CU-BBA-SEM-IV-Risk management-Second draft

Figure 6.1: Risk Transfer Risk Transfer Example A buys car insurance for $5,000, which is valid only for the physical damage of the same, and this insurance is right up to 31st December 2019. A had a car accident on 20th November 2019. His car suffers from severe physical damage, and the cost of repair of the same accounts to $5,050. A can claim a maximum of $5,000 from his insurance provider, and the rest cost will be solely borne by him. Types of Risk Transfer  Insurance In an insurance mechanism, an individual or a company can purchase an insurance policy from the preferred insurance company and accordingly safeguard itself from the implications of financial risks underlying in the future. The policyholder will need to make timely payments or premiums to ensure that the undertaken insurance policy remains valid and does not fail on account of failure to make timely payments.  Derivatives 101 CU IDOL SELF LEARNING MATERIAL (SLM)

It can be defined as a financial product which attains its value from a financial asset or an interest rate. Derivatives are mostly bought by firms to protect against financial risks like the currency exchange rate, etc.  Contracts with an Indemnification Clause Contracts with indemnification clauses are also used by an individual or an organization for risk transfers. Contracts with such a clause ensure the transfer of financial risks from the indemnitee to the Indemnitor. In such an arrangement, the future economic losses shall be borne by the Inseminator.  Outsourcing Outsourcing is a type of risk transfer where a process or a project is outsourced for transferring various kinds of risks from one party to another. Importance This can be defined as a strategy for ensuring that a financial asset is safeguarded against future contingencies. It helps in the allocation of risk equitably, i.e., it places the responsibilities for financial risks on the third party (insurance company in the case of an insurance and indemnitor in the case of a contract) who has taken the in-charge to safeguard the policyholder or indemnitee against future contingencies. This means that in the occurrence of an unfortunate event, the policyholder or indemnitee can be assured that the losses arising from the consequences of such an event will be duly taken care of by the insurance company or the Indemnitor. Different Ways to Transfer Risk  Certificate of Insurance A certificate of insurance is used to minimize the financial liability of an individual or an organization. A certificate of insurance is made between the policyholder and an insurance company or insurance provider. This certificate must reflect the necessary information like the date of issue of the certificate, name of the insurance provider, policy name, policy numbers, date of commencement as well as the expiry of the insurance policy, name, address, and such other details of the insurance agent, amount of eligible coverage for each type of financial risk, etc.  Hold-Harmless Clause It is also known as a save-harmless clause. These are contracts with indemnity clauses that take place between an Indemnitor and an indemnitee. This agreement must reflect the critical 102 CU IDOL SELF LEARNING MATERIAL (SLM)

information such as the responsibility of the Indemnitor against any loss, damage, or future contingencies towards the indemnitee, etc. 6.4 ADVANTAGE AND DISADVANTAGE Advantages Safeguard Against Future Contingencies – It shields an individual or an organization against unforeseen financial risks that could be in the form of damage, theft, losses, etc. A policyholder or an indemnitee can always be assured that the contingencies lying ahead in the future will be borne by the insurance provider or the Indemnitor because of the transfer of risk through an insurance policy or hold-harmless agreement. Disadvantages  Expensive – One of the most common drawbacks could be the level of expenses that an individual or an organization is supposed to bear for purchasing and maintaining insurance, derivatives, or an indemnity clause.  Time-Consuming – Time-consuming is another drawback. Purchasing an insurance policy might take a lot of time, and so does the claiming of the insurance. This could be tiresome and one of the discouraging factors of availing risk transfer. 6.5 METHODS OF RISK TRANSFER Risk transfer is a risk management and control strategy that involves the contractual shifting of a pure risk from one party to another. One example is the purchase of an insurance policy, by which a specified risk of loss is passed from the policyholder to the insurer. Other examples include hold-harmless clauses, contractual requirements to provide insurance coverage for another party’s benefit and reinsurance. When done effectively, risk transfer allocates risk equitably, placing responsibility for risk on designated parties consistent with their ability to control and insure against that risk. Liability should ideally rest with whichever party has the most control over the sources of potential liability. Consider the following prior to making an agreement:  Because your business may be part of several contractual relationships at one time, it is important to control the type and magnitude of the liabilities you assume.  Where legally possible, identify opportunities to manage risk by having others contractually assume their share of liability.  The effective management of liabilities can save you money by lowering your overall costs, thus helping to keep you competitive in the marketplace. 103 CU IDOL SELF LEARNING MATERIAL (SLM)

6.5.1 Insurance Policy Risk transfer is most often accomplished through an insurance policy. This is a voluntary arrangement between two parties, the insurance company, and the policyholder, where the insurance company assumes strictly defined financial risks from the policyholder. In very simple terms, if a worker is injured, the insurance company pays the cost. If a building burns down, the insurance company pays to replace it. Insurance companies charge a fee, or an insurance premium, for accepting this risk. In addition, there are deductibles, reserves, reinsurance, and other financial agreements that modify the financial risk the insurance company assumes. 6.5.2 Indemnification Clause in Contracts Risk transfer can also be accomplished through non-insurance agreements such as contracts. These contracts often include indemnification provisions. An indemnity clause is a contractual provision in which one party agrees to answer for any specified and unspecified liability or harm that the other party might incur. An indemnity clause also can be termed a hold-harmless or save-harmless clause. Indemnification agreements are completely independent of insurance coverages and transfer the financial consequences of legal liability from one party, the indemnitee, to another, the indemnitor. In addition to direct financial losses, some contracts may also transfer legal defense or product recall costs. 6.6 INDEMNIFICATION Indemnification is a legal agreement by one party to hold another party blameless – not liable – for potential losses or damages. It is similar to a liability waiver but is usually more specific, applicable only to particular items, circumstances, or situations, or in regard to a particular contract. Black’s Law Dictionary defines “indemnify” as an act establishing “a duty of party A” to “make good any loss, damage, or liability incurred by party B.” The basic concept of indemnity is that of “holding harmless” – by means of indemnification, party A agrees to hold party B blameless in the event of possible loss or damage. By indemnifying the second party, the first party, in effect, agrees to pay for or make good any loss or damages that may occur. In other words, by agreeing to make the indemnitee (the party that receives, or benefits from, the indemnity) NOT liable, the indemnitor (the party granting the indemnity) effectively agrees that he/she IS liable. How Indemnification Works Indemnities can be important in protecting you and/or your business from lawsuits or other possible financial liabilities. 104 CU IDOL SELF LEARNING MATERIAL (SLM)

Suppose, for example, that you hire a contractor or remodeling company to remodel your company’s office. Your contract with the remodeler should ordinarily include an indemnity clause that protects you against events such as shabby work on the part of the remodeler that later results in someone being injured when a wall of your office collapses on them. In such a case, you should be indemnified against having to pay the injured individual, as you had no control over the quality of the construction. Instead, the contractor or remodeler will have to pay any compensation awarded to the injured party. Why Indemnification is Important Table 6.2: Importance of indemnification  Indemnification can be important to both parties entering into a transaction or contractual agreement.  If you are granting the indemnity, the provision of reasonable protection against liability may be essential to you being able to do business with the other party. Referring to the example above, if you were the contractor in the situation, unless you are willing to provide indemnification against possible future liability, the company looking to get their office remodeled might not be willing to hire you to do the work. 105 CU IDOL SELF LEARNING MATERIAL (SLM)

 If you were on the other side of the transaction, that of the company contracting for the remodeling job, without the remodeler granting you indemnification, you may be putting your company at unreasonable financial risk.  It’s important to both parties involved that any indemnification agreement be clearly stated and only applicable to specific and reasonable circumstances or situations. Indemnification clauses that are too broad or general may lead to problems. For example, a company that rents machinery may want to be indemnified against being sued if someone is injured while operating the machinery.  However, it would be unreasonable to grant the company that rents out the machinery blanket indemnification against any legal action. Someone who rents the equipment should still retain the right to seek legal remedy against the rental company if, for example, the machinery fails to do what the rental company advertised it as being capable of doing. 6.7 SUMMARY  There is a multitude of different types of insurance policies available, and virtually any individual or business can find an insurance company willing to insure them—for a price. The most common types of personal insurance policies are auto, health, homeowners, and life. Most individuals in the United States have at least one of these types of insurance, and car insurance is required by law.Insurance is a contract (policy) in which an insurer indemnifies another against losses from specific contingencies or perils.  Due to the high number of changes, the insurance industry is often one that can be easily misunderstood. The attention to detail along with terminology that is foreign to most makes the insurance industry quite intimidating. When attempting to get a better understanding of insurance, there are four unique characteristics that need to be done and they are conditional, unilateral, adhesion, and aleatory. Let's take a closer look at each of these unique characteristics as well as the traits that define them.  Although most contracts share the same concepts and philosophies, insurance contracts can differ significantly. One of the unique characteristics of insurance contracts is known as conditional. Conditional insurance contracts can be defined as those insurances that have a provision in an agreement or contract, which have the ability to limit specific things in the contract. For example, a beneficiary will receive a benefit from a trust or will upon the condition that the insured passes away. The condition must first be satisfied before the beneficiary is able to receive any type of benefit from the will or trust. 106 CU IDOL SELF LEARNING MATERIAL (SLM)

