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RISK MANAGEMENT

AN INTRODUCTION TO RISK
UNCERTAINITY DOUBT TO PREDICT THE OUTCOME RISK POSSIBILITY OF LOSS (OR) POTENTIAL VARIATION IN OUTCOMES PURE RISKS (FIRE, FLOOD, ACCIDENTS ETC.) LOSS (Financial repercussion) TO BE MADE GOOD HOW? PRINCIPLE OF INSURANCE

SPECULATIVE RISKS (RISK INVESTMENTS, GAMBLING ETC.,) LOSS/GAIN NOT INSURABLE HOWEVER ALTERNATIVE INSTRUMENTS HAVE BEEN DEVELOPING TO MANAGE MITIGATE AND REDUCE RISK

Definitions and meaning of Risk RISK refers to the possibility that something unpleasant or dangerous might happen (Dictionary meaning) A condition in which there is s possibility of an adverse deviation from a desired outcome that is expected or hoped for Refers to a situation where there is the possibility of a loss

MEANING
Risk is SUGAR AND SALT" of Life Risk can have UPSIDE or DOWNSIDE People take Risk in order to achieve some goal could not be achieved without risk taking. Can mean Danger or Loss Care has to be taken to avoid that Loss. Prevention is better than Cure

Definitions

Risk Management is an integrated process of


delineating specific areas of Risk, a comprehensive plan developing, integrating the plan, and conducting an ongoing evaluation A General management function that seeks to assess and address the causes and effects of Uncertainty and Risk of an organization. This definition is referred to as ORGANIZATION RISK MANAGEMENT or ORM.

Characteristics of Risk Management


Pure and Speculative Risks have different characteristics No Compelling reason they should be managed separately. It is a General Management function. Does not mean Risk managers do not have specialized knowledge Risk Management is broad and inter-disciplinary.

Contd..
Not amenable to be described as an insurance buying function Cost of Risk is high. Its components are Cost of Losses that do occur Cost of Uncertainty itself Worry and Anxiety Misallocation of resources Eg: Reluctance of some Pharmaceutical companies to invest in new product development of fear of product liability suits

Contd..
Risk & Uncertainty bestow benefits Organizations would seek to manage its affairs to maximize both the possibility and value of such outcomes - Organizations have motives to address Risk and Uncertainty and this motivation gives rise to Risk Management - Risk Management practiced because of negative and positive possibilities of Risk as well as Moral Considerations

RISK is the probability or chance of loss -Estimation requires accounting for causes of losses known as PERILS and HAZARDS
PERILS CAUSE OF LOSS RISK HAZARDS CONDITION THAT INCREASE SEVERITY OF LOSS

Physical hazards Eg: property conditions Or physical condition of a human being

Intangible hazards Psychological in nature (Attitudes & culture)

Moral hazards Fraud, intention to cheat

Morale Hazard Indifference

Societal hazard Legal & Cultural

Degree of Risk : Refers to the likelihood of occurrence of an event. It is a measure of accuracy with which the outcome of a chance event can be predicted.

Classification of Risks
RISK

PURE RISK

SPECULATIVE RISK

DIVERSIFIABLE/ NON DIVERSIABLE Risk that may/ may not be reduced through pooling or risk sharing agreements

STATIC & DYNAMIC Dynamic: Resulting from macro economic variables: inflation, technology changes etc., Static : Predicable not affected by economic conditions Eg: loss in business, loss due to act of others etc.,

BUSINESS RISK

PERSONAL RISK Earnings Medical expenses Liability Physical assets Financial assets Longevity

Price risk Credit risk Exchange rate Interest rate

DEGREE OF RISK
Refers to the likelihood of occurrence of an event - It is a measure of accuracy with which the outcome of a chance event can be predicted - In Risky Situations two elements are found i. Outcome is uncertain - two possible outcomes for a given situation ii. Out of two possible outcomes one is unfavorable - not liked by the individual or analyst.

S. No:
I

Level of Uncertainty

Characteristics

Examples
Physical laws Natural sciences Games of chance, cards, dice, mortality Fire, automobile accidents, many investments Space exploration genetic research

None (certainty) Outcomes are predicted with precession Objective uncertainty Subjective uncertainty Level Outcomes-identifies probabilities -known Outcomes-identified probabilities unknown Outcomes-not fully identified probabilitiesUnknown

Importance of Risk Management &


Misconceptions of risk management if not practiced properly
Financial Distress Causes Adverse Incentives Highly Risky investments Abandon promising fields Turn Myopic Weakened Commitment Sales Operating costs Financing costs Diminished Tax Shelters

Contd

Misconceptions
Waste of Money Pessimistic Approach Creates super specialists

Risk Manager-His Functions


1. Insurance Buying blended with
Safety Engineering Legal risk Management RMIS

Security

2. Full Time Risk Manager Positively related to the size of the Organization Presence of Full Time Risk Manager is positively related to Riskiness of organization

3. R.M. Activities
Identification of Risks Implementing Loss Prevention & control programs Reviewing contracts & documents for R.M. purposes Training and Education on safety related issues Compliance with Governmental mandates Arranging non-insurance financing schemes ( self insurance, captive insurance) Claims management litigation Employee Benefit programmes

4. R.M. Includes
Currency Hedging Capital Budgeting Public Relations Employee Assistance and Training Government Lobbying Services Marketing Mergers & Acquisitions

5. Placement of R.M. & Function


Traditionally located with another department Viz. Finance / H.R viewed as a staff function ORM view suggests R.M. is a linking pin of coordinating, organizing and management of risk. Should directly report to CEO

History of Modern Risk Management


Early Post World War II Insurance Buying function Viewed as a sub function of finance, owing to financial nature of purchasing insurance Employee benefit concerns made R.M. to be placed under H.R. Department Post 1960 Self Insurance Loss Prevention Important shift away from Insurance buying Attorneys influence in management of Liability Risks

Contd
Safety engineering Globalization phase Formation of Professional Associations (Risk and Insurance Management Society RIMS) 1970s,1980s & 1990s Rise of Public Sector Risk Management practices Post 1990s Four Sources of systems failure Hardware failure Software failure Organizational failure Human failure

Contd...
Harmonious with TQM Corporate R.M R.M. decisions or Financial decisions should be evaluated with firm value Financial Risk Management Principally in the Banking and Investment Community to deal with specific financial risks like credit risks, currency exchange risks, operational risks and investment risks Financial Derivatives

Risk Management Process


Defining the objectives of R.M. exercise Identification of Risk Exposures Evaluation of Risk exposures Critical Analysis of Risk Management alternatives and selecting one of them Implementation and Review

RISK MANAGEMENT METHODS (TOOLS) INTERNAL RISK REDUCTION

LOSS CONTROL

LOSS FINANCING

REDUCED LEVEL OF RISKY ACTIVITY INCREASED PRECAUTIONS

RETENTION & SELF INSCE

DIVERSIFICATION

INSURANCE

INVESTMENTS IN INFORONCTION

HEDGING LOSS REVENTION LOSS REDUCTION RISK AVOIDANCE LEVEL OF CARE

OTHER CONTRACTUAL RISK TRANSFERS

To improve forecasts of expected cash flows

Rules of Risk Management


These are applicable to Personal Risk Management and Investment Risks Dont Risk more than you can afford to loose: If particular loss has serious consequence he should take immediate action Consider the ODDS: Consider probable loss Dont Risk a Lot for Little: Eg.: Cost of Insurance premium is small compared to consequences of Risk which is higher, you should immediately go in for Insurance

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