MANAGEMENT RISK

MANAGEMENT RISK

What is risk management?

Risk management ensures that an organization identifies and understands the risks to which it is exposed.

Risk management also guarantees that the organization creates and implements an effective plan to prevent losses or reduce the impact if a loss occurs.

A risk management plan includes strategies and techniques for recognizing and confronting these threats.

Good risk management doesn’t have to be expensive or time consuming; it may be as uncomplicated as answering these three questions:

1. What can go wrong?

2. What will we do, both to prevent the harm from occurring and in response to the harm or loss?

3. If something happens, how will we pay for it?

Benefits to managing risk

Risk management provides a clear and structured approach to identifying risks. Having a clear understanding of all risks allows an organization to measure and prioritize them and take the appropriate actions to reduce losses. Risk management has other benefits for an organization, including:  Saving resources: Time, assets, income, property and people are all valuable resources that can be saved if fewer claims occur.

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 Protecting the reputation and public image of the organization.

 Preventing or reducing legal liability and increasing the stability of operations.

• Protecting people from harm.

 Protecting the environment.  Enhancing the ability to prepare for various circumstances.

• Reducing liabilities.

• Assisting in clearly defining insurance needs.

An effective risk management practice does not eliminate risks. However, having an effective and

operational risk management practice shows an insurer that your organization is committed to loss reduction

or prevention. It makes your organization a better risk to insure.

Role of insurance in Risk Management

Insurance is a valuable risk-financing tool. Few organizations have the reserves or funds necessary to take

on the risk themselves and pay the total costs following a loss. Purchasing insurance, however, is not risk

management. A thorough and thoughtful risk management plan is the commitment to prevent harm. Risk

management also addresses many risks that are not insurable, including brand integrity, potential loss of taxexempt

status for volunteer groups, public goodwill and continuing donor support.

Risk Management Process

Risk Management Comprises of mainly three steps

(a) Risk Analysis

(b) Risk Identification

(c) Risk Assessment

(d) Risk Planning

(e) Risk Controlling

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RISK ANALYSIS

Risk Analysis is the process of identifying, analyzing and communicating the major risks.

Risk analysis involves

Once risks have been identified, they must then be assessed as to their potential severity of impact

(generally a negative impact, such as damage or loss) and to the probability of occurrence. These quantities

can be either simple to measure, in the case of the value of a lost building, or impossible to know for sure in

the case of the probability of an unlikely event occurring. This process is known as risk analysis. In the

assessment process it is critical to make the best educated decisions in order to properly prioritize the

implementation of the risk management plan.

RISK PLANNING AND CONTROL

Once risk and identified and analyzed, it is important to plan and adopt a suitable strategy for controlling the

risk. Risk planning and controlling is the stage which comes after the risk analysis process is over.

There are five major methods of handling and controlling risk.

(a) Risk avoidance;

(b) Risk retention;

(c) Risk transfer;

(d) Loss control; and

(e) Insurance.

Risk Avoidance

Risk avoidance is one method of handling risk. For example, you can avoid the risk of being pick pocketed in

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Metropolitan cities by staying out of them; you can avoid the risk of divorce by not marrying; a career

employee who is frequently transferred can avoid the risk of selling a house in a depressed real estate

market by renting instead of owning; and a business firm can avoid the risk of being sued for a defective

product by not producing the product.

But as a practical matter, not all risks can or even should be avoided. For example, you can avoid the risk of

death or disability in a plane crash by refusing to fly. But is this practical and desirable? The alternatives are

not appealing. You can drive or take a bus or train, all of which take considerable time and often involve

great fatigue. Although the risk of a plane crash is present, the safety record of commercial airlines is

excellent, and flying is a reasonable risk to assume. Or one may wish to avoid the risk of business failure by

refusing to go into business for oneself. But a person may have the necessary skills and capital to be

successful in business, and risk avoidance may not be the best approach for him to follow in this case.

Risk Retention

Risk retention is a second method of handling risk. An individual or a business firm may retain all or part of a

given risk. Risk retention can be either active or passive.

Active Risk Retention

Active risk retention means that an individual is consciously aware of the risk and deliberately plans to retain

all or part of it. For example, a motorist may wish to retain the risk of a small collision loss by purchasing an

own damage insurance policy with a Rs. 2,000 voluntary excess. A homeowner may retain a small part of

the risk of damage to the house by purchasing a Householders policy with substantial voluntary excess. A

business firm may deliberately retain the risk of petty thefts by employees, shoplifting, or the spoilage of

perishable goods. Or a business firm may use risk retention in a self-insurance program, which is a special

application of risk retention. In these cases, the individual or business firm makes a conscious decision to

retain part or all of a given risk. Active risk retention is used for two major reasons. First, risk retention can

save money. Insurance may not be purchased at all, or it may be purchased with voluntary excesses; either

way, there is often a substantial saving in the cost of insurance. Second, the risk may be deliberately

retained because commercial insurance is either unavailable or can be obtained only by the payment of

prohibitive premiums. Some physicians, for example, practice medicine without professional liability

insurance because they perceive the premiums to be inordinately high.

Passive Risk Retention

Risk can also be retained passively. Certain risks may be unknowingly retained because of ignorance,

indifference, or lasiness. This is often dangerous if a risk that is retained has the potential for destroying a

person financially. For example, many persons with earned incomes are not insured against the risk of longterm

disability under either an individual or group disability income plan. However, the adverse financial

consequences of a long-term disability generally are more severe than premature death. Thus, people who

are not insured against the risk of long-term disability are using the technique of risk retention in a most

dangerous and inappropriate manner.

In summary, risk retention can be an extremely useful technique for handling risk, especially in a modern

corporate risk management program. Risk retention, however, is appropriate primarily for high frequency, low

severity risks where potential losses are relatively small. Except under unusual circumstances, an individual

should not use the technique of risk retention to retain low frequency, high severity risks, such as the risk of

catastrophic losses like earthquake and floods.

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Risk Transfer

Risk transfer is another technique for handling risk. Risks can be transferred by several methods, among

which are the following:

(a) Transfer of risk by contracts;

(b) Hedging price risks; and

(c) Conversion to Public Limited Company.

Transfer of risk by contracts

Unwanted risks can be transferred by contracts. For example, the risk of a defective television or stereo set

can be transferred to the retailer by purchasing a service contract, which makes the retailer responsible for

all repairs after the warranty expires. The risk of a substantial increase in rent can be transferred to the

landlord by a long-term lease. The risk of a substantial price increase in construction costs can be

transferred to the builder by having a firm price in the contract rather than a cost-plus contract.

Hedging price risks

Hedging price risks is another example of risk transfer. Hedging is a technique for transferring the risk of unfavorable price fluctuations to a speculator by purchasing and selling futures contracts on an organized exchange, such as NSE.

In recent years, institutional investors have sold stock index futures contracts to hedge against adverse price declines in the stock market. This technique is often called portfolio insurance. However, it is not formal insurance but is a risk transfer technique that provides considerable protection against a decline in stock prices.