With reference to Insurance

DEFINITIONAs a systematic approach to identifying, measuring and controlling risks that can threaten assets and earnings of oneself, a business or the organization.

The purpose of risk management is to enable an organization to progress toward its goal and objectives (mission) in the most direct, efficient, and effective path

OBJECTIVES OF RISK MANAGEMENT

Objectives prior to a loss

Objectives after a loss occurs

OBJECTIVES PRIOR TO A LOSS

Reduce impact of lossReduce fear and worry

OBJECTIVES AFTER A LOSS OCCURS

Survival of organization Stability of earnings Reduce impact of losses to organization and society

RISK MANAGEMENT PROCESS

IDENTIFYING POTENTIAL LOSSES

Risk identification is the process by which an organization is able to learn of the areas in which it is exposed to risk.Identification techniques are designed to develop information on sources of risk, hazards, risk factors, perils and exposures to loss.

It is everybody’s task to identify the loss exposures in

one organization.

IDENTIFYING POTENTIAL LOSSES

Losses can be classify as:– Direct damage

(damage to building)– Indirect damage (loss

of profits due to business interruption)

– Liability (court award to 3rd party since fire was caused by negligence of the owner of building)

IDENTIFYING POTENTIAL LOSSES

How to identify risk?– Questionnaires– Interviews– Financial Statements– Flow Charts– Personal inspection / Observation

EVALUATING POTENTIAL LOSSES

– Risk measurement evaluates the likelihood of loss and the value of loss in terms of frequency and severity.

– The measurement process may take the form of a qualitative assessment (using %)

– This step involves two important aspects of loss exposures• Frequency• Severity

EVALUATING POTENTIAL LOSSES

– Risk measurement evaluates the likelihood of loss and the value of loss in terms of frequency and severity.

– The measurement process may take the form of a qualitative assessment (using %)

– This step involves two important aspects of loss exposures• Frequency• Severity

EVALUATING POTENTIAL LOSSES

– Identifying and determining the loss exposures alone is not sufficient

– In evaluating the potential losses:• Estimating the

frequency and severity for each type of loss

EVALUATING POTENTIAL LOSSES

How can you determine and estimate the impact of losses– Frequency

• Referring to the number of times the loss occurs

– Severity .• Referring to the

maximum size of loss exposures

EXAMINING THE METHODS OF HANDLING THE LOSS EXPOSURES

Two main ways to classify the risk management techniques

- Risk Control • Risk avoidance• Loss control

– Loss prevention– Loss reduction

• Separation • Contractual Transfer

_Risk Financing– Retention/Assumption– Captive insurer– Insurance

RISK CONTROL

Methods seek to alter an organization’s exposure to risk.Risk control efforts help organization avoid a risk, prevent loss, lessen the amount of damage if a loss occurs or reduce undesirable effects of risk on an organization.

Risk Avoidance

If someone is afraid of risks, the best way to deal with it is to avoid it completely.Example; a manufacturer may stop production of a defective products to avoid a lawsuit. However, some risks are unavoidable although risk avoidance may be chosen as an option in handling certain risks, the exposures of losses cannot be eliminated entirely.

Loss Control

Loss control is designed to reduce both the frequency and severity of losses by changing the characteristics of the exposure so that it is more acceptable to the firm. Divided into:– Loss prevention– Loss reduction

Loss ControlLoss Prevention– Seek to reduce the

number of losses (frequency) of losses

– Is used when the benefits outweigh the costs involved.

– Either imposed by law or imposed by companies and factories to fence dangerous machinery to reduce the chances of employees being injured.

Loss Reduction– Designed to reduce or

lower the severity of losses, should it occur.

– Since some risks are unavoidable, the other alternative is to reduce its impact.

– Can be used in two circumstances: before a loss, e.g. installation of fire alarm or after a loss e.g. salvage efforts in the restoration of a building burnt down by fire.

SeparationInvolves the dispersal of the firm’s assets in several locations instead of confining it to one major area.

This measure will reduce the impact of losses should a major disaster

occurs.

Contractual TransferRisk transfer mechanism.Refers to the various methods other than insurance by which a pure risk and its potential financial consequences can be transferred to other party.

Contractual TransferTypes of contractual transfer– Incorporation

• The owner of the company transfers the risks to corporation by registering the company.

– Leasing contracts• An agreement where the owner or landlord transfers

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 agreements• An agreement between a retailer and a manufacturer

whereby the later agrees to bear losses due to the manufacturer of defective products thus relieving the retailer of any liability.

Contractual TransferAdvantages– Can transfer

potential losses that are commercially uninsurable

– Often cost less than insurance

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

Disadvantages– If the party to whom

the loss is transferred is unable to pay the loss the firm is still responsible

– Not necessarily cheaper than insurance if discounts are taken into consideration

RISK FINANCING

Methods involving generating funds to pay for these losses– Retention– Self insurance and captive insurer– Insurance

RetentionRetention – the company will bear the consequences of the lossRisk or loss exposed are normally assumed or retained when their impact and consequences are not too great or in cases when or other methods seem feasible.In an organization, the ability to assume a risk depends on one’s financial ability.

Self insurance

Self insurance implies tat the organization sets up a pool of fund to retain its loss exposures.Adequate financial agreement has to be made in advance of the occurrence of losses.

Captive Insurer

A captive insurance company is an entity to write insurance arrangement for its parent company.The captive’s parent may be one company, several companies or an entire industry.

Insurance

Risk financing method of transferring the financial consequences of potential accidental losses from an insured firm or family to an insurerTransferring the risks to another party involves a contractual agreement whereby the other party assumes the risks and is liable for the loss in the event of loss.

InsuranceIn an insurance contract, the party exposed to the risks (the proposer/insured) pays the premium to the insurance company. In return, the insurance company agrees to pay a stated sum on the happening of certain risks specified in the contract.

TO DRAW UP AND IMPLEMENT THE RISK MANAGEMENT

PROGRAMOnce a decision has been in the selection, the management must select the best and most cost effective risk management programThe selection may based of two factors– Financial criteria – whether it will affects the

organization’s profitability or rate of return.– Non financial criteria – whether it affects the

growth of the organization.