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

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 stepsin the RM process

2. Describe the four types of loss exposures

3. Describe the methods of 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

transferand retention

7. Explain how to selectappropriate risk

management techniques

8. Describe the technicaland managerial

decisionsthat must be made to implement

the selected risk management techniques.

#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

Any condition that presents a possibility of loss, whether or not an actual loss occurs

Potential financial consequences of that loss

Three Elements:

Financial value

exposed to loss Cause of loss (peril)

#1 Identify the Steps in the RM Process

• Six Steps

Identifyingloss exposures Analyzing loss exposures

Examining feasibility of RM techniques Selecting appropriate RM techniques

#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

#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

#3 Identifying Loss Exposures

•

Risk assessment questionnaires

–General questions

•Strength

•Weakness

#3 Identifying Loss Exposures

•

Loss histories

–Looks at past losses

•What happened in past may

happen in future

•Identify & analyze

–Quality? 0 5 10 15 2011 2010 2009

#3 Identifying Loss Exposures

•

Financial statements &

underlying accounting records

–Balance sheet

•Snapshot in time

–Assets –Liabilities –Equity

#3 Identifying Loss Exposures

–Income statement/Profit & loss

statement

•Shows revenue and expenses

•Shows profit or loss for a

period of time

#3 Identifying Loss Exposures

–Statement of cash flows

•Cash inflows

–Sources of income »Operations »Financing »Investments

#3 Identifying Loss Exposures

•Cash outflows

–Payments during the same period

»Operating expenses »Investing expenses »Financing expenses

#3 Identifying Loss Exposures

–Other records and documents

•Any document can help

identify loss exposures –Minutes/memorandums –Contracts

–Plans/drawings –External sources

»Associations

#3 Identifying Loss Exposures

–

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

#3 Identifying Loss Exposures

–Personal inspections

•First-hand assessment of operations

•Identify loss exposures

•Opportunities to use loss control

•Talk with employees

–Experts within and beyond the

#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

y Almost Nil Slight Moderate Definite Severe Transfer Reduce or

Prevent

Reduce or Prevent

Avoid

Significant Retain Transfer Reduce or Prevent

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 Frequency

Almost Nil Slight Moderate Definite

L os s S eve ri ty Severe Significant Slight

#4 Analyze Loss Exposures

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 2-3 2-4 (p 2.17)

Five dimensions continued:

#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

#5 Risk Control Techniques

• Loss Control Techniques:

* Separation, Duplication And Diversification increase the number of loss exposures but decrease loss severity

Avoidance Loss Prevention Loss Reduction Separation Duplication Diversification

#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

#6 Risk Financing – Transfer/Retention

Transfer

Includes insurance and noninsurance

techniques to

shift financial 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

#6 Risk Financing – Transfer/Retention

•

Methods to pay/fund for retention

–Pre-lossfunding –Current-loss funding –Post-lossfunding

BREAK TIME

You can submit questions and we will answer them after the break.

#7 Selecting Appropriate RM Techniques

•

Select

appropriate risk management

techniques that support organization’s

goals

–Quantitative financial considerations

–Qualitative nonfinancial considerations

–Involves two processes

#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

#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)

COSO –Committee of Sponsoring Organizations of the Treadway Commission

Framework of 8 interrelated components to build ERM program

#10 Describe Concept of ERM

#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)

#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 2010.

• RIMS has created a Strategic Risk Management Development Council.

#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

"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.”

Thank you!