self insurance implies tat the organization sets up
a pool of fund to retain its loss exposures.
Adequate financial agreement has to be made in
advance of the occurrence of losses.
The number of loss exposures must be large
enough to ensure the mechanism of insurance to
be operative.

Self insurance & Captive Insurer


A captive insurance company is an entity
to write insurance arrangement for its
parent company.
The captives parent may be one company,
several companies or an entire industry.

Self insurance & Captive Insurer


Advantages

Cash flow advantages


Safe money
Lower expenses
Encourage loss
prevention

Disadvantages
Possible higher losses
Possible higher
expenses

Insurance
Risk financing method of transferring the
financial consequences of potential
accidental losses from an insured firm or
family to an insurer
Transferring the risks to another party
involves a contractual agreement whereby
the other party assumes the risks and is
liable for the loss in the event of loss.

Insurance
In an insurance contract, the party exposed
to the risks (the proposer/insured) pays the
premium to the insurance company.
In return, the insurance company agrees to
pay a stated sum on the happening of
certain risks specified in the contract.

Selection of Risk Management


Techniques
FREQUENCY
LOW

HIGH

Risk Assumption/retention
Also:
Loss prevention and loss
reduction if the cost
justifies the benefits.

Loss Prevention
Also:
Loss reduction if cost can be
justified.

Insurance
Also:
Risk transfer, loss reduction,
loss prevention.

Risk Avoidance:
Also:
Loss prevention and loss
loss reduction is possible

TO DRAW UP AND IMPLEMENT THE


RISK MANAGEMENT PROGRAM
Once a decision has been in the selection, the
management must select the best and most cost
effective risk management program
The selection may based of two factors
Financial criteria whether it will affects the
organizations profitability or rate of return.
Non financial criteria whether it affects the growth
of the organization, humanitarian aspects and legal
requirements.