INSURANCE & RISK MANAGEMENT (BBAA04A52)

Unit -1 : Risk Management

Dr. J.Mexon ,
Department of Management,
Kristu Jayanti College, Bengaluru.
What is Risk ?
 Risk
• Risk can be defined as the chance of loss or an unfavorable
outcome associated with an action.
• According to the Dictionary, risk refers to the possibility
that something unpleasant or dangerous might happen.
• In business risk includes changing demand, price falls,
change in desire and taste of consumers, change in market
conditions, high competitions, new inventions, floods and
accidents etc. The risk bearing objects must be insured so
as to cover the unexpected losses caused by uncertain
events.
In most of the risky situations, two elements are commonly found:
• The outcome is uncertain i.e. there is a possibility that one or other
may occur.
• Out of possible outcome one is unfavourable or not liked by
individual or analyst.

‘At its most general level, risk is used to describe any

situation where there is uncertainty about what outcomes
will occur, life is obviously risky” – S.E. Herrinton
 Types of Risk
I. General Point of view: II. Business point of view:
1. Pure Risk (Personal, Property 1. Strategic Risk
and Liability) 2. Compliance Risk
2. Speculative Risk 3. Operational Risk
3. Particular Risk 4. Financial Risk
4. Fundamental Risk 5. Reputational Risk
5. Static Risk
6. Dynamic Risk
 I. General Point of View
1. Pure Risk: Pure risk is a situation that holds out only the
possibility of loss or no loss. There is no prospect for gain or
profit.
For example, if you buy a new textbook, you face the prospect of the
book being stolen or not being stolen.  The possible outcomes are loss
or no loss. 
• Personal Risk
• Liability Risk
• Property Risk
a. Personal Risk- Personal risks are those risks that directly
affect an individual.
Premature Death- Dying too early
Old Age – Dying too late
Sickness – Loss of income and Medical expenses
Unemployment – Financial Insecurity
b. Liability Risk- Arise out of human mistake, Attract liability
for damage under the law.
c. Property Risk- Property owners face the risk of having their
property stolen, damaged or destroyed by various causes. 
2. Speculative Risk:
Speculative risk is a situation that holds out the
prospects of loss, gain, or no loss no gain (break-even
situation).  Speculative risks are very common in
business undertakings. 
For example, if you establish a new business, you
would make a profit if the business is successful and
sustain loss if the business fails.
3. Particular Risk:
A particular risk is a risk that affects only an individual and not
everybody in the community.  Particular risks are the
individual’s own responsibility, and not that of that society or
community as a whole. 

  For example, if your textbook is stolen, the full impact of the

loss of the book is felt by you alone and not by the entire
members of the class.  You bear the full incidence of the loss. 
4. Fundamental Risk:
A fundamental risk is a risk which is non-discriminatory in its attack and
effect. It is essentially, a group risk caused by such phenomena like bad
economy, inflation, war, earthquake, covid-19 etc.  Fundamental risk arise
from the nature of the society we live in or from some natural occurrences
which are beyond the control of man.

They affect large proportion of the population and in some cases they can
affect the whole population. The responsibility of dealing with fundamental
risk lies with the society rather than the individual.   
5. Static Risk:
Static risks are risks that involve losses brought about
by irregular action of nature or by dishonest misdeeds
and mistakes of man. 

For example, if all economic variables remain constant,

some people with fraudulent tendencies would still go
out steal, embezzle funds and abuse their positions. 
 
6. Dynamic Risk:
Dynamic risk is risks brought about by changes in the economy
or environment.  Changes in price level, income, tastes of
consumers, technology etc. (which is examples of dynamic
risk) can bring about financial losses to members of the
economy.  In the long run, dynamic risks are beneficial to the
society. 
For example, technological change, which brings about a more
efficient way of mass producing a higher quality of products at
a cheaper price to consumers than was previously the case,
has obviously benefited the society.
 II. Business Point of View
1.Strategic Risk:
It’s the risk that your company’s strategy becomes less effective and
your company struggles to reach its goals as a result. It could be due to
technological changes, a powerful new competitor entering the market,
shifts in customer demand, spikes in the costs of raw materials, or any
number of other large-scale changes.

It is a fact of life that things change, and your best-laid plans can
sometimes come to look very outdated, very quickly. This is strategic
risk.
2. Compliance Risk:
The business needs to complying with all the necessary laws
and regulations that apply to their business sector and region.
You may follow everything as per regulations but laws change
all the time, and there’s always a risk that you’ll face additional
regulations in the future. And as your own business expands,
you might find yourself needing to comply with new rules that
didn’t apply to you before. ( Example: Companies Act,1956 –
Companies Act,2013)
3. Operational Risk:
Anything that interrupts your company’s core operations comes under
the category of operational risk. It could be a technical failure, like a
server outage, or it could be caused by your people or processes. In
some cases, operational risk can also stem from events outside your
control, such as a natural disaster, or a power cut, or a problem with
your website host. In some cases, operational risk has more than one
cause.
For example, consider the risk that one of your employees writes the
wrong amount on a cheque, paying out $100,000 instead of $10,000
from your account. That’s a “people” failure, but also a “process”
failure.
4. Financial Risk:
If any risk concerned with financial loss, it is termed as
financial risk. Most categories of risk have a financial impact,
in terms of extra costs or lost revenue.
For example, let’s say that a large proportion of your revenue
comes from a single large client, and you extend 60 days credit
to that client. In that case, you have a significant financial risk.
If that customer is unable to pay, or delays payment for
whatever reason, then your business is in big trouble.
5. Reputational Risk:
Reputational risk can take the form of a major lawsuit, an
embarrassing product recall, negative publicity about you or
your staff, or high-profile criticism of your products or
services. And these days, it doesn’t even take a major event to
cause reputational damage; it could be a slow death by a
thousand negative tweets.
 Uncertainty

Uncertainty refers to a situation where the outcome

is not certain or unknown. Uncertainty refers to a
state of mind characterized by doubt, based on the
lack of knowledge about what will or what will not
happen in the future.
Decision under uncertain situations is very difficult for
the decision maker. It all depends upon the skill, the
judgement and of course luck.
 Comparison of Risk and Uncertainty
BASIS FOR
RISK UNCERTAINTY
COMPARISON
Meaning The probability of Uncertainty implies a
winning or losing situation where the future
something worthy is events are not known.
known as risk.
Ascertainment It can be measured It cannot be measured.

Outcome Chances of outcomes The outcome is unknown.

are known.

Control Controllable Uncontrollable

Minimization Yes No
 Perils
A peril refers to the cause of loss or the contingency that may
cause a loss. In literary sense, it means the serious and
immediate danger. If a house burns down, then fire is the
peril. Insurance policies provides financial protection against
losses caused by perils.
• Natural Perils
• Man made perils
(a) Theft (b) Riots, Strikes and Malicious Damage (c) Accidents:
• Economic Perils
1. Natural Perils:
There are unexpected natural
phenomena, which year in and year
out cause untold misery, loss of life
and property. These perils are also
called Act of God perils, and there
is little that mankind can do to stop
them, he can only learn to live with
them and devise means to lessen
the negative impact. (Example:
Volcanic eruptions, cyclones,
hurricanes, storms, floods etc.)
2. Man made Perils
a.) Theft: We witness different kind
of incidents such as thefts of
motorcycles, daylight robberies
and burglaries loss to human life by
accident, terrorism, enmity,
adulteration murder etc. Not only
outsiders but insiders also steal.
Employees steal tools, equipment
and goods from their employers
worth millions every year.
(b) Riots, Strikes and Malicious
Damage: - These are perils, which
every property owner faces. During
Riots miscreants’ damage, Public
and Private property, loot stores,
inflict injury or death to innocent
people and the police personnel and
bring business to a standstill causing
untold damage. Similarly strikes
sometimes turn violent resulting in
damage to life and property.
Vandals target unoccupied houses
when the proprietors are on
vacation and damage the property,
in some cases setting it on fire.
(c) Accidents: - Accidents are
caused by people and they cause
injury to themselves or to others
and also damage to property. A
carelessly dropped cigarette can
lead to fire resulting in heavy
losses to property and even life.
Thousands of workers lose their
lives and limbs every year in
industrial accidents caused by
human error or carelessness.
3. Economic Perils:
The examples of this type of Risk
are Depression, Inflation, Local
fluctuations and the instability of
Industrial firms.  This fluctuation in
the general economy can cause
unfavourable deviation from the
expectations and create risks for
both Industries firms as well as
individuals.
 Hazards
Hazards are the conditions that increase the severity of loss or the
conditions affecting perils. These are the conditions that create or
increase the severity of losses. Hazards can be classified as follows:

Types of Hazards:
Physical Hazards: Physical hazards are actions, behaviors, or
conditions that cause or contribute to peril. (Example stocking
crackers in a packed commercial complex increases the peril of fire).
Intangible Hazards: More or less psychological in nature (Attitude &
Culture)
Moral Hazard –Morale Hazard –Societal Hazard
• Moral Hazard – (Fraud): Increase in the possibility or severity of loss
emanating from the intention to deceive or cheat. Putting fire to a
factory running in losses
• Morale Hazard – (Carelessness): Carelessness or indifference to a loss
because of the existence of insurance contract. For example –
smoking in an oil refinery, careless driving etc.
• Societal Hazard – (Legal & Cultural): The increase in the frequency and
severity of loss arising from legal doctrines or societal customs and
structure. For example, the construction or the possibility of
demolition of buildings in unauthorized colonies.
 What is Risk management?
• 
 Risk Management
It includes the identification, analysis and economic
control of those risks, which can threaten the assets or
earning capacity of an enterprise.
Risk management is concerned with direction of
purposeful activities towards the achievement of
individual or organizational goals. Risk can be
prevented, reduced, shifted, spread and accepted.
Risk management helps a business to face risk in a better and
prepared manner. Thus risk management is a process, which
assures that:
• Achievement of aim is more likely to happen
• Harmful things do not happen or are less likely to happen
• Advantageous thing will be or more likely to be achieved.

‘Risk management is an integrated process of delineating (define)

specific areas of risk, developing a comprehensive plan,
integrating the plan, and conducting the ongoing evaluation’ – Dr.
P.K. Gupta.
 Objectives of Risk Management
• Preserve the operating effectiveness of the organisation.
• Facilitates an organisation in the avoidance of great financial
losses that may result into bankruptcy.
• Provides security to employees from accidents that might
result in death or injury.
• Contribute to effective utilization of resources.
• Helps in maintaining good relations with society and public.
• Contributes to reduced cost of handling risks.
 Features and Benefits of Risk Management

• Evaluate the risk faced by the business enterprise

• Create the right business policies and strategy
• Manage and control men and machines effectively
• Create risk awareness and understanding among the people
• Effectively handle and monitor risks
• Decides which risks are worth taking/pursuing and which are not
• Decide whether to take insurance or not
• Select the suitable technique or method to handle the risks.
 Limitations of Risk Management

1. Leads to time wastage in dealing with risk of losses that are

not likely to occur.
2. Spend too much time on risk assessment.
3. Risk assessment is subjective and lacks consistency.
4. Concentrating too much on the risk management process
of a project may keep an organization away from ever
completing that project.  
 Risk Management Process

1. Establish the Context

2. Risk Identification
3. Risk Assessment
4. Potential Risk Treatments
5. Review and Evaluation of the Plan
1. Establish the Context :
The purpose of this stage of planning enables to
understand the environment in which the respective
organization operates, that means the thoroughly
understand the external environment and the internal
culture of the organization. There is a need to map the
scope of the risks and objectives of the organization.
2. Risk Identification:
Risks identification can start with the source of
problems, or with the problem itself. Risk identification
provides the foundation of risk management.
Risk identification requires knowledge of the
organization, the market in which it operates, the legal,
social, economic, political, and climatic environment in
which it does its business.
3. Risk Assessment :
Once risks have been identified, they must then be assessed
as to their potential severity of loss and to the probability of
occurrence. These quantities can be either simple to measure,
in the case of the value of a lost building, or impossible to
know for sure in the case of the probability of an unlikely
event occurring.
Therefore, in the assessment process it is critical to make the
best educated guesses possible in order to properly prioritize
the implementation of the risk management plan.  
4. Potential Risk Treatments:
Once risks have been identified and assessed, all techniques to
manage the risk should be considered for implementation.
a) Risk Transfer: (Transfers whole or part of the losses -insurance) 
b) Risk Avoidance: (Not entering a business to avoid the risk of
loss)
c) Risk Retention: (Risk assumed by the party or a deliberate
decision to retain)
d) Risk Control: (Controlled by avoidance or by controlling losses)
5. Review and Evaluation of the Plan :
Risk management plans should be updated and evaluated
periodically depends on situations and changes.There are two
primary reasons for this –
• a) To evaluate whether the previously selected security
controls are still applicable and effective and 
• b) To evaluate the possible risk level changes in the business
movement.
 Various means of Managing Risk

a) Avoidance
b) Loss Prevention
c) Loss Reduction
d) Separation
e) Duplication
f) Diversification
a) Avoidance - Avoidance is
the best means of loss control.
This is because, as the name
implies, you are avoiding the
risk completely. If your
efforts at avoiding the loss
have been successful, then
there is a 0% probability that
you will suffer a loss.
b) Loss Prevention – Loss
prevention is a technique that
accepts the risk but attempts to
prevent the loss as a result of it.
For example, storing inventory in
a warehouse means that it is
susceptible to theft. Prevent this
by patrolling security guards,
video cameras, and secured
storage facilities.
c) Loss Reduction- This
technique will seek to minimize
the loss in the event of some
type of threat. For example, a
company might need to store
flammable material in a
warehouse and decides to install
state-of-the-art water sprinklers in
the warehouse. If a fire occurs, the
amount of loss will be minimized
d) Separation- Separation is
a risk management technique
that involves dispersing key
assets. This ensures that if
something catastrophic
occurs at one location, the
impact to the business is
limited to the assets only at
that location.
e)Duplication–It essentially
involves the creation of a
backup plan. This is often
necessary with technology.
A failure with an
information systems server
should not bring the whole
business to a halt.
f) Diversification
-Diversification is a risk
management technique that
allocates business resources
to create multiple lines of
business that offer a variety
of products and / or services
in different industries.
Diversify investments.