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Risk Management in General Insurance

1.1 INTRODUCTION

Risk management as a subject and as a function function of businss management andtherefore the purpose of unit is to explore some of the basic concept of risk and

management of it.

• The Entrance Arch into ords !here the "orld #up $%%% culminated& carries the

follo!ing inscription& excerpted from the 'oem "IF" of Rud(ard )ipling& "If you

can cope equally well with triumph and diater! OU #ill pro$a$ly do all ri%ht

for yourelf. Apparentl(& )ipling !as !riting about large and enduring things but

his sentiments *er( emphaticall( can be applied to an( modern commercial enterprise

+including that Great #ommercial Enterprise of International #ricket,. In a real sense&

-usiness process is as much about coping !ith problems as it is do !ith ales

'erformance and -ottom line. This continuous process of problem sol*ing& like an(other /acult( of Management& is an Art as !ell as a cience. This presentation aims

to identif( a fe! critical areas of the "Ri& 'ana%ement Function". /or the purpose

of ease in comprehension& this !rite up !ould use the !ord "Ri&" as interchangeable

!ith "(a)ard" +though essentiall(& 0a1ard is the cause and Risk is the resultant,.

i&

The term Risk Management first appeared in print in the 0ar!ard -usiness Re*ie! in an

article b( Russel Galigar in $%23& although this term has been in con*ersational use some

(ears before. E*er since insurance !as transacted as a separate discipline& the term Risk

Management has been interchangeabl( used !ith insurance. The !ord risk has shades of

uncertaint(. In common parlance the !ord risk has been used more to indicate the chancesof failure. ife in this planet has e*ol*ed around a lot of uncertaint(. E*er since life on this

planet e*ol*ed from the amoeba stage to the current le*el of human race& there ha*e

al!a(s been uncertainties in the en*ironment for billions of (ears. It !as through a process

of mutation one species e*ol*ed into another& thereb( o*ercoming the risks of uncertain

destinies. As !e !ill see in the later chapters& Risk and 4ncertaint( ha*e a direct relationship.

-ut then both are still different.

$.5 6E#EIT7 8/ RI) MA6AGEME6T

"e all are familiar !ith resources that ha*e man( forms 9 Men& Materials& /inance& and

Intellectual 'ropert( etc. All of us are also a!are that the human life in*ol*es a large le*elof d(namism. "hether one chooses to call it as progress or deterioration& human life has

mo*ed from one phase to another.

In the 5:th centur( !e ha*e seen Industrial Re*olution emerge into Technological Re*olution

and in the 5$ st centur( !e are seeing e*en -asic ciences undergoing tremendous amount



4nit $ -asic #oncept of Risk Management

of change in their approach and focus. -ut the problem !ith resources is that the( are

limited in ;ualit( and ;uantit(& e.g.& /ossil fuels like 'etrol& <iesel. Though reser*es of

these t(pes of fuels are being disco*ered from time to time& the fact remains that the( are

all depletable. o& !e ha*e a situation& !here there are se*eral opportunities& these

opportunities re;uire resources& but there are limitations in terms of the ;uantit( and ;ualit(

of resources. o& !e are forced to choose bet!een the *arious opportunities and allocate

the limited resources in such a !a( that the optimum benefit from such an opportunit( can

be deri*ed.

Risk Management is all about efficient allocation of resources to *arious risks so that an

optimum utili1ation of these resources takes place.

"hen !e talk of optimum utili1ation of resources& this process is not confined onl( to

-usiness 8rgani1ations. E*en in indi*idual life !e come across se*eral opportunities and

!e similarl( face the resource crunch !hich organi1ations face. "e are therefore forced to

allocate priorities and use our personal limited resources in the best possible manner. 6ot

onl( commercial organi1ations but also 6on9'rofit entities like hospitals& charitable institutions

and e*en Go*ernment <epartments !ill ha*e to undertake the process of Risk Management

for efficient use of resources. o long as there is a limitation on resources and so long as

there is a *ariet( of options a*ailable for using these resources then there has to be a

process of Risk Management.

JJ&*cti+ity *,

#omment on =Risk Management is necessar( for efficient use of resources.=

1.- I'ORT*NC/ OF RI0 '*N*2/'/NT

Risk creates anxieties and anxieties result in lesser than efficient utili1ation of resources.

Risk Management enables a business to handle its ordinar( businesses in a better manner.

/reed of concern about both accidental losses as !ell as usual business risks& a business

can more aggressi*el( and intelligentl( organise its regular acti*ities. "hether it is introduction

of ne! product or extending the operation into a ne! territor( or making in*estments to

expand the le*el of operations& all !ill hinge upon the perceptions of risk both of accidental




and regular nature. The increasing complexit( of both business and personal life Risk

Management is no longer an option.

Think of the number of 6on9-anking /inancial Institutions that suffered a collapse in our o!n countr(. Man( of them had a fundamental deficienc( in that> the( did not manage their

risks of their in*estments properl(& !ith a result man( in*estments floundered. imilarl(&

think of se*eral /ortune 2:: companies in the 4nited tates of America collapsing one

after another in recent !eeks. These companies again had a fundamental fla! that the

#orporate Management !as less efficient in the management of risks related to #orporate

Go*ernance.

3*cti+ity 4 ,

7ou are a <irector of a drug manufacturing factor( and !ant to appoint a risk manager.

"rite do!n (our *ie!s on =Responsibilit( of a risk manager= in (our factor(.

1.5 D/FINITION OF RI0

Risk is defined in *arious !a(s& in *arious contexts. This !rite9up !ill define Ri& as

"illiams ? 0eins chose to define@ "the +ariation in the outcome that could occuro+er a pecified period in the %i+en ituation."

If onl( one outcome is possible& the risk is ero. The greater the *ariation& the greater the

risk.

A risk ma( be defined as follo!s@

• Risk is the possibilit( of an unfortunate occurrence.

• Risk is a combination of ha1ard.

• Risk is unpredictabilit( B the tendenc( that actual results ma( differ from predicted

results.

• Risk is uncertaint( of loss.

• Risk is the possibilit( of loss.




Risk and probabilit( are closel( linked. The probabilit( associated !ith a certain outcome

is the relati*e likelihood that the outcome !ill occur. 'robabilit( *aries bet!een ero and

8ne. If the probabilit( is ero& the outcome !ill not occur. If the probabilit( is 8ne that

outcome !ill occur. ince !e ha*e defined risk as a function of outcome& mathematicall(

risk can be *isuali1ed as the characteristics of the probabilit( distribution of certain outcome.

'ana%ement of ri&

In the case of an indi*idual& it is simple that either the indi*idual person or his famil( organises

the process of Risk Management either in a deliberate or a routine manner.

-ut in the case of #orporate& the recent trend has been that an exclusi*e Risk Management

position is created and the Risk Manager handles the process of Risk Management. -ut&

as (ou !ill see in the one of the later chapters& Risk Management need not be isolated or

become insular. ince Risk per*ades throughout the organisation& Risk Management alsohas to per*ade e;uall( !ell.

1.6 RI0! RO4*4I7IT8 *ND UNC/RT*INT8

ince Risk Management is about managing risks& !e need to kno! clearl(& the meaning of

the term Risk. This !ould again re;uire clarit( on meaning of associated terms like 'robabilit(

and 4ncertaint(.

"e !ill first start !ith the definition of the concept of 'robabilit(. The probabilit( associated

!ith a certain outcome is the relati*e likelihood that the outcome !ill occur. -efore the

start of a #ricket match !e ha*e all seen the ri*al captains marching out to the centre of the

field and one of them tossing the coin and the other calling either 0ead or Tail. There are

t!o possible outcomes 9 0ead or Tail and therefore the possibilit( that one of the outcomes

!ill occur during the toss of a coin is one b( t!o. #ontrast this !ith the possibilities& !hich

emerge out of a single ball being bo!led. There are a *ariet( of possibilities for such a ball

being bo!led 9 It could be a run out& it could be a hit !icket& it could be a stumping& it

could be a clean9bo!led etc. Therefore the probabilit( that out of a ball being bo!led the

result !ill be run out is certainl( not one b( t!o or one b( six but it is far less than that.

'robabilit( *aries bet!een 1ero and one.

If the probabilit( is 1ero& a particular outcome !ill not occur at all. If the probabilit( is onethen that outcome !ill certainl( occur. The closer the probabilit( is to one the more likel(

it !ill occur. If one starts plotting the probabilit( of *arious outcomes out of a particular

e*ent along a graph& then one gets !hat is called as the 'robabilit( <istribution.




'lease see the illustration /igure $.$ and $.5 !herein t!o probabilit( distributio

gi*en. 7ou !ill find that the possibilities in the probabilit( distribution $.$ are more

compared to the possibilities gi*en in the /igure $.5. These illustrations !ill be us

understanding the concept of risk !hich !e !ill define subse;uentl(.

$

ro$a$ility

0199 :99 -99 599 699 ;R. Crore<

Fi% 1 , Total 7oe in a financial year

ro$a$ility

0199 :99 -99 599 699 ;R. Crore<

Fi% : , Total 7oe in a financial year




Take the case of a factor( manufacturing electric bulbs. /or e*er( thousand bulbs& the

probabilit( that there !ill be 1ero defects !ill ha*e a number attached to it. imilarl(& the

probabilit( that for e*er( thousand bulbs& hundred bulbs !ill be defecti*e !ill also ha*e a

certain number attachable.

ike!ise& the probabilit( the ele*ator in a high rise building consisting of C: store(s !ill

al!a(s reach the desired floor or an( particular floor also !ill ha*e a certain number

attachable to it. 'erhaps if it is a good ele*ator s(stem& almost close to one. 8n the other

hand the probabilit( that (our boss is going to be good to (ou in office on an( particular

da( cannot ha*e a clear number attached to it. imilarl( the probabilit( that the stock

market index !ill reach a particular le*el on a particular da( cannot also ha*e a clear

number attached to it.

The reason being the former t(pe of examples like the manufacture of electric bulbs or lift

reaching a particular floor has !hat is called as an underl(ing probabilit( to it and this

underl(ing probabilit( is more often than not an objecti*e probabilit(. -( objecti*e !e

mean that there is statistical e*idence !hich ma( be a*ailable or !hich can be established

through !hich this objecti*e probabilit( can be figured out.

All the examples gi*en the probabilit( can be estimated b( computing the proportion of times the outcome in ;uestion occurs in a long series of repeated obser*ations& e.g. for computing the probabilit( of a certain number of bulbs being defecti*e !e can repeat theobser*ations for a period of lets sa( $:: da(s or so and then !hate*er probabilit( emerges

out of that or !hate*er proportion emerges out of that these series of obser*ations can beclose to the underl(ing objecti*e probabilit(.

There is a theorem called as the a! of arge 6umbers !hich ma( be pro*ed mathematicall(

and !hich goes as follo!s =As the number of independent obser*ations increases the

proportion of times as certain outcome occurs tends to approach the underl(ing probabilit(=.

That this statement is subject to the assumption that if the underl(ing conditions undergo a

change then still statistical e*idence ma( be a*ailable that !ould indicate the trends& c(cles

or seasonal fluctuations that !ill affect the outcome. /or e.g. The probabilit( that the D0ole

in 8neD situation !ill happen in a golf course ma( undergo a change if the landscape of the

golf course is drasticall( altered. "hat is to be remembered ho!e*er is that if you go on

+MgppE-iF,fcc*GHI under essentially the same #JMitiJFFaKFJK*!?fei! 8sss?*oFt

/ing objecti*e probabilit(.

As there exists objecti*e probabilit(& there is also a possibilit( of probabilit( being estimatedsubjecti*el( 9 because there !as lack of an( statistical histor(. 7ou ha*e seen it happen inthe film making industr(. The chances that a particular film starring& let us sa(& e*en a *er(




popular hero like hah Rukh )han& !ill be a box office hit& cannot be *er( statistica

established and therefore it has to be a highl( subjecti*e estimate 9 Though academici

!ill dismiss subjecti*e probabilit( as more of a belief. ubjecti*e probabilit( has al!

been utili1ed gainfull( in human endea*ors.

Think of eonardo da Linci !ho !as tr(ing to simulate the flight path of birds 9 all he !

doing !as to estimate probabilistic the chances of successful fl(ing so long as the fli

mechanism of birds !as copied. -ut it took se*eral centuries for the "right -rothe

actuall( to bring this concept into realit(. Therefore& subjecti*e probabilities ha*e al!

had lent inner strength to creati*e talents of mankind.

Uncertainty i a peron= conciou awarene of the ri& in a %i+en ituation.

depends upon the personDs estimation of the risk that is !hat the person belie*es to be

state of the !orld and the confidence he or she has& in this belief. "e could sa( that t

concept of uncertaint( implies doubt about the future based on a lack of kno!ledge

imperfect kno!ledge. Therefore the concept of uncertaint( is close to !hat one can sa(

the subjecti*e estimation of the risk& and naturall( an( commonl( accepted (ardstic

cannot measure uncertaint(.

s

6o!& !e !ill get to define the crucial concept namel( Risk. The 8xford English <iction

defines Risk as =#hance of danger& injur(& loss=& etc. The same dictionar( defines Risk a

*erb as =exposed to risk& *enture on& takes chances of=. There ha*e been other definiti

of risk. Risk has been defined as =subject of insurance& uncertaint( concerning the outcom

etc. "e ha*e to be clear that risk does not necessaril( ha*e a negati*e implication. "e !

see more of this later& but for the current purpose& Ri& will $e defined a the +ariatin outcome that could occur o+er a pecific period of time! in a %i+en ituation

onl( one outcome is possible the *ariation is 1ero and therefore the risk is 1ero. If ma

outcomes are possible the *ariation is greater and therefore the risk is greater. The grea

the *ariation& the greater the risk. ince !e call these graphics as probabilit( distributi

it is to be understood that Risk is a characteristic of the probabilit( distribution.

7ou can readil( understand the concept of risk if (ou go back to the example gi*en earl

of the coin tossing before the cricket match and the possibilities& !hich can arise out o

single ball being bo!led.

The Risk in coin tossing is less as *ariations are onl( t!o. -ut& in e*er( ball& the Risk batsman or e*en bo!ler is more& as *ariations are more.




3*cti+ity C ,

"hat is a difference bet!een risk and uncertaint(

1.> C7*00IFIC*TION OF RI00

There are *arious !a(s to categories risk. 8ne thing is certain that almost all human acti*ities

in*ol*e some risk and some uncertaint(. In a Metropolitan cit( like Mumbai& e*en lea*ing

the home and returning home safel( is an acti*it( !hich carries a si1eable amount of risk.As indi*iduals& as 8rgani1ations& !e face as N*ariet( of risks. "e !ill first look at a broad

categori1ation of risks.

ure ?ere 0peculati+e Ri&

'ure Risk is !here there is a chance of a loss but there is no chance of a gain. This means

that if the e*ent associated !ith the risk does happen& there is onl( a chance that there !ill

be a financial or personal or social or economic loss and no gain !hatsoe*er.

Think of a tra*el in a boat across the ri*er 9 If the boat capsi1es& there can be onl( loss of

life or loss of propert(. 0ere the e*ent& !hich carries the risk& is the boat tra*el. The

outcome !hich can happen out of this tra*el is a possible capsi1ing or safe landing on the

other shore. o the contingenc( called the capsi1ing of the boat reall( comes about& then

there is ob*iousl( no gain. #ompare this !ith the film making.

peculati*e risk is a t(pe of risk !here there is a possibilit( of either gain or a loss occurring

out of an e*ent. A film !ell made !ith the right script and right cast can succeed or can

flop.

To get this clear& let us once again examine the *ariations !hich can arise out of tra*eling in

a boat across the ri*er. 8ne possibilit( is that (ou !ill reach the other shore safel(. 8ther

possibilit( is that the boat ma( drift and take (ou to another location. The third possibilit(

is that there is a !eather storm or high currents in the ri*er& !hich !ill make the boat

capsi1e.




If (ou look at onl( these three possibilities or possible outcome then there is associated

probabilit( of each of these e*ents. /or e.g. for e*er( $:: trips made across a particular

ri*er in a particular t(pe of boat the probabilit( that the boat ma( capsi1e ma( be one in

hundred& and the probabilit( that the boat might drift ma( be 2 in hundred and the balance

%C out of hundred is the probabilit( that the boat !ill take (ou across safel(. It is not to be

understood that just because the probabilit( of capsi1ing is .:$ or one in hundred the risk

is lo!. Actuall( the risk is lo! in this tra*el scenario onl( because there are just O possible

outcomes.

As against this going back to the example of the outcome that can arise out of a cricket ball

being bo!led there are so man( *ariations possible. Though each of them might ha*e a

high or lo! probabilit( associated !ith it& just because the *ariet( is huge& the risk is huge.

#oming back to 'ure Risk in the boat tra*el& the e*ent that the boat could capsi1e represents

a pure risk situation. If the boat capsi1es there is onl( a loss of life or loss of propert( and

therefore a loss situation.

In contrast to this in*estment in share markets represents a speculati*e risk situation. A

stock can appreciate or depreciate depending upon *arious factors and therefore an in*esto

can either gain on its holdings or lose on its holdings.

'ure risks also differ from peculati*e risk situations in that the( are generall( repeatabl

and ha*e essentiall( the same outcome under the same conditions and are therefore mor

amenable to the a! of arge 6umbers. Except in a game of chance !herein again due t

repetition the a! of arge 6umbers is still applicable and one can estimate e.g. in ho!

man( thro!s one could get the number six in a dice.

Examples of pure risks are fire at a factor(& storm& accidental death or injur( at !ork an

theft of goods from a store. The *arious business risks cited are all speculati*e risks. Mo

pure risks can be dealt !ith b( insurance& but speculati*e risks are generall( uninsurable

Another difference is that most pure risk situations result in loss and if an indi*idual loos

the societ( also loses. As (ou kno!& if there is a major catastrophe like in an Earth;ua

or /lood torms& all indi*idual loses sum up to huge loses for the societ( or countr( a

!hole. The onl( exception perhaps is !here an indi*idual looses his possessions b( t

!a( of an act of theft or burglar( and this mans loss results in gain to another indi*idu

!ho has taken possession of it.

Another interesting aspect about 'ure and peculati*e risk is that both ma( coexist.

illustrate& think of an indi*idualDs holdings in gold. Gold is subject to burglar( or theft an4nit -asic #oncept of Risk Management

this represents the 'ure Risk situation !hereas gold is also subject to price fluctuations bo

up!ards and do!n!ards and this represents the peculati*e Risk aspect.

3*cti+ity D ,



"rite do!n four examples each of pure and speculati*e risks.

1.>.: Dynamic ?eru 0tatic Ri&

<(namic risks arises from the changes that take place in e*er( societ(& that is& econom

social& technological& en*ironmental and political changes. The static risks are those t

!ould exist in the absence of such changes.

#hange in price le*el& consumer tastes& income and outgo& financial loss due to change

technolog( are some examples of <(namic risks. These risks are less predictable.

In static risks in*ol*es destructions of asset and hence loss to the indi*idual and ultimatel(

the societ(. Generall( these risks are predictable.

<(namic risks are closel( related to the speculati*e risks !hereas most pure risks are a

examples of static risks.

tatic risks are insurable !here as <(namic risks are not insurable.

3*cti+ity /,

"rite fe! !ords on =<(namic risks ma( affect a large number of indi*iduals =.




1.>.- Fundamental ?eru articular Ri&

/undamental risks are those !hich arise from causes outside the control of an( one indi*idual

or e*en a group of indi*iduals and affect the !hole of societ( or a major part thereof& such

as uncertainties arising out of the economic or political s(stem or natural catastrophes such

as earth;uake& flood& famine& *olcano and other natural disasters. The( are both impersonal

in cause and effect.

'articular risks are much more personal both in their cause and effect and affect mainl( the

indi*idual or firm and arise from factors o*er !hich he ma( exert some control such as fire&

theft& !ork related injur( robber( in bank and motor accidents.

It ma( be argued that societ( collecti*el( should accept responsibilit( for the losses incurred

b( indi*iduals arising from fundamental risks& !hereas indi*idual should make their o!n

arrangements for dealing !ith particular risks.

8*er time& *ie!s change as to the di*ision bet!een fundamental and particular risks. /or

example& in the past unemplo(ment !as regarded as a matter of indi*idual responsibilit(&

but is no! uni*ersall( recogni1ed as a responsibilit( of go*ernment. *

£$ Activity />

D/undamental and speculati*e risks are usuall( uninsurable.D Explain !hether this is a true

statement.

1.@ C7*00IFIC*TION 48 0IA/ OF 7O00

A classification of risk can also be done according to potential loss se*erit( for the indi*idual

or firm exposed to loss& as follo!s@

#lass I 9 Those losses !hich do not disturb a firmDs basic finances.

#lass n 9 Those losses !hich !ould necessitate rising additional finance b( borro!ing or

a share issue.4nit -asic #oncept of Risk Management

#lass III 9 arger losses !hich might bankrupt the firm.

"here as it ma( be possible for a firm to handle internall( #lass I and e*en

#lass II risks& normall( #lass III losses can onl( be handled b( transferring

them&

usuall

( to an

insurer



.

3*cti+ity 2,

=7oung dri*ers pa( higher premiums than other dri*ers e*en if the car insured is

a smaller one.= 0o! !ould (ou explain this

1.B OT(/R T8/0 OF RI00

8ther than the abo*e9mentioned categori1ation there are also man( other !a(s

in !hich risks are specified or categori1ed.

roduction Ri& @ A firm ma( fail to produce its planned output at a planned unit

cost due to the operation of man( t(pes of uncertain e*ents& or a change in

market conditions ma( ad*ersel( affect the a*ailabilit( and Por cost of materials

and parts its purchases.

The 'ar&etin% and Ditri$ution Ri& @ A firm must be able to sell all its

products at a planned price deli*er it to its customers. -ut due to change in

fashion& general economic conditions& introduce better product b( competitors

etc it ma( fail to do so.

Financial Ri&@ If the earning falls due to increase in rate of interest of bank finance or change in exchange control regulations& change in credit facilities

offered b( financers& failure of debtors etc results in financial loss.

eronnel Ri& @ The success or failure of an( enterprises depends on the

abilit( & integrit( and enthusiasm of its directors& managers and emplo(ers

.oss of a ke( man due to injur(& sickness or death ma( disturb the future

planning of a compan( or poor industrial relations lead to fre;uent stoppages of

!ork.

/n+ironmental Ri& @ <ue to increase in a!areness of pollution due to

disposal of industrial !astage on land and into !ater courses or release of contamination into air& industrial firms ma( run the risks of hea*( fines due to

*iolation of pollution la!s.

$O




All organi1ations ha*e an inherent risk but the t(pes of inherent risk *ar( depending upon

the t(pe of organisation. /or e.g.& a manufacturing unit has a larger exposure to occurrence

like /ire and explosion& !hereas a financial institution has lesser exposures in respect o

these kind of contingencies. 8n the other hand the latter is substantiall( exposed to a risk

of speculati*e nature.

Contin%ent Ri&@ !here e*ents and circumstances be(ond the control of an organisation

dictate these t(pe of risks for e.g. the market forces& the customers profile getting

affected 9 all these are contingent risks.

Cutomer Ri& @ <ependenc( on a certain t(pe of customers creates *ulnerabilit( because

if the customer preference shifts& then the suppl(ing organisation suffers directl(.

"e ha*e also the Fical or Re%ulatory Ri&. imilarl( 0upplier Ri& !hich used to

in*ol*e onl( e*aluation of the abilit( of the suppliers to ensure supplies on minimum standardis no! e*en expanding be(ond such considerations to concepts such as supplier

complianceDs regarding En*ironmental considerations.

In a project de*elopment situation& both the promoters and lenders of theF project carr( an

enormous amount of and *ariet( of risks& !hich ultimatel( the( tr( to balance b( retaining

and transferring such risks to *arious participants in the project situations& and this is !ha

results in a number of project agreements. imilarl(& the financial institutions carr( the risk

of lending& non9performing assets& interest rate risk& s!ap risk& currenc( risk= etc.

'olitical changes can bring more go*ernment inter*ention in emplo(ment& marketing

in*estment and other policies ma( lead nationali1ation !ithout compensation.

8rganisations and indi*iduals also carr( !hat is called as Reputation Risk !hich ma( aris

out of considerations like errors and omissions& defamation& professional malpractice etc

Another ne! and unsettling source of risk is political risk. "e ha*e seen the effects o

eptember $$ and !e ha*e also seen the build up of tensions along the Indo9'akistan

border and the conse;uent Tra*el Ad*isories issued b( man( de*eloped countries.

An on9going organi1ation encounters a continuous spectrum of risks. This risk could b

either internal or external to the organisation& this risk could be one of those !hich are

controllable b( the organi1ations Management or those !hich are be(ond.

Risk need not al!a(s ha*e a negati*e halo. The famous American educationist Qohn

Gardner& once said& "ro$lem are all $rilliantly di%uied opportunitie". The sam

!a( risk can also induce positi*e de*elopments. The risk of being left behind b( competitors



4nit $ -asic #oncept of Ri& Management

indeed compels man( organisations to stretch themsel*es to the limits of creati*it( and be

constantl( inno*ati*e.

3*cti+i ty (,

A food Manufacturer has a large factor( !ith sophisticated machiner( and production

lines. 0e produces a range of foodstuffs for both home and export market. ist out risks

faced b( this factor(.

1. T8/0 OF RI00 R/UIR/D TO 4/ '*N*2/D

An( professional Risk Manager in a business organisation !ould be concerned about

'ure risks. 0e or she !ill be in*ol*ed !ith peculati*e risk situations onl( to the extent that

the creation of peculati*e risk& forces them to face certain 'ure risk. /or instance& the

ac;uisition of a ne! propert( b( a business enterprise represents both peculati*e and

'ure risks. The peculati*e risk is created b( the possibilit( that this in*estment ma( result

in either financial gain or financial loss to the organisation. "hereas& a t(pical 'ure risk is

represented in such ne!l( ac;uired propert( b( the possibilit( that it ma( undergo a loss

due to fire or c(clone.

3*cti+ity I,

=6o!ada( it is felt that /undamental risks are responsibilities of the societ(.= 0o! !ould

(ou explain thists of

constantl( inno*ati*e.

E%3*cti+ity (,

A food Manufacturer has a large factor( !ith sophisticated machiner( and

production lines. 0e produces a range of foodstuffs for both home and export

market. ist out risks faced b( this factor(.

1. T8/0 OF RI00 R/UIR/D TO 4/ '*N*2/D

An( professional Risk Manager in a business organisation !ould be

conce

rned

about

'ure

risks.

0e or

she!ill be

in*ol*

ed

!ith

pecul

ati*e

risk

situati

ons

onl(



to the extent that the creation of peculati*e risk& forces them to face certain

'ure risk. /or instance& the ac;uisition of a ne! propert( b( a business

enterprise represents both peculati*e and 'ure risks. The peculati*e risk is

created b( the possibilit( that this in*estment ma( result in either financial gain

or financial loss to the organisation. "hereas& a t(pical 'ure risk is represented

in such ne!l( ac;uired propert( b( the possibilit( that it ma( undergo a lossdue to fire or c(clone.

3*cti+ity IG

=6o!ada( it is felt that /undamental risks are responsibilities of the societ(.=

0o! !ould (ou explain this

$2




1.19 0U''*R8

In this unit !e ha*e introduced the concept of Risk and 4ncertaint(. The occurrence of

some e*ents ma( result in either gain or loss !hereas others cause onl( loss. ome e*entsare the results of human beha*iors& others are be(ond human control. /undamental risks

are normall( so uncontrollable& !idespread and indiscriminate that it is felt the( should be

the responsibilit( of societ( as a !hole.

In this unit !e also discussed *arious t(pes of risks !hich an indi*idual or organi1ation

ha*e to face in their da( to da( life and !orking. "e ha*e also seen the impact of *arious

risks on firms& industries and organi1ations.

1.11 /8 #ORD0

Ri& 'ana%ement

ro$a$ility

Uncertainty

Ri&

ure Ri&

0peculati+e Ri&

Dynamic Ri&

0tatic Ri&

Fundamental Ri&

A scientific approach to the problem of dealing !ith the pure

risks facing an indi*idual or an organi1ation in !hich insurance

is *ie!ed as simpl( one of se*eral approaches for dealing

!ith such risks. *

The probabilit( associated !ith a certain outcome is the relati*e

likelihood that the outcome !ill occur.

It is the conscious a!areness of the risk in a gi*en situation.

It is the *ariation in the outcome that could o*er a specific

period of time in a gi*en situation.

'ure risk is !here there is a chance of a loss but there is no

gain.

is !here there is a chance of gain.

arises due to.economic& social& political& en*ironmental and

technological changes.

are exists in the absence of such changes.

are those !hich arise from causes outside the control of an(indi*idual or group.

articular Ri& are much more personal both in cause and effect.




:.1 INTRODUCTION

Imagine for a moment& if the ca*e man did not step out of confines of the ca*e& all of

!ould still be ca*e men or !omen. There is a compulsi*e characteristic present in thuman race& !hich makes us *enture out and explore. Acti*ities are inherent in all !alkshuman life. 0uman curiosit( about the !orld and en*ironment about us has led to tde*elopment of *arious bodies of kno!ledge and *arious endea*ors. As the great Germthinker 6ietsche once said =A heart full of courage and cheerfulness needs a little dangfrom time to time or the !orld gets unbearable=. o& this takes us back to the ;uesti!h( should !e tr( to manage risk. The reason is& that risk and its associated le*elsuncertaint(& all ha*e an economic cost..

Allan 0. "illet& in his discussion of the Economics of insurance refers to the cost uncertaint(. According to him& the cost of uncertaint( arises out of@ $. The unexpect

losses that do occur. 5. The cost of uncertaint( itself.

5.5 RI0 (*ND7IN2 CO0T

ome cost !ill be incurred to identif(& e*aluate and handle risks. Insurance premiu

charges for loss pre*ention de*ices are some examples& hi addition there !ill be opportuncost too& time spent on risk handling b( management cannot be de*oted to other acti*ities

oss producing e*ents results in both direct and indirect losses. uddenl( hea*( rainsMaharshtra&Gujrath and Rajsthan causes hea*( losses to indi*idual and societ( direcand indirectl(. "e !ill no! discuss it in detail.

:.- T(/ CO0T0 OF UN/H/CT/D ;DIR/CT< 7O00/0

E*er(da(& indi*iduals& businesses and societies suffer losses on account of 'ure risituations. "e see indi*iduals losing their life or getting disabled in road accidents. imilartake the case of the disastrous floods& !hich hit parts of German( and #1echoslo*akrecentl(. Millions of small and medium business ha*e been forced to close because tra! materials and finished goods !hich these businesses !ere storing !ere either !asha!a( in the floods or made unfit for sale. The direct cost to a firm due to compensation

a injured person& loss of production due to accident.

Tsumani taking more than $2:::: li*es and rendering fe! thousands homeless and injure

The terrorist act of $$th eptember& 5::$ in 4A !hich de*astated the entire !orld.



4nit 5 The 'rocess of Risk Management

In most of these cases& the losses& !ere unexpected either to the indi*idual or to the firm or

to the societ( and these losses resulted in irretrie*able loss of the assets to the societ(. If

there is an( !a( to either foresee these losses or if the( are unforeseeable& manage the

losses once the( happen& then there !ill be tremendous incenti*e for indi*iduals in business

to continue in their respecti*e acti*ities.

3%T*cti+ity *,

"rite do!n an( incidence in !hich societ( and indi*idual suffers direct and indirect losses.

:.5 CO0T OF UNC/RT*INT8 IT0/7F ;INDIR/CT 7O00/0<

4ncertaint( causes ph(sical and mental strain resulting in fear and !orr(& therefore such

strain results in lesser creati*it( and lesser efficienc(. Man( studies ha*e established that

different people as also different organisations ha*e different le*els of sensiti*it( to risk.

"e ha*e to think of those earl( da( Ad*enture Tra*elers like Lasco da Garna& !ho *entured

out against all odds into unkno!n territories.

These t(pes of indi*iduals ha*e a good appetite for risk and as !e ha*e seen in 0istor(

subse;uentl(& these ad*entures ha*e indeed opened up ne! a*enues. ike!ise& in the

current da( business en*ironment& !e find ;uite a fe! enterprises going be(ond their routine to explore ne! and unkno!n territories of business. After all& all entrepreneurship

is about risk taking. The stor( of <hirubhai Ambani is a re*elation as to ho! a risk taking

indi*idual !ith limited resources could build up a huge industrial empire.

4ncertaint( itself has a cost. 4ncertaint( results in distorted use of resources. -et!een

t!o options 9 one !ith lesser le*el of uncertaint( and other !ith greater le*el of uncertaint(&

an( indi*idual or enterprise !ould choose to in*est their resources in the first opportunit(

rather than in the second. ometimes this ma( result in lopsided use of resources. If onl(

safe a*enues of in*estment !ere to be chosen& the de*elopment as !e see toda( !ould

ha*e ne*er taken place. pace Technolog( is a classic a*enue !hich is full of unkno!ns.

If the le*el of uncertaint( could pre*ent exploring space& *arious benefits of such spacetechnolog( !ould not ha*e been a*ailable to us at all. /rom out of the materials& !hich are

used for spacecraft& toda( !e ha*e no*el uses for such materials for e*en e;uipments for

disabled persons and s(nthetic #ornea for people !ith disabled e(esight.




o if there is uncertaint(& people and firms !ill either a*oid an( acti*it( in those areas

!ill di*ert their resources to acti*ities !ith lesser le*els of uncertaint(. It has to

remembered here that !hen !e sa( uncertaint(& it is all percei*ed and not objecti*e a

hence in this process of either holding back acti*ities or di*erting acti*ities !e !ould ha

ne*er progressed the !a( !e ha*e toda(.

FActi*i t( - @

#omment on =If !e a*oid the risk& !e lose the benefits accompan(ing it.=

5.2 'RILATE A6< 8#IA #8T

^,

'ri*ate costs are those costs necessaril( incurred b( the indi*idual or firm engaging in

particular acti*it(.

ocial cost is the cost flo!ing from these acti*ities fall on the communit( at large.

#ost of ra! materials& labour etc. are pri*ate cost of a manufacturing compan(.

"hereas smoke into air& untreated effluents into adjacent !ater courses or addition

cleaning charges fall on the communit(.

-oth pri*ate and social costs associated !ith man( pure risks. A serious fire ma( clo

do!n a factor( !ith a loss of emplo(ment !ho !orked there and also its suppliers a

retailers.

Therefore& !e can conclude that uncertaint( has a cost and therefore it results in a reducti

in !ell being because of fear and !orr( and also less than optimum production or pri

le*els or price structures. -ecause 'ure risks present no offsetting benefits& indi*iduafamilies and businesses ha*e strong reasons to manage these risks successfull(.




3*cti+ity C,

uppose there is a 'A'ER factor( in (our area. Gi*e (our suggestions to control pollutions

and thus pri*ate as !ell social cost should be minimum.

:.> T(/ RI0 '*N*2/'/NT ROC/00

Risks and uncertaint( has its economical costs. 0uman life is full of risks. "ithout risks

nobod( can progress.

Risk Management function includes

• 'lanning

• Implementation

• #ontrol

for the protection of economic *alue of assets and earnings of an( organi1ation against

ad*erse effects of risks.

Risk Management is the identification measurement and treatment of 'ure risk exposures

in 'ropert(& iabilit( and 'ersonal areas. This process in*ol*es fi*e steps.

• Identif( all significant risks

• E*aluate potential fre;uenc( and se*erit( of losses

• <e*elop and select methods for managing risks

• Implement risk management methods chosen

• #ontrol on the performance

0tepl

Ri& Identification

This is first and perhaps the most difficult function. The loss exposures of either the business

or famil( must be currentl( identified. Risk identification is as on9going process depending

upon the nature of acti*ities& the process or manner of execution.




/ailure to identif( all the exposures of the firm or famil( means that the Risk Manage

ha*e no opportunit( to deal !ith these unkno!n exposures intelligentl(.

/or identification follo!ing aspects must be considered@ $

. 6ature& place& process of the acti*it( performed

2. 'olitical background

3. 'h(sical& social and legal en*ironment

4. tud( of past records etc.

Example @ Risk is depends on t(pe of construction of a building& ocation of the

propert(& surrounding en*ironment production method emplo(ed. < @

#orporation has gi*en permission to a #RA#)ER factor( in a residential area .Ide

risk in*ol*ed in this situation.

0tep :

/+aluate otential Frequency and 0e+erity of 7oe

The next important step is a proper measurement of the losses associated !ith the expo

identified. Risk Measurement !ould include a determination of.

a) The probabilit( or chance that the losses !ill occur.

b) The impact& the losses !ould ha*e upon the financial status of the firm or the fam

if at all the( occur.

c) The abilit( to predict the losses that !ill actuall( occur o*er a particular perio

time.

The measurement process helps in grading of exposures from the most serious to the irrele*ant as !ell as from the most urgent to the least urgent.




3*cti+ity /G

0o! !ould (ou e*aluate exposures of a gas dealer and a retailer of a sugar.

0tep -

De+elop and 0elect 'ethod for 'ana%in% Ri&

Treatment of the Ri&

8nce the exposures ha*e been identified and measured& the *arious tools of Risk

Management should be considered and the decision made !ith respect to the best

combination of tools to be used for treating the exposures. This stage of Risk Management

in*ol*es use of tools !hich primaril( aim at 9

a) A*oiding the risk.

b) Reducing the chance that the loss !ill occur or reducing the magnitude of the loss if it

does occur.

c) Transferring the risk to a Third 'art(.

d) Retaining or bearing the risk internall(.

The alternati*e +c, includes but is not limited to the use of insurance. In selecting an

appropriate tool& the cost and other conse;uences of using such tools or combinationDof

tools !ill be e*aluated.

3*cti+ity FG

=Insurance is the best remed( to transfer a risk.= "rite do!n (our *ie!s.




0tep 5

Implementation Ri& 'ana%ement 'ethod Choen

8nce a decision on treatment of risk is made then comes the ;uestion of implementation o

such decision. This ma( be happening in the form of either purchase of insurance o

transferring the risk to capital market etc.

0tep0

Control on the erformance

All Management decisions do ha*e a critical element of monitoring& re*ie!ing the decisio

made& the implementation status and then the results. o that& during the process

implementation if there is a need to correct the course then it can be done at the appropria

time. It has to be remembered that indi*iduals as !ell as organi1ations do not !ork isolation the( are ultimatel( elements in an en*ironment and therefore there has to be

continuous process of monitoring ho! the( are related to the en*ironment and change a

objecti*es or action plans depending upon the changes in the en*ironment.

5.H T(/ 4/N/FIT0 OF RI0 '*N*2/'/NT

Risk Management makes fi*e t(pes of contribution to the betterment of a business.

a. Risk Management ma( make a difference bet!een sur*i*al and failure. As (ou ha

seen earlier& a major catastrophic loss like floods can lead to a total halt of busine

processes& and the business ma( run into a -ankruptc( situation. -( managing surisks properl( the business can ensure continuit( e*en in the case of such a loss.

b. Risk Management can contribute dkectl( to business profits b( helping an organi1atio

to lo!er expenses through pre*enting or reducing accidental losses or transferrin

serious losses to others at lo!er transfer fees and through electing to retain risk a

thereb( sa*ing a transfer fee. Risk Management helps to impro*e the bottom lin

imagine if a serious loss is uninsured and there is no reco*er( possible from an insuranc

firm& then the business enterprise has to carr( this loss in its o!n books and therefor

it ma( become uncompetiti*e as far as its product pricing is concerned. -( transferrin

the cost of such losses to an insurance compan( for a competiti*e rate of premium

the firm is able to price its product appropriatel(.

$




nof

e or

sions

ess of

priate

ork in

obea

gean(

ss.

(ou ha*e

f business

ging such

a loss.

gani1ation

ansferring

an risk and

pttomline

m insurance

d therefore

transferring

f premium&

c. Risk Management can contribute to business profits at least in six indirect !a(s @

i. -( insuring proper management of 'ure risk the management of a firm ensures

for itself peace of mind and confidence& e.g. if an existing firm has to tap ne!

markets in an area of the countr( !hich is Earth;uake prone& !ithout a proper

Risk Management measure& the management ma( not *enture into that area at

all for fear of Earth;uakes. -ut if the Management has a proper Risk Management

for earth;uake losses then the( are free to *enture into e*en such areas and the(

!ill be able therefore to enhance their market share here.

ii. -( handling pure risk aspects of speculati*e *entures the Management impro*es

the ;ualit( of decisions into such *entures. /or e.g. if some ha1ardous material is

re;uired for a manufacture of a product !hich is *er( much in demand& then b(a proper Risk Management procedure& the concern o*er storage and use of

such ha1ardous materials can be properl( mitigated and the firm or enterprise is

in a position to impro*e its top line.

iii. Risk Management also ensures that there are no !ild fluctuations in the cash

flo!s and the annual profits. This is done b( proper Risk Management exercise

so that pure risk losses do not upset the balance sheet.

i*. Risk Management also helps ensure business continuit(. -usiness continuit( is

important particularl( !hen (ou ha*e *alued customers in a highl( competiti*e

market. If (ou are not in a position to continue supplies to these customers& then

the( ma( migrate to other suppliers. Therefore b( ensuring business continuit(&

Risk Management helps (ou to retain (our customers. E*en customers& creditors

and suppliers strongl( prefer a compan( !ith a proper Risk Management

philosoph(& the reason being that the( all kno! that this firm !ill continue to be

in business e*en in the case of major calamities.

*. -( ensuring the peace of mind and !ell9being of the management& Risk

Management also transforms the Management into a *aluable non economic

asset.

*i. astl(& since Risk Management plans also take care of continuation of emplo(ment

as also !ork situation& losses to personnel& the business enterprise is able tofulfill its responsibilit( to the societ( at large.

Risk Management& as !e mentioned earlier is not necessaril( confined onl( to business

and commercial enterprises. It also brings in benefits to indi*idual and famil( units. Think

of a simple life insurance polic( !hich is purchased b( the head of a famil(. In the e*ent of




the death of the earning member& the famil( is assured of financial protection. This Ri

Management tool of bu(ing life insurance gi*es peace of mind to the famil(. imilarl

proper storage of *aluables helps the famil( to a*oid the hassles of a burglar( or a theft. A

insurance polic( !hich can respond to this kind of grie*ance& further enhances the securi

feeling of the famil(. imilar protection also ensures the !ell9being b( the purchase

health and medical insurances.

3*cti+ity 2,

=4sing the a*ailable resources to achie*e maximum profit is the goal of Risk Manager

"rite do!n (our *ie!s.

:.B O4/CTI?/0 OF RI0 '*N*2/'/NT

An( Management process begins !ith a statement of mission& a statement of objecti*e

"hat could be the possible objecti*es of Risk Management /rom the discussion of t

possible contributions of Risk Management& !e can deri*e the possible objecti*es for th

Risk Management process. The( are as follo!s@

1. #ontinuit( of the firm or indi*idual.2. 'eace of mind.

3. o!er Risk Management costs and therefore higher profits.

4. table earnings.

5. 4ninterrupted business operations.

6. #ontinued gro!th.

7. /ulfillment of responsibilities.

8. #ompliance of se*eral obligations imposed b( either societ( or legislation.

The abo*e listing gi*es a fair range of the possible Risk Management objecti*es. 0o!e*

the order in !hich an( or man( of this objecti*es are important to an( organisation depend

upon the firmDs general business objecti*es& e.g. some firms might be on the brink of

disaster !herein& a mere sur*i*al !ill be their priorit(. ome firms !hich are ongoing !il4nit. The 'rocess of Risk Management

not onl( look at mere sur*i*al but also continuit( and stable earnings. 4ltimatel(& therefor

the Risk Management objecti*es for an( organisations ha*e to be integrated !ith th

business objecti*e of the organisation.



3*cti+i ty (,

Assume (ou are a Risk Manager of a firm. ist do!n at least 2 points so that (ou ca

increase the profit and minimi1e the se*erit( of loss.

:. 0U''*R8

In this unit !e ha*e introduce that Risk is e*er(!here and !ithout risk nobod( can progre

Risk and uncertaint( has economic *alue. As Risk cost ma( be of pri*ate and social co

that is !h( it must be managed to the benefit of the societ(. "e ha*e also discussed abo

Risk Management 'rocess. It consists of fi*e steps and is the identification measureme

and treatment of 'ure risk exposures in propert(& liabilit( and personal areas.

8nce the risks ha*e been identified and measured *arious tools of Risk Management a

used to treat the exposures and ensure business continuit( and profitabilit( and stabilit(

business.

"e ha*e also discussed the treatment of Risk and ho! the risk management is benefic

to the indi*idual and societ( and pla( important role in success and sur*i*al of th

organi1ation.

:.19 /8 #ORD0

The Ri& 'ana%ement roce

Treatment of Ri&

ri+ate Cot

Risk Management is the identification measureme

and treatment of pure risk exposures in proper

liabilit( and personal areas

8nce the risks ha*e been identified and measur

*arious tools of Risk Management are used to tre

the exposures.

#osts incurred b( indi*idual or firm engaged in

particular acti*it(.




0ocial Cot #osts fall upon the societ( due to a particular

acti*it(.

30 :.11 0/7F *00/00'/NT U/0TION0

i. imited Resources 9 4nlimited Risks. Gi*e the challenges faced b( and ho!

the 0ead and onl( Earning member of a famil( is expected to handle them. 7o




FI2. 1 FR/U/NC8 DI0TRI4UTION 2R*( OF TOT*7 7O00

d

>and

co



the

axis Insurance

*alue in recei*ed.

o make

-

1




FI2. : FR/U/NC8 DI0TRI4UTION 2R*( OF TOT*7 7O00

500

coCD

400

300

200

100




-.1 INTRODUCTION

The task of risk identification breaks do!n into t!o sub9parts@

1. The perception of risk& that is the abilit( to percei*e that there is an exposure& and2. the identification of the operati*e cause or perils& coupled to the likel( result.

In this unit !e !ill discuss about the *arious methods regarding perception of risk.

Risk identification is a process b( !hich enterprises s(stematicall( and continuousl( identif(

propert(& liabilit(& 'ersonnel exposures as soon as or before the( emerge.

To identif( all the potential losses& the Risk Managers need first the checklist of all the

losses that could occur to an( business !hich includes information regarding 9

1) 6ature& si1e& scope of the business.2) Method of acti*ities for example production method& sub contractorDs condition

etc.L

O, 'lace of acti*ities that are at customersD premises or at shop floor etc.

4) 'h(sical& social& legal& or political background in !hich the enterprises ha*e to !o

5) tud( of past records such as e*ent anal(sis& check list etc.

6) 'rospecti*e techno9marketing report& threat anal(sis. etc.

Taking into consideration all abo*e methods& ph(sical inspection of the premises is

most realistic method.

econdl(& to e*ol*e a s(stematic approach& the checklist can be used to disco*er !hich

the potential losses are normall( a*ailable !ith Risk Management Associations& Associati

of insurers& oss 're*ention Association of India& etc.

8ne must remember that no single method is likel( to re*eal all risks that an organi1atio

exposed& econdl( due to budget constraints the risk manager must choose the best poss

method !hich pro*es best and thirdl( risk identification must be a continuous proce

In a generic checklist& the possible assets are di*ided into t!o major categories& of ph(assets and intangible assets.

4nit O Risk Identification 9$

The possible exposures to loss are categori1ed as +$, <irect Exposures +5, Indirec

#onse;uential Exposures and +O, Third 'art( iabilities.

A detailed =Assets Exposure Anal(sis= #hecklist is appended in the Annexure.

checklist pro*ides& perhaps& a good starting point. 8ther than using this& a Risk Manager

also construct his o!n checklist& !hich needs a good amount of imagination. 8ne sh

stud( the losses alread( incurred b( the Enterprise and losses reported in *arious Industr(



-usiness 'ress. 'articipating in International or 6ational Risk Management meetings !ill

help generation of ideas.

J^*cti+ity *,

A !orker from a floor shop fell from a ladder and injured seriousl(. Identif( the causes o

accident.

6o! !e !ill see in detail the methods of identification used b( risk manager.

-.: *7IC*TION OF C(/C7I0T

The second step in risk identification is to use the checklist so de*eloped& to disco*er

describe the t(pes of losses faced b( a particular business. e*en methods are suggested

for this identification process.

1. The Risk Anal(sis ;uestionnaire

2. The /inancial tatement method

3. The /lo! #hart method

4. 8n9site inspection

5. 'lanned interactions !ith other departments

6. tatistics of past cases

7. Anal(sis of en*ironment




6o one method !ill comprehensi*el( complete the identification process and simila

identification is not an one9off process. Thirdl(& !hile appl(ing the checklist for Exposu

Anal(sis& some gaps ma( de*elop in the checklist itself& !hich should be rectified.

-.- T(/ RI0 *N*780I0 U/0TIONN*IR/

The risk anal(sis ;uestionnaire does more than pro*ide a checklist of potential losses

directs the risk manager to secure in a s(stematic fashion& specific information concern

the firmDs properties and operations like

a) The nature of the organi1ations acti*ities.

b) Inter9relationships and inter9dependencies bet!een *arious parts of the organi1atio

c) Identification of profit and cost centre.

d) Identification of people !ho pro*ide technical support& make and implement ris

handling decisions.

e) 8rgani1ational !eaknesses !hich ma( exacerbate risk situations

To secure this information the Risk Manager !ill consider all the sources of informati

used in the other six methods. The difference is that the ;uestions in the ;uestionna

direct the in;uir(.

3*cti+ity 4 G

As a Risk Manager list out exposure faced b( a emplo(ees carr(ing cash from factor(

bank and to !orking site.

-.5 T(/ FIN*NCI*7 0T*T/'/NT '/T(OD

econd s(stematic procedures for determining !hich of the potential losses in the checkli

appl( to a particular firm and in !hat !a( is the financial statement method.

-( anal(1ing the balance sheet& operating statements& and supporting records& the Ris

Manager can identif( all the existing propert(& liabilit( and personnel exposures of the firm.4nits Risk Identification 9$

-( coupling these statements !ith financial forecasts and budgets the risk manager caB

disco*er future exposures. This fdlo!g because e*er( business transaction ultimatel



in*ol*es either mone( or propert(.

4nder this method& each account title is studied in depth to determine !hat potent

losses it creates. The results of the stud( are reported under the account titles. This approa

is reliable& objecti*e& based upon readil( a*ailable data& presentable in clear& concise term

and applicable b( either risk managers or professional consultants. Moreo*er it translarisk identification into financial terminolog( that is more familiar& and conse;uentl( sho

be more acceptable& to other managers in the firm and to outsiders such as accounta

and bankers. /or example& from purchase and sales accounts it is possible to obta

details of suppliers& customers& rent items re*eals !hether the *ehicles& buildings are

lease basis or o!n asset.

/inall(& in addition to determining the best !a( to handle the exposure this tool must

supplemented !ith the financial records !ith other sources of information such as

inspection of the premises or legal documents. Anal(1ing the financial statements !ill sugg

these additional steps. /or example& liabilities of construction contractor and sub9contrac

in case of injur( or damage caused b( contract !ork.

The follo!ing anal(sis illustrates in abbre*iated fashion ho! one account title& coup

!ith some appreciation of the *arious losses that could occur& can help to identif( poten

losses@

Ta$le -.1

*ccount eronnel or

Title *cti+ity

In*entor( Ra! materials@

In suppliers hands In

transit to !are9

houses& In suppliers

truck& "arehouse& In

transit to

manufacturing plant&

In firmDs o!n trucks&

Manufacturing 'lant

0pecific roperty

7o

'ropert(

losses@ <irect

9Indirect 96et

Income

*. otential er

/ire !indstorm&

explosion& other

ph(sical perils&

Landalism& Risk

burglar(& other

human perils


/inished Goods@ liabilit(

Manufacturing losses'lant& In transit to arising out

"arehouse& /irmDs of truck&

o!n truck& #ommon premises&

#arrier& "arehouse& 'roducts&

In transit to injuries to

retailers& emplo(ees

/irmDs o!n truck&

#ommon #arriers&

In

in

p

d

'

s

n

re

il

D

h

d



losses to

firmPfamil(

6egligence& brea

of !arrant(& injur

to emplo(ees

+!orkmenDs

compensation,

Automobile

accidents +no faul

<eath& poor healt

unemplo(ment&

retirement.

The stud( of these record helps not onl( to pro*ide e*idence of potential losses but als

loss probabilities and se*erities !hich helps risk manager to measure the risk.

This method does not re*eal the !ork processes and the ph(sical la(out of plants&

obtain this information& !e !ill stud( flo! charts.

3*cti+ity C,

As a /inancer 8fficer of a bank& (ou !ant to finance a sick unit. Identif( the risk facto

re*ealed from books of accounts& profit and loss account and balance sheet of a firm

-.6 F7O# C(*RT '/T(OD

To kno! the !ork processes and ph(sical la(out of the plant !e ha*e to stud( the /lo

#hart. 0ence a third s(stematic procedure for identif(ing the potential losses facing

S particular firm is the /lo!9#hart approach.




Flow Chart 'ethod

upplies

Recei*ing

Room torage

Manu9

facturing

'aint9

shop

'aci BBB &

ring

Fi% -.1

/irst& a /lo! #hart or series of flo! charts is constructed& !hich sho!s all the operations

of the firm& starting !ith ra! materials& electricit(& and other inputs at suppliers locations

and ending !ith finished products in the hands of customers. /or example& /igure abo*e

sho!s the major operations of a h(pothetical firm. More detailed pictures can and should

be prepared. econd& the checklist of potential propert(& liabilit( and personnel losses is

applied to each propert( and operation sho!n in the flo! chart abo*e& suggests& among

others& the follo!ing potential losses@

roperty 7oe ,

Replacement or repair of trucks& manufacturing plant& machiner(& ra! materials goods in

process& or finished goods& subject to ph(sical and human perils on the manufacturing

premises or in transit.

hutdo!n or slo!do!n of manufacturing operations because of direct propert( $

7ia$ility osses @

iabilit( for bodil( injur( or propert( damage to customers because of defecti*e products&

to *isitors because of defects in the premises& and to others because of negligence of the

firmDs trucks.

egal responsibilit( under +$, the !orkmenDs compensation la! for bodil( injuries to

emplo(ees and +5, Automobile no9fault la!s.

eronnel 7oe ,

osses to firm because of death or disabilit( of ke( emplo(ees.

osses.




Thus flo! chart can help to re*eal the exposure of an organi1ation to risks of disruption of

its business.

3 *cti+ity D G

ist out major points for a /lo! #hart of a chemical factor(.

-.> ON0IT/ IN0/CTION

8n9site inspections are a must for the Risk Manager. -( obser*ing firsthand the firmDs

facilities and the operations conducted thereon the Risk Manager can learn much about

the exposures faced b( the firm as it re*eals& *

1. tandard of house keeping

2. Ra! material used& !hether it is non9ha1ardous& ha1ardous or extra ha1ardous

3. 6ature of process carried on

4. After completion of each stage of process& the nature of production

5. torage arrangement of final product

6. 'ast claim records.

It also helps to re*eal organi1ational !eaknesses& inter9relationships and inter9dependencies

bet!een *arious departments.

-.@ INT/R*CTION0 #IT( OT(/R D/*RT'/NT0

A fifth !a( to identif( the losses facing a business is through s(stematic and continuous

interactions !ith other departments in the business.

Included amon% thee interaction are

+$, extended *isits !ith Managers and emplo(ees of other departments during !hich the

Risk Manager attempts to obtain a complete understanding of their acti*ities and the

potential losses created b( these acti*ities and4nit O Risk Identification 9$

+5, 8ral or !ritten reports from other departments on their o!n initiati*e or in response

to a regular reporting s(stem that keeps the Risk Manager informed of all rele*ant

de*elopments. These departments are constantl( creating or becoming a!are of



exposures that might other!ise escape the risk managerDs attention. Indeed the Risk

ManagerDs success in risk identification is hea*il( dependent upon the cooperationhe or she secures from other departments.

4nfortunatel(& Risk Managers often hear about ne! exposures long after the( are created.

/or example& one Risk Manager !as surprised to learn from his morning ne!spaper thathis emplo(er had purchased an expensi*e Ri*er -arge t!o !eeks earlier. As a result& for

t!o !eeks the firm !as exposed to some serious propert(& liabilit( and personnel losses

that !ere ignored in its risk management planning. Moreo*er& if these losses had been

explicitl( considered& the firm might ha*e e*en decided not to bu( the barge& instead

!ould ha*e chartered one.

J3*cti+ity /,

7ou ha*e done a site inspection of factor( manufacturing soft drink. "rite do!n inspection

report taking into consideration the facts (ou ha*e re*ealed during the inspection and

laborator( reports of the sample.

-.B 0T*TI0TIC*7 R/CORD0 K 7O00/0

A sixth approach that !ill probabl( fe!er exposures than the others !ill but !hich ma(

identif( some exposures not other!ise disco*ered is to consult statistical records of losses

or near losses that ma( be repeated in the future.

/rom statistical record fre;uenc( of losses as !ell se*erit( of accident re*eals. It also

pro*ides records of past losses including details of insurance claims !hich is a *aluable

information for the Risk Manager.



464nit Risk Identification 9$

-.19 0U''*R8

Ifi this !e ha*e introduced the concepts of Risk Identification and *arious methods appliedfor this process. "ith the help of this !e can find out the *arious risks and probable losses

!hich the firms ha*e to face in future. "e ha*e also discussed that Risk identification is a

ne*er ending task and no one method gi*es full information about the exposure to !hich

an organi1ation is exposed hence as !e ha*e discussed *arious benefits of each method

and ho! these methods help the risk manager in his j ob combination of all techni;ues mus

be used.

To carr( out risk identification process effecti*el( a risk manager needs a good imagination

!ith periodic re*ie! of decisions.

-.11 /8 #ORD0

Ri& Identification

*et /Lpoure *nalyi

Flow Chart 'ethod

Financial 0tatement 'ethod

Is a process b( !hich enterprises s(stematicall( and

continuousl( identif( propert(& liabilit(& personne

exposures as soon as or before the( emerge.

Is a check list !hich list out all the assets and the

corresponding exposures as !ell as *arious liabilit(

exposures. er*es as a starting point for use of other

identification tools.

4ses the operations of the firm in a process se;uenceto help identification of risks and exposures a

*arious stages in the se;uence.

4ses the *arious financial information like -alance

heets to identif( all t(pes of exposures.

-.1: 0/7F*00/00'/NT U/0TION0

1. ist out factors to be considered to identif( a loss.

2. Explain ho! the ;uestionnaire gi*e s(stematic information about organi1ation3. 0o! the scrutin( of financial statements re*eals the true picture of each department

!hich creats potential losses

4. #omment on =on site inspection is necessar( !here ha1ardous and extra ha1ardous

process in*ol*e.=




*00/T0 /HO0UR/0 *N*780I0

Assets

hyical Assets @

Real 'ropert( +a,

-uildings

(1) 4nder #onstruction

(2) 8!ned or eased

(3) Manufacturing

(4) 8ffices

+2, "arehouses

+b, 4nderground 'ropert(

(1) #ables and !ires

(2) Tanks

(3) helters& ca*es ?

• Tunnels

(6) Garages ? 0angers

(7) <!ellings and farms

(8) Tanks& To!ers and tacks

(9) "har*es ? <ocks

+$:, 'ipes ? "ires

+Abo*e ground,

(4) Mines and hafts

(5) "ells& ground!ater

(6) 'iping and pipelines

+c, and@

(1) Impro*ed

(2) 4nimpro*ed

'ersonal 'ropert( +on and off premises and in transit, +a,

E;uipment and Machiner(

(1) Machines and tools

(2) <ies& jigs& moulds& castings(3) -oilers and pressure *essels

+a, /ired *essels 9 steam and hot !ater boilers4nitO Risk Identification 9$

+b, 4nfted*essds



transformers, generators& motors& fans&

pumps& compressors Engines9diesel&

gasoline& steam Meters and gauges

(5) Turbines9steam& gas& !ater

(6) +a, #on*e(ors and lifts& trams& ele*ators(b) /urniture and fixtures

(c) Electronic data processing e;uipment

(d) Impro*ements and betterments

(e) tock9supplies& ra! materials& goods in process finished goods

(f) /ine arts9anti;ues& paintings& je!eller(& libraries

+g, afet( e;uipment 9 instruments& apparel& alarms& installations

+h, Laluable 'apers

(1) -lueprints

(2) /ormulas

(3) AP#s. Recei*able

(4) 'atents ? #op(rights

(5) Titles and deeds

(6) Tapes& cards& disks& programme

(7) 8!n securities9negotiable ? 6on9negotiable

(8) 8ther corporate securities

(9) #ash +indicate currenc(,

Miscellaneous 'ropert( 9




(1) #ommercial

(2) 'ri*ate passenger

(3) #ontractorDs e;uipment +licensed,

(4) "arehouse e;uipment

+b, Aircraft 9

(1) Missiles and satellites

(2) ighter than air

(3) Aircraft9jet& piston& fixed !ing& rotar( !ing

(c) Animals

(d) Antennas

(e) #rops& gardens& la!ns

(f) /ences

s+g, /irearms

+h, 6uclear and radioacti*e propert( isotopes& tracers& Reactors& c(clotrons&

accelerators& betatrons

+i, 'romotional displa(s9signs& models& plates& handbills& exhibits

+j, Recreational facilities9parks& g(ms& lakes& cafeterias

+k, "atercraft +including contents, boats& (achts& barges& ships& ubmersibles& buo(s

drilling rigs.

Intan%i$le Assets

+Assets not necessaril( sho!n on balance sheet or earnings statement, $.

External assets

(a) Markets

(b) Resource a*ailabilit(

1. upplies2. Transportation

3. Emplo(ees +fulltime and temporar(,

4. 'ublic utilities

5. 'ublic 'rotection

4nit O F i de n t i f i c a t i on D



+c, #ommunications

Telephone& telet(pe& tele*ision& radio& ne!spaper

(d) ocational climate& political& economic and social stabilit(& currenc( con*ertibilit(.

(e) #ouncil and specialists 9 legal& architecture& accounting& insurance& real estate&

general management& marketing& ad*ertising 'R& -anking.

5. Internal Assets @

(a) Research and de*elopment

(b) Good!ill and reputation

(c) /inancial

(1) #redit cards +3,

(2) #redit lines +reed., +H,

(3) Insurance +,

(4) #ustomer credit +%,

(5) Emplo(ee -enefits +$:,

ro%ramme

+d, 'ersonnel +emplo(ees and executi*es,

(1) Education and training

(2) Experience

(3) )e( emplo(ees

+e, Rights

(1) Mineral and oil right9abo*e ground& underground and offshore

(2) Air rights

(3) 'atents and cop(rights


/Lpoure to 7o

*. DIR/CT /HO0UR/0

$. Generall( uncontrollable and unpredictable

(a) Electrical disturbances lightning& burn9out& sunspots&

po!er surges&

demagnetisation of tapes

(b

/a

in

ob

ct

ai

ra

m

Ro(alties ? Rents

easehold interest

8!nership of stock #o9

foundations +6on9profit,

Tax loss carr(9for!ard



eors& missiles& trees

(c) and mo*ement9earth;uake& *olcano& landslide& a*alanche

(d) ound and shock !a*es9sonic boom& *ibration& !ater hammer

(e) ubsidence9collapse& settlement& erosion

(f) "ar insurrection& rebellion& armed re*olt& sabotage

(g) "ater damage9flood& rising& !aters& flash flood& mudslide&

tidal !a*es

+tsunami,& ge(ser& ground!ater& sprinkler& leakage& se!er

backup

+h, "eight of ice& sno!

+i, "indstorm 9 t(phoon& hurricane& c(clone& tornado& hailstorm&

rain dust& sandstorm.

5. Generall( controllable or predictable

+a,& -reakage of glass or other fragile items

(b) -reakdo!n 9 malfunction of part& lubricant etc.

(c) #ollision& on and off premises9!atercraft& aircraft& *ehicles

(d) #ontamination 9 li;uid& solid& gaseous& radioacti*e& pollution

(e) #orrosion 9 !ear& tear& abuse& poor maintenance

(f) Emplo(ee negligence

(g) Explosion and implosion

+h, /ailure of en*ironmental control 9 temperature& humidit(&

pr

re

/a

9

an

ls

ro

ts

in

s&

pe



Risk Identification 9$

+j, /ire

+k, Installation and construction ha1ards 9 dropping etc.

+I, International destruction9jettison& backfiring etc.

+m, 'erils of sea 9 pirates& ro*ers& barratr( etc.

+n, 'h(sical change 9 shrinkage& e*aporation& colour& milde!& expansion&

contractions.

+o, Rupture or puncture of tank or *essel

+p, moke damage& smudge

+;, pillage& leakage& paint spra(

+r, Structural defects, crane or ele vator fall

+ s, Transpor tat ion 9 o*er turn& col l is ion

+Dt, 4 n i n te n ti ona l e r ro r 9 e mplo(e e & c omput e r& c ounsel

in, Legetat ion

+*, Landalism& malicious& mischief & defacing of proper t(

+!, Riots & c i* i l d i sorders & s t r ikes & bo(cot t s & .cur fe!s

'rimaril( financial in nature 9

+ a, Emplo(ee dishones t( 9 forger( & embe11lement & l a rcen(

+ b, Expropriat ion 9 nat ionali1at ion& sei1ure& exercise of eminent domain&confiscation

i c, /raud& forger(& thef t & burglar(& robber(

i d, In*alidi t( of deed& t i t le & patent& cop(right

U e , In*entor( shortage9m(sterious disappearance& lost of mislaid propert(

' !bsolescence

$ . All direct Exposures as the( affect @

(a) uppliers

(b) #ustomers




+j, /ire

+k, Installation and #onstruction "ards9dropping etc.

+$, International destruction9jettison& backfiring etc. +m,

'erils of sea9pirates& ro*ers& bonali( -I#.

+n, 'h(sical change9shrinkage& e*aporation& colour& milde!& expansion&contractions.

+o, Rupture or puncture of tank or *essel

+p, moke damage& smudge

+;, pillage& leakage& paint spra(

+r, tructural defects& crane or ele*ator fall

+s, Transportation 9 o*erturn& collision

+t, 4nintentional error 9 emplo(ee& computer& counsel

+u, Legetation

+*, Landalism& malicious& mischief& defacing of propert(

+!, Riots& ci*il disorders& strikes& bo(cotts&.curfe!s

O. 'rimaril( financial in nature 9

(a) Emplo(ee dishonest( 9 forger(& embe11lement& larcen(

(b) Expropriation 9 nationali1ation& sei1ure& exercise of eminent domain&confiscation

"cf fraud, forger(& theft& burglar(& robber(

+d, In*alidit( of deed& title& patent& cop(right

Inventory shortage9m(sterious disaprjearanc

+f, 8bsolescence

INDIR/CT OR CON0/U/NTI*7 /HO0UR/0 $.

All direct Exposures as the( affect@

(a) uppliers

(b) #ustomers




(c) 4tilities

(d) Transportation 9 personnel and propert(

(e) Emplo(ees

2. Extra expenses& rentals& communication& product etc.

3. #oncentration of assets

4. #hange in st(le& taste& desire

5. -ankruptc( 9 emplo(ee& executi*e& supplier& customer& counsellor

6. <isruption of education s(stem 9 racial& political economic

7. Economic fluctuation inflation& recession& depression8. Epidemic& disease& plague

9. Increased replacement cost& depreciationL

$:. In*asion of cop(right& patent

11. oss of integral part of set& pair& group

12. oss of rights resulting from records destruction

13. +a, 'ricing&marketing

+b,. <istribution

(c) 'roduction

(d) Expansion

(e) Economic 'redictions

(f) 'olitical 'redictions

(g) In*estments

+h, <i*idend declaration +i,

Tax filing

$C. Recall of product

$2. poilage4nitO Risk Identification 9$

C. T(IRD *RT8 7I*4I7ITI/0 ;CO'/N0*TOR8 *ND

UNITI?/ D*'*2/0<

$. A*iation iabilit(



(a) 8!ned and leased aircraft

(b) 6on9o!ned 9 8fficers and emplo(ees licensed

(c) Grounding and sister 9 ship liabilit(

2. Athletic 9 ponsorship of teams& recreational facilities etc.

3. Ad*ertiserDs and 'ublisherDs iabilit(

(a) As agents

(b) ibel& slander& defamation of character

(c) Media use 9 radio& TL& 6e!spaper& samples& exhibits

C. Automobile iabilit(

(a) 8peration of *ehicles 9 o!ned or non9o!ned

(b) oading and unloading

(c) <angerous contents 9 flammables& explosi*es

2. #ontractual iabilit(

(a) 'urchase agreements

(b) ales agreements

(c) ease agreement 9 real or personal propert(

(d) 'erformance or ser*ice

(e) oans& mortgages& notes

(f) 0old9harmless clauses

(g) uret( agreements

6. <irectors and 8fficers iabilit(

7. Easements

(a) In gross

(b) Appurtenant

(c) 'ositi*e or negati*e under common la!




+d, Rights or access of light& !ater& drainage& support .

Emplo(erDs iabilit(

(a) 'ensions& trusts& profit sharing plans& in*estments

(b) Insured 9 life& accident& health etc.

(c) <iscrimination in emplo(ment

%. /iduciar( and /ringe -enefits plans liabilit(

(a) 'ensions& trusts& profit sharing plans& in*estments

(b) Insured 9 life& accident& health etc.

(c) #redit societ(

$:. Malpractice iabilit((a) Medical doctors& nurses& specialists

(b) a!(ers

(c) Engineers

(d) Trustees of pension plans

+e, 'atent infringement

$$. 8rdinar( negligence

(a) 8f emplo(ees

(b) 8f agents

(c) 8f in*ited or unin*ited guests

(d) 8f contractors or subcontractor

(e) /ailure to pro*ide safet( e;uipment& !arnings etc.

(f) Inade;uate enforcement of regulations

(g) Improper 'reparation of food

$5. 6on9o!nership iabilit(

(a) eased real or personal propert(

(b) -aileeDs iabilit(

(c) Emplo(ees use of *ehicle& aircraft& !atercraft

$O. 8!nerDs iabilit(



@•. +denlification 9$

$ Attracti*e nuisance

V In*ited guests

$ Trespassers +false arrest,

> I Rights of others 9 riparian& mineral& light& air& *ie!& lateral support& easement

!alls& licenses& drainage& eminent domain.

oduct iabilit( +each product sold& distributed& made,

., Implied "arrant( .

, Express "arrant(

(1) -( agents 9 sales& ad*ertising& or general

(2) -( emplo(ees

(3) 8fmerchantabilit(

(4) 8f suitabilit( or fitness for use

(5) 8ftitle

(6) -( sample

W electi*e iabilit(

i Industrial #ontractors hired i

#onstruction or demolition 9.u.oad

iabilit( i, idetrack agreements @D,

Right of !a( , Grade #rossings

Qirectors and 8fficers iabilit( +tockholder deri*ati*e suits,

"atercraft iabilit(

8!nership& leased& operation

T(pes9boats& (achts& ships& submersibles& rigs& platforms.

Reference from Risk Management b( 0I.




5.1 INTRODUCTION

In the pre*ious unit !e ha*e discussed *arious methods regarding perception of risks. In

this unit !e !ill see in detail about *arious methods of the identification of the operati*ecause or perils coupled to the likel( result.

There are se*eral techni;ues for carr(ing out the anal(sis of risk identification process and

there are other sophisticated methods !hich aim to identif( the operati*e cause or perils in

conjunction !ith the likel( result. ome of them are detailed belo!@

5.: T(R/*T *N*780I0

An alternati*e approach to the check list is to compile a list of the threats to the business.

Take& for example& the threat of den(ing access to the place of business for !hich the

completed form ma( appear as in Table belo!. <enial of access to premises can arisefrom man( causes& for example ;uarantine regulations follo!ing epidemic& collapse of

nearb( buildings& blocking the road& burst !aterPgas mains pre*enting access& strike&

picketing& go*ernment order and so on. The threats to the business in terms of both the

se*erit( and duration of the interruption probabl( !ould *ar( as sho!n.

Ta$le 5.1

Threat #ause Result Mitigating

/actors

oss Assessment

<am9age

-usiness

Interruption

<enial of Access

+i, trike 'artial

closure or

total closure

Good

industrial

relations

6il 592 !eeks

+ii, 'ickets Total

closure

uppliers

not

*ulnerable

6il $95 months

+iii, Road

subsidence

Total

closure

econd

access to rearthrough

adjoining

factor( (ard

4nit C Risk Identification 9 II

oss of +i, -urst Total loss econd 6il $95 da(s

ser*ices Main of process uppl(



+$, "ater +ii, /rost and usable a*ailable

+iii, <rought !ater

'artial loss In 6il 'rolonged

likel( to catchment seasonal

cause area !ith period

cessation high of operations reser*e

capacit(

ike this an( threat to the business can find out !ith its causes& results loss assessment etc.

3*cti+ity *,

There is a shortage of !ater suppl( to a 0ospital. <ra! a threat anal(sis table for this

taking into consideration its causes& effect on hospital !orking& assessment of loss due to

loss of ser*ice.

5.- /?/NT *N*780I0

E*ent anal(sis is a techni;ue for considering likel( e*ents !hich could cause problems and

then in*estigating cause and effects. It is illustrated in figure belo!. The *ar(ing impact

bet!een cause and effect is a function of the De*entD > for example& consider the e*ent asDfailure of boiler ser*icesD . There are man( potential causes& ranging from that of explosion&

to burst !ater tube& to failure of the priming pump.

The effect of these three causes gi*ing rise to the same e*ent !ould be ;uite different. An

explosion could lead to major interruption of processes& the destruction of propert(& and

loss of life& including potential third part( liabilit(. 8n the other hand a burst tube ma( result

in onl( minor interruption& !ith no propert( damage or personal injuries. At the other end

of the spectrum& the failure of the !ater priming pump ma( ha*e no effect at all if a stand

b( pump can be brought into ser*ice immediatel(.




C*U0/ /FF/CT

6AT4RA

'0E68ME686

-REA#0 8/ 6AT4RA A"

04MA6

A#TILITIE

IA-IIT7

<AMAGE

'R8'ERT7

<AMAGE

-8<I7 I6Q4R7

8 8/

EAR6I6G

Fi% 5.1

.%T*cti+ity 4 ,

#onsider the e*ent =/ire in a cotton factor(=. /ind out its causes and effects !ith e*entanal(sis techni;ue.

5.5 (*A*RD 7O2IC TR//0 ;(7T<

8

'R8<4#I6G

ELE6T



uch anal(sis can be aided b( the use of 0a1ard ogic Trees +0T, !hereb( the *arious

ha1ards !hich ma( precipitate the operation of the peril !hich is the cause of the loss producing e*ent can be identified. As the name implies& it is simpl( another techni;ue for

forcing one to carr( through the exposure anal(sis process in a methodical& logical manner.

In order to illustrate the techni;ue& /igure belo! takes the example of another t(pe of loss producing e*ent& the loss of !arehousing facilities. The lists of ha1ards sho!n are not

exhausti*e& and those appl(ing in an( particular case !ill be dependent upon local

circumstances. Imagination pla(s an important role in the construction of 0Ts& and the




'rima facie remoteness of either perils of ha1ards does not justif( their omission from the

lists> for too fre;uentl( it is the unexpected e*ent !hich does occur.

Ta$le 5.:

8 'R8<4#I6G ELE6T

98 8/ T8RAGE

/A#IITIE

/IRE 8RE'8I86

"ATER <AMAGE 8T0ER /8RM

8/ <AMAGE

<E6IA 8/

A##E

AR86 /88< AIR#RA/T /88<

M8)I6G T8RM LE0I#E 4-I<E6#E

EE#TRI#A -4RT 'I'E#84RE

MAI#I84 A#T R8A<

0EATI6G -4RT MAI6 4-I<E6#E E'I<EMI#

'86TA6E84

#8M-4TI86

04RRI#A6E

#0EMI#A

I6TERA#TI86

-8IER E'8I86

'REA< 8/ /IRE

/R8M 8T0ER

8#ATI86

8ne ad*antage of constructing 0Ts is that it forces one to breakdo!n the potential

causes of loss producing e*ents into their smallest components. Thereb( pro*iding at least

a subjecti*e pointer to the probabilit( and se*erit( of those e*ents. It is also of *alue at the

risk handling state& in that the identification of ha1ards is a prere;uisite to the implementation

of measures to control them.




3*cti+ity C ,

a, "ith the incidence gi*en belo! prepare 0a1ard logic tree@

b, oss producing e*ent 9 hortage of suppl( of Ra! Material to a manufacturing

factor(.

5.6 (*A*RD *ND O/R*4I7IT8 0TUDI/0

uch a stud( is designed to be used at the planning stage of a ne! plant. The objecti*e is

to examine the process as a !hole in order to identif( potential de*iations from normal

operating conditions& their causes and possible conse;uences.

The techni;ue& !hich !as de*eloped b( imperial #hemicals Industries imited& is for a

small team to examine e*er( stage of a process b( appl(ing a number of guide !ords assho!n in Table belo!.

7it of 2uide word

Guide "ords Meaning

/or continuous /or batch

'rocess 'rocess

686E 68 or 68T #omplete negation of the design Intention.

M8RE 8/ M8RE Increase in flo!& pressure etc.

E 8/ E <ecrease in flo!& pressure& etc.

'ART 8/ 'ART 8/ ome of the intent in is achie*ed e.g.& the

composition of the s(stem is different from

!hat it should be. 4nit C Risk Identification 9 II

M8RET0A6 A "E A RELERE



8T0ERT0A6

Additional

component or phase present

or another

acti*it( occurs

concurrentl(."hat else can

happen apart from 6ormal operation e.g.&

startup& shutdo!n& maintenance etc.

8pposite of the design intention e.g.& re*erse

flo! or chemical reaction.

omething ;uite different from the designintention.

/or some example& in looking at the thermal reactors in a chemical factor( the use of the

guide !ord 68 !ould lead to an examination of the !a(s in !hich there could be no

transfer from the ra! material storage or no suppl( of gas to the reactors& such as the ra!

material stores being empt( or a pipeline being fractured. ike!ise& the !ords M8RE 8/

or E 8/ !ould direct attention to !a(s in !hich there could be increases or decreases

in the flo!s or pressures of materials or gas. The next step !ould be to consider the

possible causes and conse;uences of such e*ents occurring.

C.3 T0E <8" I6<E

In the $%3:s the <o! #hemical #ompan( in the 4..A.& de*eloped a s(stem for the

identification and e*aluation of fire and explosion ha1ard potential based on a stud( of

man( plant accidents and near misses. It has subse;uentl( been de*eloped to co*er storage

units& and loading and unloading operations& and it can be applied to either the planning

stage of ne! plants& to existing plants& or to a consideration of alternati*e processes in an

existing plant.

The techni;ue is to@

• list all ra! materials& !ork in progress& products& b(9products and catal(sts presentin a plant>

identif( the dominant material on the basis of +a, ;ualit( present and +b, fire potential&

decomposition potential& or reacti*it( !ith other materials present>

• ;uantif( the ha1ards according to heats of combustion& decomposition or reaction>

• appl( additional factors to allo! for such special features as the ;uantit( of material

in*ol*ed and the t(pe of process.




The rating factors in the <o! /ire and Explosion Guide are based on operating and loss

experience. 6o credit is gi*en for safet( features& since it !as the intention to emplo( the

Guide to identif( needs for safet( features.

3*cti+ity D G

ist out the ha1ards using <o! Index method in a factor( manuf acturingli(drocloric acid.

5.@ F*U7T TR// *N*780I0

E'8I86 I6 8'E6 'AI6T

'RA7I6G -88T0

Fi% 5.:

Essentiall(& the tree is constructed b( asking !hat must occur before the loss producing

e*ent& sho!n at the top of abo*e figure& can occur. As sho!n& t!o conditions are re;uired

to cause an exolosion. a concentration of flammable paint *apour !ithin the explosi*e

ources of ignition

/lammable paintspra( in explosi*e

concentration




limits and +denoted b( the s(mbol, a source of ignition. The next step do!n the tree

is to in*estigate possible sources of ignition !hich are an electrical spark or nearb(

flames or lighted cigarettes. The latter ma( be introduced b( the operati*e or

someone else& !hereas an electrical spark ma( be caused b( a failure of the earthing

s(stem. And so on until all possible e*ents that ma( lead to the loss producing e*ent

ha*e been identified.

The anal(sis can be refined further to assist in calculating the probabilit( of the loss

producing e*ent occurring b( estimating the probabilit( of each of the e*ents on

the basis of past experience& and using that date to produce final conditional probabilities.

L%T*cti+ity /,

"rite fe! lines on use of fault tree anal(sis in the risk identification.

5.B 0*F/T8 *UDIT0

A. s(stem that brings together the *arious techni;ues relating to both the perception of

risk and the identification of operati*e causes and perils is the safet( audit.

Kn audit ma( be undertaken either internall( or outside consultants or b(

combination of Voth. The management must define exact reference about audit.

The audit team must ha*e kno!ledge about@

a) The organi1ation& its acti*ities

b) All regulations relating to the safet( of its operations and products.

Kfter *erif(ing all these details& auditors proceeds to!ards anal(sis of the ha1ards

and lerils to !hich the organi1ationDs acti*ities are exposed. <iscussion !ith

management and >raplo(ees& also spot inspection is carried out if necessar(. /or

example& !hen assessing he fire and explosion follo!ing checklist must be take

into account@

U /ire resistance of the

building

/lammabilit( of materials

U 0

ousek

eepin

g

stand

ards




• ources of ignition

• /ire alarm and extinguishing s(stems

• ecurit( and securit( patrols

• /ire training to emplo(ees

• 'roximit( of the local fire brigade

• "ater sources

• Means of escape

/urther in*estigation is also carried if necessar(.

/inall( report is prepared stating@

1) An anal(sis of the risk to !hich the organi1ation is exposed.

2) Recommendations for impro*ing safet(& contingenc( planning.

Thus a safet( audit not onl( includes identification of risk but also e*aluate and handling it.

3*cti+ity F,

#omment onD Dafet( audit is a critical examination of industrial operations to identif( risks

and ha1ards.=

5. 0U''*R8

"e ha*e discussed the usefulness of the *arious techni;ues described abo*e& the follo!ing

points are of rele*ance. The check list s(stem suffers from the fact that it pre9identifies

perilsPha1ards& lea*ing the possibilit( that unidentified perils and ha1ards ma( not be

addressed.

Threat anal(sis is a crude means of ascertaining potential exposure b( a broad examination

of the business and its en*ironment. E*ent anal(sis is a much more specific techni;ue&

!hich can be *aried to suit circumstances from the Dbroad brushD e*ent anal(sis do!n to

the consideration of specific ha1ards.4nit C Risk Identification 9 II

imilarl( ha1ard and operabilit( studies help to pinpoint at the planning stage of a

project possible design defects !hich ma( lead to the occurrence of loss producing

e*ents. /inall(& the <o! Index and /ault Tree anal(sis can be used to assist in the



identification of ha1ards and in the ;uantification of risk.

At the end !e ha*e discussed regarding safet( audit !hich brings *arious

techni;ues together to find out risk& causes and perils

5.19 /8#ORD0

Threat *nalyi

/+ent *nalyi

(a)ard 0tudie

The Dew IndeL

Fault Tree *nalyi

0afety *udit

It is a method for identification of *arious threats to the

enterprise& identif(ing their cause and result of such threat

as !ell as exploring the factors& !hich can mitigate the

threat as also& estimate the losses if threat materiali1es.

It is a techni;ue for considering likel( e*ents !hich could

cause problems and then in*estigating causes and effects.

It enables to examine the process as a !hole in order to identif(

potential de*iations from normal operating conditions& their

causes and possible conse;uences.

This method is de*eloped for identification and e*aluation of

fire and explosion ha1ard.

This can be ;uantit( the risk and identification of ha1ard.

In addition to risk identification it helps in risk e*aluation and

risk handling decisions.

I 5.11 0/7F*00/00'/NT U/0TION0

i. "h( do (ou ha*e to identif( Risks

ii. 0o! do (ou start off in the identification process

iii 7ou are a senior person in the /inance <epartment of an Automoti*e ales

outlet. Tr( to use an( t!o of the identification methods (ou ha*e studied in the

unit to efficientl( map the risks (our firm faces. 7ou should state the business

profile& manpo!er& etc. of (our firm before attempting this.




i*. ist the ad*anced identification tools enumerated in this unit and briefl( explain th purpose and method used in each.

MPs. 6arde ? -anda are in the business of publishing books for 4ni*ersities. The

ha*e their o!n printing press located in a congested area of the cit(. The firm emplo(

fort( !orkmen and fi*e senior emplo(ees. The( ha*e a godo!n for the storage

ra! materials like paper& binding materials& as !ell as finished goods like boun

books. The godo!n is part of the printing press building. A major fire takes place

the earl( hours of a unda(. /ire -rigade is summoned and the( are unable to pinpoi

the exact cause of the fire. 0o!e*er& the Risk #onsultant of the firm is expected

ad*ise them on the cause aspect. uppose (ou !ere the #onsultant& ho! !ould (o

use one of the methods studied in this chapter& to do the identification ist out thassumptions (ou make before (ou attempt this.

*. "rite short notes on@

a) E*ent anal(sis.

b) /ault tree anal(sis.

*i. 0o! do checklist helps in risk identification s

*ii. "hat is the role of safet( audit in the identification of ha1ards in the industrial

operations




NOT/0




2.5 DI'/N

Risk handling decisions can be taken onl( after monitoring the risk reduction measure9an

other information like fre;uenc( and se*erit( of loss producing e*ents and other cos

Therefore rele*ant data must be collected & collated & anal(sed and the results interpreted.

Information is needed concerning t!o dimensions of each exposure

$ , The loss fre;uentl( or the number of losses that !ill occur.

5, The se*erit( of those losses.

/or each of these t!o dimensions it !ould be desirable to kno! at least the *alue of an

a*erage budget period and the *ariation in the *alues from one budget period to the next.

The total impact of these losses if the( should be retained& not onl( their monetar( *alue&

should be included in the anal(sis.

The collection and the interpretation of information forms an important part of risk management function. Interpretation of data in*ol*es the use of statistical data and probabilit(

concept.

6.1 INTRODUCTION

After the Risk Manager has identified the *arious t(pes of potential losses faced b( his or

her firm& these exposures must be measured in order $ , to determine their relati*e importance and

5, to obtain information that !ill help the risk manager to decide upon the most desirable

combination of risk management tools . Risk Manager should use probabilit( concepts

in identif(ing and anal(1ing loss exposures

and in choosing alternati*e !a(s of handling exposures.

In particular& probabilit( concepts are used to estimate @

$ , The a*erage number of losses or a*erage aggregate amounts of losses from a specified

peril in a gi*en period.

5, The *ariabilit( around these a*erages of the number of losses or aggregate amount of

losses per period.



4nit 2 Risk Measurement

3*cti+ity *,

"hich steps (ou !ill take if (ou !ant to find out number of exposures of (our unit

6.- N//D FOR /*C( DI'/N0ION

-oth loss fre;uentl( and loss se*erit( data are needed to e*aluate the relati*e importance

of an exposure to potential loss. #ontrar( to the *ie! of most persons& ho!e*er& the

importance of an exposure to loss depends mostl( upon the potential loss se*erit(& not the

potential fre;uenc(.

K potential loss !ith catastrophic possibilities& although infre;uent& is far more serious than

me expected to produce fre;uent small losses and no large losses. 8n the other hand&

loss fre;uenc( cannot be ignored. If t!o exposures are characteri1ed b( the same loss

se*erit(& the exposure !ith a certain potential loss se*erit( ma( be ranked abo*e a loss

!ith a slightl( higher se*erit( because the fre;uenc( of the first loss is much greater than

that of the second. There is no formula for ranking the losses in order of importance& and

different persons ma( de*elop different rankings. The rational approach& ho!e*er& is to

place more emphasis on loss se*erit(.

Kn example ma( clarif( the point. The chance of a automobile collision loss ma( be greater

than the chance of being sued as a result of the collision& but the potential se*erit( of the

liabilit( loss is so much greater than the damage to the o!ned automobile that there should

•Ve no hesitation in ranking the liabilit( loss o*er the propert( loss.

i flood damage also amount of propert( damage is less than the liabilit( arises due toloss

i li*es.

MT *cti+ity 4 ,

rite do!n an( incidence in !hich liabilit( loss is greater than propert( loss.




2.C RI) ELA4ATI86

A particular t(pe of loss ma( also be subdi*ided into t!o or more kinds of losses depending

upon !hether the loss exceeds a specified amount.

/or example& consider the collision loss cited in the preceding paragraph. This loss ma( be

subdi*ided into t!o kinds of losses@

1) collision losses upto Rs. $:::: and

2) losses o*er Rs. $::::.

In the second categor( are the more important although the( are less fre;uent. Another

illustration !ould be the losses associated !ith relati*el( small medical expenses as

contrasted !ith extremel( large bills. uch a breakdo!n b( si1e of loss sho!s clearl( the

desirabilit( of assigning more !eight to loss se*erit( than to loss fre;uenc(.

In determining loss se*erit( the risk manager must be careful to include all the t(pes of

losses that might occur as a result of a gi*en e*ent as !ell as their ultimate financial impact

upon the firm. 8ften& !hile the less important t(pes of losses are ob*ious to the.& risk

manager& the more important t(pes are much more difficult to identif(. The potential direct

propert( losses are rather generall( appreciated in ad*ance of an( loss& but the potential

indirect and net income losses +such as the interruption of business !hile the propert( is

being repaired, that ma( result from the same e*ent are commonl( ignored until the loss

occurs. This same e*ent ma( also cause liabilit( and personnel losses.

The ultimate financial impact of the loss is e*en more likel( to be ignored in e*aluating themonetar( *alue of an( loss. Relati*el( small losses& if retained& cause onl( minor problems

because the firm can meet these losses easil( out of li;uid assets. ome!hat& larger losses

ma( cause li;uidit( problems& !hich in turn ma( make it more difficult or more costl( for

the firm to borro! funds re;uired for *arious purposes. /inall(& *er( large losses ma( ha*e

serious ad*erse effects upon the firmDs financial planning& and their impact ma( be much

greater than it !ould be for a firm that could more easil( absorb these.

FActi*it( # @

"rite (our *ie!s on =To determine a loss se*erit( of a firm is an important task of Risk

Manager=.4nit Risk Measurement

2.2 7O00FR/U/NC8 '/*0UR/0

8ne measure of loss fre;uenc( is the probabilit( that a single unit !ill suffer one t(pe of

loss from a single peril. /or example& there is the probabilit( that one building !ill be

damaged because of the fire or the negligent manufacture.

Richard 'rout(& the risk manager of a large 4.. business group& suggested about 52

(ears ago that instead of using numerical estimates& the risk manager might express this



t(pe of probabilit( as

$. Almost nil +meaning in the opinion of the risk manager the e*ent !ill not happen,

Example@ 'ossibilit( of accident to motor car due to part of plane drop do!n from

space is almost nil.

2. light +meaning that& though unlikel( to occur in the future,

Example@ 'ossibilit( of theft of truck is slight.

3. DModerateD +meaning that it has happened once in a !hile and can be expected to

occur sometime in the future,

Example@ 'ossibilit( of arising third part( propert( claims is moderate.

=<efinite= +meaning that it has happened regularl( and can be expected to occur

regularl( in the future,.

Example@ 8ccurrences of o!n damage claims to motor *ehicles are definite.

hough not as precise as the probabilit( measurements& these measures ha*e the ad*antage

sat& gi*en time to think about the exposures and stud( past experience& most risk managers

an pro*ide the necessar( estimates. Making these estimates also encourages a more

areful s(stematic approach to risk management.

istead of estimating the probabilit( that a single unit !ill suffer one t(pe of loss from a

ngle peril during the coming (ear& the risk manager& can& in the same !a(& estimate the

robabilit( that the unit !ill suffer that t(pe of loss from man( perils& sa( !indstorm and

Kplosion as !ell as fire. This probabilit( !ill be higher because of the additional possible

auses of loss. The probabilit( categor( ma( or ma( not be higher& depending upon the

sagnitude of the increase.

Another example is the probabilit( that a single unit !ill suffer simultaneousl( more

than S one t(pe of loss +for example& ph(sical damage to a building& loss of the use of that

building& I and liabilit( for bodil( injuries or propert( damage to others, from the single

peril. This




probabilit( !ill be lo!er because more than one t(pe of loss !ould ha*e to result from a

single occurrence the probabilit( categor( ma( or ma( not be lo!er.

Another example is the probabilit( that at least one of se*eral units& sa( fi*e buildings& !illsuffer the same t(pe of loss from the same single perils. This probabilit( !ill be higher than

the probabilit( that an( specific unit !ould suffer such a loss because there are se*eral

units that ma( ha*e a fire. The losses ultimatel( the loss could be the ruin of the business as

going concern.

3*cti+ity D ,

Gi*e t!o examples for the follo!ing@

1) ingle unit suffers from one t(pe of loss.

2) ingle unit suffers from man( t(pes of losses.

3) e*eral units suffer from one t(pe of loss.

6.> R/DICTION FRO' 0*'7/0

'f;To illustrate& a fire could destro( a building and its contents *alued at Rs. O&::&:::> the

ensuing shutdo!n of the firm for six months might cause another Rs.O&3:&:::$oss.This

Rs. 3&3:&::: loss might force the firm to shut its doors& an action that !ould result in an(

ultimate loss of the difference bet!een the going9concern *alue of the business& sa(

Rs. 5C&::&::: and the *alue for !hich the remaining assets could be sold& sa( Rs. $2&::&:::

causing a Rs. %&::&::: loss.

oss se*erit( also depends upon the number of units in*ol*ed in the loss. /or example& if



a firm

has

there

adjacen

t !arehouses& one fire ma( cause considerable damage at all three !arehouses.

/inall(& in estimating loss se*erit(& it is important to recogni1e the timing of an( losses as

!ell as their total amount. /or example& a loss of Rs. 2&::: a (ear for 5: (ears is not as

se*ere as an immediate loss of Rs. $:&::&::: because of


1) the time *alue of mone(& !hich can be recogni1ed b( discounting future losses at

some assumed interest rate& and

2) the abilit( of the firm to spread the cash outla( o*er a longer period.

^*cti+ity /G

MPs. Raj is a manufacture of a Motor car and recentl( recei*es an order for export.

uddenl( a strike is declared in his compan(. 6ote the number of losses he suffers due to

this situation.

6.@ 4/N/FIT0 OF '/*0UR/0

oss9fre;uenc( and loss9se*erit( data do more than identif( the important losses. The( are

also extremel( useful in determining the best !a( or !a(s to handle an exposure to loss.

/or example& the a*erage loss fre;uenc( times the a*erage loss se*erit( e;uals the total

dollar losses expected in an a*erage (ear. These a*erage losses can be compared !ith the

premium the firm !ould ha*e to pa( an insurer for complete or partial protection. The

*ariation +or estimated risk, in a loss fre;uenc( and loss se*erit( sheds light on the

predictabilit( of the losses and ho! serious the losses might be in a bad (ear.

'robabilit( categor( ma( be higher. 8n the other hand& the probabilit( that all of those

units !ill suffer the same t(pe of loss from the single perils !ill be lo!er and ma( mo*e into a

lo!er categor(. Gi*en all the combinations of units& t(pes of losses& and perils that are

possible& the number of probabilities that could be estimated is extremel( large. 6ot all

these probabilities are !orth the time and efforts in*ol*ed in estimating a probabilit( categor(.

8nce the Risk Manager has determined !hat probabilities are most useful in decision

naking& ho!e*er& if more precise information is not a*ailable& he or she can use 'rout(Ds

our categories or some similar approach.

.B 7O00 0/?/RIT8 '/*0UR/0

"hen de*eloping a risk management program& the Risk Manager must ha*e a good idea ,



+ maximum possible loss and the maximum probable loss and these t!o measures

ommonl( used to measure loss se*erit( @




1) The maximum possible loss to one unit per occurrence and

2) The maximum probable loss to one unit per occurrence.

/or the moment& !e !ill concentrate on occurrences causing onl( one t(pe of loss. The

maximum possible loss is the !orst loss that could possibl( happen> i.e. the total amount

of financial harm a gi*en loss could cause under the !orst circumstances. The maximum

probable loss is the most likel( maximum amount of damage a peril ma( cause under

a*erage circumstances therefore& is usuall( less than the maximum possible loss.

A !orse loss could occur but the chance of its occurrence is less than some percentage

selected b( the Risk Manager& such as once e*er( C: (ears. -ecause different Risk

Managers ma( select different percentages& the( ma( disagree on the *alue of the maximum

probable loss e*en though the( estimate the probabilit( distribution to be the same. 8f

these t!o measures& the maximum probable loss is the most difficult to estimate but alsothe most useful and *aluable risk management exercise.

In a recent article& Alan /riedlander suggested four measures of ph(sical damage losses

due to fire per building per occurrence. The 9

1. "Normal lo eLpectancy" is the monetar( loss expected from a single fire !hen

both pri*ate and public protection s(stems are operati*e.

Example@ At the time of fire& both automatic sprinkler etc of a firm and fire brigade of

the go*ernment is in operation.

:. "ro$a$le maLimum lo" is the monetar( loss expected from a single fire !hen acritical part of the protection s(stem such as an automatic sprinkler is out of ser*ice

or ineffecti*e.

Example@ 'ri*ate protection s(stem such as sprinkler installation s(stem& smoke

detector etc is not in ser*ice or inacti*e and onl( fire brigade is there at the time of fire

-. "'aLimum foreeea$le lo" is the dollar loss expected !hen none of the pri*ate

protection s(stem is functioning. The fire in this case !ould probabl( burn until stopped

b( a fire !all& until it burns all its fuel& or until the public fire department& summoned b(

an outsider& arri*es.

Example@ In high sea there is a fire to natural gas plant and it burns until it stopped b(department of go*ernment.

5. "'aLimum poi$le lo" is the loss expected from a fire !hen all pri*ate and

public protection s(stems are inoperati*e or ineffecti*e.4nit Risk Measurement

Generall(& the probabilit( of the occurrence declines as !e mo*e from the normal loss

expectanc( to the maximum possible loss. The four *alues depend upon innumerable

factors such as construction& occupanc(& pri*ate protection& and public protection.




4. 6ature& distribution and combustibilit( of contents +fire load,.

5. 4se of ha1ardous processes and substances and their degree of separation.

6. usceptibilit( of contents of damage b( smoke heat and !ater.

7. Risk of explosion from an( source.

8. 0a1ards arising from gases or corrosi*e materials.

9. #oncentration of *alues !ithin a small area.

10. tandards of Management and housekeeping.

It !ould appropriate in some cases for the total M.'.. to be built up from separate

assessments on 9

• -uildings

• Machiner( and other contents

• tocks particularl( !here the contents ha*e lo! sal*age *alue or highl( susceptible

to damage.s

In *ie! of the man( permutations of the factors mentioned abo*e& !hich can appl( to

different risks and their *ar(ing rele*ance to different risks& it is not practicable to relate a

D*alueD to each factor or the combination of factors.

3*cti+ity 2G

uppose (ou are a Risk Manager of a chemical /actor( and assign a job to calculate'aLimum ro$a$le 7o. ist out the points to be considered !hile arri*ing at the

estimate of loss.

Factor which hould not $e conidered

0o!e*er& the follo!ing factors should not be taken into account !hen assessing maximum probable loss.

1. An( hori1ontal separations

2. /ire resisting doors4nit 2 Risk Measurement

O. . The absence of an( normal source of ignition.

C. The extinguishment arrangements including sprinklers and the ade;uac( or other!ise



of fire brigade facilities.

6.19 0U''*R8

In this unit !e ha*e discussed that all indi*iduals and firms face uncertainties caused b( the

possibilit( of loss. Arisk Management program is begins !ith identification and measuremenof exposures to loss.

The identification process begins !ith the recognition of four categories of losses@

• <irect losses of propert(& such as loss of a machine in a fire.

• Indirect losses& such as loss of income due to most important machine burnt and

production stopped.

• iabilit( losses& such as Third 'art( injur( or death.

• oss of ke( personnel& such as loss of a research scientist.

Nn this unit !e ha*e seen ho! the estimate of loss fre;uenc( and loss se*erit( helps in

taking the sensible risk handling decision. The e*aluation of maximum possible loss and

maximum probable loss necessitates a careful stud( of the all t(pes of injuries or damage

that ma( arise out of the organi1ationDs acti*ities and of the la! including recent cour

a!ards. To arri*e at sensible decision the data must be collected& collated& anal(1ed and

the results interpreted. 8nce the maximum potential for loss is estimated& the risk manage

can de*elop an integrated plan to deal !ith it.

6.11 /8 #ORD0

7o Frequency

Seventy

ro$a$ility

'aLimum poi$le lo

+laLimum pro$a$le lo

It is the number of losses that !ill occur during a specific period of time.

#he financial e$tent of impact ofeacn loss.

Most likel(.

It is a loss expected from a fire in all pri*ate and public

protection s(stems are inoperati*e or ineffecti*e.

It is the loss due to fire after loss pre*ention and loss

reduction actions ha*e been applied.



84 Risk Management in General Insurance

6.1: 0/7F*00/00'/NT U/0ION0

1. 0o! the risk handling decisions depends upon loss fre;uenc( and se*erit( of

losses

2. Explain =se*erit( of loss is the major factor to be taken into account !hile

e*aluatiing

risk.=

3. 0o! are exposures catagorised

4. <ifferciate bet!een probable maximum loss and maximum possible loss.

5. ist out the factors taken into account !hile calculating maximum probable

loss !hich

affect propert(.

6.1- *NN/HUR/

3

RI0 *00/00'/NT 2/N/R*7

CON0ID/R*TION0 FOR CON0TRUCTION INDU0TR8

As !e ha*e seen Risk identification and ;uantification are the initial steps to!ard

treatment of Risks. "e no! present an assessment ;uestionnaire for a

specific industr( 9Contruction Indutry.

/ollo!ing are the main considerations in risk assessment for construction

industr(@

a) 'h(sical ha1ards of methods of construction

b) 8perational testing and commissioning

c) T(pes of constructional plant and e;uipment

#onsider the follo!ing examples and ha1ards& as the( relate to a normal building

contract@

• Exca*ation and de9!atering +collapse of sides,

• !elding +fire or explosion,

• <esign !ork +!hich can increase the ha1ard,

• concreting in lo! temperatures +frost,

• 4se of jib cranes for hea*( loads& or in soft ground conditions +o*er balancing



impact

,

• 'artl( completed !ork +storm or collapse,




• 'refabricated concrete or cladding +impact,

• -uildings !ith no separation +fire,

• To!er cranes +collapse,

• "ork near to !ater +flood,

• "ork in remote areas +aggra*ated damage and higher reinstatement cost,

• tructures supported b( insecure foundations +subsidence& collapse,

• "ork in ha1ardous areas i.e. extension of chemical !orks +explosion& fire,

7ou !ill see that the ha1ards are numerous and can arise at an( time during the construction

period& from man( directions& and !ith *ar(ing degrees of damage resulting. It is therefore

difficult for the under!riter to assess. Remember that these are onl( a fe! of the broader issues and each stage of the construction process brings its o!n specific problems.

7et u loo& at ome of them ,

Caue of 7o or Dama%e

These can be di*ided into broad groups@

• Acts of God or Act of man& or a combination of both

• easonal

• Intentional or unintentional udden or gradual

• #ontinuing or intermittent

• Mechanical& electrical or chemical

• Initial& intermediate or immediate

+lore pecifically

/ire H.

Explosion .ubsidence& hea*e& landslip %.

collapse& *ibration or undermining

/rost

easonal changes/alls& impact& o*er balancing risks

8

5Risk Management in General Insurance

4. Earth;uake

5. "ater damage



6. "inds

D/0I2N 10. Grime risk

11. Riot& ci*il commotion& malicious damage

12. -reakdo!n

Rfi <esign also pla(s a critical role in the e*aluation of construction risk. The ;uestions

!hich are addressed !hether the design is standard one or protot(pe.

• #ontractorD familiarit( !ith the design.

• <esign of temporar( !orks



e

t

c

.

T

h

i

r

d

a

r

t

y

*

p

ect

The third part( risk can arise in respect of propert( and persons !ithin the contract

site e.g. *isitors such as the Emplo(ers& architects& sur*e(ors and emplo(ees of other

contractors on site. It also arises in respect of persons and propert( outside the contract

site. 0ere the risk is to persons passing b( the site& and to adjoining propert(.

<amage to underground ser*ices is a common occurrence and if great concern

to under!riters !ith the recent appearance of fibre optic cables !hich are extremel(

expensi*e to replace.

ome of the particular liabilit( ha1ards are@

• The use or proximit( to inflammable substances>

• <angerous chemicals>

• /ragile or *aluable machiner(& either used or erected>

• Laluable feedstock +during testing and commissioning,>

• preading fire to adjoining propert(& !ith conse;uential loss of trade& and

possible

injur(>

• cutting the suppl( of utilities to adjoining properties i.e. gas& !ater& electricit(.

The

risk ma( onl( result in pure economic loss but if damage is caused to the third

part(Ds

o!n propert(. iabilit( for the conse;uence of that damage ma( be actionable.

• #ollapse of o!n or hired plant>4nit % Risk Measurement

• 'ollution risk +!ork on petro9chemical& or similar risks, !hich can take man( forms.

4nder!riter !ill not cater for claims arising from deliberate or uncontrolled discharge

ofpollutants>

• <esign risks& or defecti*e !orkmanship>

• The *arious disciplines on a site e.g. exca*ation

9 de!atering>

9 piling>

9 use of explosi*es>

tunnelling>

underpinning>

!elding>



9 use of plant>

9 la(ing of pipes and cables in built up areas>

9 operational testing and commissioning

The Contruction roce• /ollo!ing factors help in e*aluating the process relating to risk@

• <emolition

• Earthmo*ing

• Mass exca*ation

• Trenching

• haft sinking

t 'illing

• /oundations 9

$. "eight of the structure

5 Moisture changes in the ground

3. Insufficient compactness of the ground

4. General mo*ement




0ytem 4uildin%

1. i1e and *alue of their largest components

2. Actual method of erection

3. /ire

4. Method of toring major component parts

5. 0eight of high9rise building

6. ocation of the temporar( factor(

7. Transit

• teel /ramed -uilding

1. -uilding utilising high alumina #ement

2. Tall -uildings

Operational Tetin% and Commiionin%s

Main ha1ards are 9

• -reakdo!n of large generators>

• Mixers e.g. in plastic and rubber factories>

• 0ea*( presses +Motor industr(& board manufacture and other hea*( industries,

• Iron ore crushers

• Explosion of black li;uor boilers +pulp !orks,

• /ire and explosion follo!ing introduction of feedstock in oil refineries and petro

chemical plants.

Re+iew

i. 4se some of the graphs in Appendix of #hapter 0I to explain the concepts of fre;uenc(

and se*erit( of /ire losses of Indian insurance industr(& ii. "ith the data of lossfre;uenc( and loss se*erit( ho! the risk Manager takes a

proper decision to identif( the exposure of a firm m Explain the concept of

Maximum 'ossible oss. "hich factors are taken into account

and !hich are not& in measuring M'4nit 2 Risk Measurement

NOT/0




>.1 INTRODUCTION

o far in the pre*ious units !e ha*e seen the meanings of terms like Risk& 0a1ard etc.

6o! !e !ill tr( to learn the meaning of the !ord eLpoure.

The term DexposureD indicates the extent of potential for a loss.

In an earlier unit !e had come across the concept of 'robable Maximum oss or Estimated

Maximum oss. Exposure in fact is close to this concept. -( identif(ing and measuring the

potential for exposure& !e designate the extent of risk !hich is faced in a particular

contingenc(& in respect of a particular propert( or liabilit(.

"e !ill no! discuss regarding different t(pes of categories !hich is exposed to the losses

as follo!s@

1) Exposures of propert(

2) iabilit( exposures

3) Re*enue exposures

4) Interest exposures *

/irst !e !ill see exposure to propert(

>.: /HO0UR/0 OF RO/RT8

-( propert( !e mean tangible assets either of

1. 'ersonal nature or

2. #ommercial nature.

'ropert( can also be broadl( classified into mo*able and immo*able propert(. "hen !e

sa( tangible& !hat !e mean is that the propert( should be ph(sicall( present and identifiable.

In contrast to tangible propert(& there are propert( or properties& !hich the accounting

con*ention !ould classif( as assets for e.g.& the Intellectual 'ropert( or Ro(alt( or Good!ill

etc.

'ropert( again can be belonging to an indi*idual or belonging to a commercial organi1ation&

leased from others or leased to others& propert( under construction or belonging to the

go*ernment and similar public enterprises. Examples of mo*able propert( could be

automobiles& finished goods of a factor(. Examples of immo*able propert( could be /ixed

Machiner(& -uilding etc.



4nit 3 Exposures

6.3 TYPES OF EXPOSURES TO PROPERTY

Another term peculiar to Risk Management is ='eril=. -( ='eril=& !e mean a causati*e

factor. 'erils normall( trigger off a loss situation !hich affects tangible propert( and causeseither loss or damage to such propert(. /or instance Terrorism is a peril. 'erils again can

be broadl( classified into ph(sical& human& economic.

hyical peril@ The examples are causes like fire& explosion& flood.

