Chapter 5

Chapter 6:
Risk Management
and Insurance

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 Different Definitions of Risk
 Risk is a condition in which there is a possibility of an adverse
deviation from a desired outcome that is expected or hoped for.
 Risk is the chance of something happening that will impact upon
objectives.
 the objectives of a small business might be: to provide the
best quality service; to maximize revenue and
decrease expenses; to have quality employees; to
increase productivity and product quality; and to
increase market share etc.
 Risk generally results from uncertainty (All risks are uncertain, but not
all uncertainties are risks).
 In organizations this risk can come from uncertainty in the
market place (demand, supply and Stock market), failure of
projects, accidents, natural disasters etc. 2
 Classification of Business Risks
 Speculative/Market risk is the uncertainty associated with an
investment decision. It describes a situation in which there is a possibility
of loss, but also a possibility of gain.

 Pure risk is a situation that involve only the chance of loss or no loss—
there is no potential gain.

 The distinction between pure and speculative risks is that normally only
pure risks are insurable.

 which is the losses arising out of speculative risks.

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 Classification of Pure Risks
1. Personal risks consist of the possibility of loss of income or assets as a
result of the loss of the ability to earn income. The loss of the ability
might be due to;
a) Premature death
b) Dependent old age
c) Insufficient income during retirement
d) Sickness or disability
e) Involuntary unemployment
2. Property risks involve the possibility of losses associated with the
destruction e.g. fire, theft of property, Property risks embrace two
distinct types of loss: direct loss and indirect or “consequential”
loss.
 Direct loss is a loss in which physical damage to property losses or reduces
its value to the property owner.
 Indirect loss a loss arising from inability to carry on normal operations due
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to a direct loss to property
 Classification of Pure Risks…

3. Customer risks
Customers are the source of profit for business, but they are also the
source of an ever-increasing amount of business risk.
Much of these risks are:
On-premises injuries : For example: When a customer breaks an arm
by slipping on icy steps while entering or leaving a store;
Product liability: 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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 Classification of Pure Risks…

4. Liability risk is the possibility of being held legally liable for the
unintentional injury of other persons or damage to their property through
negligence or carelessness.

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 Risk Management
o Risk Management is a scientific approach to dealing with risks by
anticipating possible losses and designing and implementing procedures that
minimize the occurrence of loss or the financial impact of the losses that do
occur.
Risk Management process
 The Risk Management Process consists of a series of five steps that, when
undertaken in sequence, enable continual improvement in decision-
making.
Step 1. Identify the risks.
Step 2. Analyze the risks.
Step 3. Select methods to manage risks.
Step 4. Implement the decision.
Step 5. Monitor and review.
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 Step 1. Identify the risks
o Risk cannot be managed unless it is first identified.

o The aim of risk identification is to identify possible risks that may affect,
either negatively or positively, the objectives of the business.

o Answering the following questions identifies the risk:

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 Step 2. Analyze the risks
o During the risk identification step, a business owner may have identified
many risks and it is often not possible to try to address all those identified.
o The risk analysis step will assist in determining which risks have a greater
consequence or impact than others.
o Risk analysis involves combining the possible consequences, or impact, of an
event, with the likelihood of that event occurring. The result is a „level of
risk‟. That is:

Risk = consequence x likelihood

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 Step 3. Select methods to manage risk
• Once the risks have been identified and evaluated, the next step is
consideration of the approaches that may be used to deal with risks and the
selection of the technique that should be used for each one.
• The two approaches used in dealing with risk are risk control and risk
financing,
– Risk control consists of those techniques that are designed to
minimize, at the least possible costs, those risks to which the
organization is exposed.
• Risk avoidance
• Risk prevention
• Risk reduction
– Risk financing consists of those techniques that focus on
arrangements designed to guarantee the availability of funds to meet
those losses that do occur.
• Risk retention
• Risk transfer
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 Step 4. Implement the decision
o Once the decision has been made to use a particular technique or
techniques to manage a firm‟s risks, this decision must be followed by
action, such as purchasing insurance and setting aside dedicated funds to
cope with any risks that have been retained.

Step 5. Evaluate and review

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 Risk Management Tools
1. Risk Avoidance
o Avoidance takes place when decisions are made that prevent a risk from
even coming into existence.
o Risk avoidance should only occur when control measures do not exist or do
not reduce the risk to an acceptable level
o One way to handle a particular pure risk is to avoid the property, person or
activity with which the risk is associated.
2. Risk Retention
o When nothing is done about a particular exposure, the risk is retained by
the individual or organization.

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3. Risk Reduction
• Risk reduction consists of all techniques that are designed to reduce the
likelihood of loss (loss prevention measures), or the potential severity
of those losses that do occur (loss reduction measures)
Loss Prevention Measures
• loss prevention is on preventing the occurrence of loss
– Prohibition against smoking in areas where flammables are present
– Installing protective devices around machinery
Loss Reduction Measures
• risk reduction techniques focus on lessening the severity of those losses
that actually do occur.
– Installation of sprinkler systems (to reduce fire damage ( if is happen))

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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. Risk Transfer
• When a business organization cannot afford to cover the loss by itself, it
may look for/transfer institutions.
• The purchase of insurance contracts is a primary approach to risk
transfer
• Transfer of risk may reduce the risk to the original business without
changing the overall level of risk.
• The following matrix can determine which risk management
be used.

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 INSURANCE FOR BUSINESS
o Insurance is defined as protection against risks.
o Insurers are professional risk takers. Because they know the
probability of different types of risk happening.

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 Basic Principles of a Sound Insurance Program
o Identifying insurable business risks
• Workers‟ compensation and automobile liability insurance are
required by law.
o Limiting coverage to major potential losses
• Avoid overspending insurance resources.
o Relating premiums to probability of loss
• Insure most improbable but critical losses first.

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 Requirements for obtaining insurance
1. There must be a sufficiently large number of homogenous exposure
units to make the losses reasonably predictable
2. The loss produced by the risk must be definite and measurable
3. The loss must be fortuitous or accidental
4. The loss must not be catastrophic
5. The loss must be large loss
6. Reasonable cost of transfer

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 Thank you

Any Question, Comment????

End of the course!!!

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