Techniques of Risk Avoidance

BY:

VINAY KUMAR (018) VARUN DEEKAY(019) KRISHAN KUMAR(023

RISK- DEFINITION
Risk is defined as the chance of having a loss

due to occurrence of an event The risk is always associated with the loss aspects since the word itself has the association of DANGER OF LOSS The definition can be PROBABAILITY OF THE OCCURRENCE OF AN EVENT RESULTING IN LOSS/ GAIN

CLASSIFICATION OF RISKS
SPECULATIVE RISKS & PURE RISKS DYNAMIC RISKS & STATIC RISKS FUNDAMENTAL RISKS PARTICULAR RISKS

CLASSIFICATION OF RISKS
SPECULATIVE RISKS Operation of this leads to profit /loss Leads to speculation like investment of capital in a new venture Operation is desired
PURE RISKS These do not change with the risk The operation of these perils does bring in loss/damage to property/assets/ liability Not desired

Classification of Risks
Dynamic risks Changes with the change in fashion, buying behaviour, trends, technology etc It denotes dynamic nature of the customer behaviour and the products they like to own or use If an organization is not prepared then it may go out of existence Static risks Like pure risks these risks remain static and do not change due to other reasons like that of dynamic risks The operation of these risks always bring about losses Operation is not desired May result in partial or total cessation of activities

CLASSIFICATION OF RISKS
PARTICULAR RISKS Risks which relate to one or few firms, factories or organisations only Losses are suffered by one or few more members of the society
FUNDAMENTAL RISKS Relates to the society at large Losses are suffered by large section of the society/nation(s) Losses may be due to natural catastrophes, riots, epidemics etc

RISK MANAGEMENT
The selection of appropriate risk management

techniques is a dynamic problem.

The best method for handling a particular

exposure today may not be the best method a year from now. -Many relevant factors change regularly. -The frequency and severity of losses may vary Causing estimates for the maximum possible loss or maximum probable loss to fluctuate. -The cost and availability of different risk management tools cannot be assumed to remain constant.

Basic Concept Of Probability And Statistics

Random Variables And Probability

Distributions. A random variable is a whose outcome is uncertain. Probability distribution which identifies all the possible outputs for random variable and the probability of outcomes.

Characteristics of probability distributions

To compare probability distributions of

different random variables. How decision affect p.d will lead to better decisions. Key characteristics of p.d the expected value, variance or standard deviation, skewness and correlation.

Expected value
The expected value of a p.d provides

information about where the outcomes tend to occur. on average , a distribution with a higher expc. Value will have a higher outcomes. Expct. Value=x1 p1+x2 p2+.xmpm.

Variance and standard deviation

It gives information about the likelihood and

magnitude by which a particular outcome from the distribution will differ from the expected value. S.d it reflects the variation in outcomes of a particular sample from a distribution.

Skewness: it measures the symmetry of distribution.it has a higher probability of very low losses and a lower probability of high losses when compared to symmetric distribution. Correlation: to identify the relationship among random variables.correlatin b/w 2 random variable is 0.then random variable is not related.

Pooling of risk
Pooling arrangement with 2 persons.

Pooling arrangement with many people or business.

Pooling arrangement with correlated losses.

Selecting Risk Management Techniques

The steps for selecting among available risk

management techniques for a given situation may be summarized as follows

Avoid risks if possible Implement appropriate loss control measures

Select the optimal mix of risk retention and risk

transfer

Avoid Risks if Possible

Risks that can be eliminated without an

adverse effect on the goals of an individual or business probably should be avoided Without a systematic identification of pure risk exposures
Some risks that easily could be avoided may

inadvertently be retained

Implement Appropriate Loss Control Measures

For risks that a business or individual cannot or does not

wish to avoid alternatives

Consideration should be given to available loss control measures

In analyzing the likely costs and benefits of loss control

Should recognize that loss control will always be used in

conjunction with either risk retention or risk transfer

Therefore, part of the cost/benefit analysis regarding

potential loss control is recognition of the likely effects on the transfer or retention of the risk existing after loss control measures are implemented The selection between risk retention and risk transfer as the optimal risk management technique may change after loss control expenditures are made

