Introduction to Risk Management

1. INTRODUCTION
UNIT-1
Unit 1: Introduction to risk management-elements of uncertainty peril, hazards; Sources of risk
and exposure, pure risk and speculative risk, acceptable and non-acceptable risks, static and
dynamic risk, various elements of cost of risk. Risk management process-definition, types and
various means of managing risk –limitations of risk management.
VIPULKUMAR N M
Assistant Professor,
Department of Commerce,
Kristu Jayanti College, Bengaluru
RISK MANAGEMENT AND INSURACE
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2. WHAT IS RISK
 The term risk is generally used to refer to a situation where the
outcome is uncertain and there is a possibility of loss the loss is
random in nature It occurs by chance and may happen to
anybody and any property lt is not intentional. In insurance the
term is also identified with the peril which may cause the loss
 The word ‘peril’ is used to describe an event such as fire flood
earthquake .etc which could lead to economic loss. The
uncertainty about its happening. its frequency and its severity is
referred to as risk. Thus, risk has also been defined as the inability
to accurately predict the effects of future events
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3. RISK, PERIL, AND HAZARD
 Risk, peril, and hazard are terms used to indicate the possibility of
loss, and are often used interchangeably, but the insurance industry
distinguishes these terms.
 Risk is simply the possibility of a loss,
 Peril is a cause of loss.
 Hazard is a condition that increases the possibility of loss.
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4. RISK
Risk is nothing but possibility of loss or any other adverse
events that have the ability to interfere with an organization’s
ability to fulfil its mandate. Risk management offers a lucid
and planned approach to recognize risk. It helps in reducing
the losses or reducing the impact of loss on an organization
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5. DEFINITION OF RISK
 The Oxford English Dictionary (OED) cites the earliest use of the word
in English (in the spelling of Risque from its French original, 'Risque') as
of 1621, and the spelling as risk from 1655. While including several
other definitions, the OED 3rd edition defines risk as:
 (Exposure to) the possibility of loss, injury, or other adverse or
unwelcome circumstance; a chance or situation involving such a
possibility.
 The Cambridge Advanced Learner’s Dictionary gives a simple summary,
defining risk as
 “the possibility of something bad happening”.
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6. CAUSA PROXIMA
It is a rule of law that in actions on fire policies, full regard must be
had to the causa proxima. If the proximate cause of the loss is fire,
the loss is recoverable. If the cause is not fire but some other cause
remotely connected with fire, it is not recoverable, unless
specifically provided for. Fire risks do not cover damage by
explosion, unless the explosion causes actual ignition, which spreads
into fire. The cause of the fire is immaterial, unless it was the
deliberate act of the insured.
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7. RISK EXPOSURE
Risk exposure is a quantified loss potential of business.
Risk exposure is usually calculated by multiplying the
probability of an incident occurring by its potential
losses.
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8. RISK vs HAZARD 8

9. TYPES OF RISK 9

10. 10
BASIS OF DISTINCTION PURE RISK SPECULATIVE RISK
MEANING
Pure risk is the risk
which involves only
the possibility of loss
or no loss.
Speculative risk
involves both the
possibility of gain as
well as possibility of
loss.
POSSIBILITY OF
PROFITS/ LOSS
Occurence of this risk
may result in loss
only and no gains.
Occurrence of this risk
may result in
possibility of both gain
as well as loss.
RISK COVERAGE
Insurance services
provides coverage of
such risks.
such risks cannot be
covered under
insurance provisions.

