Risk, at the general level, involves two major elements: the occurrence probability of an adverse event and the consequences of the event. Risk estimation, consequently, is an estimation process, starting from the occurrence probability and ending at the consequence values. Risk evaluation is a complex process of developing acceptable levels of risk to individuals, groups, or the society as a whole. Generally there are several risk management strategies that can be employed to mitigate risk exposures. The strategies can be broadly categorized into three; risk control, risk financing and risk transfer.
This is a strategy that focuses on minimizing the risk of loss to which an organization is exposed. Techniques used are avoidance and risk reduction.
- Risk avoidance – this occurs when decisions are made that prevent risks from coming into existence in the first place, example an organization can avoid risks deciding not to engage in activities which it considers high risk e.g manufacture of explosives or poisonous substances. Risk avoidance should only be used where exposure to risk is catastrophic and the risk cannot be transferred or reduced. Risk avoidance is a negative approach for managing risks because the advancement of personal and economic progress requires risk taking and if risk avoidance is used extensively the organization is unlikely to achieve its primary objectives.
- Risk reduction– Risk reduction consists of all techniques that are designed to reduce the likelihood of loss or the potential severity (impact) of such losses should they occur. Efforts to reduce the likelihood of loss are referred to as loss prevention, while efforts to reduce the severity of loss are referred to as loss control.
Consideration of risk reduction
- Reduction of like hood of loss can be done through putting up signs such as no smoking sign on a petrol station or installing protective devices around machinery to reduce the number of injuries to employees. This will reduce frequency of loss or their probability.
- Reduction of severity of impact of loss. These can be done or demonstrated installing sprinkler or five extinguished or separation and dispersions of the company assets to different location in an effort to salvage company assets in case of loss.
- Engineering approach to loss prevention. This approach focuses on removal of hazard. It focuses on system analysis and mechanical unavoidable e.g air bugs can boost safety belts in vehicles.
- Human behavior approach on loss prevention. This approach focuses on the elimination of unsafe acts the person. This approach is based on the fact that most accidents are as a result of human failure e.g. alcohol and drug consumption fatigue among others.
- Timing of risk reduction measures Such measures may be designed for prior to the loss event, during the loss event and after the loss events. Measures prior to loss include:
- Training of personnel – measures before
- Measures during five; five:
- Fastening seat belts
Measures after the event may be:
- Rush victim to hospital
- Offer first aid
These concentrate on availing the funds to meet the losses arising from risks that remain after the application of risk control technique of measure. Risk financing include:
- Risk retention
- Risk acceptance
i) Risk retention/ self insurance
This is the most common method of dealing with risks whereorganization and individual face unlimited number of risks most of which nothing can be done about.
Risk retention can either be conscious (intentional) or unconscious (unintentional). It can also be voluntary or involuntary and even be funded or unfounded. When nothing can be done about the particular exposure then the risk is retained. It is in last resort on risk management strategy wherethe risk cannot be avoided, reduced or transferred. The self-assumption of risk consists of waiting for the event to happen with no effort to any financial provision in advance for the occurrence of risk. In some instances the individual subjected to the risk may provide some amount in advance to cover for the anticipated financial consequences of the risk normally referred to as self-insurance.
The major disadvantage of using insurance reserve is that:
- The amount set aside may be more or less at the time when the risk occurs.
- A loss may occur before the fund is sufficient to meet the risk
- There are chances that this fund may be mismanaged or may be misused the firm
Self-assurance is normally possible where there is a large number of risks and more of them have a large number of value. These objects are distributed such that the possibility of the risk occurring to all of them at the same time is minimal. As a general rule, the risks that are retained are those that need small losses.
Classes of risk retention
- Unintentional risk – It occurs when a risk is not recognized so that an individual or organization may unknowingly or unwillingly retain the risk of loss.
- Voluntary retention – Results from a decision to retain risk rather than avoid or transfer that risk. Sometimes voluntary retention will occur when a risk manager purchases insurance that does not cover fully the risk exposure.
- Involuntary retention – occurs when it’s not possible to avoid or reduce or transfer an exposure to an insurance company.
NB Voluntary retention occurs when its not possible to transfer, refer or avoid risks of loss e.g. death or earthquake.
- Funded Retention – This is where an organization sets side assets that are held in liquid or semi-liquid. To cater for the risk of loss. Such risks are visually accepted or retained the entity.
- Unfunded retention – Is a case where there are no budgeted allocations to meet uninsured losses.
Advantages of retention
- Saves money-The firm can save money in the long run if its actual losses are less than the loss allowance in the insurer’s premium.
- Lower expenses- The services provided the insurer can be provided the firm at a lower cost.
- Encourage loss prevention-Since the exposure is retained; there may be greater incentives for loss prevention.
- Increase cash flow- Cash flow may be increased, since the firm can use funds that normally would be held the insurer.
Disadvantages of retention.
- Possible higher losses-The losses retained the firm may be greater than the loss allowance in the insurance premium.
- Possible higher expense- Expenses may actually be higher
- Possible higher taxes- Income taxes may also be higher as the premiums paid to the insurer are income tax deductibles.
Is the shifting of the risk burden from one party to another. This can be done through several ways;
- Through risk allocation, where there is sharing of the risk burden with other parties. This is usually based on a business decision when a client realizes that the cost of doing a project is too large and needs to spread the economic risk with another firm. Also, when a client lacks a specific competency that is a requirement of the contract, e.g., design capability for a design-build project. A typical example of using a risk allocation strategy is in the formation of a joint venture.
- Through purchase of insurance. Wherein consideration of a specific payment (premium) one party, the second party contracts to indemnity the first party against specified loss that may or may not occur up to a certain limit.
- Subcontracting whereif an employee accepts work which they are not fully competent without the assistance of others, they can subcontract the extra work. Extra work would involve specialist work which that employee lacks the knowledge to handle; or which would involve excessive amount of work beyond the capability of that employee.
- Through the use of contract indemnification provisions
- Leasing and renting
RULES IN RISK MANAGEMENT
The following are the guidelines:
- Do not risk more than you can afford to risk. This does not tell us what needs to be done about a given risk but informs the individual or the company not to risk more than it can afford to retain. For instance, if the risk can result in bankruptcy, then retention is not the most appropriate method of managing the risk. The ability of a company to retain a particular risk is complicated and varies from one company to another and depends on company cash flow, liquidity position gearing level. The rule gives guideline as to which risks should never be retained that is those that are catastrophic.
- Consider the odds. If the individual can determine or predict the probability that a loss will occur then he/she is in a better position to deal with that risk than when he did not have such information. High, medium and low probability of risk enables the manager to determine which method of risk management to use.
- Do not risk a lot for a little. The risk should not be retained when possible risk is large relative to the premium saved through retention and vise versa.
This rule requires that the risk manager analyses the cost benefit of the risk when selecting the appropriate method of handing the risk