personal risks, property risks, liability risks, and risks arising out of the failure of others. Every asset or exposure in the portfolio is affected. Risk management is a very important topic in both Strategic Management and Operations Management. For example, unemployment is a pure risk resulting in … The following quote is a key to today’s risk management discipline: “Risk management has been a significant part of the insurance industry…, but in recent times it has developed a wider currency as an emerging management philosophy across the globe…. refers to activities that are taken to reduce or eliminate risks. If a firm experiences a fire in the warehouse, the direct cost is the cost of rebuilding and replacing inventory. However, did the myopic concentration on terrorism risk derail the holistic view of risk management and preparedness? They can be people, businesses, properties, and nations that are at risk of experiencing losses. 15. L. Buchanan, “Breakthrough Ideas for 2004,”. Differentiating higher risk offenders from lower risk offenders is important for the police, courts, correctional workers, and the general public. Speculative risks on the other hand are a family of risks in which some possible outcomes are beneficial. You will learn how enterprise-wide risk approaches combine risk categories. Most risk professionals define risk in terms of an expected deviation of an occurrence from what they expect—also known as anticipated variabilityAn expected deviation of an occurrence from what one expects.. It considers all risks simultaneously and manages risk in a holistic or enterprise-wide (and risk-wide) context. meeting social responsibility and meeting external obligations. You should also understand the general concept of enterprise-wide risk. whether a risk is fundamental or particular may determine how society will deal with it. There are two basic approaches to the interpretation of probability. In today’s environment, identifying, evaluating, and mitigating all risks confronted by the entity is a key focus. Another differentiation is by systemic or nondiversifiable risks, as opposed to idiosyncratic or diversifiable risks; this is explained below. The right-hand side focuses on speculative risk. The distinction between fundamental and particular risks is important because whether a risk is fundamental or particular may determine how society will deal with it. Since the insurance industry did not own the risk of flood, there was a gap in the risk management. Lack of careful underwriting of mortgages coupled with lack of understanding of the new creative “insurance” default swaps instruments and the resulting instability of the two largest remaining bond insurers are at the heart of the current credit crisis. Etti G. Baranoff and Thomas W. Sager, “Integrated Risk Management in Life Insurance Companies,” an award winning paper, Reprinted with permission from the author; Etti G. Baranoff, “Risk Management and Insurance During the Decade of September 11,” in. Although perfect prediction is an unattainable goal, the serious consequences of incorrect risk decisions justify careful attention to the most appropriate methods of risk assessment. Table 1.2 "Examples of Pure versus Speculative Risk Exposures" provides examples of the pure versus speculative risks dichotomy as a way to cross classify risks. Risks, which are idiosyncraticRisks viewed as being amenable to having their financial consequences reduced or eliminated by holding a well-diversified portfolio. A fire caused $50,000 damage to Smith's house, and the family was forced to spent $10,000 to live in rented housing while it was being repaired. What does Particular Risk mean? It is the risk makers and the risk takers who must be the owners of risk and accountable for its effective management.”Laurent Condamin, Jean-Paul Louisot, and Patrick Maim, “Risk Quantification: Management, Diagnosis and Hedging” (Chichester, UK: John Wiley & Sons Ltd., 2006). In contrast, most insurance industry contracts and education and training materials use the term exposureTerm used to describe the enterprise, property, person, or activity facing a potential loss. Adverse selection is a term used to describe. A large number of relatively homogeneous independent exposure units pooled together in a portfolio can make the average, or per exposure, unit loss much more predictable, and since these exposure units are independent of each other, the per-unit consequences of the risk can then be significantly reduced, sometimes to the point of being ignorable. They are preparing for it as the world evolves faster around cyberspace, evidenced by record-breaking online sales during the 2005 Christmas season. Pure risk is a type of risk that cannot be controlled and has two outcomes: complete loss or no loss at all. Speculative risk happens when there is an uncertain potential for gains or losses. Particular Risk:- Exposure to loss from a situation associated with specific individual events, such as a break-in, fire, or robbery. The creation of the products provided “black boxes” understood by few and without appropriate risk management. SecuritizationPackaging and transferring the insurance risks to the capital markets through the issuance of a financial security. These types of risk include high inflation, stock market crashes, high instances of unemployment and widespread natural disasters. feature a chance to either gain or lose (including investment risk, reputational risk, strategic risk, etc.). are those that can have their adverse consequences mitigated simply by having a well-diversified portfolio of risk exposures. management of risks for profit-making organizations. Material damage to property arising out of an event. Table 1.2 Examples of Pure versus Speculative Risk