Risk Management and Insurance: Module-1
Risk Management and Insurance: Module-1
Risk Management and Insurance: Module-1
INSURANCE
Module-1
CONTENTS
Introduction to risk management
Sources of risk-methods of handling risk-degree of risk-management of risk.
Risk management process.
Risk management by individuals and Corporations.
Understanding the cost of risk-individual risk management and the cost of risk.
Risk management and societal welfare.
INTRODUCTION
Uncertainty
Situation where the current state of knowledge is such that the order or nature of
things is unknown, the consequences, extent, or magnitude of circumstances,
conditions, or events is unpredictable.
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Types of Risk:
There are two different types of risk: systematic risk and unsystematic risk.
Systematic risk is volatility caused by factors in the economic system that affect all investments
resulting in either losses or gains. For example, the risk of higher oil prices is a systematic risk factor.
Higher oil prices affect transportation costs, which in turn, affects the price of almost everything else in
the economy. Higher oil prices result in losses for car rental firms, trucking firms, shipping firms, and
airlines.
They cause higher prices for food (all of which is transported from where it is grown to where it is sold
to consumers), and raw materials for manufacturers which leads to higher prices for finished goods.
Since consumers must pay higher prices for fuel, they have less money to spend on other consumer items
which produces losses for firms supplying these products. Since higher oil prices raise the prices of
everything else, and since consumption drives about 66% of the U.S. GDP, higher oil prices causes the
entire economy to slow down.
Systematic risk goes by three other names: undiversifiable risk, portfolio risk and market risk.
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Unsystematic risk is the variability of returns (risk) caused by factors associated with a particular
firm. Examples include the risk of bad or fraudulent management, the risk of a plant fire, a labor strike, or a
lawsuit. These risk factors are not likely to be present in all the firms in a portfolio at the same time. Some
firms will have them and some wont. An investor holding a well-diversified portfolio (investments in firms
in different industries and locations) will not be concerned with unsystematic risk. For example, consider the
quality of management. Some of the firms in a portfolio will have good managers and some will have poor
managers. The net effect on the return of the portfolio will be nil. In effect, investors can diversify away the
risk posed by bad managers. The same is true for the other factors causing unsystematic risk.
Economic
Natural
Human
BURDEN & SOURCES OF RISK
Marketplace.
Financing risks.
If the risks have been properly identified and ranked as described in Step 1, then an informed
decision can be made as to whether a risk should be avoided.
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Cash management procedures that require separate duties for employees or volunteers
regarding cash receipts and cash disbursements and audit functions;
Computer systems that can operate from different sites;
Ensuring an adequate number of supervisors are present for school excursions or activities to
provide back-up in case of distraction, illness, injury or other emergency;
Computer facilities back-up computer data and access to alternate computer equipment that
can be used to run the boards computer systems.
Alternate suppliers of goods and services to protect against supply chain interruption (e.g.
fue, maintenance contractors, etc.)
Maintaining access to alternate teaching facilities either by contractual agreement or by
utilizing existing schools that are not in use. For example, if a fire destroyed a high school,
where would the students be sent?
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(g) Self-Retention
This strategy is applied to manage risks that are either uninsurable due to high risk
factors, or for small, infrequent losses that can be better managed internally than by
claiming through an insurance policy (e.g. deductible level on a property insurance
policy).
Most school boards do not have many uninsurable high risks that are essential to
their business operations, so the Self-Retention strategy is most commonly applied
to supplement conventional insurance policy contracts by carrying a deductible. In
return for taking a share of the small losses by way of a deductible, school boards
are able to achieve reduced premiums on their main property insurance coverage,
saving the insurance policy for catastrophic losses, while funding the small losses
internally.
DEGREE OF RISK
3. Identify the Controls: Identify all the things (Controls) that you have in place that are
aimed at reducing the Likelihood of your risks from happening in the first place and, if they
do happen, what you have in place to reduce their impact (Consequence) eg. providing a
friendly work environment for your team; multi-skill across the team to reduce the reliance on
one person; stress the need for the required information to be supplied in a timely manner;
send a reminder before the deadline; provide additional information to the supervisor before
he/she asks for it etc.
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4. Establish your Likelihood and Consequence Descriptors, remembering that these
depend upon the context of your analysis ie. if your analysis relates to your work unit, any
financial loss or loss of a key staff member, for example, will have a greater impact on
that work unit than it will have on the University as a whole so those descriptors used for
the whole-of-University (strategic) context will generally not be appropriate for the
Faculty, other work unit or the individual eg. a loss of $300000 might be considered
Insignificant to the University, but it could very well be Catastrophic to your work unit.
You will need to establish these parameters in consultation with the Head of the work unit.
5. Establish your Risk Rating Descriptors: ie. what is meant by a Low, Moderate, High
or Extreme Risk needs to be decided upon ahead of time. Because these are more generic
in terminology though, you might find that the University's Strategic Risk Rating
Descriptors are applicable.
