RISK MANAGEMENT.

RISK IS DEFINED AS AN UNCERTANITY

CONCERNING THE OCCURRENCE OF A
LOSS.EX: THE LOSS OF BEING KILLED
BY A SPEEDING VEHICLE.UNDER RISK
MGMT RISK IS IDENTIFIED WITH LIFE
OR PROPERTY BEING INSURED. SO WE
HEAR SUCH STATEMENTS AS THE
BUILDING IS UNACCECPTABLE RISK OR
THE DRIVER IS POOR RISK.
11 July 2013 Prof. D.Gopinath 1
 TYPES OF RISK
1. OBJECTIVE RISK:-(DEGREE OF RISK) IS
DEFINED AS THE RELATIVE VARIATION
OF ACTUAL LOSS FROM THE EXPECTED
LOSS. THIS DECREASES AS THE NUMBER
OF EXPOSURES INCREASE. IT VARIES
INVERSELY WITH THE SQUARE ROOT OF
THE NUMBER OF CASES UNDER OBSERV-
ATION.SUPPOSE 10,000 HOUSES ARE BU-
ILT AND 1% OF THESE ARE TO BURN PER
YEAR.THAT MEANS 100 ARE TO BURN.
11 July 2013 Prof. D.Gopinath 2
 TYPES OF RISK.
THAT DOES NOT MEAN THAT 100 HOUSES
WILL EXACTLY BE BURNT. IT MAY VARY
PLUS OR MINUS.OBJECTIVE RISK MAY BE
CALCULATED BY USING SOME STATISTI-
CAL MEASURE LIKE SD/CV.BECAUSE OBJ-
RISK CAN BE MEASURED IT IS AN EXTRE-
MELY USEFUL CONCEPT FOR AN INSURER
AS THE NUMBER OF EXPOSURES
INCREASES AN INSURER CAN PREDICT
ITS FUTURE LOSS MORE ACCURATELY.
11 July 2013 Prof. D.Gopinath 3
 TYPES OF RISK.
THE LAW OF LARGE NUMBERS STATES
THAT AS THE NUMBER OF EXPOSURES
UNIT INCREASES THE MORE CLOSELY
THE ACTUAL LOSS EXPERIENCE WILL
APPROACH THE EXPECTED LOSS EXPERI-
ENCE.
2. SUBJECTIVE RISK:- THIS IS THE UNCER-
TAINITY BASED ON A MENTAL CONDITI-
ON OR STATE OF MIND OF A PERSON.

11 July 2013 Prof. D.Gopinath 4

 TYPES OF RISK.
EX:- A PERSON IN A DRUNKEN STATE
MIGHT DRIVE HOME.HE IS UNCERTAIN
WHETHER HE WILL REACH HOME SAFELY
OR WOULD BE CAUGHT BY THE POLICE.
THE MENTAL UNCERTAINITY IS CALLED
AS SUBJECTIVE RISK. TWO DIFFERENT
DECISION MAY ALTER THEIR COURSE OF
ACTION LIKE TAKING AN AUTO HOME
INSTEAD OF DRIVING.
11 July 2013 Prof. D.Gopinath 5
 CHANCE OF LOSS.
CHANCE OF LOSS IS CLOSELY RELATED TO THE
CONCEPT OF RISK. IT IS DEFINED AS THE
PROBABILITY THAT AN EVENT WILL
OCCUR.LIKE RISK PROBABILITY HAS BOTH
OBJECTIVE AND SUBJECTIVE ASPECTS.
OBJECTIVE PROBABILITY:- IT REFERS TO THE
LONG RUN RELATIVE FREQUENCY OF AN
EVENT BASED ON THE ASSUMPTION OF AN
INFINITE NUMBER OF OBSERVATIONS AND OF
NO CHANGE IN THE UNDERLYING CONDITIONS
11 July 2013 Prof. D.Gopinath 6
 CHANCE OF LOSS.
OBJECTIVE PROBABILITY.
OBJECTIVE PROBABILITY CAN BE DETERM-
INED IN TWO WAYS:-
1.THEY CAN BE DETERMINED BY DEDUCT-
IVE REASONING.THESE ARE ALSO CALL-
ED AS PRIORI PROBABILITIES. (TOSS
OF A COIN WHERE THE ANSWER IS ½.
ALSO IN CASE OF A DICE WHERE THE
PROBABILITY IS 1/6.

