• RISK IDENTIFICATION OF RISK PROBABILITY

CHAPTER 3

RISK EVALUATION AND ASSESSMENT

Objectives Use statistical application in risk

identification Differentiate between probability and

possibility of loss Evaluate risk using various risk

identification techniques Apply the risk identification tool for risk

assessment

3

ATTITUDE TOWARDS RISK

• RISK TAKER---- WILL DECIDE ON THE OPTION THAT WILL EITHER BRING HIGHER RETURN OR ALTERNATIVELY, THE POSSIBILITY OF A LOSS

• RISK ADVERSE--- ATTITUDE IS TRYING TO PLAY SAFE, THE OUTCOME OF HIS DECISION MUST ALWAYS RESULT IN NO LOSS

EXPECTED VALUE (EV)

EXPECTED VALUE(EV) IS THE SUMATION OF EACH OUTCOME OR THE WEIGHTED PAYOFFS

FOR EACH ALTERNATIVE BASED ON THE POSIBILITY OF EACH OCCURRENCE.

EV = Σpixi………………….(1)

pi = probability xi = value of random variable

Example 1Insurance Company A and B shows that10,000 vehicles insured. There is a 50% and20% probability of claim occur for company A and B respectively. Calculate the expected value ofaccident claims. EV(A)= 0.5 x 10000 = 5000 claimsEV(B)= 0.2 x 10000 = 2000 claims

Which company is more risky?

STANDARD DEVIATION (SD)

STANDARD DEVIATION…….• DEGREE OF DEVIATION FROM THE

PREDICTION OR THE AVERAGE OR THE EXPECTED VALUE.

• SD < 1 LESS RISKY• SD > 1 MORE RISKY• Eg. The SD is 1.5 then the undertaking is

considered to be 50% risky.

PROBABILITY OF LOSS AND MAGNITUTE (SIZE) OF LOSS

EV = Σpixi = PL x ML ……………………….…..(2)

PL = Probability of loss ML = Magnitude (size) of loss

Example 2Insurance Company A and B shows that they have the magnitude ofLoss RM1,000,000 and RM3,000,000 respectively. There is 50% and 20%probability of loss occur for company A and B respectively. Calculate theprobability of loss for both company.

EV(A) = 0.5 x RM1,000,000 = RM 500,000 EV(B) = 0.2 x RM 3,000,000 = RM 600,000

Which is more risky?

DECISION THEORY IN RISK MANAGEMENT

– Decision making under certainty----The occurance of the risks is known with certainty and there is only one option possible

– Decision making under risk----More than one possible option exists and probability calculation is available for each option

– Decision making under uncertainty---More than one possible option available but the probability calculation is not possible for all options and nothing is known about the chance of occurance.

TECHNIQUES FOR FORCASTING RETURNS ON INVESTMENT

USING EXPECTED VALUE CALCULATION

Option Return(%) Prob Payoff

1 0 1.0 RM100,000 2 6 1.0 RM106,000

3 15 or 3 0.5 RM115,000 or RM103,000 4 10, 20 or 30 0.2 RM110,000 or RM120,000 or RM130,000

CALCULATION OF EXPECTED VALUE OF ALL THE OPTIONS

OPTION1: EV1=1.0 x RM100,000 = RM100,000

OPTION2: EV2=1.0 x RM106,000 = RM106,000

OPTION3: EV3=(0.5 x RM115,000) + (0.5 x RM103,000) = RM109,000

OPTION4: EV4=(0.2 x RM110,000) + (0.2 x RM120,000) + (0.2 x RM130,000) = RM 72,000

•

CHAPTER 9

Choice of Option

Risk Adverse? Why?Risk Taker? Why?What is your choice?

ASSESSMENT OF PERSONAL LOSSPERSONAL LOSS----LOSSES ARISING FROM HUMAN LIFE CONTINGENCIES

• PEOPLE ARE THE MOST IMPORTANT ASSET THAT NEEDED PROTECTION

• ORGANIZATION SUFFER PERSONAL LOSS DUE TO:– DEATH, DIABILITY, RETIREMENT, RESIGNATION, DISCHARGE– REPLACEMENTN INCUR COST– TRAINING ALSO INVOLVE COST– LOSS VALUE OF THE PERSON’S SERVICES– ANY EXPENSES CAUSED BY THAT LOSS

POTENTIAL FINANCIAL EFFECT ARISING FROM PERSONAL LOSS

• LOSS OF PROFITS. Eg. Sale Adversely Affected

• LOSS OF FUTURE INCOME. Eg.Revenue adversely affected

• LOSS OF FUTURE EARNING, Eg.Dissatisfied employees leave organization and establish

competing firm offering the same goods or services

PROPERTY LOSSPROPERTY LOSS---DIRECT OR INDIRECTLOSSES TO PROPERTIES OWNED, LEASED OR IN CUSTODY

DIRECT PROPERTY LOSS• EARTHQUAKE, FIRE, FLOOD• REPAIR TO MOTR VEHICLE DAMAGED IN A COLLISION• DAMAGE TO SAFETY BAXES AFTER A BREAK-IN AT THE BANK• GENERALLY EASY TO VALUE AND QUANTIFY• CREDIT RISK, INVESTMENT RISK, CURRENCY EXCHANGE RISKS THAT

HAVE A DIRECT CONSEQUENCE OR DECREASE ON THE BANKS ASSETS

INDIRECT PROPERTY LOSS

• LOSS OF OPERATING EFFECTIVENESS OR EFFICIENCY

• MACHINE BREAKDOWN DECREASE PRODUCTION INTERUPTION OF SALE

METHODS OF VALUATION PROPERTY LOSSES

BOOK VALUE OR HISTORICAL COST

THE VALUE REPORTED IN THE FINANCIAL STATEMENT FOR THE ASSETS OF THE ORGANIZATION, WHICH IS ALSO THE PURCHASE PRICE OR THE ORIGINAL COST LESS ACCUMULATED DEPRECIATION.

