1. Risk, Terminology, ERM Bus 200 Introduction to Risk Management and Insurance Fall 2008 Prof. Jin Park

Based on “Uncertainty” Uncertainty concerning the occurrence of a loss Based on “Expected Value” Deviation from expectation

Pure vs. Speculative Risk

Objective vs. Subjective Risk

Fundamental vs. Particular Risk

Perils (Immediate) Causes of loss Natural perils Acts of God Human perils Human acts, errors, and omissions, whether intentional or unintentional, causing a loss Economic perils Economic events or phenomenon causing a loss Insurable and Uninsurable perils

Hazard A condition that creates or increases the chance of losses, their severity, or both. Physical hazard Moral hazard Morale hazard Legal hazard

Types of Pure Risk Personal Risk Property Risk Direct Loss Indirect Loss Liability Risk

Enterprise Risk Management Traditional risk management? Enterprise risk (Major) risks faced by an organization (or firm) Enterprise risk management The process (or discipline) by which an organization assess, controls, exploits, finances, and monitors risks from all sources for the purpose of minimizing the effects of risks on organization’s value.

10 Key ERM Risk Terms  Strategic/Franchise Risk  Legal/Compliance Risk  Staffing/Organization Risk  Credit Risk  Market Risk  Operational/Systems/Technology Risk  Environmental Risk  Sovereign Risk  Financial/Documentation Reporting Risk  Liquidity Risk

11 Key Implementation Requirements 1. Provide leadership and “set the tone from the top” 2. Allocate resources for enterprise risk management 3. Establish vision and overall plan 4. Set milestones and individual accountabilities 5. Establish risk measures and early warning indicators 6. Integrate ERM into business planning and operations

12 Example: Energy Industry Insurance Credit Market Insurance Credit Operations Insurance Business Organizational Insurance Financial Risk Management Enterprise Risk Management 1970s 1980s1990s (Deregulation)

13 Market Risk FX Interest rates Commodities Liquidity risk Operational Risk Process risk Technology risk Regulatory risk Reputational risk Credit Risk Loan default Counterparty exposure Vendor risk Risk Management and Insurance & the CRO Chief Risk Officer ART (Alternative Risk Transfer) Enterprise Risk Management Derivative Products Insurance Products Risk Managers Treasurer/ Insurance Audit/Compliance In the Financial Markets Within a Company