11 July 2013 Prof. D.Gopinath 7

 CHANCE OF LOSS.
OBJECTIVE PROBABILITY.
2. OBJECTIVE PROBABILITIES CAN BE DET-
ERMINED BY INDUCTIVE REASONING
RATHER THAN BY DEDUCTIVE REASON-
ING. Ex:- PROBABILITY THAT A PERSON
WILL DIE BEFORE 25 WHEN HIS AGE IS
21 YEARS CANNOT BE LOGICALLY DEDU-
CED.BUT IF CURRENT MORTALITY RATES
ARE SEEN THEN AN INSURANCE POLICY
CAN BE SOLD FOR PEOPLE AGED 21
YEARS.
11 July 2013 Prof. D.Gopinath 8
 CHANCE OF LOSS.
SUBJECTIVE PROBABILITY.
IT IS THE INDIVIDUAL PERSONAL ESTIMA-
TE OF THE CHANCE OF LOSS.THIS NEED
NOT COINCIDE WITH OBJECTIVE PROBA-
BILITY. Ex:- PEOPLE BUYING LOTTERY
TICKETS ON THEIR BIRTHDAY EXPECTI-
NG LUCK. FACTORS AFFECTING SUBJECT-
IVE PROBABILITIES ARE AGE, GENDER,
INTELLIGENCE, EDUCATION, BELIEFS,
USE OF ALCHOHOL ETC.
11 July 2013 Prof. D.Gopinath 9
 CHANCE OF LOSS
DISTINGUISHED FROM RISK.
CHANCE OF LOSS IS THE PROBABILITY
THAT AN EVENT THAT CAUSES A LOSS
WILL OCCUR.OBJECTIVE RISK IS THE
RELATIVE VARIATION OF ACTUAL LOSS
FROM EXPECTED LOSS.THE CHANCE OF
LOSS MAY BE IDENTICAL FOR TWO
DIFFERENT GROUPS BUT OBJECTIVE
RISK MAY BE QUITE DIFFERENT.EX:-
CHANCES OF ACCIDENTS IN 2 TOWNS.
11 July 2013 Prof. D.Gopinath 10
 PERILS AND HAZARDS
PERILS ARE THE CAUSE OF LOSS.EX:- FIRE,
LIGHTENING, FLOODS, EARTHQUAKE
ETC
HAZARDS ARE CONDITIONS THAT CREAT-
ES OR INCREASES THE CHANCE OF
LOSS. THERE ARE 4 TYPES OF
HAZARDS:-
1. PHYSICAL. 2. MORAL 3. MORALE.
4. LEGAL HAZARDS.

11 July 2013 Prof. D.Gopinath 11

 HAZARDS.
1. PHYSICAL HAZARDS:- THESE ARE THE
PHYSICAL CONDITIONS THAT
INCREASES THE CHANCE OF LOSS (BAD
ROADS)
2. MORAL HAZARDS:- DISHONESTY OR
CHARACTER DEFECTS IN AN INDIVID-
UAL LIKE FAKING INJURY OR MAKING
FRAUDULENT CLAIMS.

11 July 2013 Prof. D.Gopinath 12

 HAZARDS.
3.MORALE HAZARDS:- THESE ARE CARELE-
SSNESS BECAUSE OF THE EXISTENCE OF
INSURANCE.THESE INCREASE THE
CHANCES OF LOSS.
4.LEGAL HAZARDS:-THESE ARE THE CHAR-
ACTERISTICS OF THE LEGAL SYSTEM OR
THE REGULATORY ENVIRONMENT. Ex:-
ADVERSE JURY VERDICT,GOVT SCHEMES
OF INSURANCE GIVING UNDUE BENEFITS

11 July 2013 Prof. D.Gopinath 13

 CATEGORIES OF RISK.
1. PURE AND SPECULATIVE RISK.
2. FUNDAMENTAL AND PARTICULAR RISK.
3. ENTERPRISE RISK.
PURE RISK IS DEFINED AS SITUATION IN
WHICH THERE ARE ONLY THE POSSIBI-
LITIES OF LOSS OR NO LOSS. THE ONLY
POSSIBLE OUTCOMES ARE ADVERSE OR
NEUTRAL ( NO LOSS)

11 July 2013 Prof. D.Gopinath 14

 CATEGORIES OF RISK
SPECULATIVE RISK IS A SITUATION IN WHICH
EITHER PROFIT OR LOSS IS POSSIBLE.
DIFFERENCES:-
1.PRIVATE INSURERS UNDERWRITE ONLY PURE
RISK.
2.THE LAW OF LARGE NUMBERS APPLY TO PURE
RISK ONLY.
3.SOCIETY MAY BENEFIT FROM SPECULATIVE
RISK EVEN THOUGH LOSS OCCURS. EXAMPLE
NEW TECHNOLOGY USED BENEFITS SOME.
ISRO ROCKETS PROGRAMME HELPS SOME.

11 July 2013 Prof. D.Gopinath 15

 CATEGORIES OF RISK
FUNDAMENTAL RISK AFFECTS THE WHOLE
ECONOMY LIKE FAMINE,NATURAL DISAS-
TERS,TERRORIST ATTACKS ETC.
PARTICULAR RISK AFFECTS ONLY THE
INDIVIDUALS LIKE THEFT, ROBBERIES.
ENTERPRISE RISK ARE THE MAJOR RISK
FACED BY A BUSINESS FIRM LIKE PURE
RISK,FINANCIAL RISK, SPECULATIVE ETC.

11 July 2013 Prof. D.Gopinath 16

 TYPES OF PURE RISK
CAUSING FINANCIAL INSECURITY
1. PERSONAL RISK:- PREMATURE DEATH,
INSUFFICIENT INCOME DURING
RETIRE-MENT, POOR HEALTH,
UNEMPLOYMENT.
2. PROPERTY LOSSES LIKE DIRECT LOSS,
INDIRECT LOSSES, (loss of customers).
3. LIABILITY RISK:- (BODILY INJURY
BECAUSE OF ACCIDENTS).

11 July 2013 Prof. D.Gopinath 17

 INSURANCE.
THE AMERICAN RISK AND INSURANCE
ASSOCIATION HAS DEFINED INSURANCE
AS FOLLOWS:- IT IS THE POOLING OF
FORTUITOUS LOSSES BY TRANSFER OF
SUCH RISKS TO INSURERS WHO AGREE
INDEMNIFY INSUREDS FOR SUCH LOSSES
TO PROVIDE OTHER PECUNIARY BENEF-
ITS ON THEIR OCCURRENCE OR TO
RENDER SERVICES CONNECTED WITH
THE RISK.
11 July 2013 Prof. D.Gopinath 18
 INSURANCE:-
BASIC CHARACTERISTICS
1. POOLING OF LOSSES.
2. PAYMENTS OF FORTUITOUS LOSSES.
3. RISK TRANSFER.
4. INDEMNIFICATION OF LOSSES.
POOLING OF LOSSES:-THIS IS THE
SPREADING OF LOSSES INCURRED BY
THE FEW OVER THE ENTIRE GROUP SO
THAT IN THE PROCESS AVERAGE LOSS
IS SUBSTITUTED FOR ACTUAL LOSS.
11 July 2013 Prof. D.Gopinath 19
 BASIC CHARACTERISTICS OF
INSURANCE.
IT INVOLVES GROUPING OF A LARGE
NUMBER OF EXPOSURE UNITS SO THAT
THE LAW OF LARGE NUMBERS CAN
OPERATE TO PROVIDE A SUBSTANTIALLY
ACCURATE PREDICTION OF FUTURE
LOSSES.IDEALLY THERE SHOULD BE A
LARGE NUMBER OF SIMILAR BUT NOT
NECESSARILY IDENTICAL EXPOSURE
UNITS THAT ARE SUBJECT TO THE SAME
PERIL.
11 July 2013 Prof. D.Gopinath 20
 BASIC CHARACTERISTICS
2.PAYMENT OF FORTUITOUS LOSS
A FORTUITOUS LOSS IS ONE THAT IS UNF-
ORESEEN AND UNEXPECTED AND OCCUR
AS A RESULT OF CHANCE. THAT MEANS
THE LOSS MUST BE ACCIDENTAL AND
OCCUR RANDOMLY. INSURANCE
POLICIES COVER ONLY ACCIDENTAL
LOSSES AND NOT INTENTIONAL LOSSES.

