A risk management program
[00:02.46]The scientific method of planning to deal with losses is called risk management.
[00:08.12]A risk management program usually involves three steps:
[00:12.77]1.Identifying and measuring exposures to loss
[00:17.66]2.Developing and implementing plans to deal with potential losses after they have been identified
[00:25.50]3.Regularly reevaluating and updating the risk management program
[00:31.66]Identifying and measuring exposures
[00:34.87]The recognition that a problem exists is always the first step in solving the problem.
[00:41.01]Recognizing one's exposure to loss requires organized thinking about the subject.
[00:47.15]One starting point is to categorize the sources of loss into speculative or pure risk exposures.
[00:55.28]Speculative risks are exposures that can result in gains or losses and usually are not the subject of risk management.
[01:04.65]Losses or gains that result from bad or good management decisions,from a competitor's actions,
[01:11.60]or from government intervention in the economy are examples of speculative risks,
[01:17.64]and these are usually outside the scope of the risk manager's responsibility.
[01:22.76]Price fluctuation in commodities or foreign currencies,however,can result in gain or loss,
[01:30.44]and this speculative risk can be managed with a hedging program.
[01:35.63]On the other hand,pure risks can result only in losses and usually arise from the following sources:
[01:43.89]1.Direct losses of property
[01:47.15]2.Indirect losses of income because normal business activity has been interrupted by a direct loss
[01:54.89]3.Liability losses
[01:57.86]4.Losses due to death or disability of key personnel
[02:03.53]These pure risks usually can be managed once they have been identified and measured.
[02:09.31]Regarding measurement,it is well to remember that,before a loss occurs,measurement is merely an estimate.
[02:17.30]Not all preloss estimates will necessarily reflect with accuracy the actual amount of damages or even the actual amount of exposure to loss.
[02:27.25]Developing and implementing a risk management program
[02:32.01]After all potential sources of loss have been identified and measured,
[02:36.24]it is the job of the risk manager to develop and implement plans to deal with the potential losses before they occur.
[02:43.94]Accomplishing this task demands a knowledge of the alternative methods of dealing with risk,the uncertainty about loss.
[02:51.91]In addition to insurance,six other methods of dealing with potential losses are:
[02:57.82]1.Risk avoidance
[03:00.40]2.Risk assumption
[03:03.04]3.Self-insurance
[03:05.86]4.Loss prevention
[03:08.68]5.Loss reduction
[03:11.37]6.Risk transfer other than insurance
[03:15.06]A thorough risk management program is the result of the consideration of all these alternatives,
[03:21.35]rather than the reliance on just one method of dealing with an exposure to loss.
[03:26.63]In every case the risk manager with carefully weigh the ratio of the costs of a particular risk management approach withthe potential benefits to be produced.
[03:36.82]Since unlimited budgets for risk management are not the rule,spending priorities must be established.
[03:44.34]Also determining the choice of an appropriate tool are an estimate of the chance of loss and an estimate of the severity of a potential loss.
[03:53.69]Once a decision has been made to treat an exposure to loss with a given risk management tool,the decision must be implemented.
[04:02.73]For example,if it has been decided to purchase insurance,
[04:06.88]arrangements must be made to acquire the proper amount of insurance at the best possible price accompanied by all the service needed or desired.
[04:16.39]Equally important,once the insurance is in force,
[04:20.36]the risk manager must be familiar with the terms of the contract so that none of the firm's actions cause the coverage to be suspended
[04:28.54]or the conditions of the contract to be breached in any way either before or after a loss occurs.
[04:35.17]If a loss prevention program is decided upon,the risk manager must see to it that all affected employees,
[04:43.19]know what the plan's aims are and what part they are expected to play in the program.
[04:48.47]The risk manager must remain alert to any advances in safety engineering that may make a given operation or plant or store a safer place in which to work.
[04:59.96]The insurance mechanism
[05:02.18]One of the chief problems that risk management has had to overcome has been to differentiate itself from insurance,
[05:10.20]partly because of the insurance background of many of the pioneers in risk management thinking,
[05:15.77]and partly because risk-at least those varieties of it with which risk management is chiefly concerned-
[05:22.82]has for so long been considered the preserve of insurance alone.
[05:27.50]The confusion has been perpetuated because insurance retains such an important role as the main method of risk financing in a risk management programme.
[05:37.61]Risk management does not supersede insurance,but puts it in its proper perspective,
[05:43.30]as fulfilling a useful function determined after critical assessment of what it has to offer compared with other financing possibilities.
[05:52.52]To get the best out of any risk management programme,therefore,requires a knowledge of how the insurance mechanism works,
[06:00.52]and an appreciation of ways in which the insurance industry treats the risk passed on to it in return for the premium paid.
[06:09.35]For the purchaser,insurance provides a method of smoothing loss experience over a period of time,
[06:16.22]by exchanging the static risk which is insured for the smaller risk of the failure of the insurer to settle a claim when it is made,
[06:24.68]either through lack of funds or by some breach of the conditions of the insurance contract by the insured himself.
[06:32.25]Except for the small insured,or the catastrophic loss,it is unlikely that the cost of loss will be permanently transferred from the insured to the insurer;
[06:43.20]for the latter will seek to recover what he has paid out by increased premiums in subsequent years,
[06:49.94]or he may already have recovered it in previous years when the premiums paid have been greater than the amount needed to pay claims and meet the insurer's expenses.
[07:00.75]Where the market for a particular type of risk is not governed by rating agreements between insurers,
[07:07.05]it may be possible to defer or avoid repayment of the cost of loss by changing insurers,
[07:14.34]but in most cases this will be only a short-term solution,
[07:18.88]unless there has been some substantial improvement in loss control to improve the probable future cost of loss.
[07:26.67]A new insurer may offer a lower premium,taking the chance that the loss experience will improve,
[07:33.59]but if it does not,then the premium cost is likely to rise to,and perhaps beyond,its old level.
[07:41.19]The service of chronological loss spreading is,however,what the insured really needs,
[07:47.41]even if the total cost is not thereby reduced,for it enables him to reduce the annual cost of large losses to a size at which they can be borne in a single accounting year.
[07:58.98]From the insurer's point of view,the risk that is transferred to him has a different aspect.
[08:05.51]What was a static risk for the insured becomes a dynamic risk for the insurer,
[08:10.97]for in his hands it presents possibilities either of profit or of loss.
[08:16.54]The fact that a reinsurance market exists as a method of treating this risk is,
[08:21.84]however,a reminder that static risk and insurable risk are not synonymous terms.
[08:28.58]The methods the insurer uses to treat the risk he carries are themselves a good example of risk management in action.
[08:36.00]He seeks first of all to diminish his risk by ensuring that it is well spread.
[08:42.21]This is achieved in a number of ways.
[08:44.72]First,a good spread of risk is sought by endeavouring to ensure that the portfolio he is insuring consists of a large number of similar items.
[08:54.47]This will give the greatest play to the operation of the law of large numbers,and thus improve the predictability of the loss experience.
[09:02.90]Next,the insurer will wish these insurances to come from many different locations to provide the necessary geographical spread
[09:12.05]to minimise the chance of an abnormal loss experience due to a localised catastrophe.