BY: VINAY KUMAR

(018) VARUN

DEEKAY(019) KRISHAN

KUMAR(023

Techniques of Risk Avoidance

RISK- DEFINITION

Risk is defined as the chance of having a loss due to occurrence of an event

The risk is always associated with the loss aspects since the word itself has the association of DANGER OF LOSS

The definition can be “ PROBABAILITY OF THE OCCURRENCE OF AN EVENT RESULTING IN LOSS/ GAIN

CLASSIFICATION OF RISKS

SPECULATIVE RISKS & PURE RISKS

DYNAMIC RISKS & STATIC RISKS

FUNDAMENTAL RISKS

PARTICULAR RISKS

CLASSIFICATION OF RISKS

SPECULATIVE RISKS

Operation of this leads to profit /loss

Leads to speculation like investment of capital in a new venture

Operation is desired

PURE RISKS These do not change

with the risk The operation of

these perils does bring in loss/damage to property/assets/ liability

Not desired

Classification of RisksDynamic risks Changes with the

change in fashion, buying behaviour, trends, technology etc

It denotes dynamic nature of the customer behaviour and the products they like to own or use

If an organization is not prepared then it may go out of existence

Static risks Like pure risks these

risks remain static and do not change due to other reasons like that of dynamic risks

The operation of these risks always bring about losses

Operation is not desired

May result in partial or total cessation of activities

CLASSIFICATION OF RISKS

PARTICULAR RISKS Risks which relate

to one or few firms, factories or organisations only

Losses are suffered by one or few more members of the society

FUNDAMENTALRISKS Relates to the society

at large Losses are suffered by

large section of the society/nation(s)

Losses may be due to natural catastrophes, riots, epidemics etc

RISK MANAGEMENT

• The selection of appropriate risk management techniques is a dynamic problem. •The best method for handling a particular exposure today may not be the best method a year from now.

-Many relevant factors change regularly. -The frequency and severity of losses may vary

• Causing estimates for the maximum possible loss or maximum probable loss to fluctuate.

-The cost and availability of different risk management tools cannot be assumed to remain constant.

Basic Concept Of Probability And Statistics

Random Variables And Probability Distributions.

A random variable is a whose outcome is uncertain.

Probability distribution which identifies all the possible outputs for random variable and the probability of outcomes.

Characteristics of probability distributions

To compare probability distributions of different random variables.

How decision affect p.d will lead to better decisions.

Key characteristics of p.d – the expected value, variance or standard deviation, skewness and correlation.

Expected value

The expected value of a p.d provides information about where the outcomes tend to occur. on average , a distributi-

on with a higher expc. Value will have a higher outcomes.Expct. Value=x1 p1+x2 p2+….xmpm.

Variance and standard deviation It gives information about the

likelihood and magnitude by which a particular outcome from the distribution will differ from the expected value.

S.d – it reflects the variation in outcomes of a particular sample from a distribution.

Skewness: it measures the symmetry of distribution.it has a higher probability of very low losses and a lower probability of high losses when compared to symmetric distribution.Correlation: to identify the relationship among random variables.correlatin b/w 2 random variable is 0.then random variable is not related.

Pooling of risk Pooling arrangement with 2 persons. Pooling arrangement with many people

or business. Pooling arrangement with correlated

losses.

Selecting Risk Management Techniques

The steps for selecting among available risk management techniques for a given situation may be summarized as follows Avoid risks if possible Implement appropriate loss control

measures Select the optimal mix of risk retention

and risk transfer

Avoid Risks if Possible

Risks that can be eliminated without an adverse effect on the goals of an individual or business probably should be avoided

Without a systematic identification of pure risk exposures Some risks that easily could be avoided

may inadvertently be retained

Implement Appropriate Loss Control Measures

For risks that a business or individual cannot or does not wish to avoid Consideration should be given to available loss

control measures In analyzing the likely costs and benefits of

loss control alternatives Should recognize that loss control will always be

used in conjunction with either risk retention or risk transfer

Therefore, part of the cost/benefit analysis regarding potential loss control is recognition of the likely effects on the transfer or retention of the risk existing after loss control measures are implemented

