Common Risk Management Strategies Flashcards
What is meant by ‘Risk Management’?
The identification, measurement and economic control of the risks which threaten the assets or earnings of a company or enterprise
Risk Control can be split into LOSS CONTROL and RISK FINANCING.
What are the two elements of ‘Loss Control’?
Risk Avoidance
Risk Reduction
Risk Control can be split into LOSS CONTROL and RISK FINANCING.
What are the two elements of ‘Risk Financing’?
Risk Retention
Risk Transfer
What is meant by ‘Risk Avoidance’?
Risk avoidance is avoiding completely the activities giving rise to risk.
What is meant by ‘Risk Elimination’?
Risk elimination usually has a wider meaning; it implies removal of a risk without necessarily ceasing an activity completely.
What is meant by ‘Risk Reduction’?
Risk Reduction is where the risk is not avoided or eliminated entirely, but attempts are made to reduce the frequency and/or severity of a potential loss by use of typical safety control techniques, such as engineering solutions, procedures and behavioral measures to control risk at source
What is meant by ‘Risk Retention’?
The loss is to be financed from funds within the organisation
What is meant by ‘Risk Retention with knowledge’?
This means you have made a conscious decision to bear the burden of losses
What is meant by ‘Risk Retention without knowledge’?
This means you bear the burden of losses without any consideration whether or not to insure
What is meant by ‘Risk Transfer’?
Risk transfer involves transferring the risk to another party such as by insurance - the loss is financed from funds that originate outside the organisation.
The second main way is to engage a contractor who will take on the risks.
Risk Retention refers to financing losses from funds within the organisation.
What are the possible sources of funds that may be used?
Pay losses from current operating funds. Payments should be restricted to a maximum of about 5% of the operating costs. Losses must be predictable.
Use an unfunded reserve, such as depreciation. This is where some large item of capital expenditure is written off over a number of years. The problem is that the fund does not actually exist expect as an accounting convenience.
Use a funded reserve e.g. a fund of cash or easily obtained cash. It could be a group fund. There is no tax advantage. It takes time to build up such a reserve, so care is required in the early years. There is low interest on capital.
Insuring through a captive insurer
Borrowing to restore losses, which is not easy after a loss occurs.
Divert funds from planned capital investment; the company then uses funds set aside to buy an important capital item because there is a loss which has to be paid for.
What are the advantages of ‘Risk Retention’?
The full sum of insurance premiums is never paid out, so risk retention can be cheaper than insurance.
Retention reduces the cost of both processing claims and the detailed accounting required. The loss occurs and you just pay out.
If costs are allocated to departments, management becomes more risk conscious. This is a vital feature in risk management.
Losses are dealt with quickly
When discussing Risk Retention; every risk that is not transferred to insurance is a retained risk. What are some examples of this?
Events that are insurable - You cannot get insurance for everything. The insurance company has to be able to assess risk since they are in the business of risk management. They may quote a premium above the value you wish to insure. If you can buy a new item for the price of the premium, it is pointless to insure. Take the risk instead.
Losses not considered when setting up insurance. If you do not take into account a particular possibility, you are retaining the loss.
Hazards deliberately not insured. You have to insure a car for third-party risks, but the choice to insure comprehensively is up to you. Risk management is all about taking a risk, you have been able to reduce either the probability or the severity of a loss-making event.
Losses outside the scope of insurance. There are always exclusion clauses.
The part of the loss paid by the company (the excess). You can get cheaper insurance if you agree to pay XXX of any claim.
The part of the loss which is above the limits of the contract. There is often an upper limit to an insurance claim. The claimant pays if the loss exceeds that figure.
The person or company is unable to pay full compensation. Obtaining the cheapest insurance cover may not be sound economy if your losses put them into bankruptcy.
When discussing ‘Risk Transfer’; the two ways of doing this are through Insurance and Use of Specialist Contractors.
What are the advantages of insurance?
Loss will be dealt with smoothly. There will be few forms to fill in and enquiries, but the procedures are well known.
Cash is available. The insurer can get hold of the funds quickly, though will perhaps not release them as quickly as you would like.
Insurer can provide advice. He is dealing with this type of problem all the time and can help you to decide what is best.
Risk Management is really a type of risk sharing and involves financing risks that are manageable and transferring those that are not.
What are the methods of risk sharing?
A deductible portion of the excess - You pay the first part of each claim
Re-insurance
Co-insurance - The insurer pays a percentage of the claim. This is another way of reducing a premium. You share the risk with the insurer by paying not only an excess but a percentage of the losses which fall within a certain price range, paying another percentage of those in another range, and the insurer paying all losses above a set figure.
