RISK MANAGEMENT: CONCEPT AND

PROCESS

DEFINITION AND EVOLUTION One of the management function that

seeks to essess and address the causes and effects of uncertainty and risk on an organization.

To enable an organization to progress toward its goal and objectives(mission) in the most direct,efficient,and effective path.

Process of thinking systematically about all possible risks, problems or disasters before they happen and setting up procedures that will avoid the risk, or minimize its impact, or cope with its impact.

ISLAMIC PERSPECTIVE Should anticipate the risks that will

hinder the ultimate goal of them which is to attain success in the world and here after.

Indicates how do Muslim reduce the risk of loss and calamities

Aim to reduce the utilization of resourcess (financial and non-financial) and to minimize the negative effects of risks or maximize the opportunities and goals.

The goal must be aligned with the syariah

OBJECTIVES To preserve the operating effectiveness

of the organization, to make sure that it is not prevented from attaining its other goal by pure risks or the losses arising from those risks.

Equally important in the view of some-is the humanitarian goal of protecting employees from accidents that might result in death or serious injury.

OBJECTIVESI. PRE LOSS necessary before a loss actually takes place so

that the impact of the loss should it occur can be minimized.

Necessary before a loss since it reduce fear and worry.

necessary in some cases because is made compulsory by law.

EXAMPLE : the government sets a regulation that requires firms to install safety devices to protect workers from harm such as wearing safety helmets and eye-goggles are made compulsory in the construction industry to avoid injuries among workers.

OBJECTIVESII. POST LOSS Ensures the survival of the organization even

after a loss has taken place – organization must be able to continue its operation.

Ensures the stability of earnings – do not have to stop and the organizations can concentrate on their business activities as usual.

Reduce the overall impact of losses toward the organization and the society – loss occur not only will the organization suffer but the loss has to be burned by society as well.

RISK MANAGEMENT PROCESS

1.Indentfying existing and

potential risks.

2.Evaluating potential risks

3.Examining alternative risk management techniques

4.Selecting and implementing risk

management program

5.evaluating,riviewing and controlling the

program

RISK MANAGEMENT PROCESSSTEP 1 : INDENTIFYING EXISTING AND

POTENTIAL RISKS

by which an organization is able to learn of the areas in which it is exposed to risk.

Designed to develop information on sources of risk, hazards,risk factors, perils, and exposures to loss.

Ensure that all loss exposures are identified is not an easy task.

RISK MANAGEMENT PROCESS Losses can be claasified as those that

can result in : direct damage (damage to building) Indirect damage (loss of profit due to

business interruption) Liability (court award to third party since

fire was cause negligence of the owner of building)

Loss of key employee (CEO dies or disable as a result of fire)

RISK MANAGEMENT PROCESS Systematic approach to the problem of

risk identification :

Risk identification tools

orientation

Insurance policy

checklistquestionn

aires

RISK MANAGEMENT PROCESS Systematic approach to the problem of

risk identification :

Risk identification tools

flowcharts

Analysis of financial

statementInspection

s

RISK MANAGEMENT PROCESSSTEP 2 : EVALUATING POTENTIAL RISK Evaluate them in terms of financial loss. Measuring the severity (potential size of the loss)

and frequency (the probability that it is likely to occur).

Example : a supermarket entity that experiences high frequency of losses .losses that fall in this category would be shoplifthing of small items such as chocolate bars or snacks.we very seldom hear of a supermarket being close down because of that. – loss with high severity.

RISK MANAGEMENT PROCESS STEP 3: EXAMINING ALTERNATIVE RISK MANAGEMENT

TECHNIQUES POSSIBLE WAYS TO HANDLE IT.

-RISK AVOIDANCE-LOSS CONTROL (LOSS PREVENTTION , LOSS REDUCTION)

-SEPARATION-CONTRACTUAL TRANSFER

RISK CONTROL (NON

-FINANCIA

L)

-retentaion-captive insurer

-insurance RISK FINANCIN

G

RISK MANAGEMENT PROCESS

Focuses on minimizing the risk of loss to which the entity is exposed, and includes the techniques of risk avoidance and risk reduction.