(uman peril@ The examples are causes like negligence& riots strikes.

/conomic peril@ The examples are recession& inflation& change of go*ernment& stock of

finished goods becoming unfashionable or absolute.

Though Risk Management largel( is concerned about human and ph(sical perils& of late

economic perils are also getting a high le*el of attention.

The ?aluation of otential roperty 7oe

Risk Manager must place a *alue on potential losses. uch *alue ma( be measured b(@

$. Its replacement cost or current purchase price.

#alculating the exact propert( *alue is difficult in case !here the replacement cost is

unrelated to accounting book *alue. If the propert( is destro(ed& the actual cash

*alue is a better measure of the exposure.

2. Its current resale *alue or net reali1able *alue.

3. The net present *alue of its expected future earnings.

4suall( current asset can be *alued at their replacement cost +mainl( cash& negotiable

securities& stock of ra! materials,

3*cti+ity *,

#omment on =In an inflationar( econom(& replacement cost at the time of future loss ma(

not be the same as current replacement cost.=




>.5 7I*4I7IT8 /HO0UR/0

The term Diabilit(D indicates in a *er( rudimentar( manner& Dresponsibilit(D 9 "hich is

responsibilit( to oneDs partners& emplo(ees& famil( members& the societ( and the public atlarge. This kind of responsibilit( to others can arise out of certain la!s& regulations or be

out of e*en common la! or con*ention. 8r it can arise out of e*en certain agreements or

contacts entered into b( *arious parties.

>.6 7/2*7 7I*4I7ITI/0

It can be broadl( classified into ci*il and criminal liabilities.

Ci+il 7ia$ility,

Though the di*iding line bet!een ci*il and criminal is ;uite often a thin one& it !ill be usefulto kno! that ci*il liabilities normall( result in compensation to the affected part(. 7ou

!ould ha*e come across in 6e!spapers& of the *arious le*els of #onsumer /orums set

up b( the go*ernment. These forums pro*ide redressal to consumers !h; are aggrie*ed

at the action or inaction of certain product or ser*ice suppliers. The exposure to such

suppliers !ill be out of causes like deficienc( in ser*ice& dela( in compliance and so on. If

the #onsumers /orum finds out that a particular supplier !as deficient in ser*ice then the(

ma( a!ard a monetar( compensation to be paid b( the erring organisation to the affected

indi*idual.

Criminal 7ia$ility,

As against this criminal !rongs result in some kind of a punishment to ensure that such

crimes do not get repeated. An assault b( one indi*idual on another attracts criminal

punishment& and the indi*idual !ho had resorted to assault could be either imprisoned or

a heft( fine imposed on him.

The a! of Torts is concerned !ith ci*il liabilit( other than those arising out of breach of

a contract. 6ormall( a prudent person is expected not to commit certain acts or alternati*el(

do certain things as societ( !ould expect of him. The non9adherence to these can result in

ci*il liabilit(.

Think of a famil( residing in a high9rise building of about O2 store(s& +this famil( can beresiding in the 5:th store(,. If a flo!er pot kept in the balcon( of their apartment happens

to fall on a pedestrian on the road belo! and injures him& the famil( can suffer a ci*il

liabilit( arising out of negligence. imilarl( if a trader contracts to suppl( certain t(pe of



4nit 3 Exposures

goods in certain time and certain price to a customer and defaults either in time or in ;ualit(

of goods promised& there can be a breach of contract and the contract pro*isions ma(

either pro*ide for penalties or penalties can be in*oked under the a! of #ontracts.

Indi*iduals& families& business can therefore face a *ariet( of legal liabilities.

3*cti+ity 4 ,

"rite do!n t!o examples each in case of ci*il as !ell as criminal liabilit(.

6o!ada(s *arious liabilit( losses are increasing due to increasing a!areness of the societ(

to!ards its rights such as product liabilit(& public liabilit(& professional indemnit(& liabilit( of

!orkmenDs and en*ironmental liabilit(.

6o! !e !ill discuss it in detail.

>.> ROF/00ION*7 7I*4I7IT8

'rofessionals like doctors& la!(ers& accountants& architects can also face liabilities arising

out of their professional practices. The legal liabilit( is pa( damages arising out of negligence

in the performance of their professional duties. It is classified into t!o categories@

1. 'rofessional negligence ma( result in bodil( injuries +fatal or other!ise,

<octors& <entist fall into this categor(

2. 'rofessional negligence ma( result in financial loss.

#hartered Accountants& Architect& olicitors fall into this categor(.

oss resulting from bodil( injur( or death cannot be measured in terms of mone(. 0ence

calculation of liabilit( depends upon number of factors such as age of the claimant& earning

capacit(& nature of injur(& etc.

Medical malpractice is a major concern in de*eloped countries and !ithout ade;uate

+ftsusas*cc a@gFsLsKKcMKto?Kks& i4s6irtttaft(P impossible for medical practitioners to pursue

their profession in these countries.



4nit 3 Exposures

F A c t i * i t ( < >

A defect in a batch of injections and capsules results in a injuries to a large number of

people. Enumerate the liabilit( arises due to this incidence.

3. '4-I# IA-IIT7BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB

'ublic liabilit( arises due to accidental bodil( injur( or damage to the propert( of an(

member of the societ(. It co*ers liabilit( arises due to either breach of contract& from a tortor from liabilities imposed b( status.

The liabilit( arises in public liabilit( di*ided into three categories as follo!s@

'ublic liabilit( due to 6on Industrial risk@ 0otels& #inema 0alls& chools& /ilm studios&

Godo!n& hops& Tank farms& etc.

'ublic liabilit( due to Industrial risk@ liabilit( arises due to industrial and storage risks depots&

!arehouses& etc.

#ompulsor( public liabilit(@ in this case liabilit( arises due to handling of an( ha1ardous

substance !hich results into death or bodil( injur( to an( person or damage to propert( of an( person.

According to 'ublic iabilit( Act $%%$ imposes fault liabilit( i.e. irrespecti*e of an( !rongful

act& neglect or default on the o!ner to pa( the relief and as per act this liabilit( shall be

compulsoril( insured. The reason is because gro!th of ha1ardous industries& processes

and operations in India the number of accidents increases and ti gi*e minimum relief !hich

is based on =no fault= liabilit(.

.FActi*it( E@

Explain =As per 'ublic iabilit( Act& $%%$ the liabilit( shall be compulsor( insured.=



in? Risk Management in General Insurance

the repa(ing capacit( of the borro!ing entit( might also get affected resulting in

default of loans or interest pa(ments etc. Therefore the financial institutions !hich

ha*e assisted such indi*idual or commercial ac;uisitions do ha*e an interest and

a corresponding exposure on these assets.

Contracted artie

In the example of the commercial complex cited abo*e& it is not onl( the o!ners

!ho ha*e financial interests. "hen such a complex is put up it is ob*ious that it !ill

re;uire a sufficient le*el of occupanc( of the *arious floor spaces being offered.

The occupants also ha*e stakes in the sur*i*al of the commercial complex. If an(

major catastrophe takes place the occupants are bound to lose& as their business

operations cannot continue. Moreo*er an( rent the( ma( ha*e either paid or

supposed to pa(& depending upon the terms of the rental agreement& ma( also

ha*e to be forgone. In such cases these kinds of tenants or similar persons !ho

ha*e a contractual relationship !ith the o!ners of the asset also carr( the

exposures in respect of the asset.

3*cti+ity I,

-ank has financed a big project of chemical factor(. 4nfortunatel( one unit

burnt due to fire and production stopped. Enumerate the *arious exposures

in*ol*ed in this case.

>.1- 0U''*R8

In this unit !e ha*e introduced the concept of exposure. <ifferent t(pes of

propert( can be affected b( ph(sical& human or economical perils. In this unit !e

ha*e also discussed ho! liabilit( arises in ci*il and criminal cases. <ue to

increase a!areness in the societ( different t(pes of exposures arises like

'rofessional liabilit(& 'roduct liabilit(& Emplo(erDs liabilit(& etc.

"e ha*e discussed in detail the liabilities arises due to re*enue exposures. There

are direct and indirect losses ha*e to bear to continue the operations of the

business firms.

"e ha*e also discussed that o!ner of the propert(& /inancer& contracted parties

are also affected due to exposure of *arious kinds.nit 3 Exposures




@.1 INTRODUCTION

o far (ou ha*e seen the process of Risk Identification& Risk Measurement. "e shall no!

learn about the *arious methods and tools !hich are a*ailable for managing the risk soidentified and measured.

/rom olden da(s men ha*e been searching and de*eloping !a(s and means of controlling

and managing the risk being encountered for their safet(& sur*i*al and success& *arious

methods are de*eloped. In the process of risk management risk control is a major part.

Risk control consists of three elements. Those are

1. Risk A*oidance.

2. Risk Reduction.

3. oss #ontrol.

In this unit !e !ill discuss about these elements in details.

Risk is an una*oidable fact of life. "e cannot get an(!here if !e a*oid taking risk.

@.: *?OID*NC/

ometimes the best method of dealing !ith an exposure to loss is to a*oid all possibilities

of the loss occurring. A successful risk a*oidance results in the total elimination of exposure

to loss due to a specific risk. ometimes to a*oid risk means abandoning some acti*it(

and losing some benefits accompan(ing it.

ometimes risks are una*oidable. /or example& the risk of bankruptc(& the risk of liabilit(

suit& or the risk of premature death cannot be a*oided b( the firms or indi*iduals. The

exposure to loss can often be reduced but not eliminated. /or other exposures& a*oidance

is the onl( reasonable alternati*e.

"hen the chance of loss is high and loss se*erit( is also high& a*oidance is the best and

sometimes the onl( practical alternati*e. Risk a*oidance means the chance of loss has

been eliminated. In practice it means not introducing ne! product& ending the production

of an exiting product& discontinuing some operations or selecting a particular peril !here a

particular peril is not a*ailable.

"hen there is a significant chance of death or disablement& indi*idual a*oid such choice of

careers. If there is chance of financial failure& people generall( a*oid such business.

-usinessmen a*oid in*esting in some countries !here there is al!a(s labour unrest.4nit H Risk #ontrol 9$

H.O #*80 OF *?OIDIN2 RI0

8ne !a( to control pure risk is to a*oid the propert(& person& acti*it( !ith !hich the



exposure is associated b(

1. <eclining to assume the exposure

2. -( abandoning an exposure !hich is alread( present.

et us look at an example for the declinature part. If a geographical area is kno!n to behighl( earth;uake prone then a firm !hich !ould like to expand its business acti*ities in

such a 1one can simpl( a*oid building an( business unit there so as to a*oid the se*erit( of

an( possible earth;uake. imilarl(& an indi*idual !ho is not ha*ing a bank safet( locker

facilit( can think t!ice o*er ac;uiring expensi*e je!eller( !hich is prone to theft. 8n the

liabilit( front& a firm !hich is engaged in manufacture of general pharmaceuticals can a*oid

an( in*estment in pesticides or insecticides producing plants if it considers& the liabilit(

exposure due to an( leak in such plants is too se*ere for it to handle.

6o! let us look at a*oidance through the process of abandonment. If the exposure due to

an asset or a liabilit( is of such a nature that it poses continuous financial implications for

the firm& then the firm as !ell can choose to abandon the asset and a*oid the exposureassociated !ith the risk altogether.

/or instance if a boiler and pressure *essel plant situated inside a factor( has become

substantiall( old and it has been found that it can cause possible leak of gas or air due to its

poor condition& then the firm !hich utili1es it can as !ell replace this boiler !ith a ne! one.

imilarl( if a manufacturing process is found to produce ;ualitati*el( defecti*e products

on a continuous basis then the manufacturing firm can gi*e up the process in fa*our of a

better process> other!ise the defecti*e products might result in liabilit( exposures related

to the ;ualit( of the product. imilarl( parents !ho ha*e *er( ad*enturous teenage children

can a*oid the exposures due to automobile accidents b( selling their fast and expensi*ecar. Though a*oidance as a risk control tool& on the face of it looks to be *er( simple to

adopt& in practice it is seldom so.

There are three main reasons !hich make a*oidance a complex issue.

I. A*oidance b( itself ma( sometimes be impossible. The airline business is full of risks.

There are exposures of the aircraft crashing& there are exposures of cargo getting

lost& there are exposures of hijack etc. -ut to a*oid these entire risks one cannot

e*en dream of a*oiding air tra*el 9 The !orld is so much net!orked toda( through

air tra*el that it !ill be impossible for a*oiding in*estments in a*iation.



$: Risk Management in General Insurance

2. That brings us to the fact that sometimes there is an exposure associated

!ith an

asset or an acti*it( can in fact be for out !eighed b( the benefits such

assets or

acti*it( can bring about to the societ(. The Euro tunnel !hich links mainland

Europe

!ith 4nited )ingdom is a submarine tunnel !hich has made the tra*el

bet!een these

t!o areas such a con*enience that an( exposures !hich could be

associated !ith

such under the !ater structure is not sufficient reason to a*oid building such a

structure.

3. ometimes e*en a*oidance of one t(pe of exposure can lead to creation ofanother.

It is ;uite a common practice no!ada(s for large corporations particularl( in

the /ast

Mo*ing #onsumer Goods industr( to get their manufacturing done b( third

parties.

This t(pe of contract manufacturing facilitates them to a*oid problems

related to

labour unions as also enable them to sa*e costs significantl(. -ut ha*ing

a*oided such

exposures the ne! exposures of the ;ualit( considerations as !ell as

-usinessInterruption and *iabilit( of the business of contractor is added to the list of

exposures

of the original corporation.

An( person in*ol*ed in the process of risk mapping and management !ill

necessaril( ha*e to identif( measure and then anal(se risk !hich necessaril(

had to be a*oided. -ut as mentioned earlier this is a *er( complex exercise

!hich in*ol*es inputs from all other sections of an enterprise.

To reali1e the complexit( think of this@ !hen the famous hanmukanandha

Auditorium in Mumbai !as de*astated in a major fire fe! (ears back it took theresol*e and opportunit( e*aluation b( the managing committee to reconstruct the

edifice in its pre*ious place and restore its old glor(. This !as perhaps a

simpler decision !hen compared to the big dilemma facing the 6e! 7ork

'ort Trust !ho are the original o!ners of the ground on !hich the "orld Trade

#entre To!ers !ere built. The issue before 6e! 7ork 'ort Trust is !hether at all

a similar sk( scraper built in the area !hich !ill again stand exposed to the kind of

attacks b( terrorist on $$th eptember. This is a classic a*oidance issue.

3*cti+ity *G



Gi*et!o

examples of risk a*oidance !here (ou ha*e lost the benefits accompan(ing it.

4nit H Risk #ontrol 9$

@.5 T(/ CO0T OF RI0 *?OID*NC/

ometimes it ma( be possible to a*oid risk !ithout an( undue difficult( or exposure& but itis ne*er costless.

1. The( ma( be monetar( costs +such as additional bank charges for pa(ing !ages b(credit transfer to a*oid the risk of pa(ing in cash, or opportunit( costs +such as theincome forgone b( abandoning the production of a certain ha1ardous product,.

2. The( can be direct or indirect costs. The changeo*er to pa(ment of !ages b( credittransfer& the extra bank charges !ould be the direct costs and indirect costs ma( beincurred in ha*ing to increase !ages to o*ercome opposition from emplo(ees to the

ne! s(stem of pa(ment.

H.2 RI0 CONTRO7, 7O00 CONTRO7 K 7O00 R/?/NTION

oss control is another major step in Risk Management. oss control measures are aimedat either lo!ering the chance or probabilit( that a particular t(pe of loss !ill occur or if itoccurs reduce its se*erit( and impact. In contrast to loss a*oidance !hich eliminates therisk but forces the firm to a*oid or discontinue the acti*it(. oss control measures ha*euni;ue abilit( to pre*ent or reduce losses and enable the firm to continue.

oss 're*ention programs seeks to reduce or eliminate the chance of loss !hereas the

oss reduction programs seek to reduce se*erit( of the loss. -ut sometimes there !ill bean o*erlap that some loss control programs double up as both loss pre*ention and lossreduction programs.

@.> 7O00 R/?/NTION

There are a *ariet( of !a(s in !hich losses can be pre*ented from happening either totall(or the chances of loss occurring can be reduced significantl(. Thus successful loss pre*entionacti*ities lo!er the fre;uenc( of loss. If the benefits deri*ed from loss pre*ention exceedsthe cost& it is useful.

arge industrialist often emplo(s safet( engineers at the time of construction to identif(sources of loss or injur( and appl( pre*enti*e measures and safet( de*ices so to reducethe chances of losses and accident.

8ne major concern in human safet( in factories is the accidental injur( to !orkman.

'articularl( in construction industr( sites !orkers are re;uired to !ork in *er( ha1ardous




conditions. Either it could be !orking at a great height b( using unsafe support s(stems or

e*en at the ground le*el it !ould mean !orking !ith hea*( e;uipment like exca*ators and

bulldo1ers. -( pro*iding a proper scaffolding and support s(stem for access to higher

le*els of construction& the !orkers getting injur( due to fall can be reduced or totall(

eliminated. imilarl( b( pro*iding safet( meshes around mo*ing e;uipment& accidents to

!orkers can be either totall( pre*ented or minimi1ed.

ome losses are due to en*ironmental ha1ard such as poor la(out of machine& inade;uate

light or *entilation& inade;uate smoke detector or insufficient fire fighting e;uipment. ome

losses are related to human shortcomings and errors such as bad judgment& inade;uate

training& super*ision or lack of attention to safet( re;uirement. Good safet( programs can

be de*eloped and implemented to deal !ith these situations.

#oncerns on indi*idual safet( ha*e forced go*ernments all o*er the !orld to enact legislation

to make it compulsor( to ha*e seat belts in automobiles as !ell as ensure t!o !heeler

riders !ear safet( helmets. /ire accidents in textile mills !here a huge amount of !aste

collects or deposits itself in and around electric e;uipment and points of ignition can be

pre*ented b( installing fire and smoke detectors as !ell as ha*ing sprinkler s(stems. These

s(stems ensure timel( detection of an( increase in temperature or presence of smoke and

acti*ate the sprinkler !hich !ill douse the area !here detection has taken place !ith

appropriate fire extinguishing agent like !ater or carbon dioxide.

8ther examples of loss pre*ention acti*ities include use of safet( guards on sa! blades&

securit( guards in banks& dri*e training and safet( education programs& !arning printed on

drugs and dangerous chemicals.

imilarl( ports ha*e c(clone !arning information s(stems !ith the help of !hich the( are

able to alert the incoming and outgoing *essels about an impending c(clone or !eather

disturbance. 0o!e*er in spite of all this earl( !arning s(stems& accidents do occur&

exposures do get materiali1ed and a loss results&.

Man( loss pre*ention measures reduce death or injuries& establishing engineering solutions

or using cost benefit anal(sis. After taking all abo*e precautions some accidents occurs&

this takes us to next aspect of loss control& namel(& oss Reduction.



4nit H Risk #ontrol 9$

P%f *cti+ity 4 ,

"hat pre*enti*e measures (ou !ill take at the time of construction of a high rise building.

H.H 7O00 R/DUCTION

I

As the name implies oss Reduction aims at reducing or mitigating the impact and

extent of a loss e*ent. 8nce a loss triggers off either during the course of a lossoccurrence or immediatel( after it& se*eral measures can be taken !hich can bring

about reduction in the se*erit( of the loss e*ent.

oss minimi1ation programmes are a t(pe of loss reduction programmes. These aim

at reducing the extent of loss or transfer the loss actuall( happening. The other t(pes

of loss reduction programmes are called as sal*age programmes. These take place

after the loss has happened and ceased to continue.

To get an idea of loss minimi1ation programmes& think of a huge *olume of garments

!hich is meant for exports and !hich is stored in a large !arehouse. If this !arehouse

happens to be located in a lo! l(ing area and if there are hea*( rains !hich flood thelocation and the flood !aters rise to such a le*el !ithin the !arehouse then most of the

stored garments !ill be affected b( flood !ater damage. If the garments o!ner !as

a!are of the potential for flooding then he !ould ha*e taken ade;uate care to store the

garments !ell abo*e the ground le*el on speciall( designed racks so that the flood

!ater could not ha*e reached the bottom la(ers of the garment stacking. 0o!e*er

ha*ing been affected b( the flood !aters entr(& the best !a( to reduce the loss or

minimi1e the loss is to make sure that these garments& particularl( the affected ones are

remo*ed to a properl( ele*ated place of safet(& dried there& !ashed there and an( textile

processing method !hich can restore the ;ualit( if a*ailable should be used.



In

case

all

these

metho

ds do

not result in restoring the pre lost ;ualit( of the fabrics then the( ma( not be fit for

exports or e*en sale as ne!. Then comes the ;uestion of further loss reduction b(

sal*aging efforts. If the garments after proper cleansing and finishing can be sold as

DsecondsD there could be a fair amount of realisation of the original price. This

realisation then !ould reduce the impact of the loss as compared to the total rejection

of these garments.




In the same manner !e find that automobiles !hich meet !ith major accidents are also

reco*ered and then& because the( cannot be reconditioned or repaired the( are sold as

scrap. pecialist scrap bu(ers bu( this kind of !reckages and the( cannibalise the damaged

*ehicle to retrie*e at least some parts !hich can be reconditioned and sold as DsecondsD.

In the de*eloped !orld there are specialist Reco*er( companies !ho ha*e de*eloped

expertise in sal*aging and rec(cling goods and commodities of an( t(pe.

al*aging also has a special meaning in the realm of Maritime Trade. There are fre;uent

casualties on the high seas and the Inland "ater !a(s and 'ort premises in !hich ocean

going *essels or other t(pe of !aterborne *essels get affected due to *arious t(pes of

perils and then sink. uch casualties not onl( result in financial loss to the o!ners of the

ship or *essel but also the( sometimes block ocean !a(s or port areas pre*enting the

maritime transit. Again there are specialist agencies like al*age #orps& !hich help in

reco*ering the !reck and remo*ing it to a designated place.

oss reduction measures also can be classified as follo!s@

$. pre*entati*e@ eliminating the cause of loss.L&

2. protecti*e@ protecting things or persons exposed to damage or injur(.

3. minimi1ing@ to limit the loss as far as possible.

4. sal*ing@ to preser*e as much as possible of the *alue of damaged propert( or the

abilit( of injured persons.

/Lample of +ariou meaure ,

7o pro$a$ility reducin% meaure@ /ittings of safet( guards to dangerous machiner(&

remo*ing potential sources of ignition& remo*al of obstacles& spillage and slipper( surfaces

from gang!a(s& stairs& etc. eparation of *ehicular and pedestrian traffic.

7o e+erity reducin% meaure @ torage of !ater susceptible goods abo*e floor

le*el& installation of sprinkler s(stems and smoke *ents& pro*ision of first aid facilit(& fittings

of !ater tight compartments in the ship& fire !alls and doors in the buildings.

'iLed meaure@ Replacement of combustible !ith fire resistant building material& limiting

stocks of explosi*esPcombustible material& education to emplo(ees regarding ha1ard.

Training to emplo(ees in the form of first aid for personal injuries or protection of damaged

plant to pre*ent further is necessar( to cut the losses.4nit Risk #ontrol 9$

Another classification of risk reduction measures is as follo!s@

1. Education and training

2. 'rocedural de*ices

3. 'h(sical de*ises.



In brief !e !ill see these measures

1. /ducation and trainin%@ #ourses in securit(& fire pre*ention& producti*it( securit(&

speciali1ed courses for ke( staff.

2. rocedural de+ice@ 'eriodical conditions of safet( de*ises& securit( petrol including

night !atchman& inspection of premises before closure for e*ening or !eekend&

effecti*e internal audit s(stem& stand b( e;uipment& stocks and alternati*e sources of

po!er ser*ices.

3. hyical de+ie@ Lenting of toxic and explosi*e fumes& separation of ha1ardous

process& and automatic s!itch off de*ices of machines if fault arises& safet( guards&

*al*es& securit( locks& fire and burglar( alarm !ith connection !ith police and fire

station& !arning de*ices for leakage of gases and radioacti*e materials.

3*cti+ity C,

a, "rite do!n risk reduction measures for the cotton industr( assuming that (ou are aRisk Manager.

b, uggest a method for reduction of loss due to cotton !aste.




@.B 7O00 CONTRO7 T/C(NIU/0

oss #ontrol Techni;ues normall( are classified.

a. Those !ith Engineering approach

b. Those !ith 0uman Relation approach.

"e !ill no! understand =The Domino Theory= proposed b( 0.". 0einrich& a pioneer

in safet( concepts. According to D<omino Theor(D a pre*entable accident has one of the

fi*e factors in a se;uence that results in an injur(. The se;uence is as follo!s@

1. 0istor( and ocial En*ironment

2. /aults or the person +inherited or ac;uired faults of the person constituting approximate

reasons for committing unsafe acts or for the existence of mechanical or ph(sical

ha1ards,.3. 4nsafe act andPor mechanical or ph(sical ha1ard.

4. Accidents

5. Injur(Vs

According to 0einrich& in accident control& the bullDs e(e of the target is the third step in the

se;uence.

The Engineering approach traces emphasis on the mechanical or ph(sical causes of

accidents. In realit( there are numerous such causes. It could be a defecti*e electrical

!iring !hich can spark off and ignite materials !hich can easil( catch fire. It can be poor braking s(stem in a automobile !hich can lead to serious accidents. It can be lack of

proper lubrication in mo*ing machiner( parts !hich can lead to high le*els of friction and

heat and result in jamming of e;uipment.

Examples can be numerous but the underl(ing phenomenon is one of either a defecti*e

material& a defecti*e design& defecti*e !orkmanship or defecti*e handling. It has ho!e*er

to be remembered that neither the engineering approach nor the human approach can be

used in isolation of each other.

"hile 0einrichDs <omino Theor( still is acclaimed to ha*e *alidit(& a recent da( expert&

<an 'etersen has added a sixth factor to 0einrichDs se;uence namel( 'ana%ementFault. According to him this is !hat primaril( dri*es other fi*e factors in motion. "ith

increasing sophistication in e;uipments and tools and e;uall( increasing concern for human

safet(& it is no !onder that ManagementDs responsibilit( and accountabilit( to ensure loss

pre*ention and minimisation has increased tremendousl(.4nit Risk #ontrol 9$

afet( engineering has de*eloped into an exclusi*e facult( b( itself !ith the interdisciplinar(

cross pollination of kno!ledge across Medical ciences& Engineering ciences& Information

Technolog(& En*ironmental ciences ha*e all blended and ha*e contributed in the



de*elopment of safet( engineering. "hile basic concerns remain the same& the access to

information across *arious disciplines has resulted in ad*anced methods of oss pre*ention

and minimisation. 4sing the Engineering approach& there are techni;ues !hich !e ha*e

seen earlier like 0a1ard and 8perabilit( tudies& /ault Tree Techni;ue& Root #ause Anal(sis

etc.& these all pro*ide predicti*e techni;ues in*ol*ing the process& products and se;uences.

imilarl( starting from the Time and Motion stud( !hich !as e*ol*ed in the mid forties to

the latest 's(cho -iological tools ha*e gi*en immense scope for proper anal(sis from the

human safet( point of *ie!. 'articularl( after fe! major industrial disasters& oss 're*ention

and 0uman afet( pla(s a priorit( item on the agenda on an( management. Man( Industrial

undertakings either b( regulation or as part of their social and corporate responsibilit(

ha*e a dedicated safet( department in their premises. "ith a result& practicall( e*er( acti*it(

of human endea*or currentl( has a state of the art oss pre*ention and reduction

programmes a*ailable.