11 July 2013 Prof. D.Gopinath 21

 BASIC CHARACTERISTICS.
3.RISK TRANSFER.
RISK TRANSFER MEANS THAT A PURE RISK
IS TRANSFERRED FROM THE INSURED
TO THE INSURER WHO TYPICALLY IS IN
A STRONGER FINANCIAL POSITION TO
PAY THE LOSS THAN INSURED. FROM
THE POINT OF AN INDIVIDUAL PURE
RISKS ARE PREMATURE DEATH,POOR
HEALTH, DESTRUCTION OF PROPERTY
PERSONAL LAWSUITS ETC.
11 July 2013 Prof. D.Gopinath 22
 BASIC CHARACTERISTICS.
4. INDEMNIFICATION
INDEMNIFICATION MEANS THAT THE INS-
URED IS RESTORED TO HIS OR HER APP-
ROXIMATE FINANCIAL POSITION PRIOR
TO THE OCCURRENCE OF LOSS.THIS IS
FEASIBLE ONLY IN CASE OF NON LIFE
INSURANCE LIKE FIRE, MARINE AND
OTHER NON LIFE POLICIES.

11 July 2013 Prof. D.Gopinath 23

 MEANING OF RISK MGMT.
IT IS A PROCESS THAT IDENTIFIES LOSS
EXPOSURES FACED BY AN ORGANISAT-
ION AND SELECTS THE MOST APPROPRI-
ATE TECHNIQUES FOR TREATING SUCH
EXPOSURES. RISK AS A TERM IS VERY
AMBIGUOUS SO USING THE TERM LOSS
EXPOSURE IS CONSIDERED MORE
APPROPRIATE.

11 July 2013 Prof. D.Gopinath 24

 RISK MANAGEMENT
LOSS EXPOSURE IS ANY SITUATION OR
CIRCUMSTANCE IN WHICH A LOSS IS
POSSIBLE, REGARDLESS OF WHETHER A
LOSS OCCURS.HERE RISK MANAGERS
CONSIDER ONLY PURE RISK EXPOSURES
FACED BY THE FIRM.OF LATE EVEN
SPECULATIVE LOSS EXPOSURES ARE
BEING CONSIDERED.

11 July 2013 Prof. D.Gopinath 25

 RISK MANAGEMENT-OBJECTIVES.
1.PRELOSS OBJECTIVES.
2. POST LOSS OBJECTIVES.
PRELOSS OBJECTIVES:- THE IMPORTANT
OBJECTIVES BEFORE A LOSS OCCURS
INCLUDE ECONOMY, REDUCTION OF
ANXIETY AND MEETING LEGAL
OBLIGATIONS.

11 July 2013 Prof. D.Gopinath 26

 PRELOSS OBJECTIVES
1. THE FIRM SHOULD BE PREPARED FOR
POTENTIAL LOSSES IN THE MOST
ECON-OMICAL WAY.THIS PREPARATION
INVOLVES AN ANALYSIS OF THE COST
OF SAFETY PROGRAMS,PREMIUMS PAID
AND THE COST HANDLING LOSSES.
2. REDUCTION OF THE ANXIETY OF THE
RISK MANAGER AND THE KEY
EXECUTIVES.(CATASTROPHIC LAW SUIT

11 July 2013 Prof. D.Gopinath 27

 PRELOSS OBJECTIVES.
3. TO MEET ANY LEGAL OBLIGATIONS:-
THIS MAY BE ASKING THE FIRM TO
INSTAL SAFETY DEVICES, POLLUTION
CONTROLING DEVICES, WASTE
DISPOSAL ETC. THE INSURANCE
MANAGER MUST TRY TO ENSURE THAT
THESE ARE PROVIDED.

11 July 2013 Prof. D.Gopinath 28

 POST LOSS OBJECTIVES
RISK MANAGEMENT ALSO HAS CERTAIN
OBJECTIVES AFTER A LOSS OCCURS:-
1. SURVIVAL OF THE FIRM. (RESUME
OPERATIONS IN A SHORT TIME)
2. CONTINUE TO OPERATE.(COMPETITORS
WOULD TAKE UP THE BUSINESS)
3. STABILITY OF EARNINGS.4. GROWTH
OF THE FIRM.5. MINIMISE THE EFFECTS
OF LOSS TO THE OTHERS/SOCIETY.