IDENTIFY AND ANALYZE LOSS
EXPOSURES
This is the process of determining the potential sources of loss, or hazards,
that your school board is exposed to which may result in loss or injury. This is
a critical component, as it will assist you in determining where to divert your
resources.
Risk Identification: There are several ways to identify sources of loss, but the
most common approaches are:
a. Analyze past claims experience and determine categories or types of losses
that you have had.
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b. Analyze past incident report data to determine where minor injuries that did
not result in claims were occurring.
c. Conduct a survey of each department or operating division to determine
where potential losses can occur. Such surveys can be done professionally, or
can be completed in-house using the sample template (Figure 1). Within a
department, each activity can also be assessed using this form. Once completed,
each risk factor can be ranked Low, Medium or High and appropriate strategies
can be documented to address each one (see Risk Management Steps 2 and 3).
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d. Site inspections can also be used to provide a visual perspective of where
your exposures are e.g. proximity to nuclear facilities, manufacturing plants,
natural hazards, isolated/remote location, high crime area, etc. Again, these
inspections can be conducted professionally or could be done in-house.
The types of risk identified by any of the above methods generally fall into the
following categories, and can be charted as illustrated in Figure 1:
ANALYZING/ASSESSING RISK:
It must be recognized that all risk elements are not equal in terms of frequency
(how often a loss will occur) and severity (how serious the loss is). Since
scarce resources cannot be devoted to address all risks equally, it is necessary
to rank or prioritize your risks into categories that can be dealt with based on
the degree of threat that is posed to the school board.
Risk can be ranked many ways, but a simple and effective method is to use
Low/Medium/High rankings, as follows (See Figure 2):
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There is also a sub-class in this category called High medium, which applies to
activities where relatively few losses occur, but because of the nature of the hazards,
result in catastrophic types of losses occurring. Activities and operations under this sub-
category need to be carefully considered, and if selected, managed with more caution
than the medium risks, and includes things like wilderness excursions, rock climbing,
high ropes, canopy walks, technical studies programs, etc.
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High The nature of the activity or the presence of obvious hazards results in
a High probability of a loss occurring with catastrophic results (high severity);
it is foreseeable that a loss will occur, and/or you have no control over the risks
that are present. Some characteristics of high risk factors include, but are not
limited to: fall heights exceeding 8 feet; severe weather conditions, high
speeds, uncontrolled/free falls or jumps, strong water currents or tidal effects,
inexperienced or unqualified supervisors and/or participants, students driving
vehicles, etc.
SELECT APPROPRIATE RISK
MANAGEMENT
TECHNIQUE/STRATEGIES
Once the risks have been identified and ranked as previously outlined, then the
selection and application of strategies can be completed. Usually, various
combinations of strategies will work together to address the identified risks, or
more information accumulates on the risk profile of an activity.
The following table provides a guide to the general application of the various
risk management strategies based on the assessed risk level Figure 3
provides an illustration of a risk map with typical examples of risk by
category and the applicable strategies:
RISK MANAGEMENT TECHNIQUES:
NONINSURANCE METHODS
Risk Avoidance
When particular risks cannot be avoided actions may often be taken to reduce
the losses associated with them known as loss control.
The firm or individual is still engaging in operations that give rise to particular
risks involves making conscious decisions regarding the manner in which
those activities will be conducted.
Focus of Loss Control
Some loss control measures are designed primarily to reduce loss frequency
called frequency reduction.
Some firms spend considerable funds in an effort to reduce the frequency of
injuries to its workers.
IMPLEMENT AND MONITOR THE
RISK MANAGEMENT PROGRAM
Feasibility of the retention program.
If the decision to retain losses involves advance funding.
Administrative issues may need to be considered.
If the risk is likely to result in several losses over time.
There will be administrative expenses associated with investigating and paying
for those losses.
Administrative issues are of particular concern when a firm decides to set up a
self insurance.
RISK MANAGEMENT FOR
INDIVIDUALS AND CORPORATIONS:
Over the last couple of decades, institutional risk management has become an
integral process at almost every large organization. Corporate risk managers
concern themselves not only with financial risks, but with strategic and
operational risks as well, evaluating possible future outcomes and their effect
on their organizations.
The International Standards Organization has even attempted to standardize
the process of organizational risk management, defining it as "the effect of
uncertainty on objectives." It defines risk management as "the identification,
assessment and prioritization of risks followed by coordinated and economical
application of resources to minimize, monitor and control the probability
and/or impact of unfortunate events."
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Most individuals, too, and their advisors are already managing risk in their
investment process, even if they don't know it. Specifically, they try to curb the risk
of suffering shortfalls when it comes time to cover future liabilities. The insurance
they buy protects them against certain rare but costly events. But saving and
investing is a type of insurance as well-essentially it's self insuring against all other
future liabilities, trying to prevent catastrophes in the future that you can't predict
and whose magnitude is uncertain.
The goal of diversification is to manage liquidity and uncertainty in the asset class
returns of a client's portfolio to cover future expenditures.
RATIONALE AND APPLICATION:
The overall purpose of the management of risk process is to help a decision-
maker understand a situation, along with the likely outcomes.
This process is in two parts: