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Chapter 3

Chapter 3 BU353.docx

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Heather Graham

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BU353 Chapter 3 – Risk Management Process Week 1 Risk Management Overview Risk Management Frameworks -The core risk management process involves identification, analysis, evaluation, and treatment of risk -The most common risk management frameworks are: -Australia Standards (AS) -Casualty Actuarial Society (CAS) -Committee of the Sponsoring Organizations of the Treadway Commission (COSO) -International Organization for Standardization (ISO) ISO 31000 -Designed to help all organizations better manage risk -Defines risk as the effect of uncertainty on objectives -Recognizes that all activities of an organization involve risk – both positive and negative -Risk is often characterized by reference to potential events and consequences and is often quantified in terms of those consequences and the associated likelihood of occurrence -It outlines risk management frameworks, processes and activities that will help organizations to achieve their objectives -The process involves the following activities: 1. Communication and consultation 2. Establishing the context 3. Risk assessment 4. Risk treatment 5. Monitoring and review Communication and Consultation -Effective communication and consultation will help to ensure that both those responsible for implementing the risk management process and other stakeholders understand the basis on which decisions are being made -A plan needs to be implemented which will ensure that risk information is reported to the right people, at the right time, in the right manner -Critical for achieving effective risk management Establishing the Context -External factors that could impact risk include regulation, economic forces, climate and natural disasters -Internal factors include corporate culture, expertise, resources and financial strength -Attention to a wide range of relevant factors should help ensure that the risk management approach adopted is appropriate to the circumstances of the organization and to the risks affecting the achievement of its objectives -The process always requires as its first step defining the goals and objectives for the risk management activities -The measurement of risk is expressed as risk criteria -A commonly used risk measure for financial risk is value at risk (VAR) -VAR is a measure of the risk of loss on a specific portfolio of financial assets -For a given portfolio, VaR is defined as a threshold value such that the probability that the loss on the portfolio over the given time horizon exceeds this value is the given probability level -Another important aspect to define is the organization’s risk appetite by answering the key question: What type and amount of risk is the organization willing to accept in pursuit of its objectives? Risk Assessment -Includes: BU353 Chapter 3 – Risk Management Process Week 1 1. Risk identification 2. Risk analysis 3. Risk evaluation Risk Identification: Organizational Exposures -The identification of risk sources, events, their causes and their potential consequences or impacts -Risk identification requires an overall understanding of the business and the specific economic, legal, and regulatory factors that affect the business Hazard Risk Property Loss Exposures -In addition to identifying what property is exposed to loss and the potential causes of loss, the firm must consider how property should be valued for the purpose of making risk management decisions -Book value – the purchase price minus accounting depreciation -Market value – the value that the next-highest-valued user would pay for the property -Firm-specific value – the value of the property to the current owner -Replacement cost new – the cost of replacing the damaged property with new property -Extra expense exposure is the resulting exposure to higher costs Liability Loss Exposures -Firms face potential legal liability losses as a result of relationships with many parties, including suppliers, customers, employees, shareholders, and members of the public Losses to Human Resources -Losses in firm value due to worker injuries, disabilities, death, retirements, and turnover can be grouped into two categories: -Compensate employees -Indirect losses – employees cannot be replaced with zero cost -In some cases, firms purchase life insurance to compensate for the death or disability of important employees Financial, Operational and Strategic Risks -The most significant risk exposures in a company are financial, operational or strategic - these risks cannot be insured -Financial risks can be hedged -Operational risks can be managed through contractual transfers -Strategic risks are managed through strategic market analysis and planning Risk Identification: Individual Exposures -Potential events that cause decreases in the availability of fund or increases in uses of funds represent risk exposures -Financial planners can help identify and manage personal risks -One of the most important sources of risk for most individuals is from medical expenses -Individuals can be sued and help liable for damages inflicted on others – from driving a car -The risk associated with preretirement savings and thus the risk of not having sufficient assets during retirement to fund expenses depends on how the assets are invested Risk Analysis -After identifying risk exposures, the next step is to analyze the likelihood and consequence of different outcom
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