Risk management

1
Risk management

• Professor Allen Seward
• Hankamer School of Business

2

• The revolutionary idea that defines the boundary
  between modern times and the past is mastery of
  risk the notion that the future is more than a
  whim of the gods and that men and women are not
  passive before nature. Until human beings
  discovered a way across that boundary, the future
  was a mirror of the past or the murky domain of
  oracles and soothsayers who held a monopoly over
  knowledge of anticipated events
• Peter L. Bernstrin, Against the Gods, p.1

3
Risk

• Uncertainty concerning future outcomes
• The chance of a particular outcome
• high-risk policyholder

4
Types of Risk

• Credit
• Debtors fail to make payments
• Pure
• Damage to assets
• Legal liability environmental
• Worker injury
• Employee benefits

5
Note on employee risks

• personnel, including strikes, WC
• espionage

6
Types of Risk Price risk

• Output or Input
• Commodity price risk
• Exchange rate risk
• Interest rate risk
• Losses associated with gains to another party

7
Pure versus Speculative Risk

• Pure risk
• losses are sudden, and can be large
• physical, as opposed to purely financial
• Firm specific, therefore frequency and severity
  can be reduced
• Risks can be shifted to a third party
• loss not offset by gains to another party
• firm can gain if losses are less than expected
• Speculative risk

8
Losses from pure risks

• Direct
• physical losses
• employee injury/illness
• defense costs
• Indirect
• reduced cash flow
• continuing expenses
• increased cost of capital

9
Traditional Risk Management

• set objectives to minimize BOB
• bolt out of the blue
• identify problems perils, exposures, and
  hazards
• evaluate problems frequency and severity
• identify, choose and implement alternatives
• monitor

10
The alternatives

• Avoidance
• Loss control prevention (frequency)
• Loss control reduction (severity)
• Loss financing retention
• Loss financing transfer
• incorporate
• by contