The Role Of Risk Management In Producing An Effective Method Of Handling Risks

Risk is a part of every day life, it is at the heart of free market societies, since it creates a

chance for profits to be made. As such it can be defined as the combination of an event

and it's consequences. Inverse to this is that risks can also have a down side to them,

and may destroy the very enterprises that they help create.

It is for this pivotal reason that it is necessary for firms to seriously have procedures

to adequately respond to the risks that they face. The two major categories of risks

poised to an organization are;

Speculative risks- Where a specific value of capital is knowingly put at risk in the hope

 that a profit may be derived from it. E.g. pricing decisions or marketing strategies.

Operational risks- where something unforeseen and unpleasant happens to the organization

 or it's responsibility. E.g. loss of client information after a computer hitch.

The structured process of responding to risk is known as risk management, and is implementable to all types of firms, from service providers such as HMOs' to industrial equipment production firms.

The risk management process

The process follows a rather similar approach, where we begin first identifying risks

that affects the earning capacity of the firm. E.g. is there a risk that contracted health providers will fail to maintain desired level of service? Can the regulators fail to renew our operational licenses? Can client information leak out of the organisation to unauthorized third parties?

This process of risk identification can be done in various ways using various tools available

to the risk manager.

The identified risks will then need to be assesed and analysed, using methodologies such as; dependency models, and hazard indices.

Such analysis can either be qualitative or quantitative in nature. Depending on what kind of risks we are measuring and the background knowledge of the user of this information. Qualitative analysis is generally subjective in nature and is used by business managers without statistical background, whereas quantitative analysis is statistical in nature and used by the actuaries and the likes.

Having analyzed the risks affecting our organisation it is necessary for the risk manager to prioritise this in relation to the risk appetite of the organisation; that is at what point is the risk a problem to the organization, this is based on the corporate philosophy and the type of risk.

Prioritization of risk is also dependant on statutory and management requirements.

Once this task has been accomplished risk control plans must be put in place to bring either eliminate this risks completely or to bring them down to acceptable levels. Such plans must essentially include business continuity plans which will enable an organization manage through an exposure once it has occurred.

Various types of exposures will require various types of controls. Taking the example of a health insurance provider, the various risks that it can be exposed to will include;

Risks within the service chain, and the chances of that chain being broken, leading to non delivery of service.

Technological and e-commerce risks which has been brought about by the use of the internet to sell products across borders.

Damage risks to its physical assets and its people.

Intellectual asset exposures including the leakage of organizations’ information to third parties, reputation and brand risks.

Liability risks such as those associated with the public, its products, employees, workplace legislation and even professional indemnity.

Product risks is worthy of mention on it’s own and the risks under this exposure include, quality control, brand risks, research and development exposures and product recall.

Other exposures will include, political risks, external environment risks, contractual risks and counter party risks.

Various options exist to control exposures; they can be classified into;

Retained risks- those risks which after analysis were seen to be better of managed within the organization. Methods include;

Self insurance or funding where the organization say sets up a fund from which dental and optical claims can be financed.

Captive insurance company; where a completely autonomous organization or subsidiary is set up to manage its exposures. This has tax incentives for large multinationals that can use the strengths of their balance sheet to manage their risks.

Absorbing the exposure as a risk to the organization, this is best seen in the retail supermarket where shoplifting, or stock shrinkage is a simply factored in as a loss to the organization.

Any financing method must be thoroughly analysed including a cost benefit analysis. And a written plan must be prepared and implemented to ensure that no potentially destructive risk is left unmanaged.

It is important to note that some of the killer risks to an organization are often without any form of insurance to protect them. Hence innovative ways must be thought out by the risk manager of how to best handle these exposures.

Transferring risks-this is transferring the consequences of any exposure to a third party to whom the organization bears no responsibility. Can be done through;

 Use of contract wordings, thereby ensuring that risks are not brought into the organization or those risks are transferred out of the organization. It is important to however note that in the event that the counterparty fails to meet its obligation, the risk will inevitably fall back on the risk manager’s organization, which may inevitably be less prepared to handle it.

Risks can also be transferred through the insurance industry, which is best for low frequency, high severity risk since it brings down the cost of protection by effecting the benefits of the law of large numbers.

However as stated earlier conventional insurance is not available for some types of risks, especially those catastrophic in nature. This has led to the creation of what is known as the alternative risk transfer mechanisms (ART) such instruments transfer risks into the capital markets of the world therefore ensuring a wider capital base against exposures.

Such control plans should be frequently reviewed and monitored to ensure they remain up to date and relevant.

Summary

The brief over view shows that every organization should with the help of a professional risk consultant, seriously conduct an in depth look at the exposures that they carry to ensure that these don’t hinder them from attainment of their objectives, and also to ensure that the risk are managed in the most cost effective manner to ensure maximum value to an organization and it’s stakeholders.