The selection between risk retention and risk transfer as the optimal risk management technique may change after loss control expenditures are made

Analyzing Loss Control Decisions Capital budgeting techniques from finance

and accounting can be applied to risk management decisions regarding loss control

For example, Cole Department Store has been experiencing substantial shoplifting losses and occasional vandalism to its building The company is considering hiring 24-hour security

guards to decrease the frequency and severity of these losses Its estimated annual cost of the protection is $60,000

Covers salaries and employee benefits for the guards Cole estimates that the presence of security guards

will decrease shoplifting losses by $30,000 and vandalism losses by $20,000 Additionally its insurance premiums are expected to

decrease by $5,000 Should Cole hire the guards?

Analyzing Loss Control Decisions After examining only the financial

considerations Since the estimated $55,000 in savings is

less than the estimated $60,000 cost of hiring the guards The firm should not hire the guards

However the company should consider whether there are any additional relevant factors that may have been overlooked For instance, will the presence of the

security guards make employees feel safer? Will the firm be able to hire better

employees? Will customer relations be enhanced by the

presence of a guard?

Analyzing Loss Control Decisions In the Cole Department Store

example all the benefits and costs were expected to happen in the same year

When a longer period of time is involved the calculations become more complicated

Select the Optimal Mix of Risk Retention and Risk Transfer

As previously stated, loss control decisions should be made as part of an overall risk management plan That also considers the techniques of

risk retention and risk transfer Often both of these techniques will be

used The relevant question becomes

What is the appropriate mix between these two techniques?

General Guidelines

As a rule, risk retention is optimal for losses that have a low expected severity With the rule becoming especially appropriate when

expected frequency is high Another general guideline applies to risks that

have a low expected frequency but a high potential severity In this situation, risk transfer is often the optimal

choice When losses have both high expected severity

and high expected frequency It is likely that risk transfer, risk retention, and loss

control all will need to be used in varying degrees What constitutes “high” and “low” loss

frequency and severity in applying the preceding guidelines must be established on an individual basis

Guidelines for Using Different Risk Management Techniques

Selecting Retention Amounts Because in many situations both risk retention

and risk transfer will be used in varying degrees It is important to determine the appropriate mix of

these two risk management techniques Both capital budgeting methods and statistical

procedures may be used in selecting an appropriate retention level With insurance purchased for losses in excess of that

level But because the price of insurance does not

necessarily vary proportionately with different levels of retention The appropriate mix between retention and transfer

is not an exact science

The Self-Insurance Decision The possibility of self-insurance is another way

of mixing risk retention and risk transfer The cash flow advantage of funds set aside in

a reserve fund is must be considered in assessing value of self-insurance Because losses are not always paid out in the year in

which the event producing them occurs A company has the use of self-insurance funds for

varying periods May earn interest on them until such a time as the losses are

actually paid

The Self-Insurance Decision In assessing the financial aspects of a

self-insurance program The value of operating funds to the firm

must also be considered If the money in the reserve fund is

invested in a liquid form that can be readily converted to cash The firm may experience some loss because

the funds might have been more profitably used in the business as working capital Known as an opportunity cost of funds .

The Self-Insurance Decision Even though it may be clear that a

firm can save money in the long run with self-insurance Management may prefer stable,

predictable insurance premiums each year

Some companies prefer to avoid the details of managing self-insurance programs Rather, focusing on their main

operations

The Self-Insurance Decision The following conditions are suggestive

of the types of situations where self-insurance is both possible and feasible The firm should have a sufficient number of

objects so situated that they’re not subject to simultaneous destruction The objects should also be reasonably similar in

nature and value so that the calculations of probable losses will be accurate within a narrow range

The firm must have accurate records or have access to satisfactory statistics to enable it to make good estimates of expected losses

The Self-Insurance Decision The firm must make arrangements for

administering the plan and managing the self-insurance fund Someone must pay claims, inspect

exposures, implement appropriate loss control measures, keep necessary records, and take care of the many administrative details It may be possible to contract for these services to

be done by an independent third-party administrator

The general financial condition of the firm should be satisfactory Firm’s management must be willing and

able to deal with large and unusual losses