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Risk Management? -or- When you’re told by a company/person they are a “Risk Manager” please ask “What kind of RISK are you talking about?”
(Please note that much of the information in this article comes from hours spent in classroom study at The National Alliance academy classes for Risk Management of which I am a member. It’s through these classes that I became a Certified Risk Manager.)
In my last semi-occasional post, I described |
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my “identity crises” where I suggested I’m not sure what to call myself professionally. It generated some questions as to what risk managers are and what they do. Admittedly, this article is a bit lengthy, but then again real risk management (sometimes called Enterprise Risk Management) is an all encompassing venture. Please allow me to explain……
In its simplest form, risk is the chance of loss. It can also be defined as uncertainty concerning loss, or the possibility of more than one outcome from a given set of |
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circumstances. A forth definition is the difference between expected losses and actual losses.
There are three types of loss. Pure – chance of loss only, Speculative – chance of loss or gain, and Gambling – where the chance of loss or gain (odds) favor a loss.
Risk comes in many forms or classes.
Economic risk comes from things like a companies operations, the marketplace, losing money on financial decisions. You may recall the addition of New Coke to Coke-a-Cola’s product line as an example of a bad idea. Coke thought it would bite into the Pepsi market share, but it just never went over well. Or how about the major auto companies risk of hybrid cars? Fine when gas hit $4.00 a gallon, but when it went back to half that amount the sales fell off a bit.
Legal risk includes liability issues as well as compliance and statutory issues. Things like the EPA or building codes that require adding updates when remodeling etc.
There are also Political Risks, including legal changes, government (re)interpretations or whims. Changes in the interest rate or other various violations are an example of Political Risk.
Social risk has to do with public relations, reputation, cultural problems or losing touch with social direction.
Physical risk is the form we are most familiar with covering property, people, information etc. Finally there is juridical risk involving jury decisions or a decision from a judge, like the $34 million for the leg cut off the violin player who fell under the train in Chicago.
The question for all these risks is: how do we best deal with them? Can we insure them at all, and if so at what cost? Finally, are there better ways to efficiently handle our risk? That is the essence of risk management- let’s take a closer look.
What is Risk Management? The origins of sharing risk go as far back as the Bible. In Deuteronomy 22:22 it says “build a parapet around your house to keep people from falling”. The Babylonians have claim to the oldest known written laws, called the Hammurabi Code, where responsibilities of physicians and various tradesmen were explained. The code outlined penalties for various injuries and explained that their compensation depended on the person’s station in life.
More of us are familiar with Edward Lloyds coffee shop (some say it was a pub – I’m not sure which it really was) where ship owners met prior to setting sail for America and other ports. Today we worry if the Stock Market falls 400 points – they had much greater risk of losing everything they owned in one trip. They were afraid of losing their cargo while at sea, which for them meant in all likelihood they lost their ship too!
This is what defines insurance even now. Ship owners spread the risk among themselves willing to take a small loss to offset the possibility of a large one. This is basically how insurance works today. We substitute a small certain loss in premium, to offset the possibility of a large uncertain claim loss. Ship owners would post the details of their trip and other would sign on lines below that they would cover the loss if it occurred. Thus the term Underwriter… and Lloyds of London was born.
Certified Risk Managers International defines Risk management as: “Even though various definitions of risk management exist, the basic premise is to protect organizations assets through identification and analysis of exposures, control of the exposures, financing of losses with external and internal funds, and implementation and monitoring of the risk management process”.
In a future post I may break this definition down and look at each of its parts, but first, let’s look at the overall cost of risk.
There are several components to the overall cost of risk including, but far more reaching than insurance premiums. In addition to insurance premiums many times there are other fees associated with the placement of insurance. The cost of retained losses and risk management fees for persons involved in the identification and control of risk are always present. Consultants, third party administrators, legal and actuarial costs may be added. Finally other considerations such as loss of productivity, overtime, and lost opportunity costs in the event of a loss must be counted. The risk management process oversees all of this and much more.
You can see that if you call yourself a risk manager you should be qualified to deal with all these areas of the risk management process. Unfortunately there are many insurance people and companies who claim to be risk managers but in reality only deal with a very small piece of the overall process. They usually do some sort of loss control work and then any solution they offer involves some insurance component. The fact is these people call themselves anything they want, so you must determine their qualifications. Now let’s look at the overall process.
The Risk management Process
Risk Identification The definition of Risk Identification is the process of identifying and examining the risk exposures of an organization. It includes looking at Buildings/Property, Liability issues, Human Resources and net Income. Identification Methods include: Checklists/surveys, flowcharts, insurance policy analysis, physical inspections, compliance review, contract identification/analysis, policies &procedures review, loss history review, and net income review.
Risk Analysis The analysis of risk is both Qualitative and Quantitative. Qualitative Analysis – (the what) includes risk assessment, financial assessment, and loss data assessment. Quantitative Analysis - (how much) includes quantify exposures, project losses, cost of risk calculations, cost benefit analysis and deductible/retention analysis.
Risk Control Risk control happens pre-loss as well as post loss. Pre-loss includes: avoidance, prevention, reduction, segregation, physical transfer or any combination. Post loss deals with claims management, litigation management and disaster recovery.
Risk Financing Risk Financing involves paying for your risk and can be assumed (retained) or transferred. As an example many people assume the risk of loss by driving without insurance coverage. Retention is either passive or active and transfer is either by insurance or non-insurance methods.
Risk Administration The administration of the risk management process includes planning – which is a huge part of the process touching every aspect of the company. Following the implementation of various types of policy development (insurance or non-insurance) the risk manager monitors the overall plan to make any necessary corrections.
OK – I hope you are still awake after that …. But as you can see the risk management process is very much all encompassing, including, but not limited to the insurance aspects alone. That is why it concerns me when some insurance agents or companies say they are risk managers or simply advise to check their website for your risk management advice. Certainly what they offer is very valuable information – no question there, but in my opinion their collective focus is too narrow to truly be called Risk Management as outlined above. Yes, insurance is a big component in a company’s overall risk management program and should be taken seriously. But I believe much of what these folks offer is loss control for the insurance component of your overall program – which makes since because it’s where they fit in the process. If they are not dealing with every part of your business they are not effectively dealing with your “Risk” because it’s all tied together. Every aspect of your business relates to your overall risk. You would think that an industry that is so concerned with the exact definition of words would be more careful in defining their services.
Enough already – remember you wanted to know.
Next time we’ll take a close look at “The Wedge.” |
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