MODULE 1 Risk uncertainty regarding loss There are different magnitudes of risk based on the decision maker individual organizational and society Danger does not equal risk Information does not alter risk There has to be at least one of the potential outcomes that are unwanted in order to be considered a loss Q What is the definition of risk on the individual level A Uncertainty regarding loss Q What is the definition of risk on the organizational level A Uncertainty regarding loss and things that prevent the organization from reaching their objectives It adversely affects the achievements of an organization s objectives NOTE risk management in organizations applies to the entire industry Q What is the definition of risk on the society level A Uncertainty regarding loss and things that effect society as a whole It has to effect a large portion of its constituents NOTE individuals and society have their own way of handling risk The Scientific View of Risk has an alternative definition of risk the probability of a person suffering an adverse effect from some activity or exposure over a given period of time The time element can differ because statistics can change with time and vary with habits Risk is a probability and is expressed as a fraction or ratio of the number of people who experienced the adverse effect divided by the number of people who engaged in the activity Risk is measured by Frequency Likelihood how often something is going to occur and over what time frame This is a probability of how often something happens compared to how often it could have happened Severity Impact how bad something is when it happens Severity is usually measured by financial loss Expected Value Loss probability multiplied by outcome Relative variation of actual from expected loss variation or standard deviation How far is it from what we expected to happen to what actually happened Risk Profile way of prioritizing risks Uncertainty when you do not know the outcome there is uncertainty Multiple outcomes can also lead to uncertainty Uncertainty is doubt about our ability to predict future outcomes Because uncertainty is subjective it can differ across individuals even when the risk is the same Information can alter uncertainty Reduction in uncertainty can be a good thing EX An event such as a hurricane doesn t change the likelihood of another hurricane yet our uncertainty and biases about another one occurring are now present Loss what you could have had but don t Categories of Risk Pure vs Speculative Pure risks only involve loss or no loss while speculative you could have loss no loss or a gain Static vs Dynamic Static risks are unchanging through time dynamic change through time Fundamental vs Particular Fundamental risks effect a large portion of people while particular are more on the individual level Core vs Secondary Core risks are risks that are inherent to the fundamental activities of an organization secondary are risks that are not part of the core operations of an organization Sources of Risk Personal Risks related to life health and safety on the individual level Property Risks related to potential damage to physical property and material things Liability Risks taking responsibility for your actions Financial Risks savings and investments Exposure person or property facing risk of loss Peril the immediate cause of loss Hazard condition affecting the frequency or severity of loss Types of Hazards Hazards conditions affecting perils frequency or severity of loss Physical Hazards property conditions Intangible Hazards attitudes or culture Moral hazard behavioral changes Morale hazard indifference Societal hazards legal or cultural All three of these effect the frequency severity of loss There is very little difference between moral and morale hazards Attitude Towards Risk Risk Neutral indifferent towards risk value of risky situation is expected loss Risk Averse Prefer to avoid risk willing to pay more than expected loss to avoid risk Risk Seeker prefer risk would pay more than expected return to engage in risky situation Certain Equivalent when you are willing to pay more to avoid risk This only occurs in risk aversion Burden of Risk on Society Need for Larger Emergency Funds Loss of Needed Goods and Services Fear and Worry Risk Management Scientific approach to dealing with risk Rules of Risk Management Don t risk more than you can afford to lose Don t risk a lot for a little Consider the odds All of these are pretty common sense The Risk Management Process 1 Determination of Objectives Post Loss Objectives Survival Continuity of Operations Earnings Stability Continued Growth Social Responsibility Pre Loss Objectives Economy Reduction in Anxiety Meeting Externally Imposed Obligations Social Responsibility 2 Identification of risks There are a variety of tools available to assist in risk identification including questionnaires checklists and procedure guides The preferred approach to risk identification is a combination approach in which all of the tools available are brought to bear on the problem This step includes inspections analysis of documents and interviews 3 Evaluation of risks A Loss Frequency probability distributions B Loss Severity Maximum Possible Loss worst case scenario Probable Maximum Loss most likely Use of Statistics Central tendency Measures of Variation Law of Large Numbers 4 Consideration of alternatives selection of the tool Loss Control Loss Financing Reduced Level of Risky Activity Increased Precautions Retention Self Insurance Insurance Hedging Other Contractual Risk Transfers Implementing the decision doing what you planned 5 6 Evaluation and Review Often the first step Internal Risk Reduction Diversification Investments in Formation Importance of Severity in Ranking Exposures There are two reasons that potential severity must be measured 1 Some notion of severity is necessary for classifying risks Whether an exposure will be classified as critical important or unimportant depends on the potential severity of loss 2 Severity must also be measured to determine the amount of insurance that should be purchased when the decision is made to transfer the risk Risk Measurement Questions 1 What is the probability of loss 2 What is the probability of no loss 3 What is the expected loss E Loss SUM of loss multiplied by probability of loss 4 What is the probability of business having a difficult to handle loss Business must define difficult to handle Let s assume it
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