Risk management involves identifying, analyzing, and taking steps to reduce or eliminate the exposures to loss faced by an organization or individual. The practice of risk management utilizes many tools and techniques, including insurance, to manage a wide variety of risks. Every business encounters risks, some of which are predictable and under management’s control, and others which are unpredictable and uncontrollable. Risk management is particularly vital for small businesses, since some common types of losses such as theft, fire, food, legal liability, injury, or disability- can destroy in a few minutes what may have taken entrepreneur years to build. Such losses and liabilities can affect day-to-day operations, reduce profits, and cause financial hardship severe enough to cripple or bankrupt a small business. But while many large companies employ a full-time risk manager to identify risks and take the necessary steps to protect the firm against them, small companies rarely have that luxury. Instead, the responsibility for risk management is likely to fall on the small business owner. The term risk management is a relatively recent (within the last 20 years) evolution of the term insurance management. The concept of risk management encompasses a much broader scope of activities and responsibilities than do insurance management. Risk management is now a widely accepted description of a discipline within most large organizations. Basic risks such as fire, windstorm, employee injuries, and automobile accidents, as well as more sophisticated exposures such as product liability, environmental impairment, and employment practices, are the province of the risk management department in a typical corporation. Although risk management has usually pertained to property and casualty exposures to loss, it has recently been expanded to include financial risk management-such as interest rates, foreign exchange rates, and derivatives –as well as the unique threats to businesses engaged in B commerce. As the role of risk management has increased, some large companies have begun implementing large-scale, organization-wide programs known as enterprise risk management.
Risk Management is a “process for managing the risks that we can identify and insuring those we can’t manage.” It uses accepted managerial techniques in order to preserve the assets of the organization or entity. It is essential to prevent financial disasters and achieve the objectives of capital management. The Risk Management process is comprised of two separate, but equally important components, risk control and risk financing.
The procedure to be followed in risk management is as follows:
- Identify the risk situation
- Measure the amount of risk that can be caused.
- Find out what are the chances of recurrence of the risk.
- Is there an alternative?
- Prioritize the process.
According to C. Arthur Williams Jr. and Richard M. Heins in their book Risk Management and Insurance, the risk management process typically includes six steps. These steps are
- determining the objectives of the organization,
- identifying exposures to loss,
- measuring those same exposures,
- selecting alternatives, implementing a solution, and
- monitoring the results.
The primary objective of an organization-growth, for example-will determine its strategy for managing various risks. Identification and measurement of risks are relatively straightforward concepts. Earthquake may be identified as a potential exposure to loss, for example, but if the exposed facility is in New York the probability of earthquake is slight and it will have a low priority as a risk to be managed. Businesses have several alternatives for the management of risk, including avoiding, assuming, reducing, or transferring the risks. Avoiding risks, or loss prevention, involves taking steps to prevent a loss from occurring, via such methods as employee safety training. Risk management consists of identification, measurement and control risk.
Identification of risk
It is the determination of the risk where does it lie. The risk may be related to property, life, liability and nature. Fire theft, damage, natural calamities are the various hazards. Identifying Potential Losses Potential losses consists of Property loss exposures, Liability loss exposures, Business income loss exposures, Human resources loss exposures, Crime loss exposures; Employee benefits loss exposures and foreign loss exposures.
Evaluating Potential losses
This is important so that the various loss exposures can be ranked according to their relative importance. In addition, the relative frequency and severity of each loss exposure must be estimated so that the risk manager can select the most appropriate technique, or combination of techniques, for treating the loss exposure. While evaluating risk, the following rules must be kept in mind:
- Don’t risk more than what we can afford to lose: Consider the impact of a risk. If the impact is going to be fatal or unbearable, it is prudent to insure the risk. For instance, the death of an earning member of the family can prove fatal to the financial health of the rest of the family members. This is a loss that the family cannot afford to risk. Therefore, it is important to insure the life of an earning member.
- Consider the odds of a risk occurring: If the probability of the risk occurring is high, insurance may not be the solution. For instance, if a jeweler has a shop in an area prone to high crime, it is recommended to move the shop to another, more safe area. In this case, insurance may not be the solution.
- Don’t risk a lot for too little: If the cost of acquiring insurance is very low compared to the potential loss, then it is recommended to undertake insurance.
Selecting the appropriate technique
Once risks have been identified and assessed, all techniques to manage the risk fall into one or more of these four major categories
- Avoidance (eliminate, withdraw from or not become involved)
- Reduction (optimize mitigate)
- Sharing (transfer – outsource or insure)
- Retention (accept and budget)