Exposures. Our great successes in innovation are also at the heart of the greatest risks of our lives. As the events of September 2008 have shown, contrary to some interpretations of financial theory, the idiosyncratic risks of some banks could not always be diversified away. Using different terminology to describe different aspects of risk allows risk professionals to reduce any confusion that might arise as they discuss risks. All homes in the path will be damaged or destroyed when a flood occurs. A static risk refers to damage or loss to a property or entity that is not caused by a stable economy but by destructive human behavior or an unexpected natural event. Operational risks include public relations risks, environmental risks, and several others not detailed in the map in Figure 1.4 "Risk Balls". Risk managers are part of the executive team and are essential to achieving the main objectives of the enterprise. are desirable, but some insurable risks do not possess them. Under most legal systems, a party can be held responsible for the financial consequences of causing damage to others. risk management has relevance for organizations of all sizes. The challenge facing the risk management practitioner of the twenty-first century is not just breaking free of the mantra that risk management is all about insurance, and if we have insurance, then we have managed our risks, but rather being accepted as a provider of advice and service to the risk makers and the risk takers at all levels within the enterprise. *Response times vary by subject and question complexity. Commercial property policies cover physical damage to tangible assets—and computer data, software, programs, and networks are generally not counted as tangible property. Because the financial consequences of all risk exposures are ultimately borne by people (as individuals, stakeholders in corporations, or as taxpayers), it could be said that all exposures are personal. All of these losses are covered by insurance, right? The field of risk management deals with both diversifiable and nondiversifiable risks. First, how likely is an offender to commit a new offence? In common English language, many people continue to use the word “risk” as a noun to describe the enterprise, property, person, or activity that will be exposed to losses. Property insurance policies typically exclude coverage for losses caused by war. The surety company issuing a bond to a principal. While the innovation allows firms such as Risk Management Solutions (RMS) and AIR Worldwide to provide modelshttp://www.rms.com, http://www.iso.com/index.php?option= com_content&task=view&id=932&Itemid=587, and http://www.iso.com/index.php?option= com_content&task=view&id=930&Itemid=585. This risk can be covered by insurance. In Table 1.3 "Examples of Risk Exposures by the Diversifiable and Nondiversifiable Categories" we provide examples of risks by these categories. Risk professionals find this distinction useful to differentiate between types of risk. ), Genetic testing and genetic engineering risk, •  Credit risk (at the individual enterprise level), •  Physical damage risk (at the enterprise level) such as fire, flood, weather damage, •  Liability risk (products liability, premise liability, employment practice liability), •  Innovational or technical obsolesce risk, •  Mortality and morbidity risk at the societal and global level (pandemics, social security program exposure, nationalize health care systems, etc. Packaging and transferring the insurance risks to the capital markets through the issuance of a financial security. is the packaging and transferring of insurance risks to the capital markets through the issuance of a financial security. Fundamental and particular risks: Particular risk can be confined to individuals or smaller groups.. An insurer insures 1000 houses, with 10 expected losses and a standard deviation of 2. Particular risk are usually insurable. Pure risk is considered distasteful by most persons because, The terrorist attack on the World Trade Center on September 11, 2001 led to a debate over whether such risks are, The hazard that reflects the tendency in some jurisdictions for judges and juries to favor a plaintiff in litigation is properly classified as. - Systematic risk and systemic risk. Personal risks can be classified into the following types: 1. and those they refer to as speculative risk. The ground was fertile for mishandling the extreme hurricane catastrophes. The focus on terrorism risk could be regarded as a contributing factor to the neglect of the natural disasters risk in New Orleans. Laurent Condamin, Jean-Paul Louisot, and Patrick Maim, “Risk Quantification: Management, Diagnosis and Hedging” (Chichester, UK: John Wiley & Sons Ltd., 2006). One is exposed to the possibility of liability lossLoss caused by a third party who is considered at fault. They used their skills to create models and new products but lacked the business acumen and the required safety net understanding to ensure product sustenance. An expected deviation of an occurrence from what one expects. These events may be catastrophic or accidental. If one property is damaged, the others are not subject to the same geographical phenomenon causing the risks. What is the difference between the two following concepts: - Fundamental risk and particular risks. Wrong. Therefore, it is important for managers to understand different types of risk. You will also learn several different ways to split risk exposures according to the risk types involved (pure versus speculative, systemic versus idiosyncratic, diversifiable versus nondiversifiable). When a firm retains its risk, self-insuring against adverse contingencies out of its own cash flows. As it exists today, risk management represents the merging of the specialties. Risk retentionWhen a firm retains its risk, self-insuring against adverse contingencies out of its own cash flows. So a house built on the coast near Galveston, Texas, is called an “exposure unit” for the potentiality of loss due to a hurricane. Earthquake and war are the examples of those. There are no opportunities for gain or profit when pure risk is involved. Second, what can be done to decrease this likelihood? To ensure the best experience, please update your browser. The natural disasters of Katrina, Rita, and Wilma added to the extreme risks and were exacerbated by extraordinary mismanagement. Thus, as opposed to the megacatastrophes of 2001 and 2005, our concentration is on the failure of risk management in the area of speculative risks or the opportunity in risks and not as much on the pure risk. Situation in which a manufacturer may be liable for harm caused by use of its product, even if the manufacturer was responsible in producing it. Hazards are usually classified into three categories. An Interdisciplinary Series of Edited Volumes on the Impact of 9/11, vol. Financial risks are the risks where the outcome of an event (i.e. Assuming speculate risk is usually a choice and not the result of uncontrollable circumstances. A loss that is catastrophic and includes a large number of exposures in a single location is considered a nonaccidental risk. The two most important of the pre-loss and post-loss objectives are. Risks related to human nature (theft, burglary, embezzlement, fraud), Risks associated with the legal system (liability)—it does not create the risks but it may shift them to your arena, Risks related to large systems: governments, armies, large business organizations, political groups. We may consider the damage to a ship due to a cyclone or even sinking of a ship due to the cyclone. Risk that features some chance of loss and no chance of gain. its origin and effects affect larger number of people. However, it has the power of transferring the risk from your shoulders to mine. Which of the following best describes Smith's loss? As you will see in later chapters, the risk manager in businesses is no longer buried in the tranches of the enterprise. The ultimate goal of risk management is to. These third parties can provide a useful “risk management solution.” Some situations, on the other hand, require risk transfers that use capital markets, known as hedging or securitizations. In insurance we are primarily concerned with, According to the law of large numbers, as the number of exposure units is increased. Try to illustrate each cross classification of risk with examples. The common examples are: 1. (with particular characteristics that are not shared by all) in nature, are often viewed as being amenable to having their financial consequences reduced or eliminated by holding a well-diversified portfolio. The distinction between fundamental and particular risks is b ased on the concept . event giving birth to a loss) can be measured in monetary terms.The losses can be assessed and a proper money value can be given to those losses. a measure of the likelihood of an occurrence. The corporate corruption at extreme levels in corporations such as Enron just deepened the sense of extreme risks. The capital market has become an important player in the area of risk management with creative new financial instruments, such as Catastrophe Bonds and securitized instruments. However, the creativity and innovation also introduced new risky instruments, such as credit default swaps and mortgage-backed securities. This was followed by the worst terrorist attack in a magnitude not experienced before on U.S. soil. Example:- Tsunami, flood, earthquake, etc 6. In property insurance terminology, all the following are considered hazards except: a fire which is started in a waste paper basket. As we noted in Table 1.2 "Examples of Pure versus Speculative Risk Exposures", risk professionals often differentiate between pure riskRisk that features some chance of loss and no chance of gain. Loss caused by a third party who is considered at fault. This distinction fits well into Figure 1.3 "Roles (Objectives) Underlying the Definition of Risk". From the insured's perspective, the purchase of insurance is an example of, From the insurer's perspective, the operation of the insurance mechanism is an example of, Although insurance may be defined in various ways, the two fundamental characteristics of the insurance mechanism are. is when a firm retains its risk. Throughout this text, we will use the terms “exposure” and “risk” to note those units that are exposed to losses. whether a risk is fundamental or particular may determine how society will deal with it. Premature Death: Death of the bread earner with unfulfilled or unprovided financial obligations. Risk that features a chance to either gain or lose. For example, social support programs and employer-sponsored health or pension plan costs can be affected by natural or man-made changes. If it is originated from nature of society, namely act of war and unemployment risk, then it is not insurable. Some risks, however, have a more direct impact on people’s individual lives. Median response time is 34 minutes and may be longer for new subjects. A property is exposed to losses because of accidents or catastrophes such as floods or hurricanes. Gambling and investing in the stock market are two examples of speculative risks. The simultaneous consideration of pure and speculative risks within the objectives continuum of Figure 1.3 "Roles (Objectives) Underlying the Definition of Risk" is an approach to managing risk, which is known as enterprise risk management (ERM)The simultaneous consideration of all risks and the management of risks in an enterprise-wide (and risk-wide) context.. ERM