Risk and Risk Management

Concept of Risk
 Risk arises out of uncertainty
 Possibility of adverse results flowing from
any occurrence.
 It is possibility of an outcome being
different from the expected.
 For risk to exist there must be at least two
possible outcomes

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 Risk and Risk Management

Concept of Risk
 If loss is certain there is no risk.
 At least one possible out come must be
undesirable.
 Loss in general accepted sense is something
is lost, or a gain smaller than the gain that was
possible.

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 Risk and Risk Management

Definition of Risk
“Risk is a condition where there is a
possibility of an adverse deviation
from a desired outcome that is
expected or hoped for”

There is no requirement that the possibility is

immeasurable, only that it must exist.

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Definition of Risk….Cont’d
 Our purpose is to relate risk to insurance;
 Our focus is on risk, which entails the
possibility of financial loss.
 Financial loss means decline in or
disappearance of value due to a contingency.
 Thus if a loss of value is intended or if it is
certain, it is not a risk within the context of
the definition.

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Definition of Risk -beyond insurance

It focuses on accident-centered risks of loss.

“Risk is the probability of a material

deviation from an anticipated outcome”

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Definition of Risk -beyond insurance

Thus risk has 3 crucial implications:
3. Risk is a probability- a mathematical quantity
that can be measured, calculated or estimated.
4. Risk refers not just to probabilities of losses or
gains, but probabilities of deviation, either
downward losses or upward gain
5. Risk exists only if an objective exists,only if
there is a goal ….a planned future state.
» Source: www.insurancetranslation.com

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Degree of Loss/value of loss

If risk is uncertainty,
greater the uncertainty, greater the risk.

The higher the probability of loss,

greater is the probability of an adverse
deviation from what is hoped for and therefore
greater is the risk.

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Degree of Loss/value of loss

The mathematical value of a risk at any point of

time is the probability of the loss materializing
multiplied by the amount of potential or
anticipated loss.

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 Risk and Risk Management

Risk ,Peril and Hazard

 Risk is uncertainty of loss.
 Peril is a source of loss (fire, windstorm,
embezzlement, etc.)
 Hazard is a condition which increases the
likelihood of loss (e.g., a known embezzler hired
as an accountant).

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Peril and Hazard

Peril : is cause of loss.

collision is a peril that causes the
automobile accident and loss.

Hazard: is condition for loss

foggy weather is the hazard that
creates the peril of collision.
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 Risk and Risk Management

Types of Hazard

3. Physical Hazard

5. Moral Hazard

7. Morale Hazard

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Types of Hazard …Cont’d

Physical Hazard:
Physical conditions which
that increase that increasse the likelihood of a
peril occurring.

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Types of Hazard ….Cont’d

Moral Hazard :
Human behaviour that increase
the exposure of individuals to potential perils is
moral hazard depending on the intentions of the
person.
Increase in the probability of
loss that result from dishonesty in the character
of the insured person.

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Types of Hazard ….Cont’d

Morale Hazard :
Attitude towards losses that it
will be paid by insurance, than borne by the
individual.
Morale hazard reflects the
careless attitude towards the occurrence of loss.

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Spreading of Risk
There are various methods to achieve spreading or
“averaging” of risks.
An insurer would achieve spread of risk by:
4. Writing different classes of insurance business.

6. Writing business in different geographical

locations.
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Spreading of Risk…cont’d

3. Have larger capital resources and write larger

volumes of business to have larger spread.

5. by Reinsurance

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 Risk and Risk Management

Spreading of Risk…cont’d

5. By entering into risk pools for certain risks.

6. By spreading risk over a longer period of time.

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 Risk and Risk Management
Static Risk Dynamic Risk
Losses without change in the Losses due to change in
economy economy

Affects small number of Affects large number of

individuals indivuduals
Is predictable Less predictable than static risk

Occurs with a degree of Do not occur with a precise

regularity degree of regularity

Eg: Perils of nature,Dishonesty Eg: Change in price

level,consumer taste
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 Risk and Risk Management
Fundamental Risk Particular Risk

Losses that are impersonal in Losses arising out of individual

origin and consequences events

Affect large segment or overall Affects individuals rather than

population groups

Caused by conditions beyond the Caused directly by acts of

control of individuals individuals

Society has the responsibility to Private insurance is the

deal with the losses by mechanism convenient mechanism to deal
of social insurance with this risk
Eg: Unemployment, War, Eg: Burning of Houses, bank
Inflation, Earthquake robbery
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Pure and Speculative Risk

Pure risk has the possibility of loss
only; thus, it is insurable.
Speculative risk affords the
opportunity for gain as well as the possibility of
loss. Eg: gambling and stock market investments
This type of risk is not insurable.

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Insurable Risk
A risk that meets the following criteria:
1. The insured loss must have a
definite time and place;
2. The insured event must be
accidental;
3. The insured must have an insurable
interest in the subject of coverage;

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Insurable Risk…Cont’d
4. The insured risks must belong
to a sufficiently large group of homogeneous
exposure units to make losses predictable;
5. The risk must not be subject
to a catastrophic loss where a large number of
exposure units can be damaged or destroyed in
a single event;

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 Risk and Risk Management

Insurable Risk…Cont’d
6. The coverage must be provided at a
reasonable cost;

7. The chance of loss must be

calculable.