 Another type of conditional insurance is a suicide clause, which typically specifies that a payment upon death is not authorized if the insured dies in a manner of suicide. A suicide clause is a type of subsequent condition, which is an act that occurs which terminates a contract. In contrast, a precedent condition is an act that has to occur first in order for the contract to be honored. An example of a precedent contract would be an agreement between a home buyer and seller that says an inspection must first be provided before a transaction can take place.  Another unique characteristic of insurance contracts is unilateral insurance. A unilateral insurance contract is based on the premise that a particular party makes a promise and in exchange will receive a specific act from another party. This is the opposite of a bilateral insurance contract, which is where each specific party will trade promises. When it comes to insurance contracts, which are unilateral, a policyholder is responsible for paying the premiums, while the company is responsible for paying back the policyholder for any covered losses that happen. With a unilateral contract, the policyholder has no additional requirements to fulfill on their end once they have paid the premium on the policy.  Adhesion is a third characteristic of insurance contracts and it may also sound foreign to many people. An insurance contract that has an adhesion contract clause can be described as one in which an individual or party creates a contract from beginning to end and presents it to another party on the premise that they must take it or leave it as it is. It's important to note that the receiving individual does not have the right or the option to change or edit the contract in any manner.  There many types of insurance policies. Life, health, homeowners, and auto are the most common forms of insurance.  The core components that make up most insurance policies are the deductible, policy limit, and premium.  Indemnification clauses that are too broad or general may lead to problems. For example, a company that rents machinery may want to be indemnified against being sued if someone is injured while operating the machinery.  Indemnities can be important in protecting you and/or your business from lawsuits or other possible financial liabilities.  Risk transfer is a risk management and control strategy that involves the contractual shifting of a pure risk from one party to another. 107 CU IDOL SELF LEARNING MATERIAL (SLM)

6.8 KEYWORDS  Contractual agreement: contractual agreement is a legally enforceable agreement entered into by two or more parties to do, or refrain from doing, one or more things specified in the contract.  Liability waiver: A liability waiver is a legal document that a person who participates in an activity may sign to acknowledge the risks involved in their participation.  Voluntary arrangement: A company voluntary arrangement can only be implemented by an insolvency practitioner who will draft a proposal for the creditors  Indemnity clause: To indemnify someone is to absorb the losses caused to that party. ... Indemnity clause often sets out a list of what actions a party is insured against, for example: All lawsuits, actions or proceedings, demands, damages and liabilities.  Premium: Premium is an amount paid periodically to the insurer by the insured for covering his risk. Description: In an insurance contract, the risk is transferred from the insured to the insurer. 6.9 LEARNING ACTIVITY 1. Examine and analyze how insurance helps in development of larger industries. ______________________________________________________________________________ ______________________________________________________________________________ 2. Conduct a survey on how insurance companies provide protection to its holders. ______________________________________________________________________________ ______________________________________________________________________________ 6.10 UNIT END QUESTIONS A. Descriptive Questions 108 Short Questions 1. Explain basic characteristics of insurance? 2. Write a brief note on objectives of insurance? 3. What is risk transfer? 4. Write down the advantages and disadvantages of risk transfer. 5. Explain in brief the methods of risk transfer? CU IDOL SELF LEARNING MATERIAL (SLM)

Long Questions 1. What is indemnification? 2. What is risk transfer? What are the advantages and disadvantages of risk transfer? 3. What are the basic characteristics of insurance pooling of losses? 4. Explain in detail methods of risk transfer by providing suitable examples. 5. Write a note on objectives and importance of characteristics of insurance. B. Multiple Choice Questions 1. --------------------is a risk management and control strategy that involves the contractual shifting of a pure risk from one party to another. a. insurance b. indemnification c. Risk transfer d. Business organization The insurance rate is a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the a. Risk b. Market analysis c. funds d. Premium. ----------------is a type of risk transfer where a process or a project is outsourced for transferring various kinds of risks from one party to another. a. Premium b. Outsourcing c. Insurance d. Risk It is contract which is not arrived by mutual negotiations between the parties, it means he must adhere to the policy in which way it is offered there is no chance if bargain. a. contract of adhesion b. Payment of policy amount on happening of event 109 CU IDOL SELF LEARNING MATERIAL (SLM)

c. Premium d. Development of larger industries ---------------- is a legal agreement by one party to hold another party blameless – not liable – for potential losses or damages. a. Derivatives b. Premium c. Contract of adhesion d. Indemnification Answers 1-c, 2-d, 3-b, 4-a, 5-d 6.11 REFERENCES References  https://www.researchgate.net/publication/331783796_Process_of_Risk_Managent  Braude E., Software Engineering. An Object-Oriented Perspective, John Wiley and Sons,2001.  ERM, “The Enterprise Risk Management Annual Conference”, http://www.conferenceboard.org/erm.htm, 2007.  Gamma E., Helm R., Johnson R., Vlissides J., Design Patterns: Elements of Reusable Object-Oriented Software, Addison Wesley, 1996. Textbooks  Braude E., Software Engineering. An Object-Oriented Perspective, John Wiley and Sons,2001.  ERM, “The Enterprise Risk Management Annual Conference”, http://www.conferenceboard.org/erm.htm, 2007.  Gamma E., Helm R., Johnson R., Vlissides J., Design Patterns: Elements of Reusable Object-Oriented Software, Addison Wesley, 1996. Websites  https://advocatedelhi.wordpress.com/insurance-definition-of-insurance 110 CU IDOL SELF LEARNING MATERIAL (SLM)

 https://corporatefinanceinstitute.com/resources/knowledge/other/indemnification  https://searchcompliance.techtarget.com/definition/pure-risk-absolute-risk  https://www.iedunote.com/pure-risks  https://corporatefinanceinstitute.com/resources/knowledge/strategy/risk-management 111 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT – 7: INSURANCE AND GAMBLING OR HEDGING STRUCTURE 7.0 Learning Objectives 7.1 Introduction 7.2 Meaning and Definition of Gambling or Hedging 7.3 Difference between Insurance and Gambling or Hedging 7.4 Summary 7.5 Keywords 7.6 Learning Activity 7.7 Unit End Questions 7.8 References 7.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Explain about the basic concepts of insurance and gambling.  Illustrate the meaning and Definition of Gambling or Hedging  Examine the difference between Insurance and Gambling or Hedging  Examine how gambling and insurance effects the economy  Illustrate what are factors affecting insurance and gambling 7.1 INTRODUCTION The worlds of gambling and insurance are similar in many ways. Both are built upon elements of probability, modeling, and quantification of risk. Both use a variety of means to attract individuals to participate. Professional gamblers are well informed as to the odds of one play versus another; an understanding of modelling can improve those odds to improve the chances of winning. Professional underwriters and actuaries understand premiums must be adequate to pay future claims and expenses; an understanding of modelling helps quantify risk and improve the ratemaking process. 112 CU IDOL SELF LEARNING MATERIAL (SLM)

Gambling and insurance each deal with potential outcomes involving large dollar payouts for rare events. Casinos must anticipate adverse results when there is a sporting event involving an unexpected upset or jackpots paid on a slot machine with greater frequency than expected. Likewise, insurers deal with large, unexpected claims all the time. Despite knowing the “expected” outcome, actual outcomes in both worlds will deviate (sometimes significantly) on certain days, weeks, or months. Both worlds try to mitigate the potential for such variability by embracing the law of large numbers. By increasing the number of participants (placing wagers or buying insurance policies), the difference between expectations and actual results (i.e., risk) is diversified but not eliminated. Neither wants to win or lose based on a small number of participants. There are also psychological similarities between the worlds of gambling and insurance. Individuals make conscious choices to participate. Despite laws mandating the purchase of certain types of insurance, many make the choice to go uninsured. Such individuals recognize the distinct possibility of loss but are “betting” an otherwise covered event will not happen to them. Likewise, those engaging in a game of chance understand a likely outcome is a loss. Each hope, however, to beat the odds and come home a winner. Psychological bias influences individual decisions in insurance and gambling. Participants on the other side of the table – insurance companies and gambling venues – understand the law of large numbers and will supplement their underwriting of such risk. A second significant difference between gambling and insurance is timing. Cost, gain and payout in gambling happens immediately. Conversely, timing is a significant risk factor for insurance companies. Insurance companies will not know the outcome of a policy’s profitability until years after the premium has been paid. It may take many years until all claims arising during a policy’s coverage period become known, are reported, settled, and paid. However, buying insurance is actually very different from gambling. When we enter a gambling engagement, such as buying a lottery ticket or putting money in a slot machine, we create risk of loss that did not previously exist. In other words, there was no risk of losing money to gambling until we bought the lottery ticket or put the money in the slot machine. Conversely, the risk of financial loss from other causes already exists whether we purchase insurance or not. For example, my home faces the same risk of being burned down by a fire whether I buy homeowners insurance or not. If I do not have homeowner’s insurance, I am faced with the possibility of having to pay completely out of my pocket to rebuild my home in the event of a fire. How Insurance is Better than Gambling: Even if we never end up using our insurance, we still benefit from it because it enables us to live a full, fun, free life that is unencumbered by constant 113 CU IDOL SELF LEARNING MATERIAL (SLM)