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12. TYPE OF PURE / STATIC RISK
• Personal Risks
• Property Risks
• Liability Risks
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13. SOME OTHER TYPES OF RISK
Financial and Non-financial Risks
Individual and Group Risks
Quantifiable and Non-quantifiable Risks
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14. Types of Pure (static) Risk
Pure (Static) Risk is further classified into three different types, which are explained below.
Personal risks
These are the risks that directly affect an individual’s capability to earn. Personal risks can further be
classified as:
 Premature death: Death of the bread earner with unfulfilled or unprovided financial obligations.
 Old age: The risk of not having sufficient income at the age of retirement or age causing lack of
capability to earn one’s livelihood.
 Sickness or disability: The risk of poor health or disability impairing the means to earn. For example,
the possibility of damage to the limbs of a driver caused by an accident.
 Unemployment: The risk of unemployment due to socio-economic factors resulting in financial
insecurity.
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15. Property Risks
 These are the risks incurred by a person in possession of property due to the
possibility of damage or loss. Immovable like land and building may be
damaged due to flood, earthquake or fire while, movables like appliances and
personal assets may be destroyed by fire or burglary. The losses may be direct
or consequential.
 A direct loss implies visible financial loss to the property due to mishaps,
whereas indirect loss arise from the occurrence of an incident causing
direct/physical damages or loss. Loss of crops due to flood is a direct loss
while the destruction of growing power is a consequential one.
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16. Liability risks
These are the risks arising out of intentional or unintentional injury to
persons or damages to their properties through negligence or
carelessness. Liability risks generally arise from the law,
for e.g. liability of the employer under the Workmen’s Compensation
Act or other labour laws applicable in India. In addition to the above
categories, risks may also arise due to the failure of others.
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17. Financial risks
Financial risk involves the simultaneous existence of three important
elements in a risky situation which are as follows:
 when someone is adversely affected by the happening of an event
 assets or income are likely to be exposed to a financial loss from the
occurrence of the event and
 the peril can cause the loss
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18. Non-financial risks
When the possibility of a financial loss does not exist, the
situation can be referred to as non-financial in nature. Financial
risks are more particular in nature.
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19. Individual or particular risks
Individual or particular risks are confined to individuals or small
groups. Thefts, robbery, fire, etc. are risks that are particular in
nature. Some of these are insurable. Because of their very nature
methods of handling fundamental and particular risks differ. For
instance, social insurance programmes may be undertaken by the
government to handle fundamental risks while an individual may
buy a fire protection policy to overcome the adverse
consequences of fire.
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20. Group risk or Fundamental risk
A risk is said to be a group risk or fundamental risk if it
affects the economy or its participants on macro basis. These
are impersonal in origin and consequence. They affect most
of the social segments or the entire population. These risk
factors may be socio-economic or political or natural
calamities e.g. earthquakes, floods, wars, unemployment or
situations like 11th September attack in the U.S., etc.
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21. Quantifiable and Non-quantifiable risks
Risks which can be measured, like financial risks are known to be
quantifiable,
while situations, which may cause stress or ‘loss of peace’ are
termed as non-quantifiable
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22. Types of Risk
1. Business Risk
2. Non-Business Risk
3. Financial Risk.
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23. 1. Business Risk
These types of risks are taken by business enterprises
themselves in order to maximize shareholder value
and profits. As for example, Companies undertake
high-cost risks in marketing to launch a new product
in order to gain higher sales.
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24. 2. Non- Business Risk
These types of risks are not under the control of firms.
Risks that arise out of political and economic
imbalances can be termed as non-business risk.
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25. 3. Financial Risk
Financial Risk as the term suggests is the risk that
involves financial loss to firms. Financial risk generally
arises due to instability and losses in the financial
market caused by movements in stock prices,
currencies, interest rates and more.
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26. 26

27. TYPES OF FINANCIAL RISK
1. Market Risk:
This type of risk arises due to the movement in prices of financial
instrument. Market risk can be classified as Directional Risk and Non-
Directional Risk. Directional risk is caused due to movement in stock
price, interest rates and more. Non-Directional risk, on the other hand,
can be volatility risks (risk of a change of price of a portfolio as a result
of changes in the volatility of risk factor)
2. Credit Risk:
This type of risk arises when one fails to fulfill their obligations towards
their counterparties. Credit risk can be classified into Sovereign Risk and
Settlement Risk. Sovereign risk usually arises due to difficult foreign
exchange policies. Settlement risk, on the other hand, arises when one
party makes the payment while the other party fails to fulfill the
obligations.
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28. 3. Liquidity Risk:
This type of risk arises out of an inability to execute transactions.
Liquidity risk can be classified into Asset Liquidity Risk and Funding
Liquidity Risk. Asset Liquidity risk arises either due to insufficient
buyers or insufficient sellers against sell orders and buys orders
respectively.
4. Operational Risk:
This type of risk arises out of operational failures such as
mismanagement or technical failures. Operational risk can be
classified into Fraud Risk and Model Risk. Fraud risk arises due to
the lack of controls and Model risk arises due to incorrect model
application.
5. Legal Risk:
This type of financial risk arises out of legal constraints such as
lawsuits. Whenever a company needs to face financial losses out
of legal proceedings, it is a legal risk.
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29. MEANING OF RISK MANAGEMENT
The term ‘risk management’ refers to the systematic application of
principles, approach, and processes to the tasks of identifying and
assessing risks, and then planning and implementing risk responses.
This provides a disciplined environment for proactive decision-
making.
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30. DEFINITION OF RISK MANAGEMENT
According to Jorion “Risk management is the process by
which various risk exposures are identified, measured and
controlled. Our understanding of risk has been much
improved by the development of derivatives markets”.
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31. RISK MANAGEMENT
To the layman, risk means exposure to danger. The process of managing risk
is called Risk Management It is defined as the identification analysis and
economic control of risks that threaten the assets or earning capacity of an
enterprise The importance of Risk Management has been recognized, and
organizations now employ risk managers to specifically manage the risk.
The Risk Management process involves the following important step:
 Identify all potential and significant risks
 Evaluate the cause frequency and severity of losses
 Develop and select methods to manage the risk
 Implement the method chosen
 Monitor performance on an on-going basis
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32. Risk Management Process
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33. Risk Management process
1. Risk Identification
2. Risk Evaluation
3. Risk Control
4. Risk Avoidance
5. Risk Reduction
6. Risk Retention
7. Risk Transfer
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34. 34
Risk Management Process Key Elements