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Uninsurable Risk
A risk where there is no insurable
interest;
A risk where the potential for loss is so
great it does not meet the definition of
insurance;
A risk where insurance is prohibited by
public policy or is illegal.
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Methods for treating risk

There are established and tested techniques by
which risks may be controlled.
1) AVOIDING RISK - A risk may be avoided by
not accepting or entering into the event which has
hazards. Such a choice is not always possible, or
if possible, it may require giving up some
important advantages. Nevertheless, in some
situations risk avoidance is both possible and
desirable.
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Methods for treating risk….Cont’d

2) SPREADING RISK ­ It is possible to spread the 
risk of loss to property and persons. Duplication of 
records and documents and, then, storing the 
duplicate copies elsewhere is an example of 
spreading the risk. A small fire in a single room can 
destroy the entire records of a department's 

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Methods for treating risk…cont’d

3) LOSS PREVENTION OR REDUCTION OF RISK 
­ "An ounce of prevention is worth a pound of cure," 
according to an old saying. Today, this statement 
provides the guide for the control of risk. Risk may 
be reduced, eliminated, or certainly controlled by 
using a well­planned loss prevention program.
 

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Methods for treating risk …Cont’d

4) RETENTION, ASSUMPTION OR ACCEPTANCE 
OF RISK ­ Constant vigilance is needed to avoid 
accepting risks unintentionally through unawareness 
of the exposure. Some risks have to be retained 
because insurance cannot be purchased or the cost 
of insurance is not economically sound. Therefore, 
some risks should be retained, assumed, or 
accepted. Examples of these types of risks would 
be: earthquake, war, flood, accidental breakage, 
wear and tear etc.
 
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Methods for treating risk…cont’d

5) TRANSFER OF RISK TO INSURANCE 
CARRIERS OR OTHERS ­ Risk may be transferred 
contractually to others. For example, when leasing 
facilities from others, the lease could require the 
lessor to assume all property and liability losses.

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 Risk and Risk Management

Management of Risk
The term risk management applies to a number of
diverse disciplines.
To bankers and financial officers it is sophisticated use
of techniques of currency hedging and interests swaps.
To insurance buyer and seller it is coordination of
insurable risk and the reduction of insurance cost.
To safety professionals it means reducing accidents and
injuries.

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 Risk and Risk Management

Definition of Risk Management

The process of defining and analyzing risk,

and then deciding on the appropriate
course of action in order to minimize risk,
whilst still achieving business goals

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Definition of Risk Management

The optimal allocation of resources to arrive

at cost affective investment in defensive
measures within an organization .It
minimizes both cost and risk

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Definition of Risk Management

A variety of activities undertaken by an

organization to control and minimize
threats to the continuing efficiency,
profitability, and success of its operations.

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Definition of Risk Management

The process of determining the maximum
acceptable level of overall risk to and from a
proposed activity, then using risk assessment
techniques to determine the initial level of risk ,
if this is excessive, developing a strategy to
ameliorate appropriate individual risks until the
overall level of risk is reduced to an acceptable
level.

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Process of Risk Management

 Identification and analysis of risks to which the
organization is exposed,
 The assessment of potential impacts on the business,
 Deciding what action can be taken to eliminate or reduce
risk and deal with the impact of unpredictable events
causing loss or damage.
 Includes taking out insurance against financial loss or
legal liability and
 Introducing safety or security measures.

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Risk Management v/s Insurance Mgt

Risk management deals with insurable and uninsurable
risks and the choice of the appropriate techniques for
dealing with them.
Most people equate risk management with insurance.
Insurance is one aspect of risk management, but certainly
not the only one.
Some equate risk management with disaster recovery.
Insurance and disaster recovery are necessary parts of
risk management

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Development of Risk Management

In the 1970 and 80's risk management started
to gain momentum .
It derives its origins from the insurance
industry.
Its early focus was on protecting against
catastrophe and evolved to protecting
unaffordable potential losses.
Insurers found results were enhanced by
encouraging customers to exercise reasonable
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 Risk and Risk Management

Development of Risk Management

Risk management evolved from natural intuition
and analytical thinking into a more formal
process of controls in place to influence
outcomes.

Risk management has become a universal

management process involving quality of
thought, quality of process and quality of
action.
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 Risk and Risk Management

Development of Risk Management

The main function of risk management was
insurance buying,it is still widely used
But, organizations have reduced their reliance
on the conventional techniques
They have realized insurance did not meet all
organizational needs
And internal activities could control the impact
of risk and uncertainty of the organization.
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 Risk and Risk Management

Development of Risk Management

Technical and financial aspects of risk

management are integrated under one
function.
Most large medium organizations adopt risk
management techniques because of their
benefits and legislation compliance

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 Risk and Risk Management

Decisions of dealing with risk

To retain the risk

To deal with the risk through loss prevention

To transfer the risk through insurance

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Decision to retain risk

Could be with or without a reserve or fund.

Events of high frequency and low severity fall
in this category.
Cost could be paid out of current income and
cost is less than the insurance premium.

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Decision to deal through loss

prevention

To take preventative steps to eliminate loss as

far as possible.
To anticipate risk and take steps to ensure that
incidence of risk is minimum.
If risk happens take steps to minimise the
effect of loss.
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Decisions to transfer risk

This is to transfer financial effects of risk to

other party.

Insurance is a risk transfer mechanism.

This exchanges uncertainty with certainty.

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Buying Insurance

One of the techniques for dealing with pure

risk.

Mistake of buying too little or too much.

Rely on the entire decision making process on

insurance agent or brokers.
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Alternative to buying insurance

Captive insurance company.

Risk retention group.
Risk sharing pools
Self insurance.

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 Risk and Risk Management

Thank you!

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