Topic 2. Risk and Risk Management

1
Topic 2. Risk and Risk Management

• Bus 200
• Introduction to Risk Management and Insurance
• Jin Park

2
Overview

• Terminology
• Risk
• Perils, Hazards
• ERM, IRM
• Risk Management process

3
Terminology

• Risk
• Deviation from expectation
• Worse than expected
• Better than expected
• Uncertainty concerning a loss
• Uncertainty
• Loss (cf. Loss exposure)
• Pure vs Speculative
• Fundamental vs Particular
• Systematic vs Nonsystematic (Diversifiable)
• Objective vs Subjective

4
Terminology

• Pure Risk
• Loss or no loss
• Fire
• Risk management Insurance

• Speculative Risk
• Loss or gain
• No loss/gain
• Investment
• Finance

Enterprise Risk Management deals with managing
both risks in a firm
5
Terminology

• Perils
• (Immediate) Causes of loss
• Hazards
• Physical hazards
• Moral hazards
• Morale hazards

6
Risk Management

• Risk management
• A systematic process for managing (pure) risks
  faced by an individual or organization.
• Pre-loss risk management
• Should prepare for potential loss in the
  economical way possible
• Post-loss risk management
• Survival of the organization
• Continuation of operation
• Stability of earnings

7
Risk Management Process

• Identify risks or exposures to loss
• Evaluate risks or exposures to loss
• Identify and select risk management techniques
• Implement and monitor

8
Identify Risks

• Organization
• Property
• Liability
• Business income
• Death or disability of key persons
• Job-related injuries or disease
• Fraud, dishonesty, crime
• International operation

• Individual
• Property
• Liability
• Premature death or disability
• Unemployment
• Sickness
• Liability

9
Identify Risks

• Physical inspection
• Questionnaire
• Financial statement analysis
• Flowchart
• Contract analysis
• Statistical analysis of past losses
• Risk management information system (RMIS)

10
Evaluate Risks

• Risk management matrix
• Frequency
• Severity

High
Frequency
Low
High
Low
Severity
11
Evaluate Risks

• Risk mapping

High
Frequency
Low
High
Low
Severity
12
Identify and select RM techniques

• Risk avoidance
• Risk retention (Risk assumption)
• Self-insured
• Captive
• Risk reduction (control)
• Loss prevention frequency
• Loss reduction severity
• Risk transfer
• Insurance
• Non-insurance
• Example Sprinkler, Hold-harmless agreement,
  ignorance, safety education, smoke alarm,
  deductible, warm-up, rent

13
Identify and select RM techniques

• Risk mapping
• Critical issue tolerance boundary or
  risk-tolerance boundary
• Prioritize risks

14
Implement and Monitor

• Are techniques implemented correct?
• If not,

15
Insurance

• Advantages
• Uncertainty is reduced
• Insurers can provide. their expertise such as
  loss control services.
• Insurance premium is tax-deductible.
• Insurance proceeds are tax-free.

• Disadvantages
• Insurance premium may be a major cost.
• Moral and morale hazards may be created.
• Time and effort have to be spent.
• Insurance may not be renewed.

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Others

• CAT bonds
• Forward/Future
• Swaps
• Options
• Securitizations
• CDO, CMO, CBO, CLO

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Enterprise risk management

• Integrated risk management
• The process of planning, leading and controlling
  the activities of an organization to minimize the
  effects of risk on earnings and capital
• A holistic approach to risks faced by a firm
• Risk management has to be integrated among
  various players in a firm
• Requires a (strategic) risk management policy
• Needs support from the top level of a firm

18
The Three Faces of Risk Management

• Although most companies have their bases covered
  should they meet with fire, theft or flood, such
  hazards represent
• Explains about ERM
• allows organizations to examine all the risks
  they face
• measure the potential impact of those risks on
  the long-term viability of the company
• take the appropriate steps to manage or mitigate
  those risks.
• "The goal is to ensure the continuity of the
  enterprise
• "This is an opportunity to get to know your risks
  better than your competitors. It can also leave
  you in a position to be able to take on more risk
  the type of risk that can help improve company
  performance."
• An example of an electronics manufacturer

19
Top Cops

• Explains about CRO
• Explains about ERM
• "We're building the capability internally to
  identify all risks, analyze and quantify them,
  and then determine the optimum means of
  mitigating, absorbing, or transferring them.
• When that's done, we will decide on an ongoing
  basis which risks to keep and which to transfer.
  Then we can effect the transfer through our
  trading desks, financial markets, insurance
  carriers, integrated risk policies, OTC
  over-the-counter transactions, or a contractual
  transfer to another party entirely.
• other CROs are working closely with insurance
  brokers, accounting firms, and risk management
  consultants to lead the way,

20
Illinois Power

• The Risk Register
• a comprehensive risk-assessment system
• a formal process that identifies, quantifies and
  categorizes the risks facing Illinois Power,
  develops cost-effective methods to control them
  and positions the company to achieve its stated
  goals

21
Illinois Power

• Benefits of the Risk Register
• aware of the catastrophic risks
• aware of the fact that its pre-loss risk
  management was not adequate
• developed a more efficient and effective
  post-loss risk management program
• built risk-related database

22
Illinois Power

• IDENTIFYING THE RISKS
• regardless of insurability
• CONSIDERING CONTROL TECHNIQUES
• disregarding cost or appropriateness of any
  method
• SELECTING RISK CONTROLS
• subjected to a reasonableness test and a thorough
  economic evaluation
• IMPLEMENTATION
• MONITORING

23
UPS

• Why small firms?
• Why not large firms?
• Why not pharmaceutical firms?
• Lessons
• "Use more than one delivery company.
• "August is a good time for a strike, because
  there is not a lot of stuff being done."

24
Domino effects

• ???

25
Next- Loss Exposures

• ETTI Chapter 1, pp. 16 18
• ETTI Chapter 8, pp. 162 164, 170 172, 173
  176
• ETTI Chapter 9, pp. 180 - 203
•  
• 1. Business continuity planning Preparing for
  the worst, KPMG Insiders, June 10, 2002
• 2. U.S. firms underestimate IT risks, Insurance
  Day, June 14, 2002
• 3. Prudent Man with a Plan, CFO Magazine, June
  18, 2002.
• 4. Warning A batman cape wont help you fly, New
  York Times, March 5, 1997.
• 5. Jury awards 12 million in voice-mail hang-up,
  Chicago Tribune, April 3, 2003.
• 6. 36 million awarded to heirs of 2 killed in
  freak accident, Chicago Tribune, date unknown.