35. 35
Risk Management Process Key Elements

36. Principles of Risk Management
 Organisational context
 Involvement of stakeholders
 Organisational objectives
 Reporting
 Roles and responsibilities
 Support structure
 Early warning indicators
 Review cycle
 Supportive culture
 Continual improvement
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37. Role of Risk Management
 Identify all exposures to various types of risk, such as physical,
commercial, business operations, financial and political.
 Find out the causes for different types of risks, severity and
measures to be taken.
 Discover ways of preventing or eliminating any type of risks and
if feasible, take appropriate steps.
 Evaluate residual risks and decide the means to finance them.
 Monitor the results of the whole risk management programme
and regularly review the same so as to change the situation.
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38. ADVANTAGES OR BENEFITS OF RISK
MANAGEMENT PROCESS
a) Benefits of risk identification
b) Benefits of risk assessment
c) Treatment of risks
d) Minimization of risks
e) Awareness about the risks
f) Successful business strategies
g) Saving cost and time
h) New opportunities
i) Protecting resources
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39. Disadvantages/ Limitations of Risk Management
Process
a) Complex calculations
b) Unmanaged losses
c) Ambiguity
d) Depends on external entities
e) Mitigation
f) Difficulty in implementing
g) Performance
h) Potential threats
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40. COST OF RISK
Cost of risk is the cost of managing risk and
incurring losses due to risk. It is a metric that can be calculated
for a financial period or forecast for a future period.
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41. Elements of cost of risk
Administration Costs
The costs of managing risk such as the budget of a risk
management team.
Mitigation Costs
The costs of reducing risk. For example, a firm that buys
specialized hardware and software to reduce information
security risks.
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42. Risk Control Costs
The cost of operational processes designed to reduce
risk such as credit checks that are run on customers
Transfer Costs
The cost of transferring risk using techniques such
as insurance or financial instruments
Losses
Losses that occur because of a risk. For example, losses
that occur when a customer fails to pay for delivered
services is considered a loss due to credit risk.
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43. Total Cost of Risk – Definition
 Total Cost of Risk or (TCOR) is the only accepted
measurement of an organization’s entire cost structure as it
relates to risk. Total cost of risk is the sum of all aspects of an
organization's operations that relate to risk, including retained
(uninsured) losses and related loss adjustment expenses, risk
control costs, transfer costs, and administrative costs
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44. Components of Total Cost of Risk
Total Cost of Risk is the sum of 4 major components that
are individually measured and quantified. Risk Financing Costs,
Loss Costs (Direct and Indirect), Administration Costs and
Taxes & Fees.
 Risk Financing Costs
 Loss Costs
Direct Cost of Losses
Indirect Loss Costs
 Administration Costs
 Taxes and Fees
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45.  Calculation of TCOR – The Formula
 The Total Cost of Risk Formula is as follows:
Risk Financing
+ Loss Costs (Direct and Indirect)
+ Administrative Costs*
+ Taxes and Fees
= Total Cost of Risk
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46. Uses of Total Cost of Risk
Risk Management Professionals
C-Suite Executives
Brokerage and Risk Services Providers
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47. THE END
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