2025 Spring Semester / Introduction to Risk Management

Session 3

Risk Management
Review
▪ Definition of Risk
➢ Uncertainty, Dangerous, Downside risk

▪ Hazard-Peril-Loss
➢ Physical / Moral / Morale Hazard
➢ Relationship between Peril and Loss

▪ Classification of Risks
➢ Pure / Speculative Risk
➢ Static / Dynamic Risk
➢ Objective / Subjective Risk
➢ Diversifiable / Non-diversifiable Risk
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Today’s Key Questions

1. What is risk management and the

objectives of risk management?

2. What is the major risk control techniques?

3. What is the major risk financing techniques?

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Risk Management 1

▪ The term of “Risk Management” was first used in the 1950’s,

but humans have recognized and addressed risk since the
beginning of history

▪ Systematic approach to minimize losses at the lowest cost

▪ Logical process that identifies risks faced by an organization and

selects the most appropriate techniques for treating such risks

➢ To ensure the survival of the organization

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Risk Management 2

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.

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Objectives of Risk Management 1

▪ Pre-Loss Objectives

➢ The firm should prepare for potential risks in the most economical
way
• Insurance premiums paid, cost of safety programs, costs
associated with the different techniques for handling losses

➢ The reduction of anxiety

• Certain risks can cause great worry and fear

➢ To meet any legal obligations

• Government regulation, Workers’ compensation, etc.
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Objectives of Risk Management 2

▪ Post-Loss Objectives

➢ Survival of the firm

➢ To continue operating

➢ Stability of earning

➢ Continued growth of the firm

➢ Social responsibility
• To minimize the effects that a loss will have on other persons
and on society
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Risk Management Process by ISO 1

Scope, Context, Criteria

Communication & Consultation

Risk Assessment

Monitoring & Review

Risk Identification

Risk Analysis

Risk Evaluation

Risk Treatment

Recording & Reporting

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Risk Management Process by ISO 2

Scope, Context, Criteria

Communication & Consultation

Risk Assessment

Monitoring & Review

Risk Identification

Risk Analysis

Risk Evaluation

Risk Treatment
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Step 1 : Risk Identification
▪ Identify risks

➢ Risk identification is the process of finding and describing risk. It

identifies the possible risks, that is the effects of uncertainties on
objectives, and creates a comprehensive risk list

➢ How?
• Risk analysis questionnaires and checklists
• Physical inspection
• Flowcharts
• Financial statements
• Historical loss data
• Interview
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Step 2 : Risk Analysis 1

▪ Measure and analyze risks

➢ Loss frequency ; the probable number of losses that may occur

during some given time period

➢ Loss severity ; the probable size of the losses that may occur

➢ Although the risk manager must consider both loss frequency and
loss severity, severity is more important because a single
catastrophic loss could destroy the firm

➢ The level of risk is determined by combining its consequence and

occurrence probability
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Step 2 : Risk Analysis 2

▪ Measure and analyze risks

➢ Maximum Possible Loss (MPL)

• The worst loss that could happen to the firm during its lifetime
• The maximum loss that can be theoretically expected
• Amount subject to loss, Worst case scenario

➢ Probable Maximum Loss (PML)

• The worst loss that is likely to happen
• The maximum loss that can realistically be expected

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Step 3 : Risk Treatment 1
High

Risk Reduction Risk Avoidance Risk Control

Frequency

Risk Retention Risk Transfer Risk Financing

Low Severity High

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Step 3 : Risk Treatment 2

Avoidance
Loss prevention
Loss Control
Loss reduction
Risk Control Duplication
Risk Treatment

Separation

Diversification

Insurance
Transfer
Risk Financing ART
Retention
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Risk Control – Avoidance

▪ Risk avoidance means a certain risk is never acquired or undertaken, or

an existing risk is abandoned

▪ Advantage
➢ The change of loss is reduced to zero if the risk is never acquired
➢ If an existing risk is abandoned, the chance of loss is reduced or
eliminated

▪ Disadvantage
➢ Risk avoidance can sometimes lead to other risks
➢ The firm may not be able to avoid all losses
➢ It may not be feasible or practical to avoid the exposure
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Risk Control – Loss control
▪ Loss control is designed to reduce both the frequency and severity of
losses by changing the characteristics of the risk

▪ Loss Prevention
➢ It refers to measures that reduce the frequency of a particular loss
➢ Reducing the probability of loss occurrence
➢ For example, fire-alarm system, installing safety features on hazardous products,
salting to prevent icy road, etc.

