Risk Management

And
Insurance
 Course Objectives

• Understand the risk management process, including

identifying, eliminating, reducing and transferring the risks
that can shut down a business
• Better identify internal and external risks leading to loss
exposure
• Compare and contrast the various types of insurance
policies
• Understand how to obtain and manage cost–effective
insurance program and policies
• Possess the knowledge fundamental to developing and
implementing an effective risk management program

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 Course Material/Text Book

 C. Arthur Williams, Jr. Michael L. Smith, Peter c. Young,

“Risk management and Insurance”
7th Edition, McGraw – Hill International Edition

 James S Trieschmann, Robert E Hoyt and David w Sommer

“Risk Management and Insurance”
12th Edition, South-Western Cengage Learning

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NO Is there a Risk ? YES
RISK ANALYSIS

Can it be Avoided or
NO Can it be Reduced ?
Eliminated ?

RISK EVALUATION YES

Avoid or Eliminate YES

Is the residual Risk

Disregard NO
Significant ?

Is it a YES
NO
Catastrophe ?
RISK FINANCING
Can it be Retained ?
YES Transfer

Retain Other Insurance

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 Session 1

An Introduction to Risk and Uncertainty

Topics Covered
 Essential Concepts: Certainty, uncertainty and risk

 Managing risk and uncertainty

 Some facts on insurance (introduction to risk)

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  Life is full of risks
 Personal – death, injury, sickness,
family, unemployment, loss/damage to
personal property (moveable and
immoveable), liability to others etc etc
 Business – loss or damage to
moveable and immoveable property,
liability to employees and third parties,
pollution, natural disasters, loss of
profits, legal action, death to key
employees etc etc etc

19/08/21 An Introduction to Risk and Uncertainty 6

 Concepts
 Certainty – free from doubt, definite
 Uncertainty – doubt of a future outcome or outcome cannot be known
with certainty
 Risk is potential variation in outcomes or gives rise to possible gain or
loss that cannot be predicted. Risk is an uncertainty; creates both
problems and opportunities
 Risk averse, risk neutral and risk preferer – a psychological state of
mind, respectively being worried of risk and would pay more to avoid it,
does not have a bearing and has no effect and don’t care and would in
fact seek risky situations
 Risk consists of two components (Williams and Heins, 1989)
 Objective: measurable component of the risk
 Subjective: individual’s attitude towards the risk
 Information lessens the doubt a person has about predictability
 Risks could be reduced by pooling/sharing
 Non-diversifiable risks are those which cannot be reduced by
pooling/sharing
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 The Certainty – Uncertainty Continuum
(Table 1.3)

Level if Uncertainty Characteristics Examples

None (Certainty) Outcomes can be Physical laws, natural
predicted with precision sciences

Level 1 Outcomes are identified Games of chance:

(Objective uncertainty) and probabilities are cards, dice
known
Level 2 Outcomes are identified Fire, automobile
(Subjective uncertainty) but probabilities are accident, many
unknown investments

Level 3 Outcomes are not fully Space exploration,

identified and genetic research, new
probabilities are markets
unknown
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 Uncertainty, Information and
Communication
 Reduction of uncertainty has economic value

 Information can reduce the levels of uncertainty but will

depend on the type of information to identify the possible
outcomes

 Communication can reduce the levels of uncertainty.

 Communicating and informing the stakeholders, would

reduce the levels of uncertainty in their minds

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 Moral Hazard

Stems from an individual’s mental attitude which has a

bearing on insurance/risk. Intentional actions designed
either to cause a loss or increase its severity.
Indifferent to losses. (Concealing information,
dishonesty, poor claims history, bad attitude, difficult to
negotiate, arson, fraud, profit from insurance)

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 Physical Hazard

Refers to physical condition or characteristics of the

subject matter. Such hazards may or may not be within
human control. Physical issues which are likely to
influence the frequency of the loss and/or severity, ex.
Earthquake, Forest Fire, Floods, poor storage, irregular
maintenance (housekeeping, basement storage, light
construction, risky pastimes etc.)

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 Managing risks and Uncertainty

 Risk imposes cost to the organisation (Cost of risk).

Loss by fire or burglary
 Cost of risk is the sum of
1. Expenses of strategies to finance potential losses
2. The cost of unreimbursed losses
3. Out-lays to reduce risks (fire/burglary alarms)
4. The opportunity cost of activities forgone due to
risk considerations (expansion to a country/area)
 Uncertainty of loss too has a cost on the
organisation (Cost of uncertainty). Fear, no
peace of mind, insurance cost

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 What is a Risk ?

Risk is often thought of in terms of chance or

probability of a loss

 Risk as to the frequency or probability of loss

 Risk as to the severity of the Loss when it

occurs

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 Frequency Vs. Severity
Frequency

Common fever or Bush Fires

ailments Avalanches
High Minor thefts/shop
lifting
Motor car accidents
Boiler explosion
Minor medical Major Floods
Low surgery Terrorism
3rd party property Major fire
damage Tsunami/Earthquake
Pollution
Severity
Low High

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 Frequency Vs. Severity
Frequency

High

Low

Severity
Low High

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 Definitions of Risk

Risk

Pure Speculative
There is a chance of loss There is a chance of loss,
or breakeven but no gain breakeven or a gain/profit

Ex. Fire, Accidents, Ex. Investment in stock

Sickness, Floods, Burglary, market, Venturing into new
Driving a motor car, markets, launching new
premature death etc products, Hedging,
Forward contracts

19/08/21 An Introduction to Risk and Uncertainty 16

 Definitions of Risk contd….

