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Risk
Used to describe any situation where the actual outcome of a decision, event or action is different from the expected outcome. The deviation from expected outcome may be desirable or undesirable. E.g., a fall in profits or a rise in profits. Risk is mostly used to denote the undesirable outcome; but includes desirable outcome also. Risk is defined as a variation in the possible outcome and also as the degree of uncertainty associated with a possible loss The degree is risk is estimated based on certainty level with which the outcome of an activity can be forecast. The greater the accuracy with which the outcome can be predicted, the lower is the risk. Apart from uncertainty, certainty, risk other words such as peril and hazard are also used in the field of risk.
Peril:
Is a cause of risk. Fire, earthquake, flood, criminal activities, etc., are examples of perils. Thus perils are losses. Individuals and organisations buy insurance policies and use other methods to save assets from peril.
Hazard:
Is a condition that increases the severity or frequency of a loss. E.g., chances of theft are more in case of no fencing or security. Using spurious lubricants in a machine, leading to damage. There are hazards related to human behaviour, social values and ethics. A house owner may set his house on fire with an objective of claiming damage from the insurance company. A busniessman may put his godown on fire for claiming damages. These are known as moral hazards. In some cases an individual is indifferent to the damages, thereby aggravating degree of damages. A businessman may not take adequate steps to control a fire because his stocks are insured. This causes greater loss to the stock resulting in an increase in the severity of loss. This type of hazard is termed as Morale hazard.
Risk Measurement
Risk Measurement
The risk measurement follows risk identification and risk classification. Plays an important role in handling risks effectively. As soon as the source of risk has been identified, the next step is to measure the degree of risk. However, measurement is not possible in subjective risks, and is possible only with that of objective risks, where the possible outcomes associated with risks are easily observed. Two concepts used for measuring risk
Chance of loss, and Degree of risk
Chance of loss
Refers to the probability of occurrence of a loss Chance of loss is said to be an outcome of two factors, viz., peril and hazard. Peril is potential danger that can cause a loss whereas hazard is a condition which holds a potential to increase the chances of occurrence as well as has the innate tendency to amplify the degree of risk. Hazards are classified as Physical Hazards, Moral, Morale
Degree of risk
Refers to the intensity of objective risk which is assessed by finding the difference between the expected loss with that of the actual losses
Degree of risk= difference between the expected and the actual loss/expected loss.
Classification of risk
Pure vs. speculative risk
Pure risk refers to those events whose effects cause either loss or no loss to the enterprise in all circumstances but no gain. Chances of making any profit from such risk occurrences is low. Examples: fire, theft, earthquake, death, accident etc Speculative risk refers to the events the outcomes of which may result in profit or loss. E.g., reduction in SP of products, increasing distribution outlets, mergers etc. Classification of pure risk
Property risk Personal risk Liability risk Loss of income risk
Risk Management
The process of risk management involves identification, analysis and economic control of risks, which exposes the assets (men and material) or economic capacity of an enterprise. Thus RM performs three functions.
Identifies the various risks to which enterprise is exposed. Analyzes the degree to which the enterprise is vulnerable to various sources of risks Assigns the economic value of these exposures
Risk combination : (it is a strategy in which two or more risks are retained in a proportion, so that overall risk of portfolio/combination is reduced to the minimum desired level.) Risk transfer: (if risk is borne by a party other than the one who is primarily exposed to risk, it may be risk transfer. Risk sharing: (it is an arrangement to share losses. Corporation, where investments are pooled for common adventure and insurance are examples of risk sharing.) Risk hedging: (hedging is resorted to to reduce the risk evolved in holding an investment. Corporate investments are prone to fluctuations in all kinds of financial prices like foreign exchange rate, interest rates, commodity prices and equity prices.)
Loss reduction
The aim is to reduce the degree of loss incurred by occurrence of a particular event. Does not reduce the chances of occurrence of the event, it reduces the impact of loss caused by the event E.g., seat belt in car/helmet/fire extinguishers etc does not reduce the chances of accident but reduces the severity of the damage caused by an accident. Risk chain of events leading to loss are
The hazard The environment The interaction The outcome The consequences
Major emphasis of loss reduction is on interaction as also the outcome and consequences. The outcome and consequences come into existence after the incident and the loss. These aim to reduce the severity.
