IRM - Risk Management

7/29/2019 IRM - Risk Management

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Session 4 & 5

Risk ManagementConcept of Risk, Sources of Risk, Classification of Loss

Exposures, Objectives of Risk Management, Risk

Management Process Determining the Objectives,Identifying the Risks


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Meaning of Risk

Economists, statisticians, actuaries and risk theorists each

have their own concept of risk

Traditionally, risk has been defined in terms of uncertainty.

Risk is the uncertainty concerning the occurrence of a loss.

Risk of lung cancer exists in case of smokers, because there is

uncertainty.

People in insurance industry often use the term risk to

identify the life or property being insured.


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Peril and Hazard

Peril Defined as the cause of loss.

The specific contingency that may cause a loss.

Examples: fire, lightning, theft, burglary etc.

Hazard

Defined as a condition that creates or increases the

chance of loss.

Conditions that exist which either increase thechance of a loss for a particular peril or tend to makethe loss more severe once the peril has occurred.


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Types of Hazards

Physical

hazardMoral

hazard

Moralehazard Legalhazard


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Physical Hazard

A physical condition that increases the chance ofloss.

Example:

defective wiring in the building that increases the chance

of fire.

bad road that increases the chance of accidents.

In the above examples:fire and accident are the

perils.


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Moral Hazard Dishonestyor character defectsin an individual that increase

the frequency or severity of loss.

Examples:

Submitting a fraudulent claim

Inflating the amount of claim

Intentionally burning unsold merchandise that is insured.

Moral hazard is present in all forms of insurance, and is difficult

to control.

Dishonest policyholders often try to rationalize their actions on

the grounds that insurers have plenty of money.

Premium rates tend to be higher due to moral hazard.

Moral hazard can be controlled by careful underwriting and

policy conditions like exclusions.


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Morale hazard

Carelessness or indifference to a loss because of the

existence of insurance.

Example:

leaving car keys in an unlocked car which increases the

chance of theft

Leaving a door unlocked

Smoking inside a petrol pump


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Legal Hazard

It refers to characteristics of the legal system or regulatoryenvironment that increase the frequency or severity of losses.

Examples:

Administered premium rates

Adverse jury decisions

Large damage awards in liability law suits

Statutes that require insurers to include coverage for certain benefits

such as third party cover in motor insurance


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Sources of Risk

Risk that property may be damaged, destroyed orstolen

For example, lightning, tornadoes, hurricanes,explosions, riots, collisions, falling objects, floods,earthquakes, freezing, etc.

Propertyrisks

Legal judgments may result in payments made to

compensate injured parties as well as to punish thoseresponsible for the injuries

Even if the individual is absolved of liability theexpenses involved in the defense may be substantial

Liabilityrisks


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Types of Risk


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Types of Risk

PURE & SPECULATIVE

Pure risk Possibilities of loss or no loss

There is uncertainty as to whether loss will occur

No possibility of gain, only the potential for loss

Examples:

Premature death, hospitalization, damage due to flood, tsunami,earthquake etc.

Speculative risk

A situation where profit or loss is possible

Examples:

Betting on a cricket match, investing in stock or real estate etc.


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Types of Risk

FUNDAMENTAL & PARTICULAR

Fundamental risk Affects the entire economy or large number of persons or groups

within the economy.

Govt. assistance or subsidies may be necessary to cover fundamental

risks. Examples:

Inflation, cyclical unemployment, war etc.

Terrorist attacks like 9/11, Super Cyclone of Orissa etc.

Particular risk Affects the individual and not the entire community.

Examples:

Car accidents, thefts, robberies etc.


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Types of Risk

STATIC & DYNAMIC

Situation not significantly affected bythe business environment and whichremains constant over time, such as

property. (Static risk are insurable)

Changes in the environment

Change in peoples tastes and habits

Changes in the regulatoryrequirements


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CLASSIFICATION OF PURE RIKS

PureRisk

Personal risk

Risk of premature death

Risk of insufficient incomeduring retirement

Risk of poor health

Risk of unemployment

Property risk

Direct loss

Indirect or consequentialloss

Liability risk


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The four basic methods of handling risks

Risk Management Techniques


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Risk Management Techniques

Risk

avoidance

Loss

control

Riskretention

Risktransfer


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Risk Avoidance

A conscious decision not to expose oneself to a particular risk.

For example:

An eccentric person may not drive his car on the road simply to avoid the risk ofaccident.

A customer may have the seller assume all risks of loss until the goods reach at thebuyers premises.

Possible in case of those persons who have a strong aversion to risk.

Not always feasible or may not be desirable even when it is possible.


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Risk Avoidance.continued

Relative costs and benefits associated with the activities(that give rise to the risks) are to be weighed.

Because, when a risk is avoided, potential benefits aswell as costs are given up.

For example: a doctor, who quits practice avoids futureliability risks, at the same time forfeits his income.


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Loss Controltypes of loss control

Focus of loss control:

When a factory cleans up its storage areas and discards the oilyrags stored there, it is practicing loss control to lessen the

chance that it will suffer a fire. By removing physical hazards and eliminating unsafe actions by

employees, the frequency of injuries can be reduced.

In case of a 2-wheeler rider using helmet, he is engaged inseverity reduction.

A factory may maintain spare parts for immediate replacementdamaged equipment (duplication).


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Loss Retention

Risk retention involves the assumption of risk.

If a loss occurs, an individual or firm will pay for it out of whatever funds are available.

Retention can be planned or unplanned, and losses can either be funded or unfundedin advance.

Example: Risks arising out of accidental injury.

Different ways of loss retention may be:

Credit

Reserve funds

Self-insurance


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Risk Transferdifferent forms of risk transfer

Indemnity Agreement: A landlord agreeing to indemnify the tenant for all lossescovered by the agreement, regardless of size.

Diversification: Across various businesses or geographic locations. Ex-A companywith two production centers at coastal region may suffer from tsunami. But, itcan not affect two different locations at, say, Chennai and Delhi.

Hedging: An airlines company entering into a hedging transaction in the oilfutures market to transfer the risk of oil price fluctuations.

Insurance: Most widely used form of risk transfer.


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Questions, if any

IRM - Risk Management

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