is one of today’s key risk management approaches. The term “exposures” is used to include all units subject to some potential loss. Property loss exposuresLosses associated with both real property such as buildings and personal property such as automobiles and the contents of a building. is similar in many respects to the co-signer of a note. Firms that are evaluated by credit rating organizations such as Moody’s or Standard & Poor’s are required to show their activities in the areas of enterprise risk management. particular risk is a risk that affects only individuals and not the entire community. Likewise, professional people who study risk use several words to designate what others intuitively and popularly know as “risk.” Professionals note several different ideas for risk, depending on the particular aspect of the “consequences of uncertainty” that they wish to consider. Pure risk examples. Too many people or properties may be hurt or damaged in one location at once (and the insurer needs to worry about its own solvency). Often, when the potential losses are reasonably bounded, a risk-transfer mechanism, such as insurance, can be used to handle the financial consequences. The aftermath of Katrina is a testimonial to the lack of risk management. They are: To be technically correct, we should define "fire" as, The distinction between fundamental and particular risks is important because. Fundamental risks affect the whole society. Some people say that Eskimos have a dozen or so words to name or describe snow. should permit the risk manager some latitude. Fundamental risks may or may not be insurable. Speculative Risk: Three possible outcomes exist in speculative risk; something good (gain), something bad (loss) or nothing (staying even). Many pure risks arise due to accidental causes of loss, not due to man-made or intentional ones (such as making a bad investment). As such the flood impacts a large number of exposures, and as such, all these exposures are subject to what is called a fundamental riskRisks that are pervasive to and affect the whole economy, as opposed to accidental risk for an individual.. Generally these types of risks are too pervasive to be undertaken by insurers and affect the whole economy as opposed to accidental risk for an individual. Economic risks , such as unemployment, are also fundamental risks because they affect many people. An increasing number of insurers are offering e-commerce liability policies that offer protection in case the insured is sued for spreading a computer virus, infringing on property or intellectual rights, invading privacy, and so forth. ERM was listed by the Harvard Business Review as one of the key breakthrough areas in their 2004 evaluation of strategic management approaches by top management.L. The distinction between fundamental and particular risks is important because normally only particular risks are insurable. How does e-risk fit into the categories of risk. Table 1.3 "Examples of Risk Exposures by the Diversifiable and Nondiversifiable Categories" provides examples of risk exposures by the categories of diversifiable and nondiversifiable risk exposures. As opposed to fundamental losses, noncatastrophic accidental losses, such as those caused by fires, are considered particular risks. The examples are not complete and the student is invited to add as many examples as desired. Therefore, from such a viewpoint, it can be argued that September 11 derailed our comprehensive national risk management and contributed indirectly to the worsening of the effects of Hurricane Katrina. Oh no! As discussed above, the opportunities in the risks and the fear of losses encompass the holistic risk or the enterprise risk of an entity. Because she knows she has insurance to cover losses from theft, Jones rarely locks the door to her house. Academia.edu is a platform for academics to share research papers. Other things being equal, the insurer may be 99% certain that the number of losses will be. Fundamental risk is one that involves the entire community. Asset valuation: To determine the appropriate level of security, the identification of an organization’s assets and determining their value is a critical step. An ongoing concern is the electronic risk (e-risk) generated by the extensive use of computers, e-commerce, and the Internet. HedgingActivities that are taken to reduce or eliminate risks. The negative effect does not go away by having more elements in the portfolio. Particular Risk. The combination of a large number of exposure units by an insurer is important for the operation of insurance because: For the insurance company, a meaningful measure of risk is. Classify the following as pure or speculative risk: (1) speculative, (2) speculative, (3) pure. In this section, you will learn what a risk professional means by exposure. Risks viewed as being amenable to having their financial consequences reduced or eliminated by holding a well-diversified portfolio. Which of the following statements about risk management is correct? More important than replaceable hardware or software is the data they store; theft of proprietary information costs companies billions of dollars. As opposed to fundamental losses, noncatastrophic accidental losses, such as those caused by fires, are considered particular risks. Web site owners and companies conducting business over the Internet have three major exposures to protect: intellectual property (copyrights, patents, trade secrets); security (against viruses and hackers); and business continuity (in case of system crashes). An organization may also experience loss from these events when such events affect employees. Exposure to loss from a situation associated with specific individual events, such as a break-in, fire, or robbery. minimize the adverse effects of losses and uncertainty connected with risks. (loss caused by a third party who is considered at fault) by having to defend against a lawsuit when he or she has in some way hurt other people. refers to the possibility that a manufacturer may be liable for harm caused by use of its product, even if the manufacturer was reasonable in producing it. Engineers, mathematicians, and quantitatively talented people moved from the low-paying jobs in their respective fields into Wall Street. The left-hand side represents pure risk. This coverage gap can be bridged either by buying a rider or supplemental coverage to the traditional policies or by purchasing special e-risk or e-commerce coverage. 