The Concepts of risk in managing corporate business

SUB-ENABLING OUTCOMES
• The Concept of Risk;
• Current Definitions of Risk;
• Risk distinguished from Peril and Hazard;
• Classification of Risk;
• Characteristics of pure Risk;
• Major Personal Risks and Commercial Risk;
• The Burden and Impact of Risk.
 NATURE OF RISK

In all types of undertaking, there is the potential for

events and consequences that constitute opportunities
for benefit (upside) or threats to success (downside).
Trying anything new involves risk due to
miscalculations and unknown factors
 NATURE OF RISK

• Trying nothing new also involves risk of not

responding to changes in the environment like market,
technology, which can disadvantage the organization
and or the individual

• Risk in traditional terms is viewed as a negative event

 NATURE OF RISK

• In modern terms risk is a mix of threats/danger and

opportunities

• Risk implies both doubt about the future and the fact
that the outcome can leave in a worse position than we
are in at the moment

• Risk is defined as uncertainty concerning the

occurrence of loss.
 NATURE OF RISK

Risk can be defined as the combination of the

probability of an event and its consequences.
Risk is the possibility of losses
Risk is unpredictability-the tendency that
actual results may differ from predicted results.
 NATURE OF RISK

The term risk can be used to mean different

things:
• Risk as the cause of an outcome. E.g. fire as a

risk, theft as a risk, personal injury as a risk

• Risk as the likelihood. The risk (High or low)

of something happening meaning the

probability or likelihood of it occurring
 NATURE OF RISK

• Risk as the object. The object or person at risk.

The factory, plane, machine or ship might be
referred to as the risk and someone can be sent
to look at it (going to see a risk)
 NATURE OF RISK

Examples of risks:
Reputation: public perception on you or your

organization
People: skills, communication

Health and safety: injury, death

Financial: under budgeting

 Risks Attitudes
It is important to understand personal or business

risk altitudes because:

Risk is a pervasive force that people generally try to

avoid or reduce.
Individual altitudes to risk may be viewed as falling

somewhere on a risk continuum that ranges from

feeling of extreme dislike of risk to feeling of
acceptance and even desire the risk
 Risks Attitudes

Risk Averse – Risk Averse people don’t like

uncertainty. They intend to take path that is
most certain even if it is least rewarding.
A Risk aversion type will leave a good chance
of more profits on the table and look for a
more certain scenario instead. Thereby
settling for less than would be expected as a
result.
 Risks Attitudes

Risk Seeker – People who enjoy risk. They

don’t worry too much about repercussions if
the risk materialize. They are more focused
on benefits they are going to get.
 Risks Attitudes

Risk Neutral – Risk Neutral people are quite

calculative and they weigh all pros and cons
before deciding to take risk or not.
 RISK AND UNCERTAINTY

• Uncertainty refers to unknown:

Time when loss will happen
Amount of it
Frequency of loss occurrence
 RISK AND PERIL

Peril is defined as the cause of loss

• If your house burns because of a fire, the peril or
cause of loss, is the fire

• If your car is damaged in a collision with another

car, collision is the peril, or cause of the loss
• Other causes of loss include death (diseases,
accident, suicide, poisoning), sickness, accident,
special perils and general perils
 RISK AND HAZARD

Hazard is a condition that creates or increases the

chance of loss.
The major types of hazards are:
Physical Hazard: a physical hazard is a physical
condition that increases the chance of loss e.g.
defective wiring in the building increases the
chance of fire and defective lock on door that
increases the chance of theft.
 RISK AND HAZARD

• Legal hazard: refers to characteristic of the legal

system or regulatory environment that increase
the frequency or severity of losses e.g. large
damage awards in liability lawsuits
 RISK AND HAZARD

• Moral Hazard: is dishonesty or character defects in

an individual that increase the frequency or
severity of loss. It is a carelessness or indifference to
a loss because of the existence of insurance/or
somebody to take care. Careless act increase the
chance of loss
 Classification of Risk;

Risks are classified using different criteria.

From the different criteria risk types are

determined:
Subjective vs. objective risks

Static vs. dynamic risks

Financial vs. non-financial risks

 Classification of Risk;

Fundamental vs. particular risks

Pure vs. speculative risks

Insurable vs. non-insurable risks

External vs. Internal risks

Other risk categories

Subjective and Objective Risks
Subjective risk is defined as uncertainty based on

a personal mental condition or state of mind.

The impact of subjective risk varies depending on

the individual.
Two person in the same situation can have

different perception of risk.

Subjective and Objective Risks

Objective risk (degree of risk) is defined as the

relative variation of actual loss from expected

loss.
Risk is defined as the variation in possible

outcome of an event based on chance.

