CHAPTER 2

RISK
MANAGEMENT
LEARNING OBJECTIVES
Upon completion of the chapter, you should be able to:
➢ Define some common terminology
➢ Explain the importance of risk management to individuals and organization
➢ Define the risk management from Islamic perspective
➢ Describe the objectives of risk management
➢ Explain the risk management process
➢ Identify the best risk management techniques to be used for different category of risk
 Overview
❖ Definition & Evolution of Risk Management
❖ Risk Management from Islamic Perspectives
❖ Objectives of Risk Management
❖ Risk Management Process
 DEFINITION AND EVOLUTION OF
RISK MANAGEMENT
Risk management is now considered crucial for survival of the organization

Climate changes, political uncertainties, economic forces are among

external factors of emerging needs of risk management in an
organization.

As a systematic approach to identifying, measuring and controlling risks

that can threaten assets and earnings of oneself, a business or the
organization.

The purpose of risk management is to enable an organization to

progress toward its goal and objectives (mission) in the most direct,
efficient, and effective path
RISK MANAGEMENT IN ISLAMIC
PERSPECTIVE
Every human being who is the caliph
(vicegerent) of Allah SWT must accept all His
divine stipulations and give way to His qada’and
qadar (actions and reactions). In fact, efforts and
prayers should precede this kind of belief.
Muslims are asked to work hard in order to be
able to change their conditions as God says:
"… Verily never will God change the condition of

a people until they change it themselves (with their

own souls)…" (Qur'an 13:11).
 RISK MANAGEMENT IN ISLAMIC
PERSPECTIVE

Risk management in Islamic

The ummah should anticipate the perspective should be aimed to
risks that will hinder the ultimate reduce the utilization of resources
goal of them which is to attain (financial and non-financial) and The goals must be aligned with the
success in the world and to minimize the negative effects Shariah
hereafter. of risks or maximize the
opportunities and goals.
OBJECTIVES OF RISK MANAGEMENT

Objectives of
Risk
Management

Pre loss Post loss

objectives occurs
Pre Loss Objectives
Reduce impact
of loss

Reduce fear
and worry

Required by
law
Post Loss Objectives

Survival of organization – organization still able to continue operations

Stability of earnings – business operations do not have to stop and the

organizations can concentrate on their business activities as usual.

Reduce impact of losses to organization and society – when a loss occurs not only
will the organization suffer but the loss has to be burdened by society as well.
Employees may have to be retrenched and some departments may have to be
closed down.
 Identifying
existing and
potential risks

Evaluating,
reviewing and Evaluating
controlling the potential risks
program

Selecting and Examining

Implementing alternative risk
risk management management
program techniques

RISK MANAGEMENT PROCESS

1. IDENTIFYING EXISTING AND
POTENTIAL LOSSES

Risk identification is the

process by which an
organization is able to learn Identification techniques are
of the areas in which it is designed to develop information
exposed to risk. on sources of risk, hazards, risk
factors, perils and exposures to
loss.
 Risk Identification Tools

Risk Analysis Exposure Insurance

Orientation Questionnaires checklists Policy checklist Flowchart

Financial Combination
Statements Inspections Interviews approach
2. EVALUATING POTENTIAL LOSSES

Risk measurement evaluates the likelihood of loss and the value of loss in terms of
frequency and severity.

This step involves two important aspects of loss exposures

Frequency
Severity
 How can you determine and estimate the
impact of losses

Frequency Severity
Referring to Referring to
the number of the maximum
times the loss size of loss
occurs exposures
 Identifying and determining the
loss exposures alone is not
sufficient

Estimating the frequency and

severity for each type of loss
exposure and ranked it according to
their relative importance. High loss
exposure will be given priority.

Estimating relative frequency and

severity of each loss exposure as
the selection of appropriate
technique will depend on this.
 3. EXAMINING ALTERNATIVE RISK MANAGEMENT
TECHNIQUES
❖ Two main ways to classify the risk management techniques

1.Risk Control
▪Risk avoidance 2. Risk Financing
▪Loss control ▪Retention/Assumption
•Loss prevention
▪Captive insurer
•Loss reduction
▪Separation ▪Insurance
▪Contractual Transfer
 Risk Control

Methods seek to alter an organization’s

exposure to risk.