Nature of RM
Increased competition, more demanding customers, increasing pace of technological developments and other changes, increasing complexities and novelty of business opportunities demand the need for more structured, systematic and effective approach to managing uncertainty and business risk. This led to development of the concept of RM. RM refers to the process by which a company attempts to manage its exposure to risks at an acceptable level. It is a scientific approach and deals with various kinds of risks faced by a corporate. The aim of RM is maintain overall and specific risks at the desired level with minimum possible costs. It aims at controlling risk exposure of a firm. Is a rational approach towards controlling pure risk . Can be grouped with other management functions such as financial management , human resource management etc. Risks in day to day activity are : fire, theft, loss of customers, delay in delivery of raw material, breakdown of machinery, accidents, bad debts, changes in industrial policy, changes in financial market, changes in taxation
Measurement of risk
Risk is all pervasive and there is nothing with zero risk. Best way to reduce risk is to make balanced activity choices that keep unnecessary risk to a minimum IDENTIFICATION OF RISK
Sources of risk : (Physical environment, technological envint, social envirt, political envirnt, economic envirent, legal envi, operational env, cognitive envirt, )
EXPOSURE TO RISK
Property exposure (Real and personal), Liability exposure, Human resource expo)
RISK EVALUATION
Helps to fin out the possible consequences of risk in monetary terms. Suggests the quantum of funds to be allocated towards managing and controlling risks Goals are (i) to develop a benchmark based on importance of the risk to the organisation and (ii) to apply this yardstick to all the risks identified Direct and indirect costs Hidden costs (people/Machinery material equipment)
Exposure due to unemployment Exposure due to retirement Exposure due to excessive longevity Direct exposure to an organisation
Key-man losses Credit losses Business discontinuation losses
Loss control
Loss prevention: (attempt to reduce frequency of losses) Loss reduction: (Post loss measures : Salvage, subrogation, catastrophe or contingency plan, duplication, separation are some of the techniques/mechanisms adopted for loss reduction)
INSURANCE
Definition:
an arrangement by which the losses of a few are shared by many. A group exposed to similar kind of risk come together and contribute small amounts called premiums to a common fund. As and when a member suffers a loss, his loss is made good through the pool. Insurance involves two elements (1) transfer or sghifting of risk from one individual to a group and (2) sharing of losses on an equitable basis by all members of the group. Insurance (1) primarily creates counter part of the risk which is security Does not reduce risk Does not alter the probability of risk Only spreads and reduces the financial losses Insurance is a contractual agreement whereby one party agrees, for a consideration called premium, to compensate another party for losses. Such transaction involves the following terms like insurer, Insured, Premium, Policy, Exposure to loss
Financial Definition:
Legal definition
Nature of Insurance
Pooling Insurance and gambling Insurance and bonding
Social Insurance
Meant for those who are socially weak and whose income flows are likely to be disturbed by any social or economic upheavals. It is most offered through some form of Govt intervention. Difference between a social insurance plan and private insurance plan.
Compulsions Set level of benefits Floor of protection Subsidy Unpredictability of losses Conditional benefits Contributions Required Attachment to the labor force Minimal advance funding
Principles of insurance
Five principles on which the concept and practice of insurance is based are;
Principle of indemnity
Methods of indemnification (Claim payment, repair, replacement, reinstatement)
Principle of insurable interest (Life insurance, property insurance, liability insurance) Principle of subrogation (Trot, statute) Principle of contribution Principle of utmost good faith Principle of proximate cause
Property Risk
In this case there is a lose of property because of some unforeseen events. There is always chances of loss of house because of earthquake, heavy storm and other natural calamites. The value of the property destroyed due to a given peril is a direct loss and the additional expenses incurred due to the destruction of the property is the indirect loss. In the other words, indirect loss occurs because of direct loss.
Personal Risk
Personal risk refers to the possibility of loss of income or assets as a result of the loss of the ability to earn income. This may result from untimely DEATH of the earning member, dependent old age, prolonged illness, disability or unemplyment.
Insurance Policy
Insurance is risk transfer method. It is a contract under which the insurer agrees to reimburse the losses suffered by the insured in return for a premium. Elements of Insurance
Contractual agreement btwen insurer and insured Payment of premium by the insured Benefit payment by the insured based upon a contingent event and Pool of resources held by the insurer to reimburse the losses
A formal document, provides evidence of the insurance contract Stamped according to provisions of Indian Stamps Act 1899. Some insurance contracts like fire are goverened by Tariff Insurance policy divided into following sections
(The heading, the preamble, proposal and declaration, the insuring clause, the exclusions, the conditions, endorsements, the schedule, the signature clause, definitions)
INSURANCE POLICY