1 / 31

Introduction to Risk Management

Introduction to Risk Management. Risk Management Fall 2013. Risk Defined. Risk – possibility of a deviation between actual and expected outcomes Comes from an early Italian word risicare, meaning “to dare” Thus, risk is considered a choice rather than a fate

gagan
Download Presentation

Introduction to Risk Management

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Introduction to Risk Management Risk Management Fall 2013

  2. Risk Defined • Risk – possibility of a deviation between actual and expected outcomes • Comes from an early Italian word risicare, meaning “to dare” • Thus, risk is considered a choice rather than a fate • Consider a risk that is not taken voluntary • Risk is not synonymous with “possibility of loss” or “cause of loss” • Example of starting a new business • Positive vs. negative risks

  3. Traditional vs. Contemporary View • Traditionally, risk and risk management focused on accidental and hazard exposures, with only negative outcomes • Pure risk exposures only • Risk and Risk Management has evolved to take a more holistic approach to encompass negative and positive possible outcomes • Pure and speculative risk exposures

  4. Impetus for Change in Risk Management Focus • Numerous high-profile large organizations failures • Enron • Arthur Anderson • Washington Mutual • Tyco • WorldCom • Financial Crisis of the 2000’s • 2011 Tsunami in Japan – killed approximately 16,000 people • These events made it clear that organizations need to evaluate and manage supply chain risk • Sarbanes-Oxley Act of 2002 • Requires controls to be disclosed and announced by public companies and their registered auditors in financial information. • OECD (Organization for Economic Co-operation and Development and World Bank initiatives and the European Union promoted initiatives and Solvency standards for risk management in financial organizations.

  5. Important Risk Dichotomies • Hazard (or pure) risks and speculative • Traditional focus on specific, catastrophic exposures • Examination of exposures in isolation • Speculative risks include Price and Credit Risk (p. 1.24) • Subjective and objective risk (table p. 1.24) • Diversifiable and non-diversifiable risk • Diversifiable – affects only some individuals, businesses or groups • Fire, theft, embezzlement • Non-diversifiable affects a large segment of society • Unemployment, inflation, and natural disasters

  6. Categories of Risk • Hazard • Includes property, liability, or personnel loss exposures • Operational Risk • Result from the failure in processes, systems, or controls • Financial Risk • Result from the effect of market forces on financial assets or liability; includes market risk, credit risk, liquidity risk, and price risk • Strategic Risk • Arises from trends in the economy and society; changes in the demographic, economic, political, and competitive environments

  7. Why Do We Need Risk Management? • “Ben Bernanke said in 2008 that a significant factor causing the 2008 financial crisis was risk-management weaknesses at large global financial institutions. • “Banks Bundled Bad Debt, Bet Against it and Won” article • http://www.nytimes.com/2009/12/24/business/24trading.html?pagewanted=all&_r=1& • Risk Mitigation and Risk Transfer benefit not only the individual organization but the economy as a whole.

  8. Benefits of Risk Managements to Society • Reduced waste in resources • Improved allocation of productive resources • Reduced systemic risk

  9. RM Tools • Risk Management techniques: • risk avoidance • risk control • hazard or loss reduction • risk retention • risk transfer • Hedging and sub-contracting • Insurance

  10. Total Cost of Hazard Risk • Includes • Costs of losses not covered by insurance or other sources • Insurance premiums or expenses incurred for noninsurance indemnity • Costs of risk control techniques to reduce accidental losses • Costs of administering risk management initiatives

  11. Focus of Risk Management • Reduce the potential loss frequency and loss severity • Reduce deterrence effects of Hazard risks • Reduce and managing the downside risk • Potential loss from new product from delays, errors, cost increases, market decline. • May use stop-loss limits in insurance • Intelligent Risk Taking • Maximizing Profitability

  12. Risk Management Goals • Tolerable Uncertainty • Legal and Regulatory Compliance • Survival • Business Continuity • Earnings Stability • Profitability and Growth • Social Responsibility • Economy of Risk Management Operations

