chapter 6:

Risk and insurance of Business

enterprises
What is risk?
 Risk is the possibility of loss
 Risk is uncertainty
 Risk is the dispersion of actual from expected result
 Risk is the probability of any outcome different from the one expected

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 Discuss
• What is risk
• type of risk
• Risk stakeholders
• risk management process
• How to measure risk

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 CLASSIFYING RISK BY TYPE OF ASSET
Risk may be grouped according to the type of asset-Physical or
human-needing protection.

1.Property risks
 Property-oriented risks involve tangible and highly visible assets. Many
property-oriented risks are insurable; they include:
 Fire , Natural disasters, Burglary, Business swindles (or fraudulent
transactions) and, Shoplifting.

2.Personnel risks
 Personnel-oriented losses occur through the actions of employees. The
three primary types of Personnel-oriented risks are:
 Employee dishonesty, Competition from former employees, Loss of key
executives

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3.Customer risks
 Customers are the source of profit for small business, but they are also the
source of an ever-increasing amount of business risk. Much of these risks
are: On-premises injuries and Product liability

 On-premises injuries:
 Customers may initiate legal claims as a result of on-premises injuries.
e.g. When a customer breaks an arm by slipping on icy steps while entering or
leaving a store;
 Inadequate security, which may result in robbery, assault, or other violent
crimes; Customers who are victims often look to the business to recover
their losses.

 Product liability:
 A product liability suit may be sensed when a customer becomes ill or
sustains physical or property damage from using a product made or sold by
a firm.
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 How we are going to manage risks?

Types of risks based on source

i) Internal risks
ii) External risks

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 1. Internal risks

Human Risks
• Death
• Owner
• Employee
• Illness
• Short term
• Long term
• Indefinite

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 Human Risks
• Theft and fraud
• Product and inventory theft
• Time sheet fraud
• Accounting and cash fraud
• Low morale, dissatisfaction
• Failure to perform
• Sabotage of systems,
equipment or customers

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 Equipment and Information Technology
Risks
• Equipment breakdowns
• New equipment integration
• Worn older equipment
• Damage to vehicles

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 Equipment and Information
Technology Risks
• Information technology downtime
• Lack of backup or recovery system
• Updates and repairs
• Power and connectivity (physical damage and
outdated systems)
• Lack of administrative controls

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 Other Internal Risks
• Physical plant repairs
• Breaks in lines or utilities
• Routine maintenance
• Incidents
• Work related injuries
• Damage to others’
property by employees
• Damage to your property
by others

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 Other Internal Risks
• Cash flow changes
• Unexpected costs
• Loss of credit lines
• Expenses to establish lines of credit

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 ii) External risks
Competition and Market Risks
• Loss of clients or customers
• Loss of employees
• Decrease in sales prices/fluctuating markets
• Increases in vendor costs
• Oil or gasoline price increases
• Fixed cost changes (e.g., rent)

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 …
Business Environment Risks
• Laws
• Weather
• Natural Disaster
• Community

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 Personal Conflict Risks

• Family obligations, illnesses or deaths

• Events of disaster that affect the home
• Community involvement
• Complacency

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 RISK MANAGEMENT
 The complexity of the business environment calls for or demand for
a special attention to a risk:
 Some of the factors, which increase the complexity of environment,
are:
 Inflation
 Growth of internal operation
 More complex technology
 Increasing government regulation

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What is risk management? Many definitions…
 Risk management is a systematic way of protecting business
resources and income against losses so that the organization’s aims
are reached without interruption, creating stability and
contributing to profit.
OR
 Risk management is the identification, measurement and treatment
of liability, property and personal pure risks that the business
organization is facing in order to reduce and prevent the
unfavorable effects of risk at minimum cost.
OR
 It is the science that deals with the techniques of forecasting future
losses so as to plan, organize, direct and control the adverse effect
of risk. i.e., Risk management is defined on the base of managerial
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functions.
 Risk management and Insurance management

 What is the difference in b/n?

 Risk management is broader than insurance management in that it
deals with both insurable and uninsurable risks. Insurance
management for most part it is restricted to the area of those risks
that are considered to be insurable.
 Naturally only pure risks are insurable . Speculative or market risks
are not. Even all pure risks are not insurable

 The emphasis in the risk management concept is on reducing the

cost of safeguarding against risk by whatever means.

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 The process of Business risk management
1. Risk identification
techniques for identifying risk are:
Brainstorming
Event inventories and loss event data
 Interviews and self-assessment
Facilitated workshops
SWOT analysis
Risk questionnaires and risk surveys
Scenario analysis
Using technology
Other techniques
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 Risk Identification
• Written business plan
• Outside sources to assist in
identifying risks
• Risks of your vendors or supplier
• Business continuity assessment

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 Warning Signs
• Excessive debt in relation to owners equity
(total liabilities / owner’s equity)
• Reliance on a small number of customers
• Reliance on one product
• Reliance on one or a small number of vendors

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 Warning Signs
• Cash flow problems
• Irregularities in accounting, bank or timecard
records
• Irregularities in computer system
administrative reports
• High employee turnover rate

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 2 risk measurement
To estimate the frequency and size of loss, i.e., to
estimate the probability of loss from various
sources. It is also called as risk measurement.
Risk measurement means
i. Determination of the chance of an occurrence or
relative frequency.
ii.Determination of the impact of losses upon financial
affairs.
iii.The ability to predict the losses that will actually
occur during the budget year.

