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3-1
The Nature of Risk Management
1. Scientific approach to dealing with pure risks
2. Broader than insurance management
3. Differs from insurance management in philosophy
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The Risk Management Process
1. Determination of objectives
2. Identification of risks
3. Evaluation of risks
4. Consideration of alternatives - selection of the tool
5. Implementing the decision
6. Evaluation and review
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Primary Objective
To preserve the operating effectiveness of
the organization.
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Risk Management Objectives
Post-Loss Objectives Pre-Loss Objectives
Survival Economy
Continuity of Operations Reduction in Anxiety
Earnings Stability Meeting ExternallyImposed Obligations
Continued Growth Social Responsibility
Social Responsibility
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Formal Risk Management Policy
1. States the objectives of risk management program and describes measures by which they are to be reached.
2. Objectives and risk management policy should be determined by board of directors (or other highest policy-making body in the organization).
3. Risk manager acts as staff advisor to board in formulating risk management policy.
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Risk Identification
1. Orientation2. Risk analysis questionnaires3. Exposure checklists4. Insurance policy checklists5. Flow process charts6. Analysis of financial statements7. Other internal records8. Inspections9. Interviews
The preferred approach is a combination approach.
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Evaluation of Risks
Critical Severe financial impact (e.g., losses that could result in bankruptcy)
Important Moderate financial impact (e.g., losses that would require resort to credit)
Unimportant Modest financial impact (e.g., losses that could be met from existing assets or cash flow)
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Consideration of Alternatives
Risk Control
• Avoidance
• Reduction
Risk Financing
• Retention
• Transfer
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Choosing the Technique
1. Primarily a problem in decision-making.
2. Sometimes organization’s risk management policy establishes criteria.
3. In selecting the technique for a given risk, the risk manager considers
• the size of potential loss,
• its probability, and
• the resources that would be available to meet the loss.
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Implementing the Decision
Once the decision is made on how to deal with a given risk, the decision must be implemented
• for retained risks, it may be necessary to establish a fund
• loss prevention and control measures must be designed and implemented
• decision to transfer a risk must be followed by selection of the insurer, negotiations, and placement of the insurance
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Rules of Risk Management
1. Don’t risk more than you can afford to lose
2. Consider the odds
3. Don’t risk a lot for a little
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Risk Characteristics as Determinants of Tool
HighSeverity
LowSeverity
HighFrequency
Low Frequency
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Risk Characteristics as Determinants of Tool
HighSeverity
LowSeverity
AvoidReduce
HighFrequency
Low Frequency
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Risk Characteristics as Determinants of Tool
HighSeverity
LowSeverity
AvoidReduce Transfer
HighFrequency
Low Frequency
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Risk Characteristics as Determinants of Tool
HighSeverity
LowSeverity
AvoidReduce Transfer
RetainReduce
HighFrequency
Low Frequency
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Risk Characteristics as Determinants of Tool
HighSeverity
LowSeverity
AvoidReduce Transfer
RetainReduce Retain
HighFrequency
Low Frequency
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The Special Case of Risk Reduction
1. A technique should be used when it is the lowest cost approach for the particular risk.
2. Humanitarian considerations and legal requirements sometimes dictate that risk control be used when it is not the lowest cost approach.
3. OSHA requires employers to incur expenses that might not be justified based on a marginal-revenue/marginal cost analysis.
4. Building codes impose similar mandates.
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Common Errors in Buying Insurance
1. Buying too much.
2. Buying too little.
3. Buying too much and too little at the same time.
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Priority Ranking for Insurance Coverages
Essential insures against losses that could cause bankruptcy.
Important insures against losses that would require resort to credit.
Optional insures against losses that could be met from assets or cash flow.
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Large Loss Principle
1. Probability that a loss may or may not occur is less important than potential severity of the loss.
2. Important question is not “can I afford the insurance?” but “can I afford to be without it?”
3. When available dollars cannot provide all the essential and important coverages required, a part of the loss may be assumed through deductibles.
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Insurance as a Last Resort
1. Insurance always costs more than the expected value of the loss.
2. People who purchase coverage against small loss exposures are trying to beat the insurance company at its own game.
3. Insurance should be used as a last resort.