Risk control

RISK MANAGEMENT PROCESS

Risk controlRisk avoidance : By not engaging in that particular

hazardous activity or operation. Manufacturer can avoid the risk of

liability associated with hazardous products by picking another product line.

RISK MANAGEMENT PROCESS

Risk controlLoss control : Avoidance designed to reduce the frequency,

severity, or unpredictability of losses. Two perspective : *loss prevention (reduce frequency)-

example, employees wear and use all the time any protective equipment or clothing provided.

*loss reduction (reduce severity before and after loss) - example, seat belts and air bags are designed to minimize the amount of damage at the time an accident occurs.

RISK MANAGEMENT PROCESSSeparation : Reduce the impact of losses. Example , location of each building must

be properly planned so as to minimize losses in the case of event such as fire.

The separation of warehouse from operation section in a factory.

RISK MANAGEMENT PROCESSContractual transfer : Incorporation- where the owner transfer the risk

to corporation by registering the company. Leasing contract- an agreement where the

owner or landlord transfer the risks to the tenants.

Hedging- an agreement to buy or sell a commodity at a certain price to avoid losses due to price increase or decrease.

Hold-harmless agreement- agreement between a retailer and a manufacturer whereby the later agrees to bear losses due to the manufacturer of defective products thus relieving of any liability.

RISK MANAGEMENT PROCESSContractual transfer :

advantages disadvantages

The potential loss that are uninsurable can be transfer to the third party.

The firm still have to responible in the case of third party refuse to pay.

Normally the cost is less than insurance

Not necesserily cheaper than insurance if discount are taken into consideration.

Potential loss shifted to a party who is in better position to exercise control.

Ambiguity in contract may not hold in court.

RISK MANAGEMENT PROCESS

Risk financingRetention : The company will bear the

consequences of the loss. To pay for losses it incurs. Less expensive than purchasing

insurance because many frictional costs (administrative costs of purchasing insurance, commission to insurance sales people, premium taxes, insurer profit)

RISK MANAGEMENT PROCESSSelf insurance and captive insurers : Self insurance is one of the oldest

alternatives and remains one of the most popular.

Rather than purchase an insurance policy , a company will elect to retain an eligible risk while designating an amount of money calculated to compensate for the potential future loss.

RISK MANAGEMENT PROCESS A capture insureris , in general term, a

licensed insurance company established by a non-insurance parent company to insure the risks of the parent company.

Example, maybank group is the parent company of maybank assurance sdn.bhd .

RISK MANAGEMENT PROCESSAdvantages of a captive Disadvantages of a

captive

Reduced insurance costs Capital commitments

Protected cash flow Risk of adverse results

Source of additional revenue Operating cost

Coverage for risks Time commitment

Reduced need for commercial insurance

-

Flexibility in program design -

RISK MANAGEMENT PROCESSInsurance : Financing method of transferring the

financial consequences of potential accidental from an insured firm or family to an insurer.

Use when the organization feels that it is more economical and beneficial to transfer the risk to another party.

RISK MANAGEMENT PROCESSSTEP 4 : SELECTION AND

IMPLEMENTATION OF THE RISK MANAGEMENT PROCESS

Draw up and implement the risk management program

Based on 2 factors : *financial criteria – affect the

organization’s profitability or rate of return.

*non-financial criteria- affects the growth of the organization, humanitarian aspects and legal requirements.

RISK MANAGEMENT PROCESSRisk matrix :::::

Type of risk High frequency

Low frequency

High severity Risk avoidance and reduction

Risk transfer (ex ;insurance)

Low severity Risk retention and reduction

Risk retention

RISK MANAGEMENT PROCESSSTEP 5 : EVALUATION,REVIEW AND

CONTROL Must be monitored and controlled

systematically. Periodically reviewid to ensure that the

techniques employed are still suitable and they satisfy the current conditions.

To review decisions and discover mistakes, it is hoped, before they become costly.