Section c Practice I

Read the text about risk management and define the two main types of risk, according to the text. Do the assignments below.

1. The scientific method of planning to deal with losses is called risk management. A risk management program usually involves three steps:

1. Identifying and measuring exposures to loss.

2. Developing and implementing plans to deal with potential losses after they have been identified.

3. Regularly revaluating and updating the risk management program.

IdentifyingandMeasuringExposures

2. The recognition that a problem exists is always the first step in solving the problem. Recognizing one’s exposure to loss requires organized thinking about the subject. One starting point is to categorize the sources of loss into speculative or pure risk exposures. Speculative risks are exposures that can result in gains or losses and usually are not the subject of risk management. Losses and gains that result from bad and good management decisions, from a competitor’s actions, or from government intervention in the economy are examples of speculative risks, and these are usually outside the scope of the risk manager’s responsibility. Price fluctuations in commodities or foreign currencies, however, can result in gain or loss, and this speculative risk can be managed with a hedging program.

3. On the other hand, pure risks can result only in losses and usually arise from the following sources.

1. Direct losses of property.

2. Indirect losses of income because normal business activity has been interrupted by a direct loss.

3. Liability losses.

4. Losses due to death or disability of key personnel. These pure risks usually can be managed once they have been identified and measured. Regarding measurement, it is well to remember that, before a loss occurs, measurement is merely an estimate. Not all preloss estimates will necessarily reflect with accuracy the actual amount of damages or even the actual amount of exposure to loss.

Developing and implementing a risk management program

4. After all potential sources of loss have been identified and measured, it is the job of the risk manager to develop and implement plans to deal with the potential losses before they occur. Accomplishing this task demands a knowledge of the alternative methods of dealing with risk, the uncertainty about loss. In addition to insurance, six other methods of dealing with potential losses are:

1. Risk avoidance.

2. Risk assumption.

3. Self-insurance.

4. Loss prevention.

5. Loss reduction.

6. Risk transfer other than insurance.

A thorough risk management program is the result of the consideration of all these alternatives rather than these alternatives rather than the reliance on just one method of dealing with an exposure to loss: In every case the risk manager will carefully weigh the ratio of the costs of a particular risk management approach with the potential benefits to be produced. Since unlimited budgets for risk management are not the rule, spending priorities must be established. Also determining the choice of an appropriate tool are an estimate of the chance of loss and an estimate of the severity of a potential loss.

5. Once a decision has been made to treat an exposure to loss with a given risk management tool, the decision must be implemented. For example, if it has been decided to purchase insurance, arrangements must be made to acquire the proper amount of insurance at the best possible price accompanied by all the service needed or desired. Equally important, once the insurance is in force, the risk manager must be familiar with the terms of the contract so that none of the firm’s actions cause the coverage to be suspended or the conditions of the contact to be breached in any way either before or after a loss occurs.

6. If a loss prevention program is decided upon, the risk manager must see to it that all affected employees know what the plan’s aims are and what part they are expected to play in the program. The risk manager must remain alert to any advances in safety engineering that make a given operation or plant or store a safer place in which to work.

1. The text mentions three steps which are normally part of a risk management program. From the six actions described below, choose the three, which are mentioned in the text. Identify lines in the text where you find your answers.

1. Carry out an evaluation of all the property in a company.

2. Continue to monitor the effectiveness of a risk management program.

3. Decide which potential losses to deal with.

4. Work out how to handle losses that may occur.

5. Decide where potential losses may occur and calculate their value.

6. Eliminate all possibilities of potential losses occurring.

2. Decide in what order the actions you choose for 2(a) should be carried out, according to the text.

3. Below are some descriptions and examples of risks. Mark those, which refer to speculative risk “SR”, and those, which refer to pure risk “PR”.

   	Description/example	Type of risk
   	Can only result in a loss. Managing director of company dies.
   	Quality of management decisions.
   	Can result in profit or loss.
   	Competitor goes out of business.
   	Because of fire at factory, January sale is cancelled.
   	Price of coffee beans in Brazil rises sharply.
   	Company is sued because of injury to a worker.

d) Listed below are the seven methods of dealing with potential losses. Match the method on the left with the appropriate example on the right.

Method of dealing with losses	Example of method
Insurance	A company forms a subsidiary to provide it with insurance.
Risk avoidance	A building lease includes a cancel option for outdated building.
Risk assumption	A company does not invest in a country where war is likely.
Self-insurance	An automatic fire sprinkler is installed in a warehouse.
Loss prevention	A Los Angeles firm arranges compensation in case of an earthquake.
Loss reduction	A safety officer is employed to minimize staff injuries.
Risk transfer other than insurance	A company decides to bear the possible loss of small tools.

e) Two methods of risk management are discussed in more detail in the text. Below, identify the two methods at A and B. Then write the two main points which are given about each method in the text.

Risk management method A:_________

Main points of method:

(1) _____________

(2) _____________

Risk management method B:_________

Main points of method:

(1) _____________

(2) _____________