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BY: VINAY KUMAR
(018) VARUN
DEEKAY(019) KRISHAN
KUMAR(023
Techniques of Risk Avoidance
RISK- DEFINITION
Risk is defined as the chance of having a loss due to occurrence of an event
The risk is always associated with the loss aspects since the word itself has the association of DANGER OF LOSS
The definition can be “ PROBABAILITY OF THE OCCURRENCE OF AN EVENT RESULTING IN LOSS/ GAIN
CLASSIFICATION OF RISKS
SPECULATIVE RISKS & PURE RISKS
DYNAMIC RISKS & STATIC RISKS
FUNDAMENTAL RISKS
PARTICULAR RISKS
CLASSIFICATION OF RISKS
SPECULATIVE RISKS
Operation of this leads to profit /loss
Leads to speculation like investment of capital in a new venture
Operation is desired
PURE RISKS These do not change
with the risk The operation of
these perils does bring in loss/damage to property/assets/ liability
Not desired
Classification of RisksDynamic risks Changes with the
change in fashion, buying behaviour, trends, technology etc
It denotes dynamic nature of the customer behaviour and the products they like to own or use
If an organization is not prepared then it may go out of existence
Static risks Like pure risks these
risks remain static and do not change due to other reasons like that of dynamic risks
The operation of these risks always bring about losses
Operation is not desired
May result in partial or total cessation of activities
CLASSIFICATION OF RISKS
PARTICULAR RISKS Risks which relate
to one or few firms, factories or organisations only
Losses are suffered by one or few more members of the society
FUNDAMENTALRISKS Relates to the society
at large Losses are suffered by
large section of the society/nation(s)
Losses may be due to natural catastrophes, riots, epidemics etc
RISK MANAGEMENT
• The selection of appropriate risk management techniques is a dynamic problem. •The best method for handling a particular exposure today may not be the best method a year from now.
-Many relevant factors change regularly. -The frequency and severity of losses may vary
• Causing estimates for the maximum possible loss or maximum probable loss to fluctuate.
-The cost and availability of different risk management tools cannot be assumed to remain constant.
Basic Concept Of Probability And Statistics
Random Variables And Probability Distributions.
A random variable is a whose outcome is uncertain.
Probability distribution which identifies all the possible outputs for random variable and the probability of outcomes.
Characteristics of probability distributions
To compare probability distributions of different random variables.
How decision affect p.d will lead to better decisions.
Key characteristics of p.d – the expected value, variance or standard deviation, skewness and correlation.
Expected value
The expected value of a p.d provides information about where the outcomes tend to occur. on average , a distributi-
on with a higher expc. Value will have a higher outcomes.Expct. Value=x1 p1+x2 p2+….xmpm.
Variance and standard deviation It gives information about the
likelihood and magnitude by which a particular outcome from the distribution will differ from the expected value.
S.d – it reflects the variation in outcomes of a particular sample from a distribution.
Skewness: it measures the symmetry of distribution.it has a higher probability of very low losses and a lower probability of high losses when compared to symmetric distribution.Correlation: to identify the relationship among random variables.correlatin b/w 2 random variable is 0.then random variable is not related.
Pooling of risk Pooling arrangement with 2 persons. Pooling arrangement with many people
or business. Pooling arrangement with correlated
losses.
Selecting Risk Management Techniques
The steps for selecting among available risk management techniques for a given situation may be summarized as follows Avoid risks if possible Implement appropriate loss control
measures Select the optimal mix of risk retention
and risk transfer
Avoid Risks if Possible
Risks that can be eliminated without an adverse effect on the goals of an individual or business probably should be avoided
Without a systematic identification of pure risk exposures Some risks that easily could be avoided
may inadvertently be retained
Implement Appropriate Loss Control Measures
For risks that a business or individual cannot or does not wish to avoid Consideration should be given to available loss
control measures In analyzing the likely costs and benefits of
loss control alternatives Should recognize that loss control will always be
used in conjunction with either risk retention or risk transfer
Therefore, part of the cost/benefit analysis regarding potential loss control is recognition of the likely effects on the transfer or retention of the risk existing after loss control measures are implemented
The selection between risk retention and risk transfer as the optimal risk management technique may change after loss control expenditures are made
Analyzing Loss Control Decisions Capital budgeting techniques from finance
and accounting can be applied to risk management decisions regarding loss control
For example, Cole Department Store has been experiencing substantial shoplifting losses and occasional vandalism to its building The company is considering hiring 24-hour security
guards to decrease the frequency and severity of these losses Its estimated annual cost of the protection is $60,000
Covers salaries and employee benefits for the guards Cole estimates that the presence of security guards
will decrease shoplifting losses by $30,000 and vandalism losses by $20,000 Additionally its insurance premiums are expected to
decrease by $5,000 Should Cole hire the guards?