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3.To decide the best and most economical method
of handling the risk if loss. (risk response
development)
4. Implementing the decision (risk response
control)
5.Revaluating the decision

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 Means of Risk Management
1. Avoidance
One way to handle a particular pure risk is to avoid the property, person
or activity with which the risk is associated.
 Two approaches of risk avoidance:

i. Refusing to assume an activity

e.g. For instance, a firm can avoid a flood loss by not building a plant in a
place where flood is frequently affecting. In case of refusing, we are
discontinuing the activity

ii. Abandonment of previously assumed activities:

e.g. A firm that produces a highly toxic product may stop manufacturing
that product.

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 2. Retention/Acceptance
 Bearing all the risk by that person/organization.

Types of retention

i. Planned/conscious/ active risk retention

 It is characterized by the recognition that the risk exists, and tacit
agreement to assume the losses involved.
 The decision to retain a risk actively is made because there are no
alternatives more attractive.
 Self-insurance is a special case of active retention. Self-insurance
is not insurance, because there is no transfer of the risk to an
outsider.
o E.g. A firm may keep some money to retain the risk.

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 ii. Unplanned/Unconscious/ Passive Retention
 Passive risk retention takes place when the individual exposed to
the risk does not recognize its existence.

 In this case, the person so exposed retains the financial

consequence of the possible loss without realizing that he does so.

3. Loss Prevention and Reduction Measures

 Prevention is defined as a measure taken before the
misfortune occurs.
 Generally speaking, loss prevention programs intend to
reduce the chance of occurrence.
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

Example:
 Constructing a building with a fire resistance material /
fireproofing.
 Constructing a building in a place where there is little danger.
 Regularly inspecting the machine / area
 The existence of automatic loss detection programs.
• Fire alarms
• Warning posters /NO SMOKING!! , DANGER ZONE!!/

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  Loss reduction measures and try to minimize the severity of
the loss once the peril happened/ after the event occurs.

For Example:
• Automatic sprinkler
• An immediate first aid
• Medical care and rehabilitation service
• Guards
• Cover
• Fire extinguisher
• Fire alarms

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 Information Technology Systems
• Do not share login information
• Protect systems with firewalls
• Institute levels of access
• Perform other reports
• Sample transactions or use
trial transactions
• Conduct scheduled and surprise audits

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 …
Special risks are connected to information technology (IT)
systems. Review the following risk prevention tips for IT systems:

• Safeguard login information such as personal user names and

passwords. Personal login information should not be shared
with anyone outside the business, or any other employee. Most
businesses require employees to sign an IT statement that
outlines the repercussions for sharing passwords.

• Protect systems with firewalls to stop intrusions. Use software

to scan for viruses or other irregularities. These protections
may require additional setup time and annual renewal fees.
However, consider the cost a hacker or virus could cause by
shutting down your system. In most cases, the benefit of
protection will probably outweigh the cost.
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 …
• Institute levels of access within your organization by job duty. Someone who
ships out inventory or accepts returns, for example, should have different
access than those in accounting where credit is issued. Manager override
authority should be reviewed periodically by using system-generated reports.
Monitoring reports for out-of-the-ordinary transactions gives an added layer
of security.

• Generate system reports, which might include reports on system access,

attempted security breaches, and patterns of usage. Audits of these reports, as
well as reviews of changes made by system administrators should be
conducted regularly.

• Sample transactions or use trial transactions to uncover changes in

processing or fraudulent transactions.

• Conduct scheduled and surprise audits of IT systems.

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4. Separation /Diversification

 Separation of the firm’s exposures to loss instead of

concentrating them at one location where they might all be
involved in the same loss.
 Separation==>Dispersion/Scattering the exposure in
different places.
 “Don’t put all your eggs in one basket”

 Example: Instead of placing its entire inventory in one

warehouse, the firm may elect to separate this exposure by
placing equal parts of the inventory in ten widely separated
warehouses.

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 

5. Transfer
 It is also called as shifting method.
 When a business organization cannot afford to cover the loss by itself,
it may look for/transfer institutions.
 Insurance is a means of shifting or transferring risk.

 The following matrix can determine which risk management be

used.

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 Exit Strategy
• Include exit strategy in business plan
• Revisit it periodically
• Insurance payment and liquidation of assets
• Liquidation of assets without insurance
• Trustee to handle
• Family member
• Employees

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 • End of chapter 6

• Thank you !!

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