Static and Dynamic Risks
Static Risk refers to possibility of losses that

would occur even if there were no changes in the

economy.
It involve either the destruction of an asset or

change in its possession as a result of dishonesty

or human failure.
Static risks are not source of gain to society.
 Static and Dynamic Risks
Dynamic Risks refers to possibility of losses

resulting from changes in the economy, changes in

the price levels and consumer taste
Normally benefits society in the long run since

they are the result of mis-allocation of resources.

They affect large number of individuals.
Static and Dynamic Risks

They are less predictable than static risks, since

they do not occur with precise degree of

regularity.
Financial and Non Financial Risks…

Financial risks are concerned with those risks

that involve a financial loss.

Financial risks refers to uncertainty of loss

because of adverse changes in the commodity

prices, interest rates, foreign exchange rates and
the value of money.
Financial and Non Financial Risks…

Are risks in which their impacts can be

measured in financial terms.

Non-financial risks are risks whose
consequences can not be measured in financial
terms e.g. friendship, love etc.
Financial and Non Financial Risks…

Their impacts can not be measured in financial

terms.
 Fundamentals and Particular Risks…

Fundamental risk involve losses that are

impersonal in origin and consequences

They are group risks caused for the most part by

economic, social and political phenomena,

although they may result physical occurrences.
Fundamentals and Particular Risks…

They affect large segment, or even all the population

like Unemployment, earthquake, floods, pollution

and droughts.
Particular risks involve losses that arise out of

individual events and are felt by individual rather

than by entire society.
Affect individuals e.g. Risk of death, Property

Losses.
 Pure and Speculative Risks…

Pure Risks are those situations that involve

only the chance of loss or no gain.

Nothing good can come from an exposure to

pure risks. A factory exposure to loss by fire is an

example of pure risks.
Factory either burns or it does not burn.
Pure and Speculative Risks…

There is no gain potential from this possibility.

Speculative Risks are those situations where

there is possibility of loss, but also a possibility

of gains e.g. share price, interest rates.
Pure and Speculative Risks…

It also refers to those exposures to price change

that may result in gain or loss.

Most investment, including stock market
investments are classified as speculative risks.
 Insurable and Non Insurable Risks…
These include:
The nature of risks: only pure risks are easily

insurable
The dimensions of the loss: in terms of randomness,

size and frequency; low frequency and high severity

losses are easily insurable
Insurable and Non Insurable Risks…
Insurance premium: must be calculable and
reasonable
Nature of the loss: only accidental or fortuitous

losses are insurable. Moral hazard lies behind the

well known principle that insurance can only operate
properly in relation to losses that are fortuitous or
accidental in nature
Insurable and Non Insurable Risks…

Public policy: insurance should not be granted if

doing so would tend to encourage crime, disorder,

social unrest or divisions in society e.g. criminal fines

Insurable and Non Insurable Risks…

Insurable risk arrangements

o The following are the characteristics of insurance

risks
The number of insured should be large, and they

should be independently exposed to potential loss.

Insurable and Non Insurable Risks…

The losses covered should be definite in time,

place, and amount.

The chance of loss should be measurable.

The loss should be accidental from the

viewpoint of the person who is insured.

 External and Internal Risks

Risks emanates from the activities carried out

by the individual or business.

Some of the risk factors affecting the business

are external to the organization while other are

internally driven.
External and Internal Risks

Internally driven risks facing an organization and

its operations include: accounting controls,

information system, research and development,
capital, liquidity and cash flows.
Other Risk Categories…

The external and internal risks can be categorized

further into:

 Strategic risks: refers to uncertainty regarding the

firms financial goals and objectives. Strategic risks

include: competition, customer changes, industry

changes, customer demand, Research and

Other Risk Categories…
Operational risks: They result from firms business

operations. They include: regulations, culture, board

composition, recruitment, supply chain, accounting
controls, information systems
Negative Impacts of Risks

The risk can cause either of the following

impacts:
 Negative impacts

 Positive impacts
Negative Impacts of Risks

The presence of risk results in certain undesirable

social and economic effects.

The major burdens on society are:

The size of an emergency fund must be increased.

Society is deprived of certain goods and service.

Worry and fear are present
Negative Impacts of Risks

The cost of risk

i. the evident cost of risk

ii. the hidden cost of risk
Negative Impacts of Risks

i. The evident cost of risk are things such as

insurance premiums, uninsured losses met from
the revenue budget, the cost of risk control
measures and direct administration costs
Negative Impacts of Risks

ii. The hidden cost of risk can be much harder to

identify and evaluate. The hidden cost can include
things such as a fall in staff morale, the cost of
management time spent dealing with the risk
events, damage to the reputation of the authority,
indirect administration costs and the cost of
employees being off work following an accident.
Positive Impacts of Risks

The desirable effects of risk to the society includes:

 Advancement of science and technology and health

advancement.
 By taking risky activities and adventures, human beings

have managed to advance and increase availability of

useful properties, medicine, technology, etc.