  13. Changes and trade-offs in Goals? • Profitability and tolerable uncertainty • Economy of operations and legality or social responsibility • Growth vs. tolerable uncertainty

  14. Holistic Risk Management • Manages risk across all levels and functions within an organization • Provides a more complete picture of an organization’s risk portfolio and profile • Provides for better decisions and improved outcomes for senior management • Facilitates a complete understanding of the risks involved

  15. Regulatory Requirements • Sarbanes-Oxley Act of 2002 • Requires both the management of public companies and their auditors to assess and report on financial risk and controls • Dodd-Frank Act of 2010 requires that financial bank holding companies and certain other public companies have a risk committee and at least one member of the committee must be a risk management expert • Basel III and Solvency II in Europe provide risk management requirements for financial firms and insurers.

  16. Enterprise Risk Management (ERM) • Holistic approach to risk management • Provides a way to manage all of an organization’s risks, including operational, financial, and strategic risk. • Three theoretical pillars to explain ERM • Interdependency – should not consider exposures as “silo events” • Eg., mortgage loans in different geographic areas are not independent • Correlation – increases risk • Eg., if all suppliers are in hurricane area • Portfolio Theory – assumes both individual risk and their interactions; • Eg., an airline may have increased portfolio risk with increased fuel prices; this will also impact consumer demand

  17. Organizational Relationships • CRO - Chief Risk Officer – reports to both the chief executive officer and the board risk committee • Responsibility includes helping create culture in which divisions, units, and employees become Risk Owners.

  18. Requirements for Implementing ERM • Risk managers must have authority to make and enforce necessary changes, often against significant resistance • Effective Communication • Knowledge of the type of information the CEO and other senior managers need to understand the organization’s risk portfolio. • The ability to avoid “entrenched silos”, decisions made without considering the impact on other divisions or on the overall organization.

  19. Risk Management Framework and Process – Chapter 5 • Components and sets of the RM model

  20. Traditional Steps in the RM Process • Identify and analyze loss exposures • Examine feasibility of alternative management techniques • Select risk management technique • Implement • Monitor and improve risk management program

  21. How do we identify the Risk Management exposures? • survey/questionnaire • loss history of an organization • financial statements • other records and documents • flowchart of organization’s operations • personal inspection of facilities • Professional experts

  22. Examine the feasibility of RM Techniques • risk control techniques - exposure avoidance - loss prevention - loss reduction - segregation of loss exposures - contractual transfers for risk control • risk financing techniques - retention - transfer

  23. Risk Financing • Retention • Current expensing of losses • Unfunded reserve • Funded reserve • Borrowing • Captive • Transfer • Contractual transfer for risk financing • Commercial insurance • Hedging

  24. Focus of Analysis • Potential loss frequency • Potential loss severity • Risk Control to Prevent losses • Risk financing to reimburse for losses • most risk control and risk financing techniques can be adapted to deal with business risks

  25. Select the RM Technique • forecasts • The frequency and severity of the expected loss • The effects of various RC and RF techniques will have on the predictability, frequency, and severity of loss • The cost of the technique • selection criteria • Financial and other constraints

  26. Implement the RM Decision • technical decisions • managerial decisions

  27. Monitor the RM Program • establish standards of acceptable performance • compare actual results with standards • correct substandard performance

  28. Steps to the Enterprise-wide RM Process • Scan the Environment • Identify risks • Analyze risks • Treat risks • Monitor and make sure the process is effective • (chart p. 5.19)

  29. Four components of the ERM framework • Lead and establish accountability • Align and integrate • Allocate resources • Communicate and report

  30. Establishing Accountability • Identify RISK OWNERS and their roles in the organization • Someone who is accountable for the identification, assessment, treatment, and monitoring of risks in a specific environment • Establish Key performance Indicators (KPI) • A measurement that defines how successfully an organization is progressing toward its long term goal • Establish key risk indicators (KRI) and use them to evaluate performance • Develop risk criteria to evaluate the significance of risks

  31. Power, Inc. Case. • Page 5.22-5.5.30

More Related