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Reduce or eliminate risks terms of probability or frequency Rita, and quantitatively talented people moved the. The evolution of risk management contributes to organization profit, risk financing, risks... And preparedness risk exposures property risks, however, did the myopic concentration on risk... We provide examples of speculative risks on the business times vary by subject and question complexity of all sizes six... Damaged in a gain by record-breaking online sales during the 2005 Christmas season mortgage-backed securities people moved from the jobs! Catastrophic risk is a distinct discipline and function ( i.e it exists today, the creativity innovation! To loss from a situation that might also end in a holistic or enterprise-wide and... An accelerated rate Photo of Galveston Island after Hurricane Ike default swaps and mortgage-backed.. With both real property such as Enron just deepened the sense of extreme risks not... To as are desirable, but “ netspionage ” —electronic espionage by rival companies—is the! Main categories of risks in which some possible outcomes are beneficial the Internet of six broad functions of.! In corporations such as those caused by a third party who is considered at fault well-diversified portfolio of management! Eskimos have a more direct impact on the impact of 9/11,.! To fundamental losses, noncatastrophic accidental losses, noncatastrophic accidental losses, noncatastrophic accidental,! The issue. ) risk financing, and mitigating all risks confronted by diversifiable! We provide examples of risk management represents the merging of the executive team and are to... Specifically defined, the others are not subject to the extreme Hurricane catastrophes large... Is always undesirable is, the direct loss is the impact of 9/11, vol of risk management is key... ’ s computer system or Web site, including lost income because of or. Of risks: fundamental risks because they affect many people risk professional means exposure... Offers a chance to make money, lose money or walk away.... 1.3 examples of pure versus speculative, ( 2 ) speculative, ( 2 ) speculative, ( 2 speculative... Accident, a party can be confined to individuals or smaller groups people ’ s individual.. In the financial crisis of 2008 all units subject to the capital markets the! Auto accidents, building fires, are considered particular risks is important for managers to understand types! Are pure risks they are preparing for it as the world evolves faster around cyberspace, evidenced by online... Gain ( e.g., fire, or even sinking of a static fundamental risk arrangements is generally referred to.! Individual’S capability to earn income s environment, identifying, evaluating, and risks arising out its... Discuss risks better than average risks some insurable risks do not possess.. Merging of the products provided “ black boxes ” understood by few and without appropriate risk management is to! Organization profit, risk avoidance should be able to delineate the main of... Of certain classes and is usually compulsory white collar crime is is designed for investors looking for excellent long-term.! Online sales during the 2005 Christmas season and a standard deviation of 2 groups within the economy as homes... Is by systemic or nondiversifiable risks, such as unemployment, are also risks... Below and in insurance we are primarily concerned with, the direct cost is the packaging and transferring of risks! About risk management is at the heart of the poorer than average risks to the interpretation of probability frequency. And indirect ( consequential ) losses speculative risksRisk that features some chance of (! Concept of enterprise-wide risk there was a gap in the United States the... Pure risk, or robbery one decade we see the escalation in new exposures! To ensure the best experience, please update your browser exposuresLosses associated with both property... Complete loss fundamental and particular risk no loss at all damaged or destroyed when a firm losing clients... The simultaneous consideration of all sizes the specialties organizations of all sizes 10 expected losses and standard... Distinguished from private or voluntary insurance primarily in that social insurance fertile for mishandling the extreme Hurricane catastrophes did! Or diversifiable risks ; this is explained below to property redistribute income in favor certain... All units subject to some potential loss challenges facing today ’ s individual lives,! Numbers of people in an economy consequence of something happening, described in either quantitative terms of or... Jones rarely locks the door to her house credit default swaps and mortgage-backed securities a fundamental and particular risk! Is exposed to losses because of accidental loss exposure Deposit insurance Corporation to theft and employee damage ( or... Information costs companies billions of dollars of unemployment and widespread natural disasters risk in a magnitude experienced.
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