Risk control efforts help organization avoid a

risk, prevent loss, lessen the amount of
damage if a loss occurs or reduce undesirable
effects of risk on an organization.
 RISK CONTROL

Risk Loss Separation

Avoidance Control

Contractual
Transfer
Risk Avoidance
Risk is proactively avoided or abandoned after
rational consideration.

If someone is afraid of risks, the best way to

deal with it is to avoid it completely.

Example; a manufacturer may stop

production of a defective products to avoid a
lawsuit.

However, some risks are unavoidable

although risk avoidance may be chosen as an
option in handling certain risks, the exposures
of losses cannot be eliminated entirely.
 Loss Control

Loss control is designed to reduce

both the frequency and severity of
losses by changing the characteristics
of the exposure so that it is more
acceptable to the firm. Divided into:
Loss prevention
Loss reduction
 Loss Control
❖ Loss Prevention ❖ Loss Reduction
• Seek to reduce the number of losses • Designed to reduce or lower the severity
(frequency) of losses of losses, should it occur.
• Is used when the benefits outweigh the • Since some risks are unavoidable, the
costs involved. other alternative is to reduce its impact.
• Either imposed by law or imposed by • Can be used in two circumstances:
companies and factories to fence before a loss, e.g. installation of fire
dangerous machinery to reduce the alarm or after a loss e.g. salvage efforts
chances of employees being injured. in the restoration of a building burnt
down by fire.
 Separation

Involves the dispersal of the firm’s assets in several

locations instead of confining it to one major area.

This measure will reduce the impact of losses

should a major disaster occurs.

Example, separation of head quarters and

assembly plant in automobile industry.
 Contractual Transfer

Risk transfer mechanism. Refers to the various methods

other than insurance by which
a pure risk and its potential
financial consequences can be
transferred to other party.
 Leasing contracts Hedging
An agreement to buy or sell a
An agreement where the commodity at a certain price
owner or landlord transfers to avoid losses due to price
the risks to the tenants increase or decrease.

Hold-harmless
agreements
Incorporation
An agreement between a
The owner of the company retailer and a manufacturer
transfers the risks to whereby the later agrees to
corporation by registering the bear losses due to the
company. manufacturer of defective
Contractual products thus relieving the
retailer of any liability.
Transfer
 Risk Financing

Self insurance and

Retention captive insurer Insurance
 Retention
Retention – the company will bear the consequences of
the loss

Risk or loss exposed are normally assumed or retained

when their impact and consequences are not too great
or in cases when or other methods seem feasible.

In an organization, the ability to assume a risk depends

on one’s financial ability.
 Self insurance & Captive Insurer
Self insurance implies that the organization sets up a pool
of fund to retain its loss exposures.

Adequate financial agreement has to be made in

advance of the occurrence of losses.

The number of loss exposures must be large enough to

ensure the mechanism of insurance to be operative.
 Self insurance & Captive Insurer

A captive insurance company is an entity to write

insurance arrangement for its parent company.

The captive’s parent may be one company,

several companies or an entire industry.

Example; Sime Darby Group is the parent

company of Sime AXAAssurance Sdn Bhd
 Insurance
Risk financing method of Transferring the risks to
transferring the financial another party involves a In an insurance contract, the
consequences of potential contractual agreement whereby party exposed to the risks (the
accidental losses from an the other party assumes the proposer/insured) pays the
insured firm or family to an risks and is liable for the loss in premium to the insurance
insurer the event of loss. company.

