The Concept of Risk Management

Risk management is the systematic identification, analysis and economic control of the risks whichthreaten the resources or earning powers of an enterprise.  This definition has the main important elements. These elements are:

(i)                  identification

(ii)                analysis

(iii)               economic control

Before we can measure risks, we first have to identify it and before we can know what to do with risk, we must first assess their possible impact on the enterprise.  The concept of risk management is broader than insurance.

Insurance is an aspect of risk management.  It is one of the methods of managing risk.  Insurance only deals with insurable risks, that is, the pure risks.  If you would remember, we said in an earlier chapter that insurance only deals with pure risks.  Risk management on the other hand deals with the pure risks that are not insurable.

This means that insurance only deals with the insurable risks, that is, the pure risks, while risk management deals with both insurable risks, (pure risks) and those risks, which are not insurable. 

Risk management deals with all manners of risks that threaten the resources and earning powers of an organization.  This simply means that insurance is a part of risk management process.

The first thing risk management does is to identify the risks that confront an enterprise, then it will evaluate the possible impact of the risk on the enterprise and finally decide on the best risk management technique to be used to control the risk.

Risk Identification: very organization is exposed to different kinds of risk that can cause financial loss.  So it is necessary to identify all such risks which threaten the organization.  The process of identifying these age risks is known as the process of risk identification.  This process entails the use of risk identification aids to identify all those areas where company could suffer financial.

A risk manager is a specialist in detecting risk exposure areas, but he is not limited to any one particular function of the organization.  That is he is also in a way a generalist.  For example, a architect may detect risks in his area, an engineer may detect risks in his and a builder may detect risks in his.  It is the job of the risk manager to co-ordinate all their activities.

Before deciding on the appropriate technique to use in identify risk, a risk manager must first carry out the physical inspection of the premises.  This may involve taking a brief inspection walk round the factory to complement what information he may have gathered by reading the company’s publicity material, or obtained from the factory manager.  This walk would familiarize him with the factory and help him identify risk.

After familiarization tour, the risk manager would decide on the appropriate risk management technique to be used.  The following are some of the risk identification techniques that can be used:

(i)                  organizational chart

(ii)                flow chart

(iii)               check list

Organizational chart: Organizational chart shows the organizational structure of the enterprise or plant.  It gives a graphical view of the existing relationship between and among different employees.  The chart could help the risk manager to quickly identify weaknesses in the organizational structure which could cause problem.  For example, the chart may show that the works manager has to follow a long and cumbersome procedure in reporting accidents.  The risk manager may consider the procedure to be inefficient and ineffective.  As a result of this, the risk manager may decide to streamline the system to ensure that the risk manager gets more effective information without delay.

Flow Chart : Flow chart, as a risk identification technique is more popularly used in organizations where the system of manufacture or production entails materials flowing through a process.  For example, the procedure involved in the production of Bournvita.  The main ingredient in the production of Bournvita are Cocoa, Sugar, in the cause of processing cocoa produces a bye product which is used for the production of cocoa butter.

For example, the risk manager would have to anticipate the possible effect of the destruction of plant 3 by fire on production process and on all the production process and on all those who transact business with the organization.  For instance, how would the loss of plant 3 affect the subsidiary which supplies raw material X?, will the organization have to cancel the contract it entered with customers for the supply of raw materials “Y” and “K” will the organization be held liable for breach of contract for failure to supply products “Z” and “P” will the organization have to lay off workers pending the reactivation of plants?  Will the spare parts be readily available? Will the skilled engineers required for the reactivation readily available?

Will the required finance needed for the reactivation be available.  Those and many more questions will catch the mind of the risk manager and he will answer them if the organization’s risk is to be properly managed.

Check List: This is another technique used in identifying risk.  This technique involves the risk manager in asking the same series questions about each item of plants in the factory.  To start with, the risk manager will list the areas of activity in an organization and then ask the of some series of questions about each area.  The questions would relate to the risk to which the plant could be exposed.

Risk Evaluation or Risk Analysis : After the risk manager has identified the risk, the next stage is for the risk manager to evaluate the risk, the possible impact of the risk on the enterprises.  The evaluation could be carried out by a qualitative or quantitative method.

The qualitative method involves the risk manager making some qualitative evaluations of the possible effects of which specific events would have on the enterprise.  The evaluations would be based on the study of the flow chart.  If the enterprises has no accurate records of past experiences, the risk manager would only be able to carryout qualitative evaluations.  The qualitative evaluation is based on past experience of the risk manager.

Qualitative evaluation is suitable to situation where the enterprise has reliable records of past experiences, qualitative evaluations would produce every good results.  If the records are not reliable, qualitative evaluation would produce poor results.  The  value of quantitative evaluation lies on the accuracy.

Of the records used for the evaluations.  For example, if a risk manager has kept accurate of theft losses, he would not have any problem in carrying out a quantitative evaluation, but this would be difficult to do without such records.

Risk Control: The reason why risk is identified and evaluate is to enable the risk manager decide how best to respond to it. Risk control is divided into two, these are the physical control of risk and the financial control of risk.  The primary objective of the risk manager is to secure an economic control risk.  For example, it would be uneconomic to spend $100.00 to prevent a loss of $50.00.

Physical Control of Risk:  We live in an environment, where we face one form of risk or another.  This reality has made it necessary for us to device ways of reducing and if possible prevents losses. Loss reduction is synonymous to loss prevention.  The best thing, is to prevent losses from occurring.  For example, if a worker is injured at work, the employer may have to pay compensation to him.  In addition, the employer would have to train another person to do the work of the injured worker.  There may be a loss of production at the end of the day, the employer may suffer a loss of profit. Consequent on the loss of production.  Also, the society would suffer as a result of the loss in the output of the enterprise, and so on.  So the injury suffered by the employee, would create a succession of losses.

If the employees’ injury had been anticipated in sufficient time and steps taken to prevent its occurrence, this subsequent chain of losses would have been prevented.

Risk Elimination: Another way to prevent loss is to eliminate it.  Just as it possible to eliminate some risks, it is however very impossible to eliminate others.  For example you can eliminate the risk of getting involved in a motor accident, by not travelling in motor vehicle you can eliminate the risk of getting drunk, by not taking alcohol, you can eliminate the risk of getting pregnant by not having sexual intercourse etc.  On the other hand, the risk of pregnancy which women go through is very high, but we shall not say that because of this risk, woman would no longer bear children.  Otherwise man would become extinct.

You may be worried by the possibility of your house being damaged by fire, but you would not consider selling the house just to eliminate the risk.

Loss Minimization: Since it is not possible to completely eliminate all risks, it becomes necessary to devise means of minimizing or reducing the effects of those risks that cannot be eliminated.  Loss minimization or reduction can be effected in two ways:

-The pre-loss minimization and post loss minimization efforts.

Pre-Loss Minimization: This involves taking the necessary steps before the occurrence of adverse event to reduce their impacts on the enterprise.  For example, the wearing of crash helmet by motor-cyclist or the wearing of seat belts in private cars.  Another examples is the deliberate policy of a motorist to drive within the speed limit permitted by law.  The effects of these would be seen in reduction of the frequency of occurrence of accidents and their services whenever they occur. It is customary for employers to guard dangerous machinery that could injure employees.  This is to ensure that employees are not injured.

Post-Loss Minimization: This entails minimizing losses after an accident has occurred.  This takes the form of salvage operation.  For example, if a fire breaks out in a house, effort would be made to remove some of the center of the house that have not been torched by fire out into safety.  This operation would help to minimize the extent of the fire loss. Also, the use of fire sprinkler is a good example of a device that can help minimize loss once fire has broken out.