1. EVOLVING RISK MANAGEMENT:
Fundamental Tools

2. Risk Management Process
Identify all risks.
Assess the risks, forecasting future frequency and severity of losses.
Find risk management solutions to all of the risks (create programs and conduct cost/benefit analyses on them).
Implement the chosen solutions.
Evaluate the results.

3. Risk Management Solutions
Pure Risk Solutions
Low Frequency of losses
High Frequency of Losses
Low severity of losses
Retention
Retention with loss control
High severity of losses
Transfer—Insurance/Reinsurance (Newer: Cat bonds & securitization for catastrophic risks)
Avoidance

4. Risk Management Solutions (Continued)
Other Influences
Solutions for Other Risks
- Financial condition of the firm
- Cash flow management using value at risk (VaR)
- The nature of the risk
- Using derivative instruments such as futures, swaps and options
- External market conditions
- The size of the firm

5. Risk Map
A risk map is a visual tool used to compare and contrast risk management alternatives.

6. Frequency (Number of Annual Events)
ONE FIRM’s RISK MAP
Severity In
$ million
Credit Risk
(Financial Risk)
Frequency (Number of Annual Events)

7. Common Risk Management Guidelines
Write a risk management mission statement
Communicate with every section of the organization to promote safe behavior
Identify risk management processes
Pinpoint all risks (what “keeps employees awake at night”)
Assess risk management & financing alternatives (and external insurance market conditions)

8. Common Risk Management Guidelines (Continued)
Allocate costs from losses and loss expenses
Negotiate insurance coverage and terms
Adjust claims administration in self-funded firms
Keep accurate records of losses and payments

9. Risk Management Process for a Property Exposure
Find all properties exposed to loss. This includes real property and other tangible property (e.g. computers) as well as intangible property (e.g. trademarks).
Evaluate the potential causes of losses, such as natural disasters (e.g. hurricanes) and accidents (e.g. fires and explosions).
Evaluate property value by different methods: book value, market value, reproduction cost and replacement cost.

10. Risk Management Process for Property (Continued)
Evaluate legal interest: owned or leased?
Identify loss exposures through loss runs, flow charts, personal inspection, questionnaires and accounting records.
Based on loss data, compute frequency and severity of losses for each property exposure.
Forecast future losses for each property exposure.

11. Risk Management Process for Property (Continued)
8) Create specific risk map based on forecasted frequency and severity 9) Develop risk management alternatives (such as loss control techniques) based on cost/benefit analysis or insurance 10) Compare potential solutions to existing solutions 11) Communicate solutions with entire organization

12. Risk Profiling and Mapping
Risk profiling evaluates all of an organization’s risks, measuring the frequency and severity of each risk.
Risk mapping charts entire spectrums of risk, not individual risk “silos” from each separate business unit.

13. Plotting the Risk Map: Four Basic Risk Categories
Natural and man-made risks (i.e. hurricane; anthrax threat)
Financial risks:
-Prices -Credit risk
-Volatility -Foreign exchange risk
-Liquidity -Major market recession

14. Plotting the Risk Map (Continued)
Business risks: reputation risk is a major concern
Operational risks: day-to-day issues such as IT systems failure risk

15. Forecast Frequency & Severity & Cost Benefit Analysis
Risk management matrix: provides alternative financial action for each frequency/severity combination on risk map
Forecasting: Projects the frequency and severity of losses into the future based on current data and statistical assumptions

16. Budgeting
Cash flow analysis: looks at the amount of cash that will be saved; brings it into the present-day world
Risk management information systems: computerized data systems that allows a risk manager to quantify a firm’s loss history

17. The Traditional Risk Management Matrix
Pure Risk Solutions
Low Severity of Losses
Retention—Self-insurance (Self-funding)
Retention with Loss Control—Risk Reduction
High Severity of Losses
Transfer--Insurance
Avoidance

18. Definition of Terms in the Risk Management Matrix
Transfer of risk: displacement of risk to a third, unrelated party
Loss reduction: efforts to lessen loss severity
Risk avoidance: stopping or not starting an activity due to concerns of catastrophic losses
One cannot avoid all risks
Avoiding one risk (traveling in airplanes) often triggers another risk (traveling in automobiles)

19. Main Risk Mapping Objectives
Aid identification of risks and their interactions
Provide a mechanism to select best risk management strategy
Compare, evaluate and optimize current strategies
Evaluate leftover risks once all strategies are in place
Clearly communicate strategies to management and employees

20. Linear Regression of Fire Claims
Red Line
Linear Trend:
Blue Line

21. Linear Regression of Fire Losses
$1,000
Units