fear of loss. If insurance did not exist, we may not feel comfortable buying or doing many of the things we now consider to be no big deal. When we are properly insured, we feel free to buy expensive homes, drive our own cars down the freeway, fly to Hawaii, cruise through the mountains on ATVs, ski down black diamond runs, and maybe even hike through the rainforests of South America. 7.2 MEANING AND DEFINITION OF GAMBLING OR HEDGING People can and do gamble on virtually anything. Currently, the most popular gambling activities are poker, sports betting, and various types of lotteries, bingo, casino games such as blackjack and craps, slots, and a variety of electronic gambling machines (e.g., video poker). Day trading stocks on the Internet is a more recent addition to this list, although one whose popularity may have already peaked. The gambling activities in this (partial) list vary across many dimensions. Some activities, such as poker involve a degree of skill; others, such as lotteries, are purely random, chance events. Some activities, such as poker and craps, are relatively social and involve a degree of interaction that is sometimes intense and focused; others, such as slots, are more solitary activities and are generally pursued as such. The speed of play varies as well, from craps and blackjack where the outcome is immediate, to weekly lottery drawings or wagering on sporting events where the outcome is more delayed. Moreover, gambling allows one to present certain identities, and a large part of that identity is the game or the games that one chooses to play (e.g., Holtgraves, 1988).It would be surprising if these differences between gambling activities were unimportant, yet research on gambling has often overlooked them (but see Kessler et al., 2008; Wong & So, 2003).For example, problem gamblers are often treated as a homogeneous group, and the different pathways (e.g., different gambling activities)through which one might become a problem gambler are ignored(Blaszczynski & Nower, 2002). This is unfortunate, because different gambling activities may vary in terms of the type of person they attract, as well as the role they play in the development of pathological gambling. Hence, it is possible that different types of people will engage in different gambling activities with different subsequent effects. 7.3 DIFFERENCE BETWEEN INSURANCE AND GAMBLING OR HEDGING 114 CU IDOL SELF LEARNING MATERIAL (SLM)

Table 7.1: Difference between insurance and gambling Gambling, Gambling Activities, and Problem Gambling People can and do gamble on virtually anything. Currently, the most popular gambling activities are poker, sports betting, various types of lotteries, bingo, par mutual wagering on (horse and dog) races, casino games such as blackjack and craps, slots, and a variety of electronic gambling machines (e.g., video poker). Day trading stocks on the Internet is a more recent addition to this list, although one whose popularity may have already peaked. The gambling activities in this (partial) list vary across many dimensions. Some activities, such as poker involve a degree of skill; others, such as lotteries, are purely random, chance events. Some activities, such as poker and craps, are relatively social and involve a degree of interaction that is sometimes intense and focused; others, such as slots, are more solitary activities and are generally pursued as such. The 115 CU IDOL SELF LEARNING MATERIAL (SLM)

speed of play varies as well, from craps and blackjack where the o outcome is immediate, to weekly lottery drawings or wagering on sporting events where the outcome is more delayed. Moreover, gambling allows one to present certain identities, and a large part of that identity is the game or the games that one chooses to play (e.g., Holtgraves, 1988). It would be surprising if these differences between gambling activities were unimportant, yet research on gambling has often overlooked them (but see Kessler et al., 2008; Wong & So, 2003). For example, problem gamblers are often treated as a homogeneous group, and the different pathways (e.g., different gambling activities) through which one might become a problem gambler are ignored (Blaszczynski & Nower, 2002). This is unfortunate, because different gambling activities may vary in terms of the type of person they attract, as well as the role they play in the development of pathological gambling. Hence, it is possible that different types of people will engage in different gambling activities with different subsequent effects.  Gambling and Individual Differences Are there differences between people who prefer different gambling activities? Research addressing this issue has been relatively sparse. However, there has been some research examining differences between problem gamblers and no problem gamblers. There were early mixed results reported for the traits of sensation seeking (Anderson & Brown, 1984; Kuley & Jacobs, 1988) and locus of control (Cameron & Myers, 1966; Ladouceur & Mayrand, 1984). More recently, however, several studies have converged on showing that problem gamblers tend to score higher on a cluster of traits associated with the dimensions of impulsiveness and negative emotionality (Bagby et al., 2007; Slutske, Caspi, Moffitt, & Poulton, 2005). It is possible, however, that this overall profile obscures some important differences based on preferred gambling activities. For example, it has been argued that problem gamblers can be classified into subgroups based on their approach to arousal: a subgroup that uses gambling as a means of augmenting arousal and a subgroup that uses gambling as a means of reducing arousal (Blaszczynski & Nower, 2002). Gambling activities clearly vary in this regard; some are simple and solitary (e.g., slots) and promote dissociative states that can serve to reduce arousal. Others are more complex and social (e.g., craps) and can serve to augment arousal. In one of the few attempts to examine differences in personality traits for players of different games, Slowo (1998) found that relatively higher on extraversion traits such as activity and excitement. In contrast, poker machine players were significantly higher on anxiety. Hence, the problem gambling trait of impulsiveness was more evident in one subset of gamblers (those preferring fast-paced casino games), and the trait of negative emotionality was more evident in a different subset (those who preferred poker machines). More recent research has documented the existence of other differences between people who prefer different gambling activities. For example, Petry (2003) asked participants who were 116 CU IDOL SELF LEARNING MATERIAL (SLM)

seeking admission to a state-run gambling treatment center to indicate their most problematic form of gambling. Five major groups emerged (sports, horse/dog racing, cards, slots, and lottery), and these groups differed in several ways. First, there were clear gender differences, with sports and horse/dog racing being almost exclusively men and slot players twice as likely to be women. Second, these groups differed I n terms of gambling frequency (lottery players gambled the most frequently and card players the least) and amount of money gambled (lottery players the least and horse/dog race gamblers the most). Finally, there were differences in terms of substance abuse (substance abuse, especially alcohol, was more common among sports betters) and psychiatric variables (sports and card gamblers had fewer problems than the other groups).  Differences between Gambling Activities Rather than focusing on differences between people who play different games, it is possible to focus on differences between the games themselves. One manifestation of this approach is the argument that participation in some gambling activities is more likely to result in problem gambling than participation in other gambling activities. It has been argued, for example, that Electronic Gambling Machines (EGMs) are highly addictive (Productivity Commission, 1999). In this survey, conducted in Australia, it was estimated that 22.6% of regular EGM gamblers had a significant gambling problem, a rate comparable to casino table games (23.8%) but higher than racing (14.7%) and far higher than lotteries (2.5%). It is very difficult to determine unambiguously the addictive potential of a game, however. For example, high problem gambling rates for EGM players could be the result of their playing other gambling activities. One alternative measure is to compute the percentage of gamblers indicating that an activity is their favorite (based on amount of money spent) who are problem gamblers. With this measure, people who preferred playing EGMs had the highest problem gambling rate (9.7%), followed by racing (5.2%), casino gambling (3.5%), and lotteries (.3%). Another measure is the weekly conversion rate, or percentage of people who have played an activity who report playing that activity weekly. In the Productivity Commission report (1999), this rate was 11.06% for EGMs, a rate lower than that for lotteries (48.5%) but greater than that for casino table games (2.4%).1 And another measure is the percentage of problem and no problem gamblers who engage in any activity. Not surprisingly, problem gamblers are more likely to play EGMs than are no problem gamblers (Smith & Wynne, 2004; Wynne, 2002), although this finding is true for most gambling activities. Still, relative to other activities, EGMs have been rated as one of the most popular weekly activities for problem gamblers but not for non-problem gamblers (Volberg, 1997; Wynne, 2002). Taken together, these measures suggest a relatively high addictive potential for EGMs.2 Present Research. 117 CU IDOL SELF LEARNING MATERIAL (SLM)

Prior research suggests that individuals who prefer, or at least more frequently play, different gambling activities differ from one another in some important ways. The purpose of the present research was to explore these and o their differences (and similarities) in more detail. More specifically, in this research I pursued the following two major issues. First, is there a structure for different gambling activities based on the frequency with which they are played? In other words, do gambling activities cluster together in any sort of meaningful way? For example, are people more likely to play slot machines if they play the lottery? This type of analysis will be useful for identifying similarities and differences between gambling activities, as well as the role played by these underlying dimensions in the initiation and development of gambling and problem gambling. Second, to what extent are different gambling activities associated with different rates of problem gambling? This is obviously an important question, but one that is not amenable to a single, straightforward analysis. There are no completely unambiguous measures in this regard. Accordingly, in this research I used a variety of different analyses and searched for common patterns across these analyses. First, I examined differences between gambling activities in terms of their conversion rates and levels of problem gambling. Second, I focused on differences between people in terms of their problem gambling status, and whether these differences were associated with preferences for certain gambling activities and with the number of gambling activities that one played. To examine these issues, I used a large, integrated data set comprised of responses to gambling surveys conducted in several Canadian provinces between 2001 and 2005. The use of this type of population-based survey data is important because participants in many studies in this area have been problem gamblers seeking treatment (e.g., Petry, 2003). Hence, there is a clear need to explore these differences with population-based data. 7.4 SUMMARY  The worlds of gambling and insurance are similar in many ways. Both are built upon elements of probability, modeling and quantification of risk. Both use a variety of means to attract individuals to participate  Gambling and insurance each deal with potential outcomes involving large dollar payouts for rare events  Both worlds try to mitigate the potential for such variability by embracing the law of large numbers.  Well insurance is a bit like gambling... You're gambling a small amount of money in case something bad happens you won't be out of a lot of money, and the insurance company is betting that nothing bad will happen and therefore they make a lot of money based on the 118 CU IDOL SELF LEARNING MATERIAL (SLM)