11 July 2013 Prof. D.Gopinath 29

 RISK MANAGEMENT PROCESS
1. IDENTIFY THE LOSS EXPOSURES:-
HERE WE IDENTIFY ALL MAJOR AND
MINOR LOSS EXPOSURES. THIS INVOL-
VES ANALYSIS OF ALL POTRENTIAL
LOSSES. a) PROPERTY LOSS EXPOSURE
b) LIABILITY LOSS EXPOSURES.
c) BUSINESS INCOME LOSSES.
d) CRIME LOSS. e) FOREIGN LOSS
EXPOSURES f) REPUTATION LOSS
11 July 2013 Prof. D.Gopinath 30
 RISK MANAGEMENT PROCESS
2. ANALYSE THE LOSS EXPOSURES:-
a) LOSS FREQUENCY (PROBABLE NO. OF
LOSSES IN A TIME PERIOD)
b) LOSS SEVERITY (SIZE OF THE LOSS)
THESE ARE DONE FOR EACH TYPE OF
EXPOSURE.WHEN DONE IT HELPS IN
FINDING OUT THE TECHNIQUES FOR
HANDLING THE EXPOSURES/ESTIMAT-
ING THE MAX POSSIBLE LOSSES.

11 July 2013 Prof. D.Gopinath 31

 RISK MANAGEMENT PROCESS
3. SELECTING THE APPROPRIATE TECHNI-
QUE FOR TREATING THE LOSS
EXPOSURE
a) RISK CONTROL b) RISK FINANCING.
RISK CONTROL:-THIS IS A TECHNIQUE FOR
CONTROLLING THE SEVERITY OF LOSS.
1. AVOIDANCE:- (DANGEROUS DRUGS)
2. LOSS PREVENTION.( USING MEASURES)

11 July 2013 Prof. D.Gopinath 32

 RISK MANAGEMENT PROCESS
3. LOSS REDUCTION:- THESE ARE THE ME-
ASURES TO AVOID THE SEVERITY OF A
LOSS AFTER IT OCCURS. ( FUTURE )
USING THE SPRINKLERS FOR FIRE
PREVENTION, HAVING DECENTRALISED
STORES, LIMITING OF THE AMOUNT OF
CASH SO THAT THE CHANCES OF THEFT
ARE AVOIDED, SAFETY PROGRAMS BEING
IMPLEMENTED IN THE PREMISES.
11 July 2013 Prof. D.Gopinath 33
 RISK MANAGEMENT PROCESS
RISK FINANCING:-THIS IS THE FUNDING THE
LOSSES AFTER THE LOSS HAS OCCURRED.
1. RETENTION: THIS IS RETAINING THE PART OR
ALL OF THE LOSSES THAT CAN RESULT FROM A
GIVEN LOSS.THIS MAY BE ACTIVE/PASSIVE.
ACTIVE IS THE RETENTION WHEN THE FIRM IS
AWARE OF ITS ACTS AND PASSIVE WHEN THE
FIRM NEGLECTS ITS ACTS LKE FORGETTING TO
ACT , FAILURE TO ACT, FAILURE TO IDENTIFY
THE LOSS EXPOSURE.
11 July 2013 Prof. D.Gopinath 34
 RISK FINANCING
RISK RETENTION LEVEL:- A FIRM HAS TO
DETERMINE ITS RISK RETENTION LEVEL.
A STRONG FIRM CAN RETAIN A HIGHER
AMOUNT OF RISK THAN A WEAKER FIRM.
HERE A FIRM CAN ESTIMATE THE MAXI-
MUM LEVEL OF RISK IT CAN ABSORB
WITHOUT INSURING LIKE % OF ANNUAL
EARNINGS OR % OF WORKING CAPITAL.

11 July 2013 Prof. D.Gopinath 35

 RISK RETENTION LEVEL
IF THE RISK IS RETAINED THEN THE FIRM
SHOULD THINK OF HOW IT WOULD
FINANCE THE RISK:-
a) CURRENT NET INCOME.
b) FUNDED RESERVE.
c) UNFUNDED RESERVE (BOOK ENTRIES)
d) CREDIT LINE WITH BANKERS USING
BORROWED FUNDS.
11 July 2013 Prof. D.Gopinath 36
 RISK FINANCING
2.NON INSURANCE TRANSFERS:- THESE
ARE METHODS USED IN WHICH THE
PURE RISK AND ITS FINANCIAL
CONSEQUEN-CES ARE TRANSFERRED TO
SOME OTHER FIRM LIKE LEASED
TRANSFERS, CONTRACTS, AGREEMENTS,
ANNUAL MAINTENANCE CONTRACTS ETC.
3.COMMERCIAL INSURANCE CONTRACTS
ON YEARLY BASIS.

11 July 2013 Prof. D.Gopinath 37