In summar(& oss pre*ention or oss minimisation programmes aim to map the trigger

factors !hich can set in motion a loss se;uence. The( either attack this trigger points or if after the trigger is set off the( tr( to control the conse;uences through selecti*e techni;ues.

These techni;ues comprise rec(cling& reco*eries& alternate sources of production or suppl(&

relocation and similar tools. In the Annexure to this chapter there is a brief outline of

institution based in India !hich speciali1es in oss 're*ention& Education and Research

and #ommunication. imilarl( there is another bod( called as 6ational afet( #ouncil

!hich also pro*ides useful information on afet( practices to industries.

H.% RI) #86TR8@ E'ARATI86& #8M-I6ATI86 A6< TRA6/ER

eparation

reparation is a process of segregating a firmDs exposure to *arious locations brought b(

oncentrating them at one location. A t(re manufacturer !ho caters to the length and

Vreadth of the countr( can produce t(res at one single location and transport them to

arious con*enient distribution centres all o*er the countr(. -( such spreading of the

xposure to *arious locations& the chances of the stock of t(res getting affected in /ire

a1ard is limited to the ;uantit( at an( one location. Therefore& e*en if such an e*ent

iappens in one of the locations the stock can be redistributed from other locations and

aereb( the continuit( of the supplies to the customers can be maintained.



116 Risk Management in General Insurance

imilar segregation techni;ues are used e*en in the la(out of plants and

factories. In a large factor( complex& there ma( be certain areas !here

ha1ardous processes are being carried out or ha1ardous goods are being stored.

E.g. in textile factories there is a process called as DsingeingD !hereb( the fabric is

gi*en a final finishing touch b( running the fabric o*er a controlled flame. uch

process being ha1ardous b( nature& the textile factor( la(outs normall( separate

this process into an exclusi*e area and build !hat are called as Dperfect part(

!allsD bet!een this area and the rest of the textile factor(. egregation in effect

uses the a! of arge 6umbers b( increasing the exposure units and thereb(

enabling the firms to predict !hat its loss experience !ill be.

j£$ Activity D ,

#omment on =In separation of ha1ardous process perfect part( !alls pla(s an

important role.=

Com$ination

In separation& a specified number of exposure units under the control of the

firm are relocated. In combination& the numbers of exposure units themsel*es are

being increased so that again the a! of arge 6umbers comes into pla( and

then the chances of loss are reduced. "e kno! that the larger the si1e of the

sample& the closer !ill be the probabilit( of the loss to the underl(ing probabilit(.

To illustrate this point think of an automobile compan( !hich o!ns $::

*ehicles. If the underl(ing probabilit( is that $ out of e*er( 52 *ehicles !ill meet

!ith an accident in a (ear& if the( so happen that for the $:: *ehicles o!ned b(

this compan(& it is not just that C *ehicles i.e. $P52 of $:: !ill onl( meet !ith

an accident. It ma( so happen that e*en C: *ehicles can meet !ith an accident if

the compan( is unfortunate. If the number of *ehicles o!ned is increased from

$:: to let us sa( 2:: it ma( so happen that the underl(ing probabilit( i.e. one

of 52 ma( closel( appl( to this sample. -( increasing the number of exposure

units the firm is in a position to ha*e a loss histor( closer to the underl(ing

probabilit(.

8n a similar basis if a compan( depends upon onl( O or C major suppliers for the

suppl( of its critical inputs then e*en if one or t!o of them suffer an( problem

then the compan(4nit H Risk #ontrol 9$



!ill be affected. 8n the other hand if the sourcing of suppl( is done from a large number of

suppliers then there is al!a(s a possibilit( of securing supplies from the alternate sources.

<i*ersification into man( different products or ser*ices is another example of combination

techni;ue. -( di*ersif(ing& the business risk in one or fe! lines of business can al!a(s be

balanced b( lesser business risks in some other acti*ities.

3*cti+i ty /G

a, ist out the points for the gi*en project taking into account loss control.

b, =In case of <air( project alternati*e arrangement for !ater and po!er is of prime

importance.=

Ri& Tranfer

8ne ultimate tool largel( used in risk control is a process of Transfer of Risk. This t(pe of

transfer can happen in man( !a(s b( !e shall be looking at fe! of them in this chapter.

'urchasing of insurance is a major Risk Transfer acti*it(& !hich !e shall stud(& elaboratel(in succeeding chapters. At the moment !e !ill confine oursel*es onl( to t!o methods

namel(&

• Transfer of acti*it( that creates the Risk #ontrol.

• Transfer of the financial losses arising from the risk i.e. Risk /inancing.

A, Tranfer of *cti+ity that create the Ri& Control,

There are number of ad*antages if specialists are appointed for ha1ardous task !hich

are as follo!s@

$. -eing more experienced and skilled in a !ork& specialist can complete the !ork

more safel(.




2. The e;uipments can handled more easil( b( specialists than the principal as it

ma( pro*e uneconomical to the principal.

3. 'rincipal ma( a*oid the difficulties and bad publicit( due to accident b( emplo(ingsub9contractor or e*en mere carr(ing out the !ork itself ma( cause.

To understand Risk Transfer let us take the example of the major contract for building

a fl(o*er being a!arded to a large construction compan(. To execute this contract&

the construction compan( has to procure materials of construction& emplo( labour&

emplo( construction e;uipment and also arrange for proper and timel( financing.

In each of these acti*ities there is a certain amount of exposure and risk. In the case

of procurement of materials there are issues of ;ualit(& timel( suppl( and costs. In the

case of emplo(ment of labour there are issues of a*ailabilit( of labour& problems of

trade unionism etc. as also injur( to !orkers in construction site. imilarl( e*en in thecase of use of construction e;uipments like bulldo1ers& exca*ators there are problems

of a*ailabilit(& maintenance of e;uipment& as !ell as accidental la(offs.

"ith so man( risks associated !ith e*er( t(pe of acti*it( in the construction process

this construction compan( has a *er( onerous task on its hand. If all these exposures

ha*e to be handled b( a construction compan( then it !ill be left !ith little time for the

core acti*it(& namel(& construction. Therefore the construction compan( can resort to

transfer of risk b( subcontracting *arious acti*ities listed abo*e to different firms

speciali1ing in each of these areas. abour suppl( can be subcontracted to a abour

suppl( firm and similarl( construction e;uipment can be leased from a leasing firm.

-( this process of subcontracting& the risks !hich could ha*e been other!ise resting

!ith the construction compan( are no! con*enientl( transferred to other entities.

This is an example the acti*it( !hich creates a exposure or risk has been transferred

to other entities. In the same manner e*en propert( !hich creates exposures can be

transferred to others b( !a( of a sale or lease etc.

8ne another !a( of transfer of risk is instead of transferring the propert( or acti*it(&

the risk itself can be transferred to another part(. In a 0ire 'urchase contract the title

to the goods !hich are brought under the 0ire 'urchase scheme passes off onl(

!hen final installment is being paid up. -ut the actual ph(sical propert( is in the

custod( and control of the borro!er. In *ie! of this situation& !herein the higher purchase compan( still o!ns the asset but is not ha*ing custod( or control of the

asset this hire purchase compan( ma( impose on the borro!er the safet( of the asset

in ;uestion. -( doing this as part of the 0ire 'urchase Agreement the 0ire 'urchase

compan( transfers the risk to the borro!er.4nit H Risk #ontrol 9$

4< Tranfer of the financial loe ariin% from the ri& i.e. Ri&

Financin%.

A

n



other method of Transfer of Risk is Risk financing. In Risk financing

techni;ue& the risk !hich is originall( associated !ith a person or firm is nottransferred to another person or firm but the latter is asked to finance an(

exposure !hich results on account of relationship bet!een the t!o parties.

It ma( be describes as arrangement made to manage the loss exposures presented b( currenc( fluctuations& interest rates changes and crop price

changes.

To explain this& let us take the case of /ranchise relationships like that of

Mc<onald or -urger )ing or 'i11a 0ut etc. "hen a franchisee

ac;uires a franchise from Mc<onald& an( risk associated !ith food

poisoning is still primaril( resting !ith the parent compan( Mc<onald.

0o!e*er if an( compensation is to be paid b( Mc<onald& as a result of the

food poisoning& then the actual pa(ment !ill be done b( the franchisee under

the terms of the contract. 4nder the risk financing there is no transfer of

either the propert( or acti*it( but then !hat takes place is onl( the funding of an( exposure.

3*cti+ity F,

=Risk transfer ma( take the form of transfer of the acti*it( that creates the risk.=Explain.

@.19 T(/ RO7/ OF 2O?/RN'/NT IN 0*F/T8 *ND 7O00

R/?/NTION

-ecause afet( in*ol*es the !elfare of !orkers as also public at large& the

go*ernment has also ensured that certain obligations are based on those

in*ol*ed in acti*ities of manufacturing and production to make sure that

the( follo! certain minimum safet( standards. Larious acts ha*e been

enacted to enforce these obligations. ome of the legislation !hich go*ern

safet( and oss pre*ention are@

1. /actories Act

2. Explosi*es Act

3. "orkmenDs #ompensation Act

4. 'ublic iabilit( Act

$$%




Man( ocal Go*ernments and tate Go*ernments ha*e also introduced safet( regulations

specific to certain t(pes of risk like 0igh rise buildings. imilarl( specialist organisations

ha*e a role to pla( in special areas for instance for the oil and gas industr(. The 8il Industr(

afet( <irectorate !hich !orks under the Ministr( of 'etroleum and 6atural Gas hase*ol*ed safet( standards for the industr(.

@.11 0U''*R8

In this unit !e ha*e introduced se*eral methods for handling both pure and speculati*e

risks. The( include a*oidance& loss pre*ention& loss control& risk finance and risk transfer.

The concept of risk a*oidance in*ol*es abandoning some acti*ities or declines the risk.

This is the appropriate tool !hen the chance of loss is high and loss se*erit( is also high.

"e ha*e discussed *arious methods of successful loss pre*ention and loss reduction. In

loss pre*ention& acti*ities lo!er the chance of loss. oss reduction acti*ities are designed

to reduce the se*erit( of losses that do occur. A example is an automatic fire sprinkler

s(stems that does not stop fire but pre*ent from spreading.

In this unit !e ha*e also discussed ho! the risk can be controlled b( using methods like

separation combination and transfer. To!ards the end !e ha*e seen the set up of 8

R/?/NTION *00OCITION OF INDI* for promotion of safet( and loss control

through education& training and consultanc(.

H.$5 /8#ORD0

*+oidance

7o Control 'eaure

7o Reduction 'eaure

8ne !a( to control pure risk is to a*oid the propert(&

person& acti*it( !ith !hich the exposure is associated

b(

a. declining to assume the exposure&

b. abandoning an exposure !hich is alread( present.

These are aimed at either lo!ering the chance or

probabilit( that a particular t(pe of loss !ill occur or if

it occurs reduce its se*erit( and impact.

These aims at reducing or mitigating the impact andextent of a loss e*ent.

4nit Risk #ontrol 9$

0eparation

Com$ination

Ri& Tranfer



It is a process of

segregating a

firmDs exposure

to *arious

locations

brought b(concentrating

them at one

location.

It is process b( !hich the number of exposure units

themsel*es is being increased so that again the a! of

arge 6umbers comes into pla( and then the chances

of loss are reduced.

It is achie*ed through arranging /inancing of the

exposure b( another part( or transfer to a third part(

like Insurer.

@.1- 0/7F*00/00'/NT U/0TION0

i. <istinguish bet!een the concepts of eparation and #ombination !ith suitable

examples.

ii. If (ou !ere the o!ner of a hopping Mall& !hich sells floor space as !ell as leases

out space& ho! !ould (ou handle the exposures (ou ha*e as an o!ner b( using Risk

transfer and financing methods

iii. Explain the concept of A*oidance !ith an example.

i*. <istinguish oss 're*ention from oss Reduction.

*. Is oss 're*ention possible in the case of tate like 8rissa i.e. of torms& #(clones

8r !ould (ou suggest oss Reduction measures "hich kind

@.15 *NN/HUR/

7o re+ention *ociation of India

romotin% afety and lo pre+ention

"a( back in the $%H:s& there !as a gro!ing concern in the general insurance industr(

about the magnitude of fires& road mishaps& industrial accidents& damage to cargo 9 resulting

in loss of life and propert(& most of !hich !as a*oidable. It !as this concern for pre*enting

such losses and containing their conse;uences that prompted the general insurance industr(

to promote the oss 're*ention Association of India td. or 'A as it popularl( came to

be kno!n.



b( sea& land or air is subject or an( other loss or damages arising b( an( reason

or b(

accidents caused ho!soe*er.

5. To educate or train members of the public on the measures to be taken to

pre*entincidents losses andPor damages and to minimise risks to pre*ent !aste of such

propert(.

6. To maintain liaison !ith insurance& companies& fire ad*isors. tate

Go*ernment&

/actor( Inspectors and ad*isor( ser*ices& tate Electricit( -oards&

Inspectorates of

Explosi*es& Indian Transport Authorities& Rail!a(s& hip o!ners& -ureau of

Indian

tandards& Automobile Associations& Road Transporters& 'olice& Road

ResearchInstitute& afet( /irst Association& 'ort Trusts and #ustoms& #learing and

/or!arding

Agencies& Indian Institute of 'ackaging and the like.

7. To re*ie! existing regulations and practice in the light of experience and to

suggest

impro*ements and modifications to ensure safet( in operation and to pre*ent

theft&

burglar( and pilferage and to ensure and encourage enforcement of regulations

issued b( *arious organisations.

8. 'rotection or research at *arious le*els in order to carr( out all or an( of the

objects

of the Association.

9. To in*estigate into causes of losses and build up and keep statistical records.

10. To publish periodicals& bulletins& maga1ines& hoardings and literature on loss

pre*ention

and P or loss minimi1ation !ith or !ithout collaboration !ith similarorgani1ations in

India and other countries.

11. To maintain and pro*ide librar(& books& journals& audio *isual aids& pro*ide

expert

ad*ice on ;uick and economic rehabilitation after major losses.

12. To undertake risk managements and ad*ice safet( audits.

13. T

osp

o

ns

or re

se

ar

ch

in

to

fir

e

ha

1a

rds

an

d

re

lat

ed

pr o

bl

e

ms

an

d

an

(

i

m

pr

o

*e

m

en

ts

in pa

ck

ag

in

g&

ha



ndling and transportation of different t(pes of cargo.

14. To establish a chain of !orkshops or appro*e existing !orkshops for repairs

to

insured *ehicles and organi1e ;uick sur*e( facilities.

$5O




Education& training and consultanc( ha*e been the cornerstones of 'ADs safet( promotion

strateg( for the industrial sector.

/or additional information please refer the follo!ing site@ite www.lpaindia.or%

Reference from book of III.4nit Insurance @ A Risk /inancing Tool

entire arrangement of this relationship bet!een the Insurance #ompan( and the

insured is structured in the form of a document !hich is called as the

Contract of Inurance or more popularl( the 'olic( of Insurance. Insurance

'olicies are normall( issued and executed for a specified period of time and this

period is called as eriod of Inurance.

Generall( premiums once paid for a particular period of insurance are not

returned back e*en if there ha*e been no claims during the period of insurance

+there are fe! exceptions to this practice,. This statement holds good onl( in

respect of General Insurance !ith !hich !e are no! concerned about. The

other branch of Insurance kno!n as ife insurance !hich deals !ith the life of

persons has a different mechanism for pa(ment of premiums and refund of

premiums. "e !ill no! start learning about ho! the transfer of risks takes place

through insurance and ho! insurance process operates.

.%T *cti+ity *G<iscuss =Insurance is an especiall( appropriate risk management tool.=

.O '/C(*NIC0 OF IN0UR*NC/

Inurance of property

If there are $::: housing units in a to!n& assume each of them cost Rs.$::&:::. If all these houses are to be insured and the rate of premium is $ X&

then each house !ould pa( Rs. $::: as premium and the total collection of

premium from all these housing units !ould be Rs. $ Million.

If the probabilit( of an( of these houses in this sample catching fire and

getting totall( destro(ed is let us sa( .::$ in a period of a (ear then in an( period

of insurance +this could be common to all these units,& (ou can expect one house

to suffer such a loss !hich means that the amount of mone( the Insurance

#omp

an(

has to

pa(

out

!ill

be a

lakhof

Rupee

s.

8ut

of the

total

one

Millio

n

Rupe

es

collec

ted as

premi

um&

the

insura

nce

comp

an(!hich

admin

isters

this

insura

nce&

ma(

pa(

out

Rs.



$::&::: and remaining Rs.%::&::: is left !ith it to take care of future losses as

!ell as pro*ide reasonabl( for its management expenses as !ell as a decent profit.

19Q




-ut if the probabilit( of :.::$ starts increasing than the surplus left !ith the Insurance

#ompan( !ill start diminishing and at the point of time !hen the probabilit( reached :.:$

the Insurance #ompan( !ill ha*e nothing left to pa( for future losses and !ill also run

short of mone( for its management expenses.

This is ho! General Insurance !orks. It is all about a certain si1e of the population to be

insured& certain collections b( the !a( of premium contributions from this population&

certain probabilities& certain loss e*ents actuall( taking place and certain amounts of

compensation or indemnit( paid to the sufferers of the loss.

JS *cti+ity 4 ,

Illustrate !ith example@ =/rom the collection of premia& the insurer pa(s current misfortunes

and the surplus left is used for future losses.=

B.5 IN0UR*NC/ *0 * RI0 TR*N0F/R TOO7

Inurance 'ethod

In this method there !ill be a t!o step process. #o*erages a*ailable in insurance !ill bethe focal point of the exercise. All possible exposures ha*e alread( been identified and

also measured in terms of fre;uenc( and se*erit(. 8nce this is done using the *arious t(pes

and le*els of insurance co*erages a*ailable the Risk Manager !ould proceed to classif(

the exposures or risks on the follo!ing basis@

1. Essential co*erages

2. <esirable co*erages

3. A*ailable co*erages

1. The /ential Co+era%e

It includes those that are compulsor( because the( are re;uired b( la!. <esirable co*erages

are those !hich pro*ide protection against losses that can seriousl( impair the operations

of the firm. /or instance compulsor( automobile Third 'art( Insurance and Emplo(ers

iabilit( insurance.



4nit Insurance @ A Risk /inancing Tool

ometimes it ma( be re;uired under the terms of an( contract entered that certain le*el

and t(pe of insurance co*erage !ill be re;uired to be taken. #onstruction insurances

taken b( #onstruction contractors fall into this categor(. Also in this categor( can be

included losses !hich ha*e a high se*erit( in their impact. A major fire or explosion in a

'etrochemical P Refiner( can be an example of this categor(.

:. Deira$le Co+era%e

These are those !hich pro*ide protection against losses that can seriousl( impair the

operations of the firm but !ould not certainl( be so se*ere as to put the firm out of business.

osses due to accidents !hilst the goods either finished or ra! materials are in transit&

theft of household goods& larcen( of grocer( from a shop are examples of this categor(.

-. *+aila$le Co+era%e

It includes the t(pes of protection that are not co*ered in the earlier t!o categories. The

losses protected under these t(pes of co*erages are normall(& fre;uenc( losses !hich

!ould not impact the firms& *iabilit( or continuit(. The machiner( breakdo!n of motors&

pumps& computers&electrical breakdo!n of machines etc. could be examples of this t(pe.

3*cti+ity C ,

"rite do!n t!o examples of Essential& <esirable and A*ailable co*erages.

8nce the listing as abo*e is done& there can be a re*ie! of ho! the co*erages indicated

abo*e could be either purchased or dropped or exposures can be transferred to other

than insurance mechanisms.

There can be losses that can be transferred to somebod( other than an insurance compan(

for a cost less than the insurance premium. Annual Maintenance contracts for e;uipments

are one such possibilit(. There can also be losses !hich are capable of being controlled b(

taking suitable loss pre*ention or control measures and in such cases the pre*ention costcould be e*en cheaper than corresponding insurance premiums.

The Annual Maintenance contracts !hich !ere mentioned abo*e are once again an example

of this t(pe. Moreo*er losses due to small time fre;uent thefts can also be pre*ented b(



Risk anagement in General Insurance

increasing the le*el of securit(. Thirdl( there are losses !hich are again fre;uent in nature

but are of such insignificant ;uantum that this can rather be retained !ithin the firm. /re;uent

breakdo!ns in machiner( of lesser criticalit( can be rather borne b( the firm because theinsurance might be expensi*e compared to the total !ould be losses due to this kind of

breakdo!ns.

-( carr(ing out this t(pe of classification& the Risk Manager !ill be able to prepare a list

of necessar( insurance co*erages. After this there has to be a certain amount of priorit(

listing. Essential contracts !ill be on the top of this list. <esirable co*erages !ill be either

included or dropped based on the cost considerations. A*ailable contracts ho!e*er !ill

be the least on priorit(. In order to ho!e*er decide about the cost effecti*eness there are

se*eral methods a*ailable. "e !ill no! examine one of them@ it is simpler to use but still

;uite effecti*e.

FActi*it( < @

tate in brief =In certain cases losses can be transferred to somebod( else than insurance

in less cost than premium.DD F

.2 T0E 8 MATRI

The oss Matrix is a tool to ;uantif( the effecti*eness of *arious options a*ailable for a

Risk Manager. To understand this method& let us look at an illustration as pro*ided belo!@

et us take the example of a building o!ner. In respect of a possible loss due to fire or

earth;uake the building o!ner can either retain the risk or introduce se*eral loss control

measures to bring do!n the possibilit( of as a third alternati*e purchase insurance. The

*arious cost benefit implications are listed in the sample oss Matrix.

+'lease refer the annexure to this unit,

This method appears too simplistic to stud( but in fact is the real life situation is not so

simple. There are other ;uantitati*e methods a*ailable like the "orr( method& #apital

Asset 'ricing Model& 'ortfolio Theor( Method etc. -ut since the( ha*e a high le*el of

statistical re;uirement& !e are not highlighting them here. 8ne more method called as a




#ritical 'robable Method is more or less patterned on the oss Matrix. The onl( difference

being that the method uses !hat is called as #ritical 'robabilit( e*el. This can be defined

as the probabilit( that certain t(pe and le*el of losses !ill exceed the premium sa*ings.

osses abo*e the #ritical 'robabilit( le*el !ill be desirabl( insured and losses belo! thatle*el can be better retained.

FAct i*i t( E@

tate in fe! lines the use of loss matrix regarding the decision about to retain the risk or

purchase a insurance.

B.> C/RT*IN 7/2*7 *0/CT0 OF IN0UR*NC/ CONTR*CT0

Insurance contracts are subject to certain special principles e*ol*ed under common la!

and generall( follo!ed b( courts in India. These principles are kno!n as fundamental or

basic principles of la! of insurance. These are as follo!s@

1. 4tmost Good /aith

2. Insurable Interest3. Indemnit(

4. 'roximate cause

6o! !e !ill discuss these in detail@

rinciple of Utmot 2ood Faith,

An insurance contract is supposed to be a contract of 4tmost Good /aith. The principle

emanates out of the fact that a risk !hich is being offered to an insurer for co*erage& the

proposer of the risk is in substantiall( better position to kno! about the risk than the

insurer himself. ince there is a kno!ledge gap& it becomes the dut( of the insured i.e.& the

person or the firm proposing to a*ail insurance from an insurer& to render full information to

the insurer.



should suffer financiall(. 8ther!ise this person is not entitled to an( compensation and

therefore is not entitled to an( insurance co*erage also.

The insurable interest& ma( be define as& =The financial interest bet!een the insured and

the subject matter of insurance gi*es legal right to insure=

The eential feature of the inura$le interet are

1. There must be some right& propert(& or liabilit( capable of being insured.

2. uch propert(& right etc. must be subject matter of insurance.

3. The relation must be of a nature that insured benefits from its safet( and loses due to

its loss& damage of subject matter.

4. This relationship must be recogni1ed b( la!.

The inura$le interet arie due to

1. -( common la!@ /or example o!nership 9 An o!ner of a building !ould suffer

financial loss if it is destro(ed or damage b( fire.

2. -( contract@ -( contract the person is liable for safet( of propert(. In hire purchase

agreement the hirer is responsible for damage or loss of propert( hired.

3. -( status@@ A bailee is responsible for damage to goods in his possession due to his

negligence. 8ther e.g. aundr(man& !arehouse keeper& motor *ehicle repairer.

Three main cate%orie of application of inura$le interet are

$. ife@ E*er( person has insurable interest in his o!n life& in the life of personDs husbandor !ife& -( financial interest in the other person being a business partner.

5 'ropert(@ It arises due to o!nership of the propert(& Executors and trustees responsible

for propert( in their charge& etc.

O. iabilit(@ It exists due to liabilit( !hich ma( be incurred b( !a( of damages and

other costs. /or example public liabilit(& third part( liabilit(& etc.




3*cti+ity 2,

"rite do!n !hen the insurable interest arises !ith three examples in each case.

-. rinciple of Indemnity

Indemnit( means compensation for loss or injur( sustained. The principle of indemnit(

arises under common la! !hich re;uires that an insurance contract should be a contract

of indemnit( and nothing more than that. Insured is pre*ented from making an( profit from&

out of loss or damage. 0e in other !ords placed in the same financial position before theloss occurred.

The principle of indemnit( follo!s the principle of insurable interest i.e.

i, An insured can reco*er a loss under the polic( onl( if he has insurable interest.

ii, Insured can reco*er a loss onl( to the extent of his insurable interest.

The followin% eLample will illutrate the point,

DAD has a fire polic( for Rs. $2:&:::H9 !here as the *alue of the propert( is

Rs. $::&:::H9. 0e sells the propert( on $$.O.5::3 and a fire occurs on $C.O.5::3 thenno claim !ill be pa(able as he has no insurable interest on the date of fire.

uppose =A= has not sold the propert( and fire occurs on $C.O.5::3 and propert( totall(

burnt then he !ill recei*e onl( $::&:::H9 and not Rs. $2::::H9 as his financial loss is onl(

Rs. $::&:::H9.

If the indemnit( is not applied then the transaction !ould be a mere gambling.

According to this principle no one can gain financiall( out of insurance undul(. As !e ha*e

said earlier insurance contracts are not meant for gi*ing undue financial benefits. If a person

or a firm has financial interests then if something happens to the propert( insured then& the

person or firm insuring it +the insured, should be neither better off nor !orse off than the(

!ere before the accident took place.




To illustrate& if a firm has insured its old machiner( for certain *alues& after an accident to

such old machiner(& the o!ner of the firm should not be gaining b( getting ne! machiner(

or its cash *alue. Therefore on the *alue of the machiner(& reasonable amount for depreciation

!ill be applied if the machiner( has to be replaced.

'ethod of indemnification,

Cah payment@ Majorit( of cases the claim !ill be settled b( gi*ing the insured a che;ue

for the amount pa(able under the polic(.

Repair@ This method is of extensi*e use as method of pro*iding indemnit(. Motor insurance

is the best example of this as garages are authori1ed to repair the damage *ehicle.

Replacement@ It the damaged propert( is be(ond repair then indemnit( on the basis of

replacement is offered.

Reintatement@ It refers to propert( insurance !here an insurer undertakes to restore

or rebuild a building or piece of machiner( damaged b( fire or b( breakdo!n under

engineering polic(.