MARKET VALUE

• CAN BE ESTIMATED BASED ON PRICE AT WHICH EQUIVALENT PROPERTIES HAVE BEEN TRADED MOST RECENTLY

• THE VALUE DETERMINE BY DMAND AND SUPPLY

REPLACEMENT COST NEW

THE COST OF BRAND NEWPROPERTY THAT IS IDENTICAL ORMATCHED THE FEATURES TO THEDAMAGED PROPERTY

REPLACEMENT COST NEW LESS DEPRECIATION AND OBSOLESCENCE

REPLACEMENT COST MINUSPHYSICAL DEPRECIATION AND

ECONOMIC OBSOLESCENE

LIABILITY LOSS

LIABILITY LOSS---OCCUR AS ARESULT OF LEGAL ACTIONS TAKEN BY AGGRIEVED PARTIES DUE TO ACTIONS OR INACTIOS OF THE ORGANIZATION RESULTING IN LOSS TO THEIR PERSONS OR PROPERTIES

THREE SOURCES THAT RESULTS IN A LIABILITY LOSS

1. THE QUANTUM OF DAMAGES AWARDED BY THE COURT TO THE CLAIMING PARTY

2. THE LEGAL DEFENSE COSTS

3. THE COST OF PREVENTIVE ACTIONS TAKEN TO PREVENT POTENTIAL LEGAL LIABILITY SUITS

LEGAL LIABILITY

• UNDER COMMON LAW OR STATUTORY LAW AS A RESULT OF WRONGFUL ACTIONS ARISING UNDER CONTRACT LAW, TORT LAW AND CRIMINAL LAW

TYPES OF LAW

PUBLIC LAW---RELATES TO THEPOWERS AND RIGHT OF GOVERNMENTSAND THE RELATIONSHIPS OF TOINDIVIDUALS AND ORGANIZATIONS.

Eg. EPF, INCOME TAX, OSHA, ETC.

PRIVATE LAW----GOVERNS INDIVIDUALS AND ORGANIZATIONS AND THEIR RELATIONSHIPS TO ONE ANOTHER

Eg. Tort Law, Contract Law, Property Law, Agency Law, Sales Law, Partnership Law and Incorporation Law

CRIMINAL LAW

CRIMINAL LAW---RELATES TO BREACH OF DUTY OWED TO SOCIETY IN GENERAL WHERE VIOLATORS ARE PROSECUTED BY THE STATE IN THE NAME OF ALL ITS PEOPLE.

CIVIL LAW

CIVIL LAW---RELATES TO BREACH OF DUTY OWED TO A PARTICULAR OR INDIVIDUAL WHO FILE A LEGAL IN ORDER TO ATTAIN AN APPROPRIATE LEGAL REMEDY

LAW OF TORT

A TORT IS A CIVIL WRONG FOR WHICH THE COURT WILL PROVIDE REMEDY IN THE FORM OF DAMAGES USUALLY, MONETARY IF THE AGGRIEVED PARTY COULD SUCCESSFULLY PROCECUTE HIS CASE IN COURT.

INTENTIONAL TORTS

PLANNED ACTIONS OR CONDUCT THAT RESULT IN A LOSS OR DAMAGE TO THE AGGRIEVED PARTY.

• TRESPASS—ENTRY EITHER IN PERSON OR THING INTO LAND IN THE POSSESSION OF ANOTHER WITHOUT PERMISSION.

• CONVERSATION---A WRONGFUL RETENTION OF PERSONAL PROPERTY BELONGING TO ANOTHER AND THE PENALTIES ARE THE SAME AS TRESPASS

• ASSAULT---VIOLENT OR AGGRESSIVE CONDUCT OR WORD WITOUT CONTACT TO A PERSON, FOLLOWED BY REAL THREATS AND FEEL TREATENED

• BATTERY---AN EXTENTION OF ASSAULT IS CONSIDERED BATERRY WHEN CONTACT IS MADE TO THE PERSON OF ANOTHER WITHOUT CONSENT OF THE INNOCENT PARTY

• FALSE IMPRISONMENT---THE UNLAWFUL IMPOSITION OF RESTRAINT ON ANOTHER’S FREEDOM OF MOVEMENT.

• ANY RESTRICTION WHICH PREVENTS A PERSON LEAVING A PLACE AMOUNTS TO FALSE IMPRISONMENT.

• DEFARMATION---CONSISTS OF PUBLISHING A DEFAMATORY STATEMENT WHICH REFERS TO AN IDENTIFIABLE CLAIMANT, WITHOUT LAWFUL JUSTIFICATION

Eg. Publication, Statement, picture, music.etc that triggered adverse felling or judgement against other.

UNINTENTIONAL TORTS

• NEGLIGENCE---OCCUR WHEN SOMEONE FAILS TO EXERCISE THE DEGREE OF CARE THAT IS REASONABLE UNDER THE CIRCUMSTANCES.

• THE ACTS IS WITOUT INTENTION TO INVADE, BUT MERELY FAILS TO TAKE DUE CARE OF ANOTHER PERSON’S RIGHT.

• DEFENSES AGAINST CHARGES FOR NEGLIGENCE

Eg. Privilege, Immunity of Government, Charities, etc

• STRICK OR ABSOLUTE LIABILITY

• IMPOSED BY LAW WITHOUT REGARD TO THE INTENT OF THE WRONGDOER’S ACTION

• LIABILITY WITHOUT PROVE OF FAULT

• Eg. Keeping wild animal as pet, storage of dangerous products, inherently dangerous activities, drug pusher & dealer, etc