▪ Loss Reduction
➢ It refers to measures that reduce the severity of a loss after it occurs
➢ Reducing the amount of loss damage
➢ For example, installing an automatic sprinkler system, building with an
earthquake resistant design, etc.
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Risk Control – Duplication

▪ Duplication refers to having backups or copies of important

documents or property available in case a loss occurs

▪ Duplication assume the inevitability of threats and try to reduce

losses by ensuring resources are safely stored for a reboot of
operations

▪ Duplication methods have grown more popular in recent years as

more assets become digitalized

▪ For example, using internal backup software system, backup copied

of key business record, using backup drive, etc.
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Risk Control – Separation

▪ Separation means dividing the assets exposed to loss to minimize the

harm from a single event

▪ Separation technique ensures that if something catastrophic occurs at

one location, the impact on a business is limited to only the assets at
that location

▪ For example
➢ A manufacturer may store finished goods in two warehouses in
different cities
➢ A manufacturing company may divide the production area of a plant
into four quadrants by using 6-foot-thick concrete walls
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Risk Control – Diversification

▪ Diversification is a risk control technique to promote the allocation

of business resources to create multiple lines of business that offer a
variety of products and services in different industries

▪ If the entire customer base consists of four domestic purchasers, sales

will be impacted adversely by a domestic recession. If there are
foreign and domestic customers, this risk is reduced

▪ Risk can be reduced by diversifying transactions

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Risk Control – Contractual Transfer

▪ Contractual risk transfer is a legally binding way to transfer risk from

one party to another

▪ A method of transferring legal and financial responsibility to a third

party through a contract

▪ For example, apartment and security company. An apartment

complex manager hiring a security company to ensure the safety of
the residents. When risk occurs, contractual risk transfer would have
allowed the risk to shift to the security company

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Risk Financing

▪ Risk financing refers to techniques that provide for the payment

of losses after they occur

▪ Risk financing focuses on recovering from incurred losses or

raising the funds necessary to recover losses

▪ Major risk financing techniques

➢ Retention ; Active / Passive

➢ Transfer ; Insurance / ART(Alternative Risk Transfer)

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Risk Financing – Retention 1
▪ Retention means that the firm retains part or all of the losses that
can result from a given loss

▪ When retention can be effectively used in RM?

➢ No other method of treatment is available
➢ The worst possible loss is not serious
➢ Losses are fairly predictable

▪ Active risk retention

➢ The firm is aware of the loss exposure and consciously decided to
retain part or all of it

▪ Passive risk retention

➢ The firm fails to identify a risk and to act or forget to act 22
Risk Financing – Retention 2
▪ Determining retention levels

▪ Methods
➢ Current net income
➢ Unfunded reserve
➢ Funded reserve
➢ Credit line
➢ Captive insurer ; an insurer owned by a parent firm for the
purpose of insuring the parent firm’s losses
➢ Self-insurance ; a special form of planned retention by which
part or all of a given loss is retained by the firm
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Risk Financing – Retention

▪ Advantages
➢ Save on loss costs
➢ Save on expenses
➢ Encourage loss prevention
➢ Increase cash flow

▪ Disadvantages
➢ Possible higher losses
➢ Possible higher expenses

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Risk Financing – Transfer

▪ Insurance
➢ A method of transferring responsibility for potential losses to the
insurer through an insurance contract
➢ Insurance premium – Insurance benefits
➢ Commercial insurance, social insurance

▪ ART (Alternative Risk Transfer)

➢ Methods other than insurance by which a pure risk and its potential
financial consequences are transferred to another party
➢ Risk hedge ; option, forward/futures, swap

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Step 4; Implementing and Monitoring

▪ Step 4 ; Implement and monitor the risk management programs

➢ Risk management policy statement

• It outlines the risk management objectives of the firm, as well as
company policy with respect to treatment of risks

➢ Risk management manual

• It may be developed and used in the risk management program

➢ Periodic Review and Evaluation

• To be effective, the risk management program must be
periodically reviewed and evaluated to determine whether the
objectives are being attained or if corrective actions are needed
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Sogo Shosha(General Trading Company)

▪ Sogo Shohsa is a unique business model in Japan

▪ They took charge of imports and exports, proactively expanded

overseas, and expanded their global networks

▪ They have leveraged these networks in recent years, making

investments and developing various businesses on the world stage
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Evolution of the Sogo Shosha

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Sogo Shosha RM Case - Diversification

▪ With the progress of informatization and globalization since the

1990s, the core functions of general trading companies that played a
major role in export agency, such as information collection and
marketing, have faded

▪ Sogo Shosha developed their new business models using their

overseas networking, talented people, and brand image
➢ Developing overseas resources & energy
➢ Support overseas expansion
➢ Project Financing

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Sogo Shosha RM Case - Diversification

Trading Investment
Business Business

• Business of handling commercial

products such as raw materials, • Business of investing
goods, and services management resources (people,
goods, money, and information)
• Earing commissions by acting as
in the business of promising
an intermediary between sellers
companies and earning profits
and buyers
through dividends

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Discussion

Andrew owns a gun shop in a high crime area. The store does not
have a camera surveillance system. The high cost of burglary and
theft insurance has substantially reduced his profits. A risk
management consultant points out that several methods other than
insurance can be used to handle the burglary and theft exposure.
Identify and explain other risk management methods that could be
used to deal with the burglary and theft exposure.

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