'eaurement of Indemnity @ In propert(& liabilit( and other non9life insurance& the

exact amount of compensation is not kno!n in ad*ance. 4nlike benefit t(pes of policies

and personal accidents policies. The method b( !hich indemnit( is measured is to be

measured depends upon the nature of insurance in*ol*ed.

/ollo!ing this 'rinciple of Indemnit(& there are t!o corollaries called as rinciple of 0u$ro%ation and rinciple of Contri$ution.

0u$ro%ation@ It ensures that if an insurer pa(s a large amount to the insured on account

of an( loss and if this loss has been caused b( a Third 'art(& insurer can assume the rights

and remedies of the insured after pa(ing the loss and !ork on claiming it from those !ho

caused this loss i.e. the Third 'art(.

Contri$ution @ The 'rinciple of #ontribution also makes sure that the insured sets no

more mone( than he lost. If there are more than one insurer insuring either the !hole or

part of the affected propert( then the total amount reco*erable from all these insurers in

the e*ent of a loss should not be more than the actual loss. This means that the total lossamount !ill be apportioned among *arious insurers.

Also insurers not onl( expect proper disclosure at the time of going on co*er. The( also

expect the insured to ha*e certain responsibilities i.e. to do certain actions or not to do




certain actions during the currenc( of the insurance polic(. E.g.& the insurer ma( insert a

condition in the insurance polic( that during the entire period of insurance co*er the insured

!ill maintain proper /ire protection e;uipment. These kind of conditions are called as

"arranties and if such "arranties are not obser*ed b( the insured& then the insurers ha*e

the right to a*oid pa(ment of losses particularl( if such breach of "arrant( contributed

either to the occurrence of the loss itself or increases the extent of the loss.

3*cti+ity (,

"rite do!n methods of indemnification !ith t!o examples each.

5. rinciple of roLimate Caue

If the loss is brought about b( one e*ent& no ;uestion of liabilit( arises but if the toss is due

to more than t!o or more causes& acting simultaneousl( or one after other& then it becomes

necessar( to find out the most important& effecti*e and po!erful cause !hich brought the

loss. This cause is defined as =proximate cause= all other causes are considered as remote

The claim is pa(able if the loss is resultant of peril insured against. 0ence the practical

effect is to keep the scope of insurance !ithin the limits intended b( the parties& i.e. insured

and insurer.

It defines not onl( the scope of co*erage under the contract but also to protect relati*e

rights of the parties to the contract thus maintaining a balance.

Man( losses !ill ha*e a uni;ue set of circumstances and establishment of proximate cause

!ill arise from the application of common sense.

/Lample,

1. A motor *ehicle dashed b( other *ehicle and met !ith an accident& as the single cause

!hich is !ithin the scope of the polic( and the claim is pa(able.

2. Insured met !ith an accident and admitted in the hospital for treatment. <uring the

treatment period he contracted an infection and caused his death. The proximate

cause of death !as disease and not the original accident hence claim is not pa(able

under personal accident polic(.




3*cti+ity IG

#omment on ='roximate cause= maintain the true intention of the parties to the contract

regarding the rights bet!een the insured and insurer.

B.@ 0U''*R8

In this unit !e ha*e introduced Insurance as a appropriate Risk Management Tool !hen

the chance of loss is lo! and the se*erit( of loss is high. It allo!s the purchaser to substitutea small certain premium for a large uncertain loss.

"e ha*e also seen the mechanism of insurance and essential terminolog( used in Insurance.

If the cost of insurance premium is more than to retain the risk or the cost of pre*enti*e

measures& then other form to protect the propert( is the best solution.

"e ha*e also discussed the risk can be classif( into three t(pes of co*erages and can

decide !hether the co*erage can be transferred or retained. Insurance is a legal contract

and based on certain principles. "e ha*e discussed the utmost good faith in !hich disclosure

of material fact is essential. 4nless there is insurable interest& one cannot insure his propert(

or liabilit(& "ith the principle of indemnit(& insured places in the same financial position before the loss.

After the loss is paid& the insurer subrogates the rights of the insured and exercises their

reco*er( rights. If the propert( is insured !ith more than one insurer& claim is paid in

contribution. 'roximate cause defines scope of the polic( and protect relati*e rights of the

parties to the contract.

B.B /8 #ORD0

Inurance

remium

It can be defined as a process through !hich the losses of

fe! are compensated from the contributions of man( to afund& !hich is administered b( an insurer.

The contributions to the pool& !hich are considerations for

the Insurance contract.




Inured

Claim

Contract of Inurance

or olicy of Inurance

eriod of Inurance

/ential co+er

Deira$le co+era%e

*+aila$le co+era%e

rinciple of Utmot

2ood Faith

Inura$le Interet

rinciple of Indemnity

The contributors of 'remium& !ho ha*e an insurable interest in

the subject matter of insurance.

The demand the contributors make on the insurance compan( inthe e*ent of a loss suffered b( them.

The document e*idencing arrangement of this relationship

bet!een the Insurance #ompan( and the insured.

It is the specified period of time for !hich an Insurance

document is structured.

The essential contracts includes those that are compulsor(

because the( are re;uired b( la!.

These are those !hich pro*ide protection against losses that canseriousl( impair the operations of the firm.

It !ould include the t(pes of protection that are not co*ered in

the earlier t!o categories.

Means it re;uires the Insured to render full information to the

insurer.

This rationale is that if an(thing happens to the person or

propert( insured& then the person proposing for insurance&

namel(& the insured should suffer financiall(.

If a person or a firm has financial interests then if something

happens to the propert( insured then& the person or firm

insuring it +the insured, should be neither better off nor !orse off

than the( !ere before the accident took place.

$C:




B.19*NN/HUR/

7O00 '*TRIH

<ecision /ire 8ccurs 'a(out+Rs.,

6o /ire 'a(out+Rs.,

Retain the risk osses !hich could

ha*e been insured ? 2::::: 6o osses 6il and claimed

6on9insurable accidental losses $::::

Total 'a(out 2$:::: Total 'a(out 6il

Retain the risk and osses !hich could O::::: 6o osses

implement oss ha*e been insured

're*ention

Measures 6on9insurable accidental 5:::

losses

#ost of afet( measures $5::: #ost of afet( $5:::

measures

Total 'a(out O$C::: Total 'a(out $5:::

'urchase Insurance 'remium $:::: Insurance $::::

Insurance 'remium

osses reco*ered +2:::::, 6on9 2:::

insurable

losses

6on9insurable 2:::

losses

Total 'a(out $2::: Total 'a(out $2:::



$C3 Risk Management in General Insurance

.1 INTRODUCTION

As !e ha*e seen in the earlier units insurance happens to be the most

con*enient Risk Transfer Mechanism. <ue to industriali1ation& Increasingl(complex conditions of modern life& gro!ing consciousness about the legal rights of

reco*er(& accidents resulting into injur( or death& propert( damage ha*e become

almost ine*itable.

All these de*elopments ha*e influenced the gro!th of insurance industr( in a

*ariet( of forms to pro*ide the necessar( protection. -ecause there is a great

*ariet( in the interest or subject matter to be insured& there is also great *ariet( in

the t(pes of insurance co*ers. -ut insurance can be broadl( classified to fall

into three major categories @ roperty! Caualty! and 7ia$ility. "e shall no!

see each of these classifications in greater detail.

.: RO/RT8 IN0UR*NC/

3

All t(pes of tangible propert( are the subject matter of the propert( class of

insurance. This could be mo*able assets like goods !hich are in transit or

immo*able assets like buildings& machiner( etc. This could be small units like

residential houses to huge installations like a big manufacturing factor(. Again

this could be on land or offshore. s

-( and large& the propert( class of insurance is offering protection to a great

*ariet( of subject matter and therefore it forms the largest portfolio of an(

insurance compan(& in general. 6ormall( propert( clause offers protection

against perils like /ire& ightning& Explosion& and <amage due to impact b(

Rail or Road *ehicles& <amage due to impact b( aerial de*ices etc.

"hile these kind of perils form the basic co*erage& there can be additional perils

like perils of !eather 9 flood& storm& c(clone etc.& as also catastrophic perils like

earth;uake& landslide etc. This co*erage is basicall( a*ailable for propert(

onshore and static. /or offshore propert( in addition to the perils mentioned&

there can be additional perils co*ered like impact b( *essels. There are co*ers

!hich specif( the kinds of perils co*ered as !ell as there are co*ers !hich are broader in co*erage and !hich are generall( called as #omprehensi*e& or All

Risks insurances.

/or propert( on the mo*e& the insurances a*ailable are either co*ering carriers

like ocean going *essels or passenger ferries etc. or co*ers for goods in

transit either across International borders or on high seas or in air. E*en goods

!hich are on mo*ement on land can be co*ered against Inland Transit policies.

These properties on the mo*e can be again co*ered on a 6amed 'eril basis or on

a #omprehensi*e basis& +in all our discussions the term =peril= means the cause

!hich brings about the loss e*ent,.



4nit % T(pes of Insurance #o*ers

3*cti+ity 4 ,

Explain the statement =The 'rinciple of Indemnit( undergoes a modification in #asualt(

Insurances.=

.5 7I*4I7IT8 IN0UR*NC/

"e ha*e seen earlier that in a ci*il societ( there are lot of obligations and responsibilities

on the part of citi1ens to fello! citi1ens as !ell as to the public at large or societ( at large.Also contractual relationship bet!een *arious members or units of the societ( also creates

legal obligations. 0ence a separate class of insurances called as iabilit( Insurances pro*ides

indemnit( in respect of legal liabilities. Man( of such legal liabilities insurances exist separatel(

and man( times the( also are included in certain other propert( or casualt( policies. Examples

of legal liabilit( policies are@

#omprehensi*e General iabilit(& Emplo(erDs iabilit(& ift 8!ners iabilit(& A*iation

iabilit(& hip 8!ners iabilit(& etc. General iabilit( policies take care of the compensations

or a!ards imposed b( the courts as !ell as associated defense costs and these policies

are a*ailable to an( t(pe of firm or enterprise. Emplo(erDs liabilit( policies cater to the

responsibilit( of emplo(ers for ensuring the !elfare of their emplo(ees. iabilit( policies of specific industries like a*iation and that of ship o!ners address the legal obligation on the

part of these o!ners or users to compensate for both propert( and personal injur( of

passengers and Third parties.

Man( of these liabilit( policies can be suitabl( amended to pro*ide for liabilities in respect

of en*ironmental preser*ation. 'ollution iabilit( extension is one such case. As more and

more t(pes of legal liabilities e*ol*e& insurers rise up to address these kinds of concerns.

iabilit( insurances ha*e a different (ardstick altogether for methods of fixing the polic(

*alues as !ell as methods of Indemnit(. ince the exposure to these liabilit( producing

e*ents are again a function of the probabilit( of such e*ents& ho!e*er the amount ;uantifiedfor discharging the legal liabilit( depends on so man( factors. These factors include the

general s(stem of legislation in the countr(.




egislation and regulations !hich are specific to the kind of liabilit(& the standard of li*ing&

general economic conditions& the approach of judiciar(& socio9economic influences etc.

egal iabilit( arising out of Automobile accidents is go*erned b( the Motor Lehicles Act

and related regulations. 4nder these regulations limits are prescribed for liabilities to!ards

propert( damage and the formula is prescribed for calculating compensation in the case of

personal injur(. Therefore insurance policies co*ering egal iabilit( for automobiles can

*er( specificall( co*er the limits of liabilit( in the polic(. "hereas in the case of general

liabilities one has to go b( man( of the factors mentioned abo*e taking into account also

the pre*ious case histories as decided b( the courts.

/or instance a factor( o!ner !ho is re;uired b( la! to a*ail of a "orkmenDs #ompensation

'olic( can find it eas( to bu( co*erage for compensations exactl( as prescribed in the

"orkmen #ompensations Act. 4nlike this& the same factor( o!ner !ho has to bu(

protection for pollution liabilit( has onl( to depend upon his o!n risk perception as !ell as pre*ious cases decided b( the courts of la!. ince limits of liabilit( are not clearl( determined

in man( of liabilit( policies& there is al!a(s a hidden exposure in respect of these liabilities.

The term egal iabilit( implies that the extent of liabilit( either is determinable like in the

case of emplo(erDs liabilit( or has to be decided b( courts in specific cases. o in theCatter

case it !ould appear that the parties to the case ha*e to !ait for an a!ard from the

concerned court. 0o!e*er since there are long dela(s in the judicial process& iabilit(

policies pro*ide for an out of court or agreed settlement bet!een the parties. The onl(

re;uirement for such settlements to be honored b( the insurance compan( is that the

insurer should be full( in*ol*ed in the process of settlement. 6ormall( these policies also

pro*ide for the associated expenses !hich are incurred in the carr(ing out of the proceedings. /or instance the fees of the ad*ocates& the expenses incurred in tra*eling to

appear before courts all are reco*erable from such liabilit( insurances& the limit being the

polic( limit.

Though !e ha*e seen the categori1ation of insurance co*ers a*ailable to the abo*e three&

there are still man( more t(pes of insurance !hich do not strictl( fall into an( one of these

categories.

8ne classic example is the /inancial Risk co*ers. These t(pes of co*ers straddle o*er

man( classes of insurance. 'art of them could be 'ropert(& like in the case of -ankers

Indemnit( 'olicies 9 Theft or -urglar( at -ank premises. There are legal liabilit( sectionscatering to the -ankDs responsibilit( to!ards its customers as !ell as other partners in

banking. The latest in this kind of multi class insurances are those relating to Information

Technolog( Industr(.




3*cti+ity C,

=ince limits of liabilit( are not clearl( determined in man( liabilit( policies& there is al!a(s

a hidden exposure in respect of these liabilities.= Explain !ith examples.

.6 T(/ R/*0ON0 FOR 4U8IN2 IN0UR*NC/

The reasons for bu(ing Insurance can be dealt !ith under the headings of risk transfer and

other reasons.

Ri& Tranfer

Insurance pro*ides a means for handling risks !ith a lo! probabilit( of suffering a large

loss !hich an organi1ation cannot afford to retain itself. The transfer of risk can take t!o

forms@

1. The transfer of the acti*it( that creates a risk

2. The transfer of the financial losses arising from the occurrence of the risk.

The commonest example of +a, is the subcontracting of particularl( ha1ardous acti*ities

such as under!ater pipelines in ci*il construction& installation of firefighting e;uipments in achemical factor(. Insurance is the most important form of +b, It is better to bu( insurance

for risks !ith lo! fre;uenc( and high loss se*erit(.

The other reason besides risk transfer to bu( insurance is the *alue of the *arious ser*ices

!hich an insurer ma( pro*ide as a part of insurance package. Those ser*ices are as

follo!s@

• Risk reduction ad*isor( and inspection ser*ices

• Risk financing and other ad*ices

• #laims handling ser*ices

Risk reduction ser*ices include inspection of premises& plant& s(stem of !ork and suggest

risk reduction measures compl( !ith the factor( act and other safet( regulations. imilarl(

fire and theft insurers are ad*ice on risk reduction measures during the planning stage of

the building plant. /idelit( and credit insurer ad*ice on audit and credit control s(stems.




Insurer and brokers are usuall( !illing to ad*ice on exemption& indemnit(& emplo(ee benefits&

and insurance clauses in the contracts and so on.

"hen a loss occurs& insurers pro*ide a *ariet( of ser*ices and ad*ices according to theclass of insurance concerned. The( offer expert ad*ice on sal*aging of damaged propert(&

names of specialist repairs.

3*cti+ity D ,

ist out the ser*ices pro*ided b( the insurer as part of the insurance package.

.> T(/ 4/N/FIT0 OF IN0UR*NC/

In its earliest form insurance started more or less on the patterns of a gamble.

Itstarted !ith the maritime trade& !herein the o!ners of ships and cargo !hich !ere

meant for far a!a( destinations used to pa( some amounts of mone( into a pool. If

the *o(age !as successfull( completed& then the amounts !ere returned and if not&

the losses !ere paid from the pool. "hat !e !ill ha*e to remember is that as

insurance de*eloped it !as no longer a gamble. "e ha*e seen earlier that gambling

in*ol*es peculati*e Risk. 8ne ma( gain or one ma( lose in a gamble.

-ut Insurance in*ol*es 'ure Risk. This is one of the fundamental principles of

insurance !hich is stated in !hat is called as D'rinciple of Indemnit(D. 4nder this

principle an( one !ho is insured if he or she suffers a loss& the( should be placed in

the same position financiall( as the( !ere before the loss. This means there cannot be

an( financial gain out of a polic( of insurance. 6o! let us see as to !h( people or

firms should insure. The reasons are man(@

1. Inurance pro+ide Indemnity@ If an indi*idual or a firm suffers a loss !hich

is pa(able under an insurance polic( then the( get compensated sufficientl( so

as to regain their financial position as it !as before the loss occurred. This !a(insurance has been a great pro*ider of relief.

Qust look at this. A massi*e earth;uake !hich shook Gujarat on 53th of

Qanuar( 5::$ claimed a death toll of almost 5:&::: li*es. Economic loss to the

countr( is

$




estimated at a !hopping le*el of 52&::: #rs. of rupees. 8f this& the Insured losses

are in the range of Rs. 2:: #rs. -( insured losses !e mean that the amounts pa(able

under *arious t(pes of insurance policies is just about Rs. 2:: #rs. #ompare this

!ith the total general insurance premium in India !hich !ill amount to roughl(

Rs. $5&::: #rs. 7ou !ill be able to appreciate that one loss and just one loss has

reduced the insurers b( almost Rs. 2:: #rs.

This is just an illustration as to ho! insurance is beneficial. imilarl( the recent floods

in Europe ha*e caused an Economic loss of almost Rs. 5:&::: #rs. #ompared to a

countr( like India the penetration of insurance is *er( high in countries of Europe and

therefore one can conclude that substantial part of this estimated economic loss !ould

ha*e been picked up b( insurers.

"hen !e talk of indemnit(& it is not just an amount of compensation. In the case of

li*es lost& particularl(& of heads of families or the earning members& the insuranceindustr( restores economic !ell being to the famil( b( pro*iding Indemnit(. imilarl(

in the case of firms manufacturing or pro*iding ser*ices the business are able to

regain their *iabilit( and start !orking again.

:. Reduction of Uncertainty@ In the opening chapters of the book !e ha*e studied

the economic cost of risk. Risk causes !orr( and if the uncertaint( is not either

reduced or remo*ed totall( then an indi*idual or a firm sh( a!a( from the risk bearing

acti*it(. -( transferring the risk for a small consideration& the indi*idual or firm are

free to undertake such acti*ities. "e ha*e earlier seen& the risks !hich beset a

construction compan(& !hich is about to build a huge fl(o*er.

E*en though !e ha*e seen possibilities of transferring the risk of suppl( of materials&

the labour etc.& to subcontracting companies& either the original construction companies

or subcontractors themsel*es ma( not sometimes be able to achie*e such a transfer.

If the suppl( of materials contract is !orth& let us sa( Rs. 2:: #rs. and if substantial

part of this suppl( of materials is accumulated in one location& a major natural

catastrophic e*ent like the earth;uake or flood can damage the materials in a great

!a(.

o e*en if the construction compan( has managed to transfer the risk to the material

suppl( contractor& the extent of loss is so huge that the contractor ma( become

financiall( bankrupt !ith this loss. If& either the original construction compan( or thesubcontractor ha*e a*ailed insurance for the storage of the materials& then the risk

associated !ith a catastrophe like earth;uake or flood !ould ha*e been insured

under the polic( of insurance. The insurer then& steps in to compensate the construction

compan( or the subcontractor !hich !ill help him to arrange for re9suppl( of the

Risk Management inGeneral Insurance



Tmaterials . 0ence the uncertaint( about the sur*i*al of the#onstruction #ompan( or subcontractor after such a huge loss istotall( transferred to the insurer for an appropriate premium.

Insurance meets the financial conse;uences of certain risks pro*ides aform of peace of mid. Insurance of asset is important as far as the businessman is concern but also to industr( and commerce. If the people do not in*est in the business then it !ould be fe!er jobs& lessgoods& the need for higher imports and greater reduction in the!ealth. -u(ing insurance allo!s the entrepreneur to transfer the risksof business to an insurer.

Insurance also acts to stimulate the acti*ities of the business !hichalread( in existence. Release of funds for in*estment !hich !ouldother!ise to be held in reser*e to meet future losses such as fires&thefts& serious injuries and so on. 0ence firms are free to continue its business and !ith this peace of mine it can de*elop its businessacti*ities.

3*cti+ity / ,

It is reall( possible to just in*est mone( in the premium and transfer the risk

of loss tosomebod( else

s

-. In+etment@ Another major contribution from Insurance #ompanies

to the national !ealth is in the form of in*estments. As !e ha*e seenthe mechanics of insurance is such that premiums are collected andclaims are paid out of such collections.

0o!e*er& though premiums are collected throughout a financial (ear&claims need not necessaril( happen on e*er(da( of the financial (ear.Also the extent of claims need not be so bad that the( !ill !ipe out!hate*er collections are a*ailable !ith the insurance compan(.8n account of both the reasons& the insurers al!a(s ha*e a surplusin financial terms !hich can be gainfull( utili1ed b( them.




companies !ere re;uired to in*est almost H:X of their in*entible surplus& in areas

like housing finance& Infrastructure projects& social !elfare schemes etc. Through this

kind of a contribution Insurers in India ha*e helped not onl( the go*ernment but also

the pri*ate sector b( pro*iding funds for their projects as !ell as !orking capital etc.

E%T *cti+ity FG

Gi*e reasons !h( =The insurers al!a(s ha*e a surplus in financial terms !hich can be

gainfull( utili1ed b( them in in*estment.=

5. 0ta$ility@ Insurers also help in pro*iding stabilit( of pricing in products and ser*ices.

If firms pro*iding products and ser*ices are uninsured and if the( suffer losses to their

premises or in*entor( due to either manmade perils or perils of nature& the( !ill

naturall( tr( to reco*er the lost *alues in their pricing.

Take for example the crude oil imports& this is alread( a *er( *olatile commodit(

!here pricing is affected b( political& regional and similar such reasons. Added to

this& if losses to the oil !ells or offshore platforms !hich suppl( crude& take place&

then these firms !ill ha*e naturall( to offset such losses b( increasing the price of

crude. If there is no insurance against these kinds of losses then the crude price !ill

suffer high *olatilit(. This !ill in turn ha*e a cascading effect on man( other segments

of the econom( !hich depend upon petroleum products.

Therefore& !hen insurers pro*ide indemnit( for such losses at places of production&

then the oil firms can balance their prices appropriatel(. Moreo*er& it ma( not be

al!a(s possible for all firms to bring about price increases because of competition.

mall and medium business ma( lose out if the( increase prices due to uninsured

losses and the( ma( e*entuall( e*en go out of business unable to compete !ith the

other suppliers. It !ill be interesting to note that insurance also comes hand( in ser*ices

!hich are critical to human !elfare. In countries like 4ntied tates of America !hich

are highl( litigious& the legal liabilities and costs out of medical negligence are so highthat medical practitioner simpl( cannot render ser*ices if the( do not ha*e ade;uate

insurance against negligence.




3*cti+ity 2,

tate (our *ie!s for the follo!ing statement@

=Insurance pro*ides stabilit( to the business !hich results in stable prices and ser*ices.=

6. 7o Control, Insurers do ha*e interest in reducing the fre;uenc( and se*erit( of

losses& not onl( to increase their profit but also to contribute to general reduction in

the economic !aste !hich follo!s from losses. As such insurers pla(s a major role in

loss control o*er man( (ears.

6o! a da(s insurance industr( pools its resources and funds in continuing research

!ork into pre*ention and control of man( forms of loss& de*elops expertise in the

technolog( of different forms of loss control.

s

/ormation of oss 're*ention Association of India pla(s an important role in loss

pre*ention& loss reduction and loss control. The sur*e(ors and specialists ad*ise on

pre loss and post loss control.

3*cti+ity (,

0o! does loss control help to increase profit

>. 0ocial 4enefit @ /unds are a*ailable to stimulate the business acti*ities& the social

benefit is that the j obs ma( not be lost &the sources of income are maintained and the(

can continue to contribute to the national econom(. There is a depression to the

Dsociet( if the emplo(ees cease to !ork as people ha*e less mone( to spend and then

the conse;uences are different. The same result is there b( closure of the business. If

the losses are aggregated throughout the countr( the effect is considerable. Insurance

alone keeps people in jobs but pla( significant role in ensuring that there are not

unnecessar( hardships.




-( pro*iding different t(pes of social insurance like solatium funds& Third part(

insurance& 4ni*ersal 0ealth insurance& charging lo!er premium to farmers supports

the national econom(

3*cti+ity I,

<escribe the social benefits of the insurance sector.

@. In+ii$le earnin%,

Insurance allo! people and organi1ation to spread risk among them. In the same!a( countries spread risks. arge insurances are transacted !orld !ide i.e. propert(

and liabilit( insurance. <ue to reinsurance arrangement large amount of premium

flo! into India e*er( (ear. These are described as in*isible earnings.

As a national trading !e ha*e to import goods and export goods !hich other people

bu(. "here goods are tangible& a *isible export trade exits but in case of insurance&

goods are in*isible but it also brings mone( into India& and imports are sending mone(

out.

In addition to insurance& tourism is one form of in*isible earnings.

.@ 0U''*R8

In this unit !e ha*e explained the *arious t(pes of insurance a*ailable to co*er propert(&

casualt( or liabilit(. Major portfolio is of propert( insurance. To co*er special assets different

policies are designed. 'ackages policies are introduced to pro*ide different co*ers in a

single polic( and it becomes a *er( popular form of insurance.

"e ha*e discuss the *arious reasons to bu( insurance. The primar( function of insurance

is to act as a risk transfer mechanism !hen the chance of loss is lo! but the se*erit( is high.

"e ha*e also discussed the *arious benefits of the insurance. 'eace of mind& loss control

and social benefits help to stabilit( and increase the national econom( as a !hole.




.B /8 #ORD0

roperty Inurance

Caualty Inurance

@ Insurance of all t(pes of tangible propert(.

@ It deals !ith losses relating to people as !ell as interest like

li*e stock.

7ia$ility Inurance @ It pro*ides indemnit( in respect of *arious legal liabilities.

. 0/7F*00/00'/NT U/0TION0

i. "hat kind of subject matter is co*ered under the three categories of insurance classes

(ou ha*e studied

ii. If (ou are asked to address a #hamber of #ommerce meeting& on the -enefits ofInsurance& !hat !ould (ou tell the audience

iii. Are casualt( co*ers subject to the principle of Indemnit(

i*. "rite a note on insurance benefits. s




19.1 INTRODUCTION

Retention is an e;uall( important tool of Risk Management. As important as the other

tools a*ailable. 4ltimatel( as Risk Management is all about balancing of risk and resources.Retention sometimes could be the most cost effecti*e !a( of managing risk.

As seen in the last unit& risk a*oidance and risk reduction decisions are taken !ithout

taking into account their financial costs and benefits but before taking an( decision regarding

retention& financial aspect and benefits deri*ed from them is taken into account.

-usiness firms retain the risk !hen@

• oss costs are small and !ill be funded b( current cash flo!.

• oss exposures are retained and funded !ith a cash flo!.

• oss exposures re retained and recogni1ed in an unfunded reser*e account

• A self insurance plan is operates.Vs

"e !ill see in this unit the methods of financing risks internall(@

1. #harging losses to operating costs

2. etting up contingenc( +self Insurance, funds

3. 4se of capti*e insurance companies.