number of people insured vs. The number of claims. Gambling on the other hand is wagering a sum of money, hoping for a payoff of a larger sum of money. All you have to lose is whatever you are wagering. With insurance, the payout can mean the difference of being left homeless or having the means to start over. They are both betting games, but usually in regular gambling unless someone is a complete idiot and wagers everything they own, they aren't going to lose everything they own, but with a fire, flood or other natural disaster, someone's whole life can be wiped away in a matter of moments with no means to recover.  There are also psychological similarities between the worlds of gambling and insurance. Individuals make conscious choices to participate.  Gambling and insurance inherently involve risk. In gambling, the risk is speculative, while the world of insurance deals with underwriting and timing risk. Both are conversant in probabilities, modeling and the law of large numbers. But both systems deal with people and their very human decisions to participate in each world.  Timing is a significant risk factor for insurance companies. Insurance companies will not know the outcome of a policy’s profitability until years after the premium has been paid. It may take many years until all claims arising during a policy’s coverage period become known, are reported, settled and paid.  Professional underwriters and actuaries understand premiums must be adequate to pay future claims and expenses; an understanding of modelling helps quantify risk and improve the ratemaking process 7.5 KEYWORDS  Gambling : to play a game for money or property. b : to bet on an uncertain outcome. ,to stake something on a contingency , take a chance. transitive verb, to risk by gambling .  Insurance: an arrangement by which a company or the state undertakes to provide a guarantee of compensation for specified loss, damage, illness, or death in return for payment of a specified premium  Inherently: The adverb inherently means in a natural or innate manner. ... Inherently is the adverbial form of the adjective inherent. They both come from the Latin word inhaerere, meaning \"adhere to,\" with the root haerere meaning \"to stick.\" Synonyms for inherently include intrinsically and essentially. 119 CU IDOL SELF LEARNING MATERIAL (SLM)

 Conversant: having knowledge or experience —used with with conversant with modern history is conversant with the operating system of the computer, archaic : having frequent or familiar association. 3 archaic : concerned, occupied.  Mitigate :make (something bad) less severe, serious, or painful. 7.6 LEARNING ACTIVITY 1. Examine and analyse various types of gambling or hedging across the country. ______________________________________________________________________________ ______________________________________________________________________________ In your opinion gambling is good or bad, give reasons to support your answer. ______________________________________________________________________________ ______________________________________________________________________________ 7.7 UNIT END QUESTIONS A Descriptive Question Short Questions 1. What is the meaning of insurance and gambling? 2. What are the definitions of insurance and gambling? 3. Write down differences between insurance and gambling. 4. Do you think gambling supports economy? Why or why not. 5. Conduct a survey on different ways of gambling. Long Questions 1. How insurance does play an important part in the growth of the economy. 2. In your opinion insurance and gambling are different or similar? Give reasons to support your answer. 3. Explain the main objectives of insurance as well as gambling? 4. Should gambling be banned or legalized? Give reasons. 5. Differentiate between gambling and insurance. B Multiple Choice Questions 120 CU IDOL SELF LEARNING MATERIAL (SLM)

1. Gambling and insurance each deal with potential outcomes involving: a. Large dollar pay-outs for rare events b. Economic downfall c. Substantial growth d. No monetary benefit Gambling and insurance inherently involve. a. Supply b. Risk c. Labour d. Capital There are also -----------similarities between the worlds of gambling and insurance. a. Social b. Cultural c. Political d. Psychological Insurance companies will not know the outcome of a policy’s profitability until years after the --- -----has been paid. a. Tax b. Premium c. Profit d. Income statement Insurance and gambling both systems deal with people and their very human decisions to: a. Participate in each world b. Compete with each other c. Influence others d. Unaffected with others Answers 1-a, 2-b, 3-d, 4-b, 5-a 121 CU IDOL SELF LEARNING MATERIAL (SLM)

7.8 REFERENCES References  Dowling, N., Smith, D., & Thomas, T. (2005). Electronic gaming machines: Are they the “crack cocaine” of gambling  Ferris, J., & Wynne, H. (2001). The Canadian problem gambling index: Final report. Ottawa: Canadian Centre on Substance Abuse.  Gemini Research (1994). Social gaming and problem gambling in British Columbia. Report to the British Columbia Lottery Corporation. Textbooks  Anderson, G., & Brown, R. (1984). Real and laboratory gambling: Sensation-seeking and arousal. British Journal of Psychology  Bagby, R. M., Vachon, D., Bulmash, E. L., Toneatto, T., Quilty, L. C., & Costa, P. T. (2007). Pathological gambling and the five-factor model of personality. Personality and Individual Differences Websites  https://www.pinnacleactuaries.com/blog/gambling-insurance  https://www.careersinaudit.com/article/the-importance-of-risk-management-in-an- organisation/  https://www.investindia.gov.in/team-india-blogs/overview-insurance-industry-india 122 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT – 8: RISK MANAGEMENT STRUCTURE 8.0 Learning Objectives 8.1 Introduction 8.2 Meaning and Definition of Risk Management 8.3 Objective of Risk Management 8.3.1 Pre-loss Objectives 8.3.2 Post-loss Objectives 8.4 Summary 8.5 Keywords 8.6 Learning Activity 8.7 Unit End Questions 8.8 References 8.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Initiate action to prevent or reduce the adverse effects of risk.  Minimize the human costs of risks, where reasonably practicable.  Meet statutory and legal obligations.  Minimize the financial and other negative consequences of losses and claims.  Minimize the risks associated with new developments and activities.  Be able to inform decisions and make choices on possible outcomes. 8.1 INTRODUCTION Risk Management is a field of enormous importance due to its increasing complexity and obvious economic value. More and more companies are paying attention to it, given there is not only a significant economic reward for attending to the various aspects of risk (Kauf, 1978), but that what constitutes Enterprise Risk Management has itself undergone significant change. RM 123 CU IDOL SELF LEARNING MATERIAL (SLM)

has witnessed a shift in the way firms manage the many uncertainties that stand in the way of achieving their strategic, operational, and financial objectives. Every enterprise is unique: their business models differ, the types of products and services lifecycles are context driven, organizational charts are diverse, their Mqh Aaotivation for overall business style are not the same. However, most of them have as their bottom line, the same pursuit for economic success, so their objects of interest may not be the same, but their ultimate aims are. This innovative RMIS needs be designed to be a tool for the expert user who will use it to spell out the company’s specific risk situations and their relevant and complex properties from an expert point of view. It should also be important to be able to define the insurance policies contracted to protect those resources from the consequences of potentially harmful events, whichever these might be, for each case. But it would be a tool for the non-expert user as well, the kind of user who as to deal with accident reports and tracking for example, having little or no expert knowledge regarding coverage and warranties. Risk Management refers to the identification, measurement, and treatment of expose to potential accidental losses almost always in situations where the only possible outcomes are losses or no change in the status. It is a general management function that seeks to assess and address the causes and effects of uncertainty and risk on an organization. The purpose of risk management is to enable an organization to progress towards its goals and objectives in the most direct, efficient, and effective path. Risk Management is the executive function of dealing with specified risks facing the business enterprise. In general, the risk manager deals with pure, not speculative risk. Generally, risk management is defined as a systematic process for the identification and evaluation of pure loss exposures faced by an organization or individuals and for the selection and implementation of the most appropriate techniques for treating such exposures. Many risk managers use the term “loss exposure” to identify potential losses. Loss exposure is a situation or circumstance in which a loss is possible, regardless of a loss occurs. For example, defective products that may result in lawsuits against the company. 8.2 MEANING AND DEFINITION OF RISK MANAGEMENT  Definition: In the world of finance, risk management refers to the practice of identifying potential risks in advance, analyzing them and taking precautionary steps to reduce the risk. 124 CU IDOL SELF LEARNING MATERIAL (SLM)

 Description: When an entity makes an investment decision, it exposes itself to a number of financial risks. The quantum of such risks depends on the type of financial instrument. These financial risks might be in the form of high inflation,volatility recession, bankruptcy, etc.  So, in order to minimize and control the exposure of investment to such risks, fund managers and investors practice risk management. Not giving due importance to risk management while making investment decisions might wreak havoc on investment in times of financial turmoil in an economy. Different levels of risk come under categories of asset classes. For example, a fixed deposit is considered a less risky investment. On the other hand, investment in equity is considered a risky venture. While practicing risk management, equity investors and fund managers tend to diversify their portfolio so as to minimize the exposure to risk.  During software development, there are many factors, which need to keep in mind. Every business comes with certain risk and it applies in the software industry as well. Being aware of the risk is not enough. A project manager must also be ready if certain critical situations arise. This is where risk management comes. Risk is something, which could happen and cause some loss or threaten the progress of the project. To avoid such loss we create a “Risk Management” plan. Why Risk Management is Important? i. Precaution is better than cure. Knowing the risk in advance and having a contingency plan helps in preparing in advance. This helps in lower the impact on the progress of the project and the cost in the end. ii. Consider a small example of the software industry. Today we all run on the internet. What if one fine day the lease line gets broke for any reason. What is the backup plan? How the day-to-day work is going to continue. As an organization, these are such issues, which you cannot control. For this kind of situation, you should have a backup plan. iii. Therefore, no internet is an identified risk. When you analyse it, you will know that this is a “High” priority and a major risk. This will affect your business in terms of cost and productivity. Now, what are your steps to resolve the risk? Having a backup lease line? Good idea, right? It is up to the organization how they want to recover from such a situation. In the end, it is all about reputation and money. If you cannot deliver, you cannot run in the market. 125 CU IDOL SELF LEARNING MATERIAL (SLM)