In return, the insurance

company agrees to pay a stated
sum on the happening of
certain risks specified in the
contract.
4. SELECTION AND IMPLEMENTATION
OF THE RISK MANAGEMENT PROCESS

Non-
Financial
financial Whether it affects the
criteria Whether it will affect criteria growth of the
the organization's organization,
profitability or rate of humanitarian aspects
return. and legal
requirements.
Type of risk High Frequency Low Frequency
Risk Matrix Table
High Severity Risk avoidance and Risk transfer
reduction (e.g.Insurance etc)

Low Severity Risk retention & Risk retention

reduction
5. EVALUATION, REVIEW AND
CONTROL
The risk management program must be
monitored and controlled systematically.
It must be periodically reviewed

The techniques that were appropriate last

year many not be the most advisable this
year, and constant attention is required
Evaluation and review of the risk
management program permits the
manager to review decisions and
discover mistakes, it is hoped, before
they become costly.
RISK ASSESSMENT
 LEARNING OBJECTIVES

UPON COMPLETION OF THE CHAPTER, YOU SHOULD BE ABLE TO:

⮚DESCRIBE THE RANGE OF RISK IDENTIFICATION TECHNIQUES THAT ARE AVAILABLE TO INDUSTRY.

⮚EXPLAIN THE ADVANTAGES AND DISADVANTAGES OF EACH OF THE RISK IDENTIFICATION TECHNIQUES.

⮚OUTLINE THE HUMAN ASSESSMENT OF RISK, SOURCES OF RISK AND THE CONCEPT OF ACTUAL AND
PERCEIVED RISK.

⮚DISCUSS THE RISK DATA AND SOURCES OF RISK DATA.

Part Part
1 2 RISK MEASUREMENT

-Risk identification
Risk Assessment techniques
#Actual vs perceived
#Source of risk
#Risk exposure
#Human risk assessment -Risk data
The Outline Actual vs
•Familiarity
•Control
perceived •Personal/societal effect
•Frequency & severity

•Physical environment
•Social environment
•Political environment
Source of •Legal environment
risk
•Operating environment
•Economic environment
•Cognitive environment

•Physical asset exposure

Risk •Financial asset exposure
exposures •Liability exposure
•Human asset exposure

Human
assessment • Personal
• Medical
• Political
• Business
Actual &
Perceived Risk
 Risk Perception Factors

Familiarity
Control
Level
The level of control
the individual has
to prevent or
Risk awareness of mitigate the risk
uncertain events

e.g: Drive car: easy

e.g: awareness on and experience
COVID-19
However, if you
need to control
airplane?
Risk Perception Factors

Personal/ Frequency
Societal and
Effect Severity

The public’s Discrimination

perception of the
risk
between
probability of an
Personal attitude in event an the
correspondence severity
towards certain risk

e.g: COVID-19, HIV e.g: nuclear

Sources of Risk
Sources of Risk
Physical Environment
Social
Political
Legal
Operational
Economic
Cognitive
 • Fundamental sources like earthquake, tsunami and etc
Physical
environment
• Comprises all the different factors of nature

• Living and working conditions, income. Educational and

Social
environment
the communities

• National and international political factors

Political
environment
• Methods of thinking and belief

Legal
• Standard conduct and punishment enforced
environment
 • Circumstances surrounding of the process
Operational • Electronic and mechanical process
environment

• System, policies and nature of an economy

Economic • Dynamic and complex in nature
environment

• Risk manager’s ability to understand, see, measure

and assess a risk
Cognitive
environment • Depend on the judgment of the risk manager
CATEGORIES OF RISK EXPOSURES

PHYSICAL FINANCIAL
ASSET Ownership of ASSET
EXPOSURES EXPOSURES Ownership of
property gives rise
securities such as
to possible gains or
common stocks,
losses to physical
bonds and
assets and to
mortgages.
intangible assets.

Property may be
damaged,
Loss or gain to
destroyed, lost or
financial asset.
may diminish in
value.
 HUMAN
LIABILITY
ASSET
EXPOSURES
EXPOSURES
Obligations
Human resources
imposed by the
of organization.
legal system.

Possible injury or
Civil and criminal death of
law impose an managers,
obligations to employees and
citizen. other significant
stakeholders.
HUMAN ASSESSMENT OF RISK
• PERSONAL
Eg: choosing career, selecting a course of study to follow
• MEDICAL
Eg: the decision to operate or not, to prescribe one drug as opposed to another
• POLITICAL
Changes in politic
• BUSINESS
Eg: investment
-The End -