In general& !hen the se*erit( of losses is relati*el( lo! and the fre;uenc( of loss is also

lo!& retention is desirable.

19.: R/T/NTION *0 CON0CIOU0 D/CI0ION

Retention as a deliberate measure of Risk Management happens in the follo!ing !a(s.

/irstl( !hen the exposure or risk are of either *er( lo! probabilit( or of *er( lo! se*erit(

the effect of such losses on either the propert( or business continuit( are so lo! that it

could be easier for the firm to retain such losses on its books.

Minor breakdo!ns in machiner( !hich do not disrupt the production process are exampleof such losses. -usiness often assumes the risk of losing items of relati*el( small *alue such

as hand tools for a manufacture or utensils in case of restaurant.



4nit $: Retention

The factor( ma( ha*e spare machiner( so that if an( operating machiner( breaks do!n it

can easil( be remo*ed and substituted b( the spare. -ut such breakdo!n exposures can

easil( be carried b( the firm itself as e*en if a transfer is a*ailable in the firm of insurance

the procedure for transfer as !ell as making claims might be cumbersome. Thereb( making

it cost ineffecti*e.

Moreo*er there might be also effecti*e loss minimisation or loss control measures !hich

also can bring about the ultimate exposure to lo! fre;uencies or lo! se*erit( so that the

firm can retain such losses. To illustrate& in Marine Transit policies for finished goods there

ma( al!a(s be small shortages !hen the goods are deli*ered to final destination. -(

impro*ing the methods of packing as !ell as using reputed cargo carriers> the occurrence

of such loss can be minimi1ed. Also the procedure for preferring claims for such small

shortages is so tedious that it !ould make more sense to retain such losses on the books.

econdl(& Retention can be used !here the cost of transfer to insurance and similar toolsis more expensi*e than the effect of retention itself. In the pre*ious chapter !e sa! the

oss Matrix method through !hich an e*aluation bet!een the financial impact if certain

t(pes of exposures are retained and the cost of transfer !as done.

ometimes business has to retain the risk as there are gaps in their insurance program or

somebod( neglect to purchase needed co*erage.

3*cti+ity *,

=#harging of losses from current cost is one of the effecti*e risk management tools.= <o

(ou agree

19.- R/T/NTION *0 * CO'U70ION

There !ere also circumstances under !hich retention gets compulsoril( imposed in the

Risk Management 'rocess. The classic example is that of "ar Risks. "ar Risk of such a

catastrophic nature that the economic impact of !ar could be too huge for an( firm or aninsurance compan( to carr(. 0ence in a !ar or a !ar like situation& !ar co*er for properties

on land is seldom a*ailable. 0o!e*er since it can lead to an economic collapse if small or

medium firms are allo!ed to can(on !ithout an( protection& in most countries the

go*ernment becomes the Insurer of last resort.



4nit $: Retention

be the premium. <eductibles& it is to be learnt& can be pure monetar( deductibles or at

times can be expressed in the form of time units. Monetar( deductibles are normall( used

for 'ropert( <amage Indemnities. Time deductibles are used in the case of -usiness

Interruption co*ers& !hereb( the deductible turns out to be the !aiting period before

!hich the interruption can be counted for indemnit(. o if there is a time deductible of O:

da(s for e*er( loss in a -usiness Interruption co*er& then the insurer !ill calculate the

period to be compensated b( deducting O: da(s from the total interruption period.

3*cti+ity 4 G

ist out the usefulness of the deductibles as a form of retention.

"hile selecting the method of retention& it is necessar( that the cost of losses !ill be

spread e*enl( o*er the time in order to a*oid sudden financial crises due to effect of a

large loss occurring.

19.5 T(/ C(*R2IN2 OF 7O00/0 *2*IN0T O/R*TIN2 CO0T0

An organi1ation !ill need to absorb the additional expenses of loss against the operating

budget !ithin a short duration. Its abilit( to do so depends upon the a*ailabilit( of surplusof receipts o*er other pa(ments through out the (ear or more than sufficient li;uid funds

a*ailable either in the form of bank balance or o*erdraft facilit(& in*estment funds. Therefore

the si1e of the loss that could be absorbed along !ith the current expenses !ill depends

upon the si1e of surplus plus li;uid reser*es andP or short coming borro!ing.

A*ailabilit( of mone( !hen it is needed but a*oids the idle cash bank balance makes no

contribution in the earning is the success of financial arrangement. /or small& fairl(

predictable& regular losses the funds are a*ailable but in case of large fluctuations in normal

cash flo!& the management is reluctant to set aside additional li;uid funds for replacement

of damaged propert( .Actuall( all losses are not paid in full as soon as the( occur but can

be spread o*er a considerable period of time.

/or example man( large firms retain some or all of their health insurance or !orkersD

compensation costs because these losses are predictable accuratel(. ome firms ma( gi*e


a accounting reorgani1ation to the expenses of retained risks b(

maint

ainin

g an

unfun



4nit $: Retention

2. 'rofit from the funds belongs to the insured.

Although a business recei*es some ad*antages& some disad*antages are also there !hich

are as follo!s@

1. #atastrophies as !ell as number of losses during the (ear ma( bankrupt the

organi1ation.

2. Insurer pro*ides *aluable ser*ices in the form of ad*ice on loss pre*ention& sal*agingand claim settlement. These ser*ices should be purchased from outside if self insurance

is preferred.

3. A competent personal should be appointed from outside for administration of the self

insurance program. This cost should not be incurred if the risk is transferred

4. It is not ad*isable to assume a risk before the financial arrangement is completed and

the funds are a*ailable for the pa(ment of loss.

5. #ontribution to!ards the funds is not ;ualified for tax benefit.

Risk retention& deliberatel( or unplanned& should not be confused !ith the concept of self

insurance. Although self insurance re;uires risk retention& it implies to combine a number

of its o!n similar exposures to loss sufficient to predict the losses accuratel(. /urther it

implies that ade;uate financial arrangements made in ad*ance to pro*ide funds to pa( for

losses. 4nless pa(ments to the self9insurance fund are calculated scientificall( and paid

regularl( a true self insurance s(stems does not exit.

elf insurance plans are distinguished from other insurance operations b( ha*ing the transfer

of risk and redistribution of the costs of losses takes place !ithin one business entit(.

Jg$ Activity D ,

ist out four points on =4nless pa(ments to the self9insurance fund are calculated scientificall(

and paid regularl( a true self insurance s(stems does not exit.=




19.> C*TI?/ IN0UR*NC/ CO'*NI/0

The next step of internal funding is the formation of capti*e insurance companies

!ith additional ad*antages and benefits.

Definition of capti+e,

#ommercial or industrial concerns establish an insurance compan( to insure or

reinsure risks emanating from its o!ner& subsidiar( and associated companies.

There are a number of reasons for the formation of capti*e companies !hich are as

follo!s@

1. Internal funding of risks

2. a*ing on insurance costs

3. Risk control

4. Assess to reinsurance market

5. /lexibilit( of operations

6. Global insurance arrangement F

7. 8ff shore tax ha*ens

#e will ee thee point $riefly ,

1. Internal fundin% of ri&'remium paid to capti*e are ;ualif( for tax benefits for its parent compan(&

fello! subsidiaries and associated companies as the same !a( as to pa(

insurance premium. Transfer to reser*es for unexpired risks and outstanding

claims are taken into account !hile calculating taxable profits !hich gi*es a

significant tax ad*antages o*er internal contingenc( funds.

:. 0a+in% on inurance cot

The are expenses are nil for marketing and sales if the business is ac;uired

from parent organi1ations& !hich other!ise includes in the premium of the

insurance companies. Earnings on in*estments belong to the capti*e. #laimsettlement is !ithout an( dela( and an( profit generated belongs to the capti*e

onl(.

-. Ri& control

<ue to retaining risks capti*es get automaticall( and directl( benefits from

an( impro*ement in its loss experiences due to sa*ing in the claim costs.

I-



4nit $: Retention

C. Assess to reinurance mar&et

-( building up substantial reser*es& the capti*es ha*e easil( assess to reinsurance

market and offer co*er for excess of loss !ith substantial deductible& calculate the premium on clientDs direct loss experience and flexible under!riting for unusual risks.

6. FleLi$ility of operation

#apti*e can offer conditions !hich suit their parent companies regarding timing for

pa(ment of premium& interpretation of polic( conditions and handling of claims as

the( are not bound b( tariff regulations. The( can also pro*ide co*er !hich is not

easil( a*ailable in the market for example product recall.

>. 2lo$al inurance arran%ement

Risk handling strategies is different in multi national companies and polic( adapted isdifficult in different countries and because of this local insurer is re;uired to insure

domestic risks. #apti*e controls the local insurers and reinsure the risks !rite !ith

the capti*e.

@. Offhore taL ha+en

Tax ha*en is that le*ies a significantl( lo!er rate of corporation tax than the countr(

of domicile of the parent compan(. 0ence although parent compan( !ill ha*e to pa(

its going rate of tax on profit remitted b( the capti*e& until the( are the( !ill be subject

to a lo!er rate of tax so capti*es funds built up rapidl(.

Ad*antages are discussed in the next unit.

egislation in India does not permit setting up of Insurance #apti*es.

3*cti+ity /,

<iscuss the benefits of formation of #apti*e Insurance #ompanies.




19.@ 0U''*R8

"e ha*e discussed the process of risk retention !hich pro*es one of the effecti*e tool of

risk management. Retention ma( be deliberate decision or it ma( be compulsor( in theform of deductibles. Retention is basicall( applicable !hen loss probabilit( is lo! and loss

se*erit( is also lo!.

"e ha*e also discussed !a( s of risk financing b( $. #harging losses to operating costs

5. etting up contingenc( +self Insurance, funds O. 4se of capti*e insurance companies.

Each method has its o!n peculiarit(.

#harging losses to operating costs depends upon the surplus and li;uidit( a*ailable !ith

the organi1ation. etting up contingenc( +self Insurance, funds is a decision of the organi1ation

to retain losses internall( !hich are too large and unpredictable. "hile capti*e insurance

companies are formed for additional benefits and ad*antages.

19.B /8#ORD0

Retention is a risk treatment method. s

/irstl( !hen the exposure or risk are of either *er( lo! probabilit( or of *er( lo! se*erit(

the effect of such losses on either the propert( or business continuit( are so lo! that it

could be easier for the firm to retain such losses on its books.

Retention can also be used !here the cost of transfer to insurance and similar tools is moreexpensi*e than the effect of retention itself.

<eductibles +other!ise called excess or franchie<.

"hat these mean is that for each and e*er( loss for !hich a claim is made on the insurer&

the insurer expects the insured or the claimant to retain a certain extent of loss and pa(s

onl( the balance.

19. 0/7F*00/00'/NT U/0TION0

i. 4nder !hich circumstances does it make sense to retain risks

ii. 4se the oss Matrix in the annexure of #hapter I and explain !hich is better9

retention or bu(ing insurance.



$HC Risk Management in General Insurance

11.1 INTR/DUCTION

"e ha*e discuss ho! the risk management makes an effecti*e contribution to

achie*ement of corporate objecti*e and helps to take a proper decisionregarding risk transfer and ultimatel( arri*e at the decision that I64RA6#E is

the best solution for transfer of risk. "hile insurance has been the most popular

and oldest form of risk transfer.

-ut it is obser*ed that the incidences of catastrophes insurances !hich cannot be

co*ered b( the traditional technolog( of insurance and reinsurance. The ser*ice

sectors like banking and insurance ha*e been prepared for the !orld !ide

fundamental economic changes !ith ne! mechanism or technolog( called

*RT ;*lternate Ri& Tranfer<.

11.: 4*C2ROUND OF *RT

The happenings in the rest of the financial ser*ices industr( as !ell as more acute

a!areness of ha*ing holistic Risk Management programmes has led to

disco*er( and use of other forms of risk transfer. *RT ;*lternate Ri& Tranfer<

has become the topic of discussion in the -oard Rooms across the !orld.s

Juite often& in the last fi*e decades& there ha*e been occurrences of such

catastrophic nature that insurance had failed to ser*e as a *er( reliable method of

Risk Transfer. 0urricane Andre!& the #(clone& !hich de*astated /lorida& 4 A in

$%%5& caused economic losses of 4Y O: -illion and insured losses of 4Y $H

-illion. imilarl(& the Earth;uake in #alifornia in $%%C caused economic losses of

4Y CC -illion and insured losses of 4Y $2.O -illion. -ack home.

The earth;uake in Gujarat in Qanuar( 5::$ reported almost 5:&::: deaths. The

economic loss !as put at 4Y C.2 -illion !ith insured losses in the range of 4Y $::

Million +compare the ratio of insured losses as against economic losses in these

t!o parts of the !orld 9 4 and India. This gi*es the le*el of insurance

penetration in both the parts,.

These losses are losses& !hich !ould other!ise be called as Acts of God. There

ha*e also been manmade disasters like that of eptember $$th and the rebels

on the #olombo airport destro(ing almost $C aircrafts. As (ou !ould be stud(ingor ha*ing studied alread(& insurance ultimatel( also has to be on commercial

lines and therefore has to produce in*estment returns for the stakeholders. "ith

this kind of enormit( of losses& insurers !orld o*er are struggling to find mone(s

to pa( these losses.

If the losses exceed the capital and reser*es of insurers& then man( of the insurers

!ill go bankrupt. E*en if the remaining insurers charge heft( premiums& still the

capacit( for bearing



& e*en it it i& pooled from all o*er the !orld& !ill be still !ell belo! the mone( re(uired

for& one single catastrophe. ike in e*er( other business& there are al!a(s demand9suppl( e;uations and also business c(cles resulting in alternating c(cles of lo! returns and

high returns on in*estments.

E%T *cti+ity *Gist out the points on =6eed for Alternati*e Risk Transfer.=

11.- F*I7UR/ OF IN0UR*NC/ *0 * 0O7/ RI0 TR*N0F/R

'/C(*NI0'

In the preceding paragraph& !e had mentioned that Alternati*e Risk Transfer methods are

being disco*ered and used. "hat are the reason for !hich insurance had failed to li*e up

1. The kind of losses& !hich are being faced b( insurers& either out of natural catastrophes

or out of manmade disasters is so great in magnitude.

2. The fre;uenc( and se*erit( of these catastrophic losses are alarming but particularl(

!hether losses are occurring !ith increased recurrence.

3. Insurers !orld o*er ha*e limited capital. This capital is deplo(ed in the hope that

after pa(ing for all the losses& insurers !ill be left !ith some surplus to take care of their management expenses and desired profit le*els .If this does not happen then

there is no proper return on capital emplo(ed and therefore insurance as a a*enue for

in*estment !ill lose its attraction.

4. Insurers are !itnessing for the first time& occurrences like 6ine Ele*en& the probabilit(

and the magnitude& of !hich !ere simpl( unimaginable.

5. Insurers ha*e al!a(s been balancing their technical losses !ith income from their

in*estments the( make in stock markets& bond markets and other areas of in*estments.

8*er the (ears !ith declining interest rate and poor economic conditions the !orld

o*er& the Return on In*estments in these areas has also been coming do!n. Therefore&there is no more balancing possible.



)is* anagement in +eneral Insurance

/or all these reasons there has been diminishing of capacit( for insurers to carr( risks.

Therefore& the facult( of risk management had to resort to solutions from other than insurance.

3*cti+ity 4 ,

#omment on =Insurance industr( cannot cope up !ith the situation created b( natural

calamities.=

11.5 *RT

The abbre*iation *RT tand for =*lternati+e Ri& Tranfer.= 'articularl( for large

corporations& !hich are the order of the da( toda(& risk management does not simpl(

mean bu(ing traditional insurance. "ith man( DuninsurableD risks emerging as also because

of the limitations imposed b( insurers& Risk managers had to find alternate sources of

financial protection.

The incidence of unlimited catastrophe insurance loss has made the under!riters look for

ART technolog( to create more capital and more financial strength. o the insurer& bankers

and in*estors ha*e come together !ith their roles in the risk transfer technolog( for their

mutual benefits.

The earth;uake& hurricane& flood and other natural catastrophic perils and their e*er

increasing exposures ha*e brought some re*olution and break traditional reinsurance practice

for the purpose of increasing the financial capacit( to co*er these uncontrolled& unlimited&

unexpected catastrophic exposures !hich is be(ond the capacit( of Insurance& Reinsurance&

and 6et!ork capacit(. This inade;uac( ART came into existence.

The term ART !as mainl( used to describe *arious forms of self9 insurance& pools and

/inite Risk co*ers. ART as it stands toda( includes not onl( capti*e insurance companies

but also extends to the areas gi*en belo!@

• Industr( and exposure specific mutuals.

• arge direct corporate retentions.



4nit $ $ Emerging Trends in Risk Management

• 'rograms from insurers that in*ol*e commitment of capacit( often across lines of

co*erage and across se*eral (ears.

• En*ironmental liabilit( and credit risks.

• 0olistic financials of risk.

• -asket aggregate.

• Risk retention groups.

• Insurance deri*ati*es.

• -lended programs.

• oss portfolio transfers.

• Across class& aggregate programs.

• ART products are long term contracts as against annual contracts in insurance and

reinsurance arrangement.

• ART co*ers entire portfolio of risk !ith adjustments and returns to the In*estors.

The *ariet( is ama1ing but for the limited purpose of discussion& !e shall be looking at onl(

fe! specific ART solutions @

# @

"rite do!n fe! points on scope of ART taking into account the current natural calamities&man made loses such as floods in Mumbai and Gujarat& bomb blasts in Maharashtra& etc.

in India.

$$.2 #A'TILE I64RA6#E #8M'A6IE

arge corporations particularl( spreading o*er man( countries and continents& ha*e a

substantial need for a *er( effecti*e risk management. -( adopting an external suppl( of

risk transfer these corporations are still subject to the *agaries of insurance markets. /or

reasons mentioned in the pre*ious paragraphs& insurers can not pro*ide all risk solutions.



insurers suffer from lack of funds. 8ther in*estors in capital markets sometimes findlack of proper a*enues for in*estment. There are major catastrophes either natural or man9made recurring in a period of time. 'ut all these three together and (ou !ill find that there is scope for !hat are called as ecuritisation of Insurance Risks.

Transfer of risks in insurance market to in*estors in the capital market is donethrough ecuritisation to cope up !ith the incidence of huge catastrophiclosses and a*oid their conse;uent insol*enc(& In simple terms& ecuritisation& pro*ides access to the Insurance business for capital market in*estors !ithoutactuall( running an insurance compan(.

These in*estors are not insurance exports or under!riters. The( simpl( in*est for Insurance #ompan( through capital market. In*estors in ART products are#orporate /inancial Institutes& Mutual /unds and -anks.

Insurance ecuritisation in*ol*es the process of transfer of propert( andcasualt( risks from insurer to the in*estors !ith the issuance of a securit(& theultimate returns depends upon the occurrences of catastrophic e*ents andreference of performance index.

"e !ill no! look at a recent example for understanding this better. <isne(landTok(o& a subsidiar( of <isne( group of 4A& !hen the( !ere to setup theTheme 'ark in Tok(o& the( faced a major concern on the earth;uake proneness of the location. "hile con*entional insurance co*ers could ha*e still been a*ailable&the cost and the limitation pro*ed a problem for <isne(land.

Therefore& the( issued !hat are called as #atastrophe -onds for Earth;uake for the *alue of the 4Y $:: million. These -onds carr( a coupon rate or !hat isan e;ui*alent of interest paid on bonds. The purchases are in*estors from the#apital Markets. The bonds operate in such a !a( that if an( earth;uakehappens in area !here the Theme 'ark is located& then all losses due toearth;uake !ould be paid for b( the bond holders. These bonds ha*e limitedtenure and therefore if no earth;uake losses happen on during the tenure of the bond then the bondholders earn all their coupon rates and incur no losses!hatsoe*er.

An added ad*antage to the in*estors is that these bonds are li;uid in that

the( can be traded. #atastrophic bonds ha*e reall( caught up the fanc( of in*estors as !ell as insurers that the ha*e been hundreds of such bonds issuedas of no!.

$H%




"%QR*cti+ity /,

"rite (our opinion on =ART brings the con*ergence of insurance markets !ith capital

markets b( !a( of securitisation.=

11.@ FINIT/ RI0 RODUCT0

Another major de*elopment in the de*elopment of ART products is /inite Risk products.

#urrentl(& most of them are used more for the benefit of insurers rather than the insured.These are multiline products in the sense that the( cut across se*eral classes of insurances

like 'ropert(& #asualt( and iabilit(. These are also multi (ear products as contrasted !ith

annual contracts.

/inite Risk 'roducts deri*e their terminolog( from the fact that the ultimate liabilit( of the

pro*ider of this facilit( is limited at a particular financial le*el. It is more of a participati*e

program !herein the pro*ider as !ell as the customer& share their experience of the loss

histor( o*er a period of time. If the loses are minimal or controllable and an( surplus

emerges then it is shared bet!een the pro*ider and customer in the form of profit

commissions.

/or example& if the loss limit agreed !as Rs. $:: crores o*er a 2 (ear period& but losses

didnDt exceed let us sa(& Rs. 3: crores in this period& then the pro*ider of this product and

the user& share this surplus in the form of certain amount of premium paid b( the user to the

pro*ider being returned as profit commission. In the same manner& the re*erse also holds

good. If the losses exceed a certain pre9agreed le*el then additional premiums ha*e to be

paid b( the customer to the pro*ider.

!iss9Re& one of the major pla(ers in the field of financial reinsurance& obser*es that the

main functions performed b( finite risk products are@

A. moothening of fluctuations of the customersD loss experience o*er a gi*en period.

-. 8ptimi1ation of balance sheet structure although finite risk products !ere largel(

used b( insurance companies of late e*en companies in non9insurance sectors ha*e

found them useful.



4nit $$ Emerging Trends in Risk Management

3*cti+ity F,

Explain ho! the /inite Risk 'roducts are more beneficial to the insurer than the insured.

11.B D/RI?*TI?/ RODUCT0

6ormall( deri*ati*e products are& as the name implies& deri*ed from certain core financialser*ice products. 'articularl( !hen the core product in ;uestion is of *olatile nature& then

deri*ati*es help the user of such products to smoothen out the effects of such !ild fluctuations.

To dra! an example from the capital market& the exchange rate bet!een *arious currenciesis again a highl( speculati*e risk area. arge *olume users of foreign exchange ha*e to protect themsel*es against *olatilities of exchange rates& then the( resort to the deri*ati*e products. The deri*ati*e is linked to these dollar *alue and if the dollar9rupee exchangerate fluctuates abo*e a certain pre set limit& then the pro*ider of <eri*ati*e ser*icescompensates the user for such o*er shooting.

"hich means that the risk of huge increase in exchange rate is transferred to the ser*ice pro*ider for sa( a fee or premium@ Generall(& traders in large *olume of exchange related

businesses hedge their risks in exchange rates !ith such deri*ati*es imilarl(& for a portfolioof insured risks or e*en for a single risk& an( customer& e*en insurers can protect themsel*esagainst fluctuations in the performance of the risk. 8ne such possibilit( is& that linking the performance of a risk& to the index of the performance of similar risks.

To understand it better& let us look at the portfolio of risks comprising 8il refineries !hichrefine crude oil for producing finished petroleum products like petrol& diesel& etc. Either the refiner( o!ners or insurers of certain refineries can protect themsel*es through aderi*ati*e product linked to the loss histor( of the pool of let us sa( about $:: refineries.If the loss percentage of a particular refiner( exceeds the general performance of the poolof refineries then such excess exposure !ill be compensated b( the pro*iders of the

deri*ati*e product. 8b*iousl(& similar to the premium paid b( a customer to the insurancecompan(& the same !a(& a fee has to be paid for the deri*ati*e products. -( doing this thecustomer or the insurance companies ensure that their losses are not ad*erse.



$5 Risk Management in General Insurance

FActi*i t( />

0o! the deri*ati*e products helps insurance companies so that loss ratio should

not be ad*erse.

11. D/?/7O'/NT OF *RT IN INDI*

Art products ha*e not found significant place in Indian Insurance Industries.

Recentl( IR<A is set to allo! insurers to in*est in interest deri*ati*es tohedge risks in order to ensure that their future liabilities do not exceed their

assets.

Re insurance protection for catastrophic losses arising from single e*ent is not so

large so at present Indian General Insurer does not find much difficult( for re

insurance protection. -ut in future due to increasing operations of -

A6#A4RA6#E b( General Insurance companies& introduction of credit

insurance b( state o!ned companies like 6e! India Assurance and prospect

of Agriculture Insurance ha*e the potential of Rs. 2:::: crores in India& so there

!ill be need of ART products in Insurance Industr( in near future.

As per recent IR<A regulations on sol*enc( margins for insurers& reinsurers&rising

market expectations for more efficient risk financing programs and re*olutionar(

de*elopment of Indian #apital Market to the !orld class standard are all

including factors for insurers& reinsures and bankers to make proper use of essential ART products of transfer of insurance risks from insurance market to

capital markets for !ider capital base !ith minimum cost

FAct i*i t( G@

Express (our *ie!s on =4se of ART products is essential as India is going to

be the economic po!er house in the !orld !ith gro!th in all sectors including

insurance sector.=



4nit $$ Emerging Trends in Risk Management

11.19 0U''*R8

<r. Alan 'unter !ho speciali1es in Alternati*e Risk Transfer products summari1es the

emerging trends as follo!s@

• ARTs extend the range of risk co*ered be(ond the traditional propert(9 casualt(

ha1ards to include other non9core risks to the compan(Ds business. These include

ho! to insure risks such as en*ironmental exposures and financial risks such as foreign

exchange rates& interest rates& stock market prices and commodit( prices.

• Extend the period of co*er be(ond the normal one9(ear insurance to multi (ear

contracts to pro*ide greater stabilit(.

• 'ro*ide holistic or enterprise !ide co*ers from a clientDs perspecti*e.

• 'ro*ide risk9financing instruments that respond !ith greater speed& clarit( and securit(.

These represent the demand side of the ART process.

8n the suppl( side <r. 'unter feels that there are certain factors that !ill continue to dri*e

the de*elopment of ART@

• #onsultants and intermediaries& some outside the traditional insurance industr( such

as Management Accountants and In*estment -ankers are seeking to expand their

in*ol*ement in all aspects of #orporate Risk Management and financing.

• In*estors are al!a(s interested in ne! opportunities particularl( in a lo! or a non9correlated asset class like insurance.

• Alternati*e solutions and capital !ill ad*ance so that !hene*er there is a contraction

in the suppl( of traditional reinsurance capacit( due to either c(clical or catastrophic

losses.

This in effect sums up the de*eloping trends in ART industr(. As traditional insurers& one

can expect the di*iding line bet!een insurance and non9insurance financial ser*ices to get

thinner and thinner.




11.11 /8#ORD0

*lternati+e Ri& Tranfer ;*RT<

Capti+e Inurance companie

0ecuritiation

Finite Ri& roduct

Are non insurance methods !hich offer risk transfer solutions.

These are special purpose insurance outfits

created to cater to the needs of the parent are

group companies.

In simple terms& securitisation pro*ides access

to the Insurance business for capital market

in*estors !ithout actuall( running an insurance

compan(.

These are multiline products in the sense that the(cut across se*eral classes of insurances like

'ropert(& #asualt( and iabilit(. These are also

multi (ear products as contrasted !ith annual

contracts. /inite Risk 'roducts deri*e their

terminolog( from the fact that the ultimate liabilit(

of the pro*ider of this facilit( is limited at a

ti l fi i l l l

risk management g insurance

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