IRM - Risk Management
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Transcript of 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