Risk

Fundamental Dynamic Particular Static

Impersonal both in origin and Has its origin in individual events
consequence. Not normally caused and its impact is felt locally
by one individual and their impact
generally falls on a wide range of Ex. Theft of property, Fire, Boiler
people. Arise out of the nature of explosion, accidental damage to
the society we live in or some personal effects, death etc
physical occurrence beyond the
control of man
Ex. War, Inflation, Terrorism, Riots,
Changing customs, Natural
Hazards, Recession, epidemics,
changing of laws etc
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 Definitions of Risk contd….

Risk

Subjective
Mental state or attitude of an
individual who experiences doubt
or worry as to the outcome of a
given event. Essentially a
psychological uncertainty.
Objective
More precisely observable,
hence, measurable. Probable
variation of actual from expected
experience.

19/08/21 An Introduction to Risk and Uncertainty 18

 Definitions of Risk contd….

Risk

Pure Speculative

Static Dynamic Static Dynamic

Subjective Objective Subjective Objective Subjective Objective Subjective Objective

Source: Risk Management and Insurance 12th Edition by Trieschmann, Hoyt, Sommer

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 Sources of Risks
 PROPERTY RISKS:
Fire damage
Burglary
Natural catastrophes
Loss or destruction of supplier’s and/or customer’s premises
 LIABILITY RISKS:
 Court awards for compensation to 3rd parties
 Legal suit costs in defending
 Injury or damage in the premises (Public Liability) or by the
premises/business (Environmental Liability), injury or damage
due to use/consumption (Product Liability), losses due to
professional advise or service (Professional Negligence)
19/08/21 An Introduction to Risk and Uncertainty 20
 Sources of Risks contd…

 LIFE, HEALTH AND LOSS OF INCOME RISKS

 Health and safety risks (Workmen’s Compensation,
Medical Insurance)
 Death of a key/important employee (key Man Insurance)
 Unemployment (Loss of Income, Loss of License) and
financial losses
 FINANCIAL RISKS
 These are speculative losses
 Financial Loss following property loss or damage
(Business Interruption Insurance)
 Credit risk, Foreign exchange risk, Commodity risk,
Interest rate risk

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 What do we do ? ? ?

 We could eliminate the risk

 We could reduce the risk

 We could transfer the risk

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 Management
Can be defined as :
Organizing of activities and
controlling the use of resources
in such a manner
as to achieve some desired objective or goal.
(Source: CII study course material)

Goals could be either :

profit maximization, Occupancy,
Increase in Revenue, Market Share,
Net worth or just to stay in business

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 Risk Management
Is concerned with the
planning, arranging and controlling
the activities and resources
in order to minimize the impact of uncertain
events.
(Source: CII study course material)

• Production Risks,
• Distribution Risks,
• Financial Risks,
• Personal Risks and
• Environmental Risks
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 Management of risks
 Need to identify the sources of risks and measure
 Need to decide on how the risk should be handled
 If a pure risk is not identified, it will not disappear, but an
opportunity is lost to consciously deal with it
 The process of systematically managing the risk exposures is
known as Risk Managements
 The head of the department charged with overseeing risk
management activities of the organization is titled Risk Manager
 In implementing more integrated approach, some firms have
formed Risk Management Committees.
 Some firms have created the title Chief Risk Officer (CRO) for
more accountability, responsibility and span

19/08/21 An Introduction to Risk and Uncertainty 25

 Management of risks contd…

 CRO will be involved in many aspects of firm’s activities,

such as, developing employee safety programs,
examining planned mergers and acquisitions, analyzing
investment opportunities, purchasing insurance, setting up
pensions and health plans for employees
 The traditional risk management has now developed into
more formal “Integrated Risk Management” and
“Enterprise Risk Management” to manage all forms of risk,
regardless of type.
 This holistic view of RM encompasses building a structure
and a systematic process of managing all of an
organization’s risk portfolio
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 Risk Management Process

 Identify Risks not only from pure risks but from an

enterprise risk management perspective which
includes operational, financial and strategic
 Evaluate Risks for each source of risk identified.
Evaluate as to the frequency and severity of the of the
losses.
 Select risk management techniques that are optimal
methods to deal with. In some cases, plan may be to
do nothing
 Implement and review decisions as RM is an ongoing
process.

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 What is Insurance ?

Insurance is known as a “Risk Transfer Mechanism”

whereby a person

facing some risk of loss or damage or injury

transfers to an insurer

this unknown cost

for a known cost – the premium

(Source: CII study course material)

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 Why buy Insurance ?
In order to :
 Secure company’s survival
 Improve efficiency and contribute growth
 ROE/ROI/ROCE
 Protect stakeholders
 Alleviate stress or peace of mind
 Assume social responsibility
 As part of good governance

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 What risks are insurable?
 Risks which results in a financial loss to the
insured but not SPECULATIVE where there is
a gain or loss. These lines are changing
 Risk must be capable of financial evaluation
 Must be fortuitous – not definite but not sure
 There must be a recognised relationship
between the insured and the loss
 There must be a large number of similar
events capable of insuring (homogeneity)
 Must not be against the public policy

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End of Session 1