Analyzing Loss Control Decisions

Capital budgeting techniques from finance and

accounting can be applied to risk management decisions regarding loss control For example, Cole Department Store has been experiencing substantial shoplifting losses and occasional vandalism to its building
The company is considering hiring 24-hour security guards to

decrease the frequency and severity of these losses

Its estimated annual cost of the protection is $60,000
Covers salaries and employee benefits for the guards

Cole estimates that the presence of security guards will decrease

shoplifting losses by $30,000 and vandalism losses by $20,000

Additionally its insurance premiums are expected to decrease by $5,000
Should Cole hire the guards?

Analyzing Loss Control Decisions

After examining only the financial considerations
Since the estimated $55,000 in savings is less than the

estimated $60,000 cost of hiring the guards

The firm should not hire the guards

However the company should consider whether there are any additional relevant factors that may have been overlooked
For instance, will the presence of the security guards

make employees feel safer? Will the firm be able to hire better employees? Will customer relations be enhanced by the presence of a guard?

Analyzing Loss Control Decisions

In the Cole Department Store example all the

benefits and costs were expected to happen in the same year When a longer period of time is involved the calculations become more complicated

Select the Optimal Mix of Risk Retention and Risk Transfer

As previously stated, loss control decisions

should be made as part of an overall risk management plan

That also considers the techniques of risk

retention and risk transfer

Often both of these techniques will be used
The relevant question becomes
What is the appropriate mix between these two techniques?

General Guidelines
As a rule, risk retention is optimal for losses that have a

low expected severity

frequency is high

With the rule becoming especially appropriate when expected

Another general guideline applies to risks that have a low

expected frequency but a high potential severity expected frequency

In this situation, risk transfer is often the optimal choice

When losses have both high expected severity and high

It is likely that risk transfer, risk retention, and loss control all will

need to be used in varying degrees

What constitutes high and low loss frequency and

severity in applying the preceding guidelines must be established on an individual basis

Guidelines for Using Different Risk Management Techniques

Selecting Retention Amounts

Because in many situations both risk retention and risk

transfer will be used in varying degrees

It is important to determine the appropriate mix of these two risk

management techniques

Both capital budgeting methods and statistical

procedures may be used in selecting an appropriate retention level

With insurance purchased for losses in excess of that level

But because the price of insurance does not necessarily

vary proportionately with different levels of retention

The appropriate mix between retention and transfer is not an

exact science

The Self-Insurance Decision

The possibility of self-insurance is another way of mixing

risk retention and risk transfer The cash flow advantage of funds set aside in a reserve fund is must be considered in assessing value of selfinsurance
Because losses are not always paid out in the year in which the

event producing them occurs

A company has the use of self-insurance funds for varying periods
May earn interest on them until such a time as the losses are actually paid

The Self-Insurance Decision

In assessing the financial aspects of a selfinsurance program
The value of operating funds to the firm must also be

considered

If the money in the reserve fund is invested in a liquid form that can be readily converted to cash
The firm may experience some loss because the funds

might have been more profitably used in the business as working capital
Known as an opportunity cost of funds .

The Self-Insurance Decision

Even though it may be clear that a firm can

save money in the long run with selfinsurance

Management may prefer stable, predictable

insurance premiums each year

Some companies prefer to avoid the details

of managing self-insurance programs

Rather, focusing on their main operations

The Self-Insurance Decision

The following conditions are suggestive of the types of situations where self-insurance is both

possible and feasible

The firm should have a sufficient number of objects so

situated that theyre not subject to simultaneous destruction

The objects should also be reasonably similar in nature and value so that the calculations of probable losses will be accurate within a narrow range

The firm must have accurate records or have access to

satisfactory statistics to enable it to make good estimates of expected losses

The Self-Insurance Decision

The firm must make arrangements for administering the plan and managing the self-

insurance fund

Someone must pay claims, inspect exposures,

implement appropriate loss control measures, keep necessary records, and take care of the many administrative details
It may be possible to contract for these services to be done by an independent third-party administrator

The general financial condition of the firm should be satisfactory

Firms management must be willing and able to deal

with large and unusual losses