THE CONCEPT OF RISK AND RISK MANAGEMENT
DEFINITION OF RISK
One of the major characteristics of our environment is the presence of risk and uncertainty. Risk can be defined as the exposure to losses or injuries. Risk is caused by the occurrence of an unfavourable or undesirable event. Risk is not only the centre of insurance but also inseparable from our daily life. Every living being faces occurrence of risk in one form or the other.
Risk is often referred to in a somewhat pessimistic sense in that insurers have in mind the possibilities of loss or misfortune. Everybody is exposed to risk but some are exposed to greater risk than others giving the fact that loss may occur in several forms or ways:-
(i) Loss of life (ii) Property (iii) Health
(iv) Theft (v) Accident
CLASSIFICATION OF RISKS
Risks can be classified in line with the type of consequence
of the problems involved:
PURE RISK: This is the type of risk that involves only a chance of loss. The uncertainty is usually whether the destruction will happen at all, and in the case of death, the uncertainty is “when, where, how!PURE RISK are the misfortunes which cause damage or hurt. If the possibility of a harm is the only outcome of the occurrence of a specific event, then it is a pure risk. Pure risks are known, for losses once they occur. It is against these types of risks that insurance offers protection (e.g. fire, theft of goods, disability, death etc)
SPECULATIVE RISK: This is a situation which there is a chance of loss or a possibility of gain or break even. If a beneficial or adverse outcome could stem from a specific event, then there is a speculative risk. Speculative risks are not insurable, and provision against the possibilities of loss with this type of risk is usually made by commercial transactions such as diversifying business activities. Examples are Gambling, new invention, stock exchange transactions, and investments in future price of landed property, import and export trade etc.
FUNDAMENTAL RISK: A further method of risk is by looking at their effects. A fundamental risk is one that affects society as a whole. They are impersonal both in origin and consequence. This type of risk affects either the society in general or a section of the society or group of people rather than individuals. They are beyond the control of individual or man e.g. earth quake, typhoons, wild – wind, cultural change, political instability, windstorm, etc.
PECULIAR RISKS: They are risks which take place due to the decisions and actions of man. The causes or effects are personal. They have their origin and consequence from the individual decisions and actions. Peculiar or particular risks are insurable e.g. decision to build house, own car, go to university are personal but with their peculiar risks.
Risk management can be defined as the planning, arranging and controlling of activities and resources in order to minimize the impact of uncertain events. Risk management can also be defined as the protection of assets, earnings, liabilities and people of an enterprises with maximum efficiency at a minimum cost-Risk management as a discipline, is an up shoot of
insurance studies. The concept of risk management involve three (3) stages
a. Risk identification
b. Risk evaluation (assessment)
c. Risk control (management)
A. RISK IDENTIFICATION: Individual and firms are exposed to the problems of risk, in a variety of ways due to nature of its operation, locations and property owned etc. risk identification involves the identification of the risks to which the enterprise liable.
Risk identification is primarily concerned with vigorous search for the possible causes (events, situations or activities) that are responsible for losses to a firm. Some risks are obvious e.g. the loss of property through fire, theft and loss in. transit, and liability for injury to employee which the enterprise liable while other risks are less obvious.
The first step is to identify areas that are liable to risk and the associated events that can give rise to loss.
The 2nd step is identify possible cause of losses The third step is to identify the resulting damage to property, personal injury.
B. RISK EVALUATIONS This requires that risks shall be measured and assessed according to likelihood and value. This is second stage in risk management process. Risk evaluation involves the compilation of accurate records of past events to aid decision making. In the course of evaluation, the following factors need considered:
The no of possible losses each year
The possible size of each loss
The value of assets at risk (Maximum possible loss)
C. RISK CONTROL: This is the final stage in the process of risk management. Once the loss making situations have been identified and assessed, the next step is how to handle the risk, that is, control them to avoid adverse effects on the firm.
Risk control requires the exercise of judgment. Among the possibilities are:-
Risk Avoidance: A risk may be avoided by a change in location, procedure materials, process or equipment, or by giving up the activity that gives rise to risk.
Risk Reduction: Risks can be reduced in a variety of ways (elimination of hazards),
By physical security devices e.g. alarms looks , safety etc.
By procedural device such as inspections, security patrol, checks on employee etc
By education and training in safe method of working and in procedure for dealing with emergencies. By providing for risk reduction when designing production processes.
iii. Risk retention: this is aspect of financial risk control. This is building up a contingency fund to finance the loss. A concerned business man may assume the risk himself and make appropriate financial reserves for this purpose.
iv. Risk Transfer: this is the legal assignment of potential loss to another party. This is the second method of financial risk control. It is a situation where a company shifts the responsibility of meeting its own losses, to some other person or company, The losses can be transferred to an insurance company, the most potent risk transfer mechanism. However, concerted effort should be made towards the avoidance of most of the risks. Insurance is all about risk and every organization, individual faces one form of risk or another with various level of degree effects. Furthermore, practicing good management to prevent risks. An effective way to meet certain kind of business risk is to practice good managerial techniques e.g. be alert to price changes, maintain a good research department etc.