Analyzing Loss Control Decisions After examining only the financial
considerations Since the estimated $55,000 in savings is
less than the estimated $60,000 cost of hiring the guards The firm should not hire the guards
However the company should consider whether there are any additional relevant factors that may have been overlooked For instance, will the presence of the
security guards make employees feel safer? Will the firm be able to hire better
employees? Will customer relations be enhanced by the
presence of a guard?
Analyzing Loss Control Decisions In the Cole Department Store
example all the benefits and costs were expected to happen in the same year
When a longer period of time is involved the calculations become more complicated
Select the Optimal Mix of Risk Retention and Risk Transfer
As previously stated, loss control decisions should be made as part of an overall risk management plan That also considers the techniques of
risk retention and risk transfer Often both of these techniques will be
used The relevant question becomes
What is the appropriate mix between these two techniques?
General Guidelines
As a rule, risk retention is optimal for losses that have a low expected severity With the rule becoming especially appropriate when
expected frequency is high Another general guideline applies to risks that
have a low expected frequency but a high potential severity In this situation, risk transfer is often the optimal
choice When losses have both high expected severity
and high expected frequency It is likely that risk transfer, risk retention, and loss
control all will need to be used in varying degrees What constitutes “high” and “low” loss
frequency and severity in applying the preceding guidelines must be established on an individual basis
Guidelines for Using Different Risk Management Techniques
Selecting Retention Amounts Because in many situations both risk retention
and risk transfer will be used in varying degrees It is important to determine the appropriate mix of
these two risk management techniques Both capital budgeting methods and statistical
procedures may be used in selecting an appropriate retention level With insurance purchased for losses in excess of that
level But because the price of insurance does not
necessarily vary proportionately with different levels of retention The appropriate mix between retention and transfer
is not an exact science
The Self-Insurance Decision The possibility of self-insurance is another way
of mixing risk retention and risk transfer The cash flow advantage of funds set aside in
a reserve fund is must be considered in assessing value of self-insurance Because losses are not always paid out in the year in
which the event producing them occurs A company has the use of self-insurance funds for
varying periods May earn interest on them until such a time as the losses are
actually paid
The Self-Insurance Decision In assessing the financial aspects of a
self-insurance program The value of operating funds to the firm
must also be considered If the money in the reserve fund is
invested in a liquid form that can be readily converted to cash The firm may experience some loss because
the funds might have been more profitably used in the business as working capital Known as an opportunity cost of funds .
The Self-Insurance Decision Even though it may be clear that a
firm can save money in the long run with self-insurance Management may prefer stable,
predictable insurance premiums each year
Some companies prefer to avoid the details of managing self-insurance programs Rather, focusing on their main
operations
The Self-Insurance Decision The following conditions are suggestive
of the types of situations where self-insurance is both possible and feasible The firm should have a sufficient number of
objects so situated that they’re not subject to simultaneous destruction The objects should also be reasonably similar in
nature and value so that the calculations of probable losses will be accurate within a narrow range
The firm must have accurate records or have access to satisfactory statistics to enable it to make good estimates of expected losses
The Self-Insurance Decision The firm must make arrangements for
administering the plan and managing the self-insurance fund Someone must pay claims, inspect
exposures, implement appropriate loss control measures, keep necessary records, and take care of the many administrative details It may be possible to contract for these services to
be done by an independent third-party administrator
The general financial condition of the firm should be satisfactory Firm’s management must be willing and
able to deal with large and unusual losses