EXAM REVIEW Overview of Risk Management

minimize Risk Management is a methodology that helps managers minimize the financial impact of risk on organizations/businesses What is Risk Management?

It is a fact of life that chance events will occur and affect the outcome of your life or for business; profitability, sustainability, etc Murphy’s Laws codify this “knowledge”  If anything can go wrong, it will!  Of things that could go wrong, the one that causes the most damage will occur!

The 4 major process steps are:

1. Economic 2. Natural 3. Human

1. Economic Risk: risk associated with the possibility of loss due to a change in the economy Some examples: Competition Changing consumer lifestyles Inflation Population changes Obsolescence Government regulation Recession Limited usefulness or popularity of some products

 Natural Risk: risk associated with possibility of loss due to natural causes Some examples: Drought Earthquakes Hurricanes Tornadoes Lightning Fire Other weather related problems.

 Human Risk: risk associated with the possibility of loss due to human factors. Some examples: Employees Dishonesty/Fraud Incompetence Accidents Illness Negligence Customer unpredictability Employee unpredictability Other Human mistakes Non-Economic Human Risks Political = Revolution, responses to pollution Social = “Buy American” slogan Cultural = Values & behaviors we bring to workplace

After identifying and analyzing the risks, you can evaluate. What is the likelihood of the risk event occurring? What is the likelihood of the risk event occurring? Evaluate the risks Almost certainAlmost certain LikelyLikely ModerateModerate UnlikelyUnlikely Rare?Rare? Almost certainAlmost certain LikelyLikely ModerateModerate UnlikelyUnlikely Rare?Rare? What is the consequence if the risk event occurs? ExtremeExtreme Very highVery high ModerateModerate LowLow Negligible?Negligible? ExtremeExtreme Very highVery high ModerateModerate LowLow Negligible?Negligible?

After establishing ‘Likelihood’ and ‘Consequence’ you can use a table like this to set a level of risk. ExtremeVery highModerateLowNegligible Almost certain Severe HighMajorModerate LikelySevereHighMajorSignificantModerate HighMajorSignificantModerateLow UnlikelyMajorSignificantModerateLowVery low RareSignificantModerateLowVery lowVery Low You must define what these risk levels mean to you. Evaluate the risks

Types of Risks  Pure and Speculative Risks  Pure risk  Pure risk is a chance of loss with no chance for gain. ▪ (2 future states: Loss or No loss) ▪ Pure risks are random ▪ (can happen to anyone) and result in loss ▪ (never a gain).  Examples of pure risk include the following: ▪ Fire, Flood, Death, Sickness, Acts of nature Easy to write insurance for pure risk

Types of Risks  Pure and Speculative Risks  Speculative risk  Speculative risk may result in either gain or loss.  Speculative risks are never “accidental” or “random” ▪ May result in either gain or loss, you cannot protect yourself from losses in a traditional manner. ▪ Hedging (making an investment to help offset against loss) is a technique used to help reduce losses from such risky acts, it does not reduce the risk itself.

Types of Risks  Static vs. Dynamic Risks  Static risk ▪ Doesn’t change significantly over time ▪ Always present Examples: Fire, Theft, Flood, Death, Sickness,  Dynamic risk ▪ Arises out of changing circumstances ▪ New laws &Emerging technology Examples: Privacy, ID Theft, Health, Political Risk Fire, Theft, Flood, Sickness, Death Privacy, ID Theft, Health, Political Risk

Factors Affecting Risk  Peril – Random Events  Immediate cause of the loss ▪ Examples: fire, flood, theft, injury, sickness, death  Frequency & Severity ▪ Frequency: How often do losses occur? ▪ Severity: How severe is the loss? ▪ Give that a loss occurs how bad is it in terms of $$$$ ▪ Conditional upon frequency being positive  If frequency is zero, severity is not an issue

Factors Affecting Risk  Hazard  Underlying condition behind a loss occurrence which either: ▪ Increases frequency or severity of the loss ▪ Or, increases both frequency and severity  Physical Hazard (Location) ▪ Flood, living at the shore is a physical hazard (frequency) ▪ Fire, distance to a fire hydrant is a physical hazard (severity)

Factors Affecting Risk  Hazard  Construction Material ▪ Fire Peril ▪ If peril is fire, wood structure is physical hazard (Frequency and Severity)  Use of facility ▪ Classroom Building vs. Church ▪ If peril is fire, the use of the building as a church poses a physical hazard

Factors Affecting Risk  Moral Hazard  Behavior Changes ▪ Presence of insurance affects behavior ▪ People act differently because of the existence of insurance

Factors Affecting Risk  Moral Hazard (Fraud/Dishonesty)  Insurance Fraud (Examples) ▪ Have your car stolen and collect insurance ▪ Arson: Burn your own building ▪ Husband kills wife for insurance  Common Thread ▪ Presence of insurance ▪ Change in behavior

 Avoid (Prevent) the risk  Transfer the risk  Assume/Avoid the risk

Involves dealing with risks before they occur

1. Screening potential employees 2. Properly train new employees 3. Provide safe work environment 4. Discourage theft/poor behavior

 Involves passing risk

1. Purchasing insurance against a potential loss 2. Using warranties to transfer risk to manufacturer 3. Selecting right business formation

 Involves assuming or acknowledging a business risk and outcome  Why? ▪ Some risks are inevitable or uncontrollable ▪ Some risks cannot be transferred, avoided, insured or prevented

 Can be achieved by:  Anticipating business risk  Preparing for risk in advance  Also other ways to AVOID RISK  Pursue an option or options that involves less risk  Don’t get involved in the activity presenting or causing the risk

20 Questions: 100pts