iv. Risk management is as important as project development. If the organization cannot prevent or handle the risk, then it is highly likely to vanish. Risk is involved in every type of business. According to a study called “Chaos Report” for projects in information technology, the following conclusion has drawn: v. 39% of projects finish on time and budget. vi. 43% of projects are challenged. vii. 18% are cancelled before its deployment to summarize the benefits of risk management: viii. It ensures the successful completion of the project. ix. It enhances the revenue by saving the expenses. x. It gives confidence and a competitive edge over other industry. xi. It also helps in exploring new opportunities. It helps to avoid a big disaster. 8.3 OBJECTIVE OF RISK MANAGEMENT  Pre-loss Objectives  Post-loss Objectives The objectives of risk management can be broadly classified into two: 8.3.1 Pre-loss Objectives: An organization has many risk management objectives prior to the occurrence of a loss. The most important of such objectives are as follows:  The first objective is that the firm should prepare for potential losses in the most economical way possible. This involves as analysis of safety program, insurance premiums and the costs associated with the different techniques of handling losses.  The second objective is the reduction of anxiety. In a firm, certain loss exposures can cause greater worry and fear for the risk manager, key executives and unexpected stockholders of that firm. For example, a threat of a lawsuit from a defective product can cause greater anxiety than a possible small loss from a minor fire. However, the risk manager wants to minimize the anxiety and fear associated with such loss exposures. 126 CU IDOL SELF LEARNING MATERIAL (SLM)

 Another example is the threat of a catastrophic lawsuit from a defective product can cause greater anxiety than a small loss from a minor fire.  The third prelist’s objective is to meet any externally imposed obligations. This means that the firm must meet certain obligations imposed on it by the outsiders. For example, government regulations may require a firm to install safety devices to protect workers from harm. Similarly, a firm’s creditors may require that property pledged as collateral for a loan must be insured. Thus, the risk manager is expected to see that these externally imposed obligations are met properly.  Another example is thatgovernment regulations may require a firm to install safety devices to protect workers from harm, to dispose of hazardous waste materials properly, and to label consumer products appropriately. The risk manager must see that these legal obligations are met. Figure 8.1: Pre loss Objectives 8.3.2 Post-loss Objectives: Post-loss objectives are those which operate after the occurrence of a loss. They are as follows: 127 CU IDOL SELF LEARNING MATERIAL (SLM)

 The first post-loss objective is survival of the firm. It means that after a loss occurs, the firm can at least resume partial operation within some reasonable time period.  The second post loss objective is to continue operating. For some firms, the ability to operate after a severe loss is an extremely important objective. Especially, for pub lic utility firms such as banks, dairies, etc, they must continue to provide service. Otherwise, they may lose their customers to competitors.  Stability of earnings is the third post-loss objective. The firm wants to maintain its earnings per share after a loss occurs. This objective is closely related to the objective of continued operations. Because, earnings per share can be maintained only if the fi rm continues to operate. However, there may be substantial costs involved in achieving this goal, and perfect stability of earnings may not be attained.  Another important post-loss objective is continued growth of the firm. A firm may grow by developing new products and markets or by acquiring or merging with other companies. Here, the risk manager must consider the impact that a loss will have on the firm’s ability to grow.  The fifth and the final post-loss objective is the social responsibility to minimize the impact that a loss has on other persons and on society. A severe loss can adversely affect the employees, customers, suppliers, creditors and the community in general. Thus, the risk manager’s role is to minimize the impact of loss on other persons.  Thus, there are the pre-loss and post-loss objectives of risk management. A prudent risk manager must keep these objectives in mind while handling and managing the risk. 128 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 8.2: Post loss objectives Business Risks Every Business Should Plan For Building a business takes work—and risks. But some risks are more dangerous than others. Here are a few risks that every business owner should keep in mind. Running a business takes hard work, which can reap the rewards of customers, revenue, and satisfaction. While success is the goal, business risk may stop you from achieving the goals you set. When it comes to risk management, there are steps you can take, however. Here are seven types of business risk you may want to address in your company.  Economic Risk The economy is constantly changing as the markets fluctuate. Some positive changes are good for the economy, which lead to booming purchase environments, while negative events can reduce sales. It's important to watch changes and trends to potentially identify and plan for an economic downturn. 129 CU IDOL SELF LEARNING MATERIAL (SLM)

To counteract economic risk, save as much money as possible to maintain a steady cash flow. Also, operate with a lean budget with low overhead through all economic cycles as part of your business plan.  Compliance Risk Business owners face an abundance of laws and regulations to comply with. For example, recent data protection and payment processing compliance could impact how you handle certain aspects of your operation. Staying well versed in applicable laws from federal agencies like the Occupational Safety and Health Administration (OSHA) or the Environmental Protection Agency (EPA) as well as state and local agencies can help minimize compliance risks. If you rely on all your income from one or two clients, your financial risk could be significant if one or both no longer use your services. Start marketing your services to diversify your base so the loss of one won't devastate your bottom line. Non-compliance may result in significant fines and penalties. Remain vigilant in tracking compliance by joining an industry organization, regularly reviewing government agency information, and seeking assistance from consultants who specialize in compliance. By providing your e-mail address, you agree to receive the Business Class newsletter from American Express. For more information about how we protect your privacy, please read our Privacy Statement.  Security and Fraud Risk As more customers use online and mobile channels to share personal data, there are also greater opportunities for hacking. News stories about data breaches, identity theft and payment fraud illustrate how this type of risk is growing for businesses. Not only does this risk impact trust and reputation, but a company is also financially liable for any data breaches or fraud. To achieve effective enterprise risk management, focus on security solutions, fraud detection tools and employee and customer education about how to detect any potential issues.  Financial Risk This business risk may involve credit extended to customers or your own company's debt load. Interest rate fluctuations can also be a threat. Adjusting your business plan will help you avoid harming cash flow or creating an unexpected loss. Keep debt to a minimum and create a plan that will start lowering that debt load as soon as possible. If you rely on all your income from one or two clients, your financial risk could be 130 CU IDOL SELF LEARNING MATERIAL (SLM)

significant if one or both no longer use your services. Start marketing your services to diversify your base so the loss of one won't devastate your bottom line.  Reputation Risk There has always been the risk that an unhappy customer, product failure, negative press or lawsuit can adversely impact a company's brand reputation. However, social media has amplified the speed and scope of reputation risk. Just one negative tweet or bad review can decrease your customer following and cause revenue to plummet. To prepare for this risk, leverage reputation management strategies to regularly monitor what others are saying about the company online and offline. Be ready to respond to those comments and help address any concerns immediately. Keep quality top of mind to avoid lawsuits and product failures that can also damage your company's reputation.  Operational Risk This business risk can happen internally, externally or involve a combination of factors. Something could unexpectedly happen that causes you to lose business continuity. That unexpected event could be a natural disaster or fire that damages or destroys your physical business. Or it might involve a server outage caused by technical problems, people, or power cut. Many operational risks are also people related. An employee might make mistakes that cost time and money. Whether it's a people or process failure, these operational risks can adversely impact your business in terms of money, time, and reputation. Address each of these potential operational risks through training and a business continuity plan. Both tactics provide a way to think about what could go wrong and establish a backup system or proactive measures to ensure operations aren't affected. For example, more businesses are using cloud storage to protect company data and rely on remote team members to maintain operations. Automating more processes also helps to reduce people failures.  Competition (or Comfort) Risk While a business may be aware that there is always some competition in their industry, it's easy to miss out on what businesses are offering that may appeal to your customers. In this case, the business risk involves a company leader becoming so comfortable with their success and the status quo that they don't look for ways to pivot or make continual improvements. Increasing competition combined with an unwillingness to change may result in a loss of customers. 131 CU IDOL SELF LEARNING MATERIAL (SLM)

Enterprise risk management means a company must continually reassess their performance, refine their strategy, and maintain strong, interactive relationships with their audience and customers. Additionally, it's important to keep an eye on the competition by regularly researching how they use online and social media channels. Accept, But Plan although you will never be able to eliminate business risk, proactively planning for it can help. Awareness is key in helping you save money and time while protecting the trust, reputation, and customer base you've worked so hard to achieve. 8.4 SUMMARY  Risk management is a firm-wide strategy to identify and prepare for hazards with a company's finances, operations, and objectives.  RM allows managers to shape the firm's overall risk position by mandating certain business segments engage with or disengage from particular activities.  Traditional risk management, which leaves decision-making in the hands of division heads, can lead to soloed evaluations that do not account for other divisions.  RM techniques have evolved substantially over the last decades.  A firm may grow by developing new products and markets or by acquiring or merging with other companies. Here, the risk manager must consider the impact that a loss will have on the firm’s ability to grow.  A severe loss can adversely affect the employees, customers, suppliers, creditors and the community in general. Thus, the risk manager’s role is to minimize the impact of loss on other persons.  A common definition of investment risk is a deviation from an expected outcome. We can express this deviation in absolute terms or relative to something else, like a market benchmark.  While that deviation may be positive or negative, investment professionals generally accept the idea that such deviation implies some degree of the intended outcome for your investments. Thus to achieve higher returns one expects to accept the greater risk. It is also a generally accepted idea that increased risk comes in the form of increased volatility. While investment professionals constantly seek—and occasionally find—ways to reduce such volatility, there is no clear agreement among them on how it's best done.  How much volatility an investor should accept depends entirely on the individual investor's tolerance for risk, or in the case of an investment professional, how much 132 CU IDOL SELF LEARNING MATERIAL (SLM)

tolerance their investment objectives allow. One of the most commonly used absolute risk metrics is standard deviation, a statistical measure of dispersion around a central tendency. You look at the average return of an investment and then find its average standard deviation over the same time period. Normal distributions (the familiar bell- shaped curve) dictate that the expected return of the investment is likely to be one standard deviation from the average 67% of the time and two standard deviations from the average deviation 95% of the time. This helps investors evaluate risk numerically. If they believe that they can tolerate the risk, financially and emotionally, they invest.  firms, the ability to operate after a severe loss is an extremely important objective. Especially, for public utility firms such as banks, dairies, etc, they must continue to provide service. Otherwise, they may lose their customers to competitors. 8.5 KEYWORDS  Imposed: to establish or apply as a charge or penalty. to lay on or set as something to be borne, endured, obeyed, fulfilled, paid, etc.: to impose taxes. to put or set by or as if by authority: to impose one's personal preference on others. to obtrude or thrust (oneself, one's company, etc.)  Obligations: an act or course of action to which a person is morally or legally bound; a duty or commitment.  Strategic: relating to the identification of long-term or overall aims and interests and the means of achieving them.\"strategic planning for the organization is the responsibility of top management\"  Perational: of or relating to operation or to an operation the operational gap between planning and production.  Hazards: A hazard is any source of potential damage, harm or adverse health effects on something or someone. Basically, a hazard is the potential for harm or an adverse effect (for example, to people as health effects, to organizations as property or equipment losses, or to the environment). 8.6 LEARNING ACTIVITY 1. Give your opinion on the statement “Risk Management is an extremely important activity, and a key aspect not only for insurance companies, which deal directly with risk as their most important business element, but also for any type of business activity.” ____________________________________________________________________________ 133 CU IDOL SELF LEARNING MATERIAL (SLM)

____________________________________________________________________________ “Risk management field and needs analysis sheds light on the fact that regardless of the specific type of risk to face, the resources or processes exposed to that specific risk, the shape the threat might take, the different consequences it might have: the approach in dealing with risks” Study the different kind of risks involved here and prepare a report. ______________________________________________________________________________ ______________________________________________________________________________ 8.7 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What is risk management? 2. What are the various objectives of risk management? 3. What are the definitions and meaning of risk management? 4. What are pre-loss objectives of management? 5. What are post-loss objectives of management? Long Questions 1. What do you mean by Risk Management? Explain giving reasons. Describe the Risk Management framework. What are the different types of risks that banks are exposed to in the present-day context? What is the difference between non-financial and financial risks? Can a market risk lead to credit risk? If so, under what circumstances? B. Multiple Choice Questions 1. When an entity makes an investment decision, it exposes itself to a number of a. Financial risks. b. Economic risks c. Qualitative risk d. Quantitative risks 134 CU IDOL SELF LEARNING MATERIAL (SLM)

A severe loss can __________affect the employees, customers, suppliers, creditors, and the community in general. a. Favourably b. Adversely c. Ineffectively d. Rightly Firm should prepare for potential losses in the most economical way possible. This involves. a. selection of business b. verification of data c. bringing the solutions d. analysis of safety program The risk manager must consider the impact that a loss will have on the firm’s ability: a. To suffer losses b. To grow. c. To bring new staff d. To build infrastructure Eexternally imposed obligations means that the firm must meet certain obligations imposed on it by the a. insiders b. family c. friends d. Outsiders Answers 1-a, 2-b, 3-d, 4-b, 5-d 8.8 REFERENCES References Annual Conference”,  ERM, “The Enterprise Risk Management http://www.conferenceboard.org/erm.htm, 2007. 135 CU IDOL SELF LEARNING MATERIAL (SLM)

 Gamma E., Helm R., Johnson R., Vlissides J., Design Patterns: Elements of Reusable Object-Oriented Software, Addison Wesley, 1996.  Gulías V., Abalde C., Castro L., Varela C., “A New Risk Management Approach Deployed  over a Client/Server Distributed Functional Architecture”, Proceedings of 18th  International Conference on Systems Engineering (ICSEn’05), IEEE Computer Society,  Gulías V., Abalde C., Castro L., Varela C., “Formalisation of a Functional Risk Management  System”, Proceedings of 8th International Conference on Enterprise Information Systems Textbooks  Booch G., Jacobson I., Rumbaugh J., The Unified Modeling Language, Addison Wesley,1998.  Braude E., Software Engineering. An Object-Oriented Perspective, John Wiley and Sons,2001.  Cabrero D., Abalde C., Varela C., Castro L., “ARMISTICE: An Experience Developing  Management Software with Erlang”, Proceedings of Principles, Logics and  Coopers & Lybrand, Los nuevos conceptos del Control Interno, Díaz de Santos, 1997.  Erikson E.H., Business Modeling with UML (Business patterns at work), John Wiley and Sons, 2001. Websites  https://www.clearrisk.com/what-is-risk-management  https://www.investopedia.com/terms/r/riskmanagement.asp  https://thismatter.com/money/insurance/handling-risk.htm 136 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT – 9: RISK MANAGEMENT PROCESS STRUCTURE 9.0 Learning Objectives 9.1 Introduction 9.2 Meaning and Definition - Risk Management Process 9.3 Steps in Risk Management Process 9.3.1 Risk Identification 9.3.2 Risk Measurement 9.3.3 Identifying the Tools of Risk Management 9.3.4 Selection of Risk Tools 9.3.5 Risk Implementation 9.4 Steps in Personal Risk Management 9.5 Summary 9.6 Keywords 9.7 Learning Activity 9.8 Unit End Questions 9.9 References 9.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Identifying and tracking risks that might arise in a project offers significant benefits, including:  Examine More efficient resource planning by making previously unforeseen costs visible  Evaluate Better tracking of project costs and more accurate estimates of return on investment  Examine Increased awareness of legal requirements  Illustrate Better prevention of physical injuries and illnesses  Evaluate Maxmise flexibility, rather than panic, when changes or challenges do arise 137 CU IDOL SELF LEARNING MATERIAL (SLM)

9.1 INTRODUCTION Risk management is the decision-making process involving considerations of political, social, economic, and engineering factors with relevant risk assessments relating to a potential hazard to develop, analyze and compare regulatory options and to select the optimal regulatory response for safety from that hazard. The risk management process is a framework for the actions that need to be taken. There are five basic steps that are taken to manage risk; these steps are referred to as the risk management process. It begins with identifying risks, goes on to analyze risks, then the risk is prioritized, a solution is implemented, and finally, the risk is monitored. In manual systems, each step involves a lot of documentation and administration. It's simply that: an ongoing process of identifying, treating, and then managing risks. Taking the time to set up and implement a risk management process is like setting up a fire alarm––you hope it never goes off, but you’re willing to deal with the minor inconvenience upfront in exchange for protection down the road. Identifying and tracking risks that might arise in a project offers significant benefits, including: 1. More efficient resource planning by making previously unforeseen costs visible. Better tracking of project costs and more accurate estimates of return on investment Increased awareness of legal requirements Better prevention of physical injuries and illnesses Flexibility, rather than panic, when changes or challenges do arise. Decentralized control is best when communication among engineers is necessary for achieving a solution. Centralized control is best when speed of development is the most important goal, and the problem is well understood. An appropriate organization tries to limit the amount of communication to what is necessary for achieving project goals, no more and no less. An appropriate organization may have to consider goals other than speed of development. Among these other important goals are lower life-cycle costs, reduced personnel turnover, repeatability of the process, development of team members at junior level into senior members, and widespread dissemination of specialized knowledge and expertise among personnel. 138 CU IDOL SELF LEARNING MATERIAL (SLM)

9.2 MEANING AND DEFINITION - RISK MANAGEMENT PROCESS  “Risk management is an integrated process of delineating specific areas of risk, developing a comprehensive plan, integrating the plan, and conducting the ongoing evaluation.”-Dr. P.K. Gupta  “Risk Management is the process of measuring or assessing risk and then developing strategies to manage the risk.”-Wikipedia.  ‘Managing the risk can involve taking out insurance against a loss, hedging a loan against interest-rate rises, and protecting an investment against a fall in interest rates.”  Oxford Business Dictionary  ‘Decisions to accept exposure or to reduce vulnerabilities by either mitigating the risks or replying to cost-effective controls’- Anonymous.  The future is largely unknown. Most business decision-making takes place based on expectations about the future.  Deciding based on assumptions, expectations, estimates, and forecasts of future events involves taking risks.  Risk has been described as the “sugar and salt of life”.  This implies that risk can have an upside as well as the downside.  People take a risk to achieve some goal they would otherwise not have reached without taking that risk. 9.3 STEPS IN RISK MANAGEMENT PROCESS Whether the concern is with a business or an individual situation, the same general steps can be used to analyze systematically and deal with risk. This is known as risk management process. The risk management process has five steps to be implemented by the risk manager:  Risk identification  Risk measurement  Identifying the tools of risk management  Selection of risk tools  Risk implementation 139 CU IDOL SELF LEARNING MATERIAL (SLM)

9.3.1. Identifying the Potential Losses: (Risk Identification) Risk identification is the process by which a business systematically and continually identifies property, liability, and personnel exposures as soon as or before they emerge. The risk manager tries to locate the areas where losses could happen due to a wide range of perils. Unless the risk manager identifies all the potential losses confronting the firm, he or she will not have any opportunity to determine the best way to handle the undiscovered risks. To identify all the potential losses the risk manager needs first a checklist of all the losses that could occur to any business. Second, he or she needs a systematic approach to discover which of the potential losses included in the checklist are faced by his/her business. The risk manager may personally conduct this two-step procedure or may rely upon the services of an insurance agent, broker, or consultant. Generally, a risk manager has several sources of information that can be used to identify major and minor loss exposures. They are as follows: Physical inspection of company plant & machineries can identify major loss exposures. Extensive risk analysis questionnaire can be used to discover hidden loss exposures that are common to many firms. Flow charts that show production and delivery processes can reveal production bottlenecks where a loss can have severe financial consequences to the firm. Financial statements can be used to identify the major assets that must be protected. Departmental & historical claims data can be invaluable in identifying major loss exposures. Risk managers must also be aware of new loss exposures that may be emerging. More recently, misuse of the internet and e-mail transmissions by employees have exposed employers to potential legal liability because of transmission of pornographic material and theft of confidential information. 9.3. 2. Evaluating Potential Losses (Risk Measurement) The second step in the risk management process is to evaluate and measure the impact of losses on the firm. This involves an estimation of the potential frequency and severity of loss. Loss frequency refers to the probable number of losses that may occur during some given period, while loss severity refers to the probable size of the losses that may occur. Once the risk manager estimates the frequency and severity of loss for each type of loss exposure, the various loss exposures can be ranked according to their relative importance. Both loss frequency and loss severity data are needed to evaluate the relative importance of an exposure to potential loss. However, the importance of an exposure depends mostly upon the 140 CU IDOL SELF LEARNING MATERIAL (SLM)

potential loss severity not the potential frequency. A potential loss with catastrophic possibilities although infrequent, is far more serious than one expected to produce frequent small losses and no large losses. On the other hand, loss frequency cannot be ignored. If two exposures are characterized by the same loss severity, the exposure whose frequency is greater should be ranked more important. There is no formula for ranking the losses in order of importance, and different persons may develop different rankings. The rational approach, however, is to place more emphasis on loss severity. Risk Measurement and Probability Distribution A more sophisticated way to measure potential losses involves probability distributions. However, this method is more difficult to explain, and the data needed to construct the required probability distribution are commonly not available. Nevertheless, probability distributions make possible more comprehensive risk measurements than other techniques; and, they are becoming a more common tool of modern management, and data sources are improving. Furthermore, probability distributions improve one's understanding of the more popular risk measurements and are extremely useful in determining which risk management devices would be best in each situation. A probability distribution shows for each possible outcome, its probability of occurrence. It is used to estimate numerically the potential loss from a risk. Using the probability distribution, it is possible to measure the various aspects of a risk, such as:  The total losses per period  The number of occurrences per period  The total losses per occurrence 9.3.3. Tools of Risk Management The third step is to identify the available tools of risk management. The major tools of risk management are the following:  Avoidance  Loss control  Retention  Non-insurance transfers  Insurance Avoidance and Loss control are called risk control techniques because they attempt to reduce the frequency and severity of accidental losses to the firm. On the other hand, retention, non- 141 CU IDOL SELF LEARNING MATERIAL (SLM)

insurance transfers and insurance are called risk financing techniques, because they provide for the funding of accidental losses after they occur.  Avoidance: Avoidance means that a certain loss exposure is never acquired (refusal), or an existing loss exposure is abandoned. For example, a firm can avoid earthquake loss by not building a plant in an earthquake prone area. An existing loss exposure may also be abandoned. For example, a pharmaceutical firm that produces a drug with dangerous side effects may stop manufacturing that drug. The major advantage of avoidance is that the chance of loss is reduced to zero if the loss exposure is not acquired. In addition, if an existing loss exposure is abandoned, the possibility of loss is either eliminated or reduced because the activity that could produce a loss has been abandoned. However, avoidance has two disadvantages. First, it may not be possible to avoid all losses. For example, a company cannot avoid the pre-mature death of a key executive. Second, it may not be practical or feasible to avoid the loss exposure. In the above said example, the pharmaceutical company can avoid losses arising from the production of a particular drug. However, without any drug production, the firm will not be in business.  Loss Control: It is another method of handling loss in a risk management program. Loss control measures attack risk by lowering the chance a loss will occur (loss frequencies) or by reducing the amount of damage when the loss does occur (loss severity). Loss control tools can be classified as: loss prevention and loss reduction measures. The following are the examples that illustrate how loss control measures reduce the frequency and severity of losses. Measures that prevent loss frequency are quality control checks, driver examination, strict enforcement of safety rules and improvement in product design. Measures that reduce loss severity are the installation of an automatic sprinkler or burglar alarm system, employing fire extinguishers, early treatment of injuries and rehabilitation of injured workers.  Retention: Retention means that the firm retains part or all the losses that result from a given loss exposure. It can be effectively used when three conditions exist. First, no other method of treatment is available. Insurers may be unwilling to write certain type of coverage. Non-insurance transfers may not be available. In addition, although loss control can 142 CU IDOL SELF LEARNING MATERIAL (SLM)

reduce the frequency of loss, all losses cannot be eliminated. In these cases, retention is a residual method. If the loss exposure cannot be insured or transferred, then it must be retained. Second, the worst possible loss is not serious. For example, physical damage losses to automobiles in a large firm’s fleet will not bankrupt the firm. Finally, losses are highly predictable. Retention can be effectively used for workers compensation claims, physical damage losses to automobiles, etc. Based on experience, the risk manager can estimate a probable range of frequency and severity of actual losses. Determining Retention Levels: If retention is used, the risk manager must determine the firm’s retention level, which is the Dollar / Birr number of losses that the firm will retain. A financially strong firm can have a higher retention level than one whose financial position is weak. Though there are many methods of determining retention level, the following two methods are very important. First, a corporation can determine the maximum uninsured loss it can absorb without adversely affecting the company’s earnings can dividend policy. One rough rule is that the maximum retention can be set at 5% of the company’s annual earnings before taxes from current operations. Second approach is to determine the maximum retention as a percentage of the firm’s net working capital, such as between 1% and 5%. Although this method does not reflect the firm’s overall financial position for absorbing a loss, it measures the firm’s ability to fund a loss. Paying losses: If retention is used, the risk manager must have some method for paying losses. Normally, a firm can pay losses by one of the following three methods: The firm can pay losses out of its current net income, with the losses treated as expenses for that year. However, many losses could exceed current net income. Then, other assets may have to be liquidated to pay losses. Another method is to borrow the necessary funds from a bank. A line of credit is established and used to pay losses as they occur. However, interest must be paid on the loan and loan repayments can aggravate cash flow problems the firm may have. Another method for paying losses is an unfunded or funded reserve. An unfounded reserve is a bookkeeping account that is charged with the actual or expected losses from a given risk exposure. A funded reserve is the setting aside of liquid funds to pay losses. Private employers 143 CU IDOL SELF LEARNING MATERIAL (SLM)

do not use funded reserve, in their risk management programs, because the funds may yield higher return if it is used in the business. Advantages of Retention: The firm can save money in the long run if its actual losses are less than the loss allowance in the insurer’s premium. The services provided by the insurer may be provided by the firm at a lower cost. Some expenses may be reduced, including loss-adjustment expenses, general administrative expenses, commissions, and brokerage, etc. Since the risk exposure is retained, there may be greater care for loss prevention. Cash flow may be increased since the firm can use the funds that normally would be held by the insurer. Disadvantages of Retention: The losses retained by the firm may be greater than the loss allowance in the insurance premium that is saved by not purchasing the insurance. Expenses may be higher as the firm may have to hire outside experts such as safety engineers. Thus, insurers may be able to provide loss control services less expensively. Income taxes may also be higher. The premiums paid to an insurer are income-tax deductible. However, if retention is used, only the amounts actually paid out for losses are deductible. Contributions to a funded reserve are not income-tax deductible.  Non-Insurance Transfers: Non-insurance Transfers is another method of handling losses. Non-insurance transfers are methods other than insurance by which a pure risk and its potential financial consequences are transferred to another party. Examples of non-insurance transfers include contracts, leases, and hold-harmless agreements. For example, a company’s contract with a construction firm to build a new plant can specify that the construction firm is responsible for any damage to the plant which it is being built. A firm’s computer lease can specify that maintenance, repairs, and any physical damage loss to the computer are the responsibility of the computer firm. Otherwise, a firm may insert a hold- harmless clause in a contract, by which one party assumes legal liability on behalf of another party. Thus, a publishing firm may insert a hold-harmless clause in a contract, by which the author and not the publisher is held legally liable if anybody sued the publisher. Advantages of Non-Insurance Transfers: 144 CU IDOL SELF LEARNING MATERIAL (SLM)

The risk manager can transfer some potential losses that are not commercially insurable. Non-Insurance transfers often cost less than insurance. The potential loss may be shifted to someone who is in a better position to exercise loss control. Disadvantages of Non-Insurance Transfers: The transfer of potential loss would become impossible if the contract language is ambiguous. If the party to whom the potential loss is transferred is unable to pay the loss, the firm is still responsible for the claim. Non-Insurance Transfers may not always reduce insurance costs since an insurer may not give credit for the transfers.  Insurance: Insurance is also used in a risk management program. Insurance is appropriate for loss exposures that have a low probability of loss, but the severity of loss is high. If the risk manager uses insurance to treat certain loss exposures, five key areas must be emphasized. They are as follows.  Selection of insurance coverages  Selection of an insurer  Negotiation of terms  Dissemination of information concerning insurance coverages  Periodic review of the insurance program (I) Selection of insurance coverages: The risk manager must select the insurance coverages needed. Since there may not be enough money in the risk management budget to insure all possible losses, the need for insurance can be divided into three categories.  Essential Insurance  Desirable Insurance  Available Insurance Essential Insurance includes those coverages required by law or by contract, such as workers compensation insurance. It also includes those coverages that will protect the firm against a loss that threatens the firm’s survival. Desirable insurance is protection against losses that may cause the firm financial difficulty, but not bankruptcy. Available insurance is coverage for slight losses that would merely inconvenience the firm. 145 CU IDOL SELF LEARNING MATERIAL (SLM)

(ii) Selection of an Insurer: The next step is that the risk manager must select an insurer or several insurers. Here, several important factors are to be considered by the risk manager. These include the financial strength of the insurer, risk management services provided by the insurer and the cost and terms of protection. The insurer’s financial strength is determined by the size of policy owner’s surplus, underwriting & investment results, adequacy of reserves for outstanding liabilities, etc. The risk manager can identify the financial strength of the insurer by referring the rating given to that insurance company. For example, in America, A.M. Best Company is one of the famous rating companies that publishes the rating of insurers based on their relative financial strength. Besides, the financial strength, the risk manager must also consider the risk management services by the insurer and the cost & terms of protection. (iii) Negotiation of terms: After the insurer is selected, the terms of the insurance contract must be negotiated. If printed policies, endorsements, and forms all used, the risk manager and insurer must agree on the documents that will form the basis of the contract. If a specially tailored manuscript policy is written for the firm, the language and meaning of the contractual provisions must be clear to both parties. If the firm is large, the premiums are negotiable between the firm and insurer. (iv) Dissemination of information concerning insurance coverage: Information concerning insurance coverage must be given to others in the firm. The firm’s employees must be informed about the insurance coverage, the records that must be kept, the risk management services that the insurer will provide, etc. (v) Periodic review of the insurance program: The entire process of obtaining insurance must be evaluated periodically. This involves an analysis of agent and broker relationships, coverages needed, cost of insurance, quality of loss- control services provided, whether claims are paid promptly, etc. Advantages of Insurance: The firm will be indemnified after a loss occurs. Thus, the firm can continue to operate. Uncertainty is reduced. Thus, worry and fear are reduced for the managers and employees, which should improve their productivity. Insurers can provide valuable risk management services, such as loss-control services, claims adjusting, etc. Insurance premiums are income-tax deductible as a business expense. Disadvantages of Insurance: 146 CU IDOL SELF LEARNING MATERIAL (SLM)

The payment pf premiums are a major cost. Under the retention technique, the premiums could be invested in the business until needed to pay claims, but if insurance is used, premiums must be paid in advance. Considerable time and effort must be spent in negotiating the insurance coverages. The risk manager may take less care to loss-control program since he has insured. But such a lax attitude toward loss control could increase the number of non-insured losses as well. 9.3.4. Selection of Risk Management Tools: Risk Management Matrix Type of Loss Loss Frequency Loss Severity Appropriate Risk Management Technique 1 Low Low Retention 2 High Low Loss Control & Retention Insurance 3 Low High Avoidance 4 High High Table 9.1 Risk management Matrix In determining the appropriate method or methods of handling losses, the above matrix can be used. It classifies the various loss exposures according to frequency and severity. The first loss exposure is characterized by both low frequency and low severity of loss. One example of this type of exposure would be the potential theft of a secretary’s Note pad. This type of exposure can be best handled by retention since the loss occurs infrequently and when it occurs it does not cause financial harm. The second type of exposure is more serious. Losses occur frequently, but severity is relatively low. Examples of this type of exposure include physical damage losses to automobiles, shoplifting and food spoilage. Loss control should be used here to reduce the frequency of losses. In addition, since losses occur regularly and are predictable, the retention technique can also be used. The third type of exposure can be met by insurance. Insurance is best suited for low frequency, high severity losses. High severity means that a catastrophic potential is present, while a low probability of loss indicates that the purchase of insurance is economically feasible. Examples include fires, explosion, and other natural disasters. Here, the risk manager could also use a combination of retention and insurance to deal with these exposures. The fourth and most serious type of exposure is characterized by both high frequency and high severity. This type of risk exposure is best handled by avoidance. For example, if a person has 147 CU IDOL SELF LEARNING MATERIAL (SLM)

drunken and if he attempts to drive home in that drunken stage, the chance of meeting with an accident is more. This loss exposure can be avoided by not driving at the drunken stage or by having a driver to drive his car. 9.3.5. Risk Administration or Implementation The next and the final step in the risk management process is implementation and administration of the risk management program. It involves three important components. i. Risk management policy statement ii. Co-operation with other departments iii. Periodic review and evaluation (I) Risk management policy statement: A risk management policy statement is necessary to have an effective risk management program. This statement outlines the risk management objectives of the firm, as well as company policy with respect to the treatment of loss exposures. It also educates top level executives regarding the risk management process and gives the risk manager greater authority in the firm. In addition, a risk management manual may be developed and used in the program. The manual describes the risk management program of the firm and can be a very useful tool for training new employees who will be participating in the program. (ii) Co-operation with other departments: The risk manager must work in co-operation with other functional departments in the firm. It will facilitate to identify pure loss exposures and methods of treating these exposures. The Accounting Department can adopt Internal Accounting Controls to reduce employee’s fraud and theft of cash. The Finance Department can provide information showing how losses can disrupt profits and cash flow. The Marketing Department can prevent liability suits by ensuring accurate packaging. Besides, safe distribution procedures can prevent accidents. The Production Department must ensure quality control and effective safety programs in the plant can reduce injuries and accidents. The Personnel Department may be responsible for employee benefit program, pension program and safety program. (iii) Periodic review & evaluation: The risk management program must be periodically reviewed and evaluated to see whether the objectives are being attained or not. Especially, risk management costs, safety programs and loss preventive programs must be carefully monitored. Loss records must also be examined to detect any changes in frequency and severity. Finally, the risk manager must determine whether the firm’s overall risk management policies are being carried out, and whether the risk manager is 148 CU IDOL SELF LEARNING MATERIAL (SLM)

receiving the total co-operation of the other departments in carrying out the risk management functions. 9.4 STEPS IN PERSONAL RISK MANAGEMENT Follow these risk management steps to improve your risk management process. Figure 9.2: Steps of personal risk management Identify the Risk. Anticipating possible pitfalls of a project doesn't have to feel like gloom and doom for your organization. Quite the opposite. Identifying risks is a positive experience that your whole team can take part in and learn from. Leverage the collective knowledge and experience of your entire team. Ask everyone to identify risks they've either experienced before or may have additional insight about. This process fosters communication and encourages cross-functional learning. Analyze the Risk. Once your team identifies possible problems, it's time to dig a little deeper. How likely are these risks to occur? And if they do occur, what will the ramifications be? 149 CU IDOL SELF LEARNING MATERIAL (SLM)

During this step, your team will estimate the probability and fallout of each risk to decide where to focus first. Factors such as potential financial loss to the organization, time lost, and severity of impact all play a part in accurately analyzing each risk. By putting each risk under the microscope, you’ll also uncover any common issues across a project and further refine the risk management process for future projects. Prioritize the Risk. Now prioritization begins. Rank each risk by factoring in both its likelihood of happening and its potential effect on the project. This step gives you a holistic view of the project at hand and pinpoints where the team's focus should lie. Most importantly, it’ll help you identify workable solutions for each risk. This way, the project itself is not interrupted or delayed in significant ways during the treatment stage. Treat the Risk. Once the worst risks come to light, dispatch your treatment plan. While you can’t anticipate every risk, the previous steps of your risk management process should have you set up for success. Starting with the highest priority risk first, task your team with either solving or at least mitigating the risk so that it’s no longer a threat to the project. Effectively treating and mitigating the risk also means using your team's resources efficiently without derailing the project in the meantime. As time goes on and you build a larger database of past projects and their risk logs, you can anticipate possible risks for a more proactive rather than reactive approach for more effective treatment. Monitor the Risk Clear communication among your team and stakeholders is essential when it comes to ongoing monitoring of potential threats. And while it may feel like you're herding cats sometimes, with your risk management process and its corresponding project risk register in place, keeping tabs on those moving targets becomes anything but risky business. 9.5 SUMMARY  An appropriate organization may have to take into account goals other than speed of development. Among these other important goals are: lower life-cycle costs, reduced personnel turnover, repeatability of the process, development of team members at junior level into senior members, and widespread dissemination of specialised knowledge and expertise among personnel.  Risk can mean that some danger or loss may be involved in carrying out an activity and therefore, care has to be taken to avoid that loss. 150 CU IDOL SELF LEARNING MATERIAL (SLM)