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THE CONCEPT!
Risk Management in terms of the handling of risk is as old as life itself. Man has always been involved in taking risks and subsequent decisions related to risk management.
Risk Management has developed out of insurance thanks to the insurance managers in the USA during the years after WWII. They came to realise that there was more to be gained from spending money on avoiding and reducing risks and on preventing and reducing loss compared to merely buying insurance.
THE RISK-MANAGEMENT TECHNIQUES!
The process of Risk Management consists of the certain steps/activities:
Risk Identification:
This is the first step (often combined with analysis) in the process. It implies a complete inventory of all possibilities of loss from fortuitous sources and is normally a gradual process. Recorded, therefore, will be details of risks in areas such as tangible and intangible assets, the sources of direct and indirect earnings, exposures to product liability which can be imposed by common law or statute etc.
Risk Analysis:
All of the exposures identified must be analysed with particular reference to the financial risk presented to the organisation. The Risk Manager will need to evaluate on questions such as
How frequently will a loss occur ?
How severe will the loss be ?
What is the probability of a total loss from a single occurrence ?
All of the implications of every possibility will need to be analysed in depth to identify the ramifications of a potential incident.
Loss/Risk Reduction:
Proper housekeeping and the introduction of protective devises are standard techniques of risk reduction. Also commonly used are techniques such as quality control, frequent inspections, maintenance of equipment and effective warnings.
Preventive maintenance is an essential area of study as the potential for risk control and risk reduction in this are is most significant.
Financing Analysis:
When all the likely exposures have been identified and analysed, the of the organisation risk mangers can evaluate each risk in the light of the philosophy of the organisation and indeed also its financial capacity. Selection of the appropriate combination of risk management techniques for the treatment of each loss exposure is basically a financial decision. The organisation invests some of its funds in risk management techniques, receiving in return, benefits such as security of operations, reduction in actual losses and reduction in the cost of these losses.
It is not considered a sound practice to place undue emphasis on those losses where the potential is too small to affect the financial stability of the firm or where the loss exposures are so consistently stable and so related to the firm's operations that it can be considered as a normal part of doing business. These expected losses should be predicted as accurately as possible and then budgeted.
Risk control:
Risk control is at the heart of risk management and therefore those aspects of controlling risk that is the responsibility of the risk manger constitute a field that has far too many facets to be even touched on here. It would suffice it to say that he should be planning activities on the basis of pre-event and post-event stages of those losses which may have significant financial impact upon the firm and have an awareness of the control measures that can be adopted as part of the direct responsibilities of a Risk Manager.
Risk financing:
To pay for the losses, an organisation must rely on either internally generated funds (risk retention) or funds from outside source (risk transfer). Transfer is most commonly achieved through purchasing insurance. The key risk management questions are whether or not to purchase insurance, whether to purchase full coverage and with whom to insure.
Risk Retention:
One of the important decisions in the risk management process is to establish what risk or part of the risk can be retained by the organisation, together with those where outside financing must be employed.
Risk Transfer:
Once the risk manger has systematically followed the steps in the risk management process to this stage than there is little choice but to transfer the financial aspects of the remaining risks to someone else. The first attempts at risk transfer usually involve non-insurance means. However, the purchase of a good insurance cover is the most important means of risk transfer, although it will not normally make a positive contribution to profitability. Insurance is a more expensive financing alternative than risk retention.
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