3/28/2012. Associate in Risk Management ARM 54 -Chapter 2. Understanding the RM Process. Understanding the RM Process. Educational Objectives

Transcription

1 Associate in Risk Management ARM 54 -Chapter 2 Presented by: Lynne Lovell RHU CLU ChFC CIC CRM ARM CPCU AFSB ASLI AINS MLIS CRIS Understanding the RM Process Educational Objectives 1. Identify the steps in the RM process 2. Describe the four types of loss exposures 3. Describe the methodsof identifying loss exposures 4. Explain how to analyzeloss exposures along dimension of loss frequency, loss severity, total dollar losses, time and data credibility 5. Describe various risk control techniques Understanding the RM Process 6. Describe the risk financing techniques of transfer and retention 7. Explain how to selectappropriate risk management techniques 8. Describe the technicaland managerial decisions that must be made to implement the selected risk management techniques. 9. Identify reasons whya risk management program may need to be revised. 10. Describe concept of Enterprise Risk Mgmt 1

2 #1 Identify the Steps in the RM Process RISK MANAGEMENT PROCESS Systematic approach to assess and treat accidental loss exposures #1 Identify the Steps in the RM Process LOSS EXPOSURE Any conditionthat presents a possibility of loss, whether or not an actual loss occurs Three Elements: Financial value exposed to loss Cause of loss (peril) Potential financial consequences of that loss #1 Identify the Steps in the RM Process Identifying loss exposures Analyzing loss exposures Six Steps Examining feasibility of RM techniques Selecting appropriate RM techniques Implementing selected RM techniques Monitoring results & revising RM program 2

3 #2 Four Types of Loss Exposures Step 1: Identifying Loss Exposures Risk Manager needs to identify loss exposures interfering with organization achieving its goals Categorize all possible loss exposures #2 Four Types of Loss Exposures Four Types of loss exposures 1. Property loss exposures Possibility of financial loss resulting from damage, destruction, taking or loss of use Financial interest Ownership, use or revenue production association with property #2 Four Types of Loss Exposures Tangible physical form Real property Tangible personal property other than real property Intangible personal property 3

4 #2 Four Types of Loss Exposures 2. Liability loss exposures Conditions that presents possibilities of allegations of legal responsibility for property damage or bodily injury Can be sued for having breached a legal duty Breach of contract #2 Four Types of Loss Exposures 3. Personnel loss exposures Key personnel Death Disability Retirement Unemployment Obligation to pay employee benefits #2 Four Types of Loss Exposures 4. Net income loss exposures Due to a reduction in income Results from Reduction in revenue Increase in expenses Both 4

5 Risk assessment questionnaires General questions Strength Weakness Loss histories Looks at past losses What happened in past may happen in future Identify & analyze Quality? Financial statements & underlying accounting records Balance sheet Snapshot in time Assets Liabilities Equity 5

6 Income statement/profit & loss statement Shows revenue and expenses Shows profit or loss for a period of time Statement of cash flows Cash inflows Sources of income» Operations»Financing»Investments Cash outflows Payments during the same period» Operating expenses» Investing expenses» Financing expenses 6

7 Other records and documents Any document can help identify loss exposures Minutes/memorandums Contracts Plans/drawings External sources» Associations Flowcharts Diagram depicting activities of an organization or process Winery flowchart p 2.10 Exhibit 2-1 Strength Weakness Organizational charts Management structure Key employees Personal inspections First-hand assessment of operations Identify loss exposures Opportunities to use loss control Talk with employees Experts within and beyond the organization 7

8 #4 Analyze Loss Exposures Step 2: Analyzing Loss Exposures Five dimensions used to analyze losses 1. Loss Frequency number of losses within a specified period Relative frequency 2. Loss Severity -amount of the loss MPL estimate of the largest possible loss that might occur PML value of largest loss likely to occur Loss frequency & loss severity interaction PROUTY APPROACH Loss Severity Almost Nil Slight Moderate Definite Severe Transfer Reduce or Prevent Reduce or Prevent Significant Retain Transfer Reduce or Prevent Avoid Avoid Slight Retain Transfer Prevent Prevent PROUTY APPROACH EXERCISE. Assign the following losses to the most appropriate place on the chart: 1.Bodily injury and property damage from a collision involving a tractor trailer 2.Slip and fall of grocery store customers 3.Shoplifting in a men s clothing store 4.Meteor striking a building 5.Display window cracking or shattering Loss Severity Severe Significant Slight Loss Frequency Almost Nil Slight Moderate Definite Loss Severity Loss Frequency Almost Nil Slight Moderate Definite Meteor Tractor Trailer Severe Significant Slip & Fall Slight Display Shoplifting Window 8

9 #4 Analyze Loss Exposures Five dimensions continued: 3. Total Dollar Losses dollar amount of all losses for all occurrence during a specified period 4. Timing -needed to analyze losses Property losses paid quicker Liability Disability claims Environmental/health claims 5. Data Credibility level of confidence that the data represents accurate indicators of future losses Exhibits (p 2.17) #5 Risk Control Techniques Step 3: Examining Feasibility of Risk Management Techniques Exhibit 2-5 p2.19 RISK CONTROL Conscious act or decision not to act that reduces the frequency and severity of losses or makes losses more predictable RM TECHNIQUES Avoidance Loss Prevention Risk Control Loss Reduction Separation Duplication RM Techniques Diversification Risk Financing Transfer Insurance Noninsurance Risk transfer Hold-Harmless Indemnity Agreements Retention Hedging 9

10 #5 Risk Control Techniques Loss Control Techniques: Diversification Avoidance * Separation, Duplication And Diversification increase the number of loss exposures but decrease loss severity Duplication Separation Loss Prevention Loss Reduction #6 Risk Financing Transfer/Retention RISK FINANCING Conscious act or decision not to act that generates the funds to pay for losses or offset the variability in cash flow that may occur. Can be classified into two groups: transfer and retention. RM TECHNIQUES Avoidance Loss Prevention Risk Control Loss Reduction Separation Duplication RM Techniques Diversification Risk Financing Transfer Insurance Noninsurance Risk transfer Hold-Harmless Indemnity Agreements Retention Hedging 10

11 #6 Risk Financing Transfer/Retention Transfer Includes insurance and noninsurance techniques to shiftfinancial consequences of loss to another party. Retention Involves absorbing loss by generating funds within the organization to pay for the loss. #6 Risk Financing Transfer/Retention Transfer Insurance certain specified loss exposures transferred from insured to insurer Noninsurance risk transfer all or part of financial consequences transferred #6 Risk Financing Transfer/Retention Retention pay for losses with funds generated within Types of retention Planned retention Unplanned retention Complete retention Partial retention Funded retention Unfunded retention 11

12 #6 Risk Financing Transfer/Retention Methods to pay/fund for retention Pre-loss funding Current-loss funding Post-loss funding BREAK TIME 10 minutes silent break this time! You can submit questions and we will answer them after the break. #7 Selecting Appropriate RM Techniques Selectappropriate risk management techniques that support organization s goals Quantitative financial considerations Qualitative nonfinancial considerations Involves two processes Forecasting effectiveness on ability to fulfill goals & costs of techniques Define & apply selection criteria to measure financial & nonfinancial contributions to goals 12

13 #7 Selecting Appropriate RM Techniques First process Forecasting effects of RM techniques need to understand loss exposures to be managed & benefits & costs of each RM technique Three forecasts Frequency & severity of future losses Effects on frequency, severity, & predictability of future losses Costs of these techniques #7 Selecting Appropriate RM Techniques Second process Review forecasts against other RM techniques by applying selection criteria in terms of financial & nonfinancial considerations Selected based on least expensive, effectiveness & practicality #7 Selecting Appropriate RM Techniques Financial considerations Greatest positive (least negative) effect on organization s value or rate of return Cash outflows & cash inflows Nonfinancial considerations RM techniques not generating least rate of return but support organizations nonfinancial goals»stability of earnings over time» Legal & social responsibility 13

14 #8 Technical/Managerial Decisions Risk Management program Must be planned & implemented using every technique chosen Decision that will support given techniques Technical decisions Managerial decisions #9 Why RM Program May Be Revised Last step in RM decision making process is monitoring results & revising RM program Reasons for revising New loss exposures Existing loss exposures more significant Different RM techniques now more appropriate #10 Describe Concept of ERM ERM unique, holistic approach to risk management Enhancement to traditional RM Traditional RM looks at activities or business lines in isolation (silos) ERM looks across business lines and activities 14

15 #10 Describe Concept of ERM COSO Committee of Sponsoring Organizations of the Treadway Commission Framework of 8 interrelated components to build ERM program #10 Describe Concept of ERM Theoretical concepts why ERM works Interdependency No assumption that risks are unrelated Inflation effect Correlation proposition that all risks facing an organization are either associated to some degree with each other or they are not associated #10 Describe Concept of ERM Portfolio theory combination of risks having less volatility (risk) than the sum of the individual components volatility (risk) 15

16 #10 Describe Concept of ERM Reasons to make ERM work Help achieve compliance with Sarbanes-Oxley (SOX) New York Stock Exchange & Securities and Exchange commission Rating agencies (S&P or AM Best) use ERM as criteria to grade an organization High correlation between compliance with government & rating agency requirements & improved management accountability & financial transparency #10 Describe Concept of ERM Competitive Advantage Exploit opportunities not identified by competitors More efficient risk management program STRATEGIC AND ENTERPRISE RISK PRACTICE RIMS increased its focus on the evolving role of risk management with the creation of a Strategic and Enterprise Risk Practice in RIMS has created a Strategic Risk Management Development Council. RIMS defines SRM as a business discipline that drives deliberation and action regarding uncertainties and untapped opportunities that affect an organization s strategy and strategy execution. 16

17 #10 Describe Concept of ERM Not fully embraced outside financial services industry Impediments to applying ERM Inability to quantify economic benefits Corporate culture & turf wars Technological deficiency Thank you! Now it s time for Open Mic Q&A "The chains of habit are too weak to be felt until they are too strong to be broken." --Samuel Johnson This quote is also attributed to Warren Buffett The chains of habit are too light to be felt until they are too heavy to be broken. 17