Risk Management & Insurance

Chapter Two
Risk Management
 Contents/Chapter Agenda
2

Chapter 2:
Risk Management
2.1. Meaning of risk Management
2.2. Objectives of risk Management
2.3. Process of Risk Management
2.3.1. Identification of potential risks
2.3.2. Measurement potential risks
2.3.3 Selection of due Tools of Risk Management
2.3.4 Administration of the Entire Program
 After studying this chapter you should be able to:
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Learning Objectives

1. Describe the meaning and nature for risk management.

2. Describe the difference b/n risk mgt and insurance mgt.

3. List and describe pre and post-loss objectives.

4. Describe the process/steps of risk management.

5. List the source of risk exposures identifications.

6. Describe the risk financing and risk control techniques.

7. List the steps of applying insurance.

 2.1. Meaning of risk management
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 The term risk management can be defined as “A

systematic process for Identification and Evaluation of
Pure risk exposures exposed to an organization or
individual and for the Selection and Implementation of
most appropriate techniques for treating such
exposures

 R.M is a systematic process

 Deals with pure risks
 Risk Management Vs Insurance Management

Risk management (RM) Insurance Mgt.

 R.M is a broader concept & deals with
 Deals Only those risks having
all pure risks exposures.
high severity and low frequency.
 In addition to insurance, R.M uses
 It is only insurance
avoidance, loss prevention, loss
 Has lesser impact.
control, retention, non- insurance
 Needs a few number of
transfer, separation. e.t.c as a tool to
employees in the organization.
handle risk.
 R.M has a greater impact on the org’n.
 R.M. needs the coordination and help
of all employees and departments in an
organization.
 2.1. Risk Management Objectives
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 Risk management has objectives before and after a loss occurs

 Risk management objectives serves as a:
 prime source of guideline
 bunch mark to evaluate the performance.

Pre-loss objectives Post-loss objectives

1. The objective of economy. 1. Insure Survival of the firm

2. Reduction of anxiety. 2. Continued operation
3. Discharging externally 3. Stabilize earning
imposed obligations. 4. Maintain growth
5. Minimize the effects on the
society or stack holders.
 2.3. Steps in the Risk Management Process
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The process/ steps of risk

management involves:

2.3.1. Identify potential losses

2.3.1. Evaluate potential losses

2.3.1. Select tool(s)

2.3.1. Administration of the program

 2.3.1. Identification of potential risk exposures
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
This is the first and most difficult step

 Identification is a process by which a business

systematically and continuously identifies property,
liability and personal risk exposures

 Both hidden and oblivious risk exposures should be

identified.

 If we fails to identify a given risk we will not have

any due opportunity to determine the best way.
 2.3.1. Identification of potential risk exposures (Cont…)
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Sources of Identifying Loss Exposures

 Risk Managers have several sources of information
to identify loss exposures both hidden and obvious:
1. Risk analysis Questionnaires

2. Physical observation and inspection

3. Analyzing production and delivery flowcharts

4. Analyzing Financial statements

5. Through Historical and departmental loss claim data

 2.3.2. Evaluation of potential risk exposures
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 It is about the measurement of the impact of a given risk on

the organization

 Done through Estimate of frequency and severity.

 Loss frequency: refers to the probable number of losses that may
occur during some given time period
 Loss severity: refers to the probable size of the losses that may occur

 Once loss exposures are analyzed, they can be ranked

according to their relative importance

 Loss severity is more important than loss frequency:

 2.3.2. Evaluation of potential risk exposures(cont…)
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Ranking potential risks based on severity:

 Critical risks
 Losses which may lead the firm to bankruptcy

 Important risks
 Losses which may lead the firm to external assistance like
borrowing

 Negligible/ unimportant risks

 Losses which may have negligible financial impact on the
firms financial wellbeing
 3.3.2. Select the Appropriate Risk Management Technique
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 It is about selecting or looking for appropriate tool (s) of risk management to treat the risk
already identified and evaluated.
 Roughly classified in two:
1. Risk control techniques:
 refers to techniques that reduce frequency and severity of losses
 The following are the common tools of risk management tools
1. Avoidance
2. Loss prevention
3. Loss reduction
2. Risk financing techniques:
 refers to techniques that provide for the funding of losses
 The following are the common tools of control tools
4. Retention
5. Non-insurance Transfers
6. Commercial Insurance
 Risk Control Methods: 1. AVOIDANCE
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1. AVOIDANCE
 Avoidance means a certain loss exposure is never acquired or an

existing loss exposure is abandoned.

 Is done either:

 through refusing to assume a property, person, or activity which gives

rise to possible loss even momentarily
 or by abounding an existing exposure to loss assumed earlier and has
been giving rise to a risk.
 Examples:
 1
 2
 3
 Advantages and disadvantages
 1
 2
 3
 Risk Control techniques: 2. & 3
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2. LOSS PREVENTION
 It is measures that reduce the “frequency” of a particular loss

3. LOSS CONTROL /REDUCTION

 It is a measures that reduce both frequency and severity
 Examples of loss prevention measures (frequency)
 Institution of quality-control checks
 Regular inspection of machinery
 Due drivers exam
 Improvement on product design.
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 Examples of loss reduction measure (severity)

 Installation of an automatic fire alarm sprinkler system

 Having warehouses with inventories at different locations (diversification).

 Early treatment of injury

 Etc
 Tools of risk management: Retention
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4. Retention
 It is the most commonly and frequently used tools of risk management
 The source of finance for retention is both internal and external sources

 There are of two types of retention.

Passive retention
1. When we don’t know the risk exposure at all
2. When we poorly/wrongly measure the potential risk exposure

Active retention
 When we properly, actively, identify and evaluate a risk
exposure and decide retention as a best tools of risk
management.
 Tools of risk management: Retention(cont…)
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 Conditions to use Retention: 3 condition

1. When there is no other tools or risk management techniques
2. When the worst possible loss is negligible.
3. When the risk is easily predictable and we have an advantage over
retaining the risk

 Determination or retention level

1. As a maximum level of 5% of the annual net income.
2. As a maximum level of 1%-5% of the working capital of the
firm.

 Methods for paying losses

1. Out of the firms current capital (Internal source of finance )
2. Out of the funded or unfunded reserves (Internal source finance)
3. Out of borrowing (external source of finance)
 Tools of risk management: Retention(cont…)
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Advantages Disadvantages
1. May Save money 1. Possible higher losses
2. May have Lower expenses 2. Possible higher
3. Encourage loss prevention expenses
4. Increase cash flow 3. Possible higher taxes
 Tools of risk management: Non-Insurance
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transfer
5. A non-insurance transfer:
 Is a method other than insurance by which a pure risk and its potential
financial consequences are transferred to another party usually who is in
a better position to exercise loss control and or other tools.
 Typical Examples: of non insurance transfer include:
Transferring risks through CONTRACTS
Example: AAU and XYZ constriction PLC
 Transferring risks through LEASES and
Example:
Transferring risks through HOLDING -HARMLESS AGREEMENTS
Example: An Author and Publisher of a Book , Music e.t.c
 Tools of risk management: Non-Insurance transfer(cont…)
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Advantages Disadvantages

1. Can transfer some losses that are 1. Contract language may be

not insurable ambiguous, so transfer may fail

2. May Save money 2. If the other party fails to pay, firm

3. Can transfer loss to someone who is still responsible for loss

is in a better position to control 3. Insurers may not give credit for

losses transfers
 Chapter 2: Agenda
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2.1. Meaning of risk Management

2.2. Objectives of risk Management

2.3. Process of Risk Management

2.3.1. Identification of potential risks

2.3.2. Measurement potential risks

2.3.3 Selection of due Tools of Risk Management

2.3.4 Administration of the Entire Program

 Tools of risk management: Insurance
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6. Insurance
Insurance is appropriate for loss exposures that happens infrequently and have
a bigger magnitude of loss

If we decide to apply insurance we have to have the following steps duly:
1. Selection of insurance coverage

2. Selection of an insurer (S)

3. Negotiation of terms and conditions.

4. Dissemination of information concerning the coverage

5. Periodic review of the insurance program

 Tools of risk management: Insurance(cont…)
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Advantages Disadvantages
1. Firm is indemnified for losses 1. Premiums may be costly: Opportunity
cost should be considered
2. Uncertainty is reduced
2. Negotiation of contracts takes time
3. Insurers may additionally provide
and effort
other risk management services
3. The risk manager may become lax in
4. Premiums are tax-deductible
exercising loss control
 Tools of risk management: Risk Management Matrix
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 3.3.2. Select the Appropriate Risk Management Technique
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1. Risk control techniques:

1. Avoidance

2. Loss prevention

3. Loss reduction

2. Risk financing techniques:

4. Retention

5. Non-insurance Transfers

6. Commercial Insurance
 2.3.4. Implement & administer the R. M Program
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 This step of risk management process involves three major issues:

1. Preparation or risk management policy statement

 Implementation of a risk management program begins with a risk
management policy statement that:
 Outlines the firm’s risk management objectives
 Outlines the firm’s policy on loss control and other mechanisms

 A risk management manual may be used to:

 Describe the risk management program
 Train new employees
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2.3.4. Implement & administer the R. M Program(cont…)

2. Cooperative work with all other departments

 A successful risk management program requires active
cooperation from other departments in the firm.
3. Periodic review and evaluation of the entire program
 The risk management program should be periodically reviewed
and evaluated to determine whether the objectives are being
attained and to update the R.M program with the changing
environment.

 The risk manager should compare the costs and benefits of all
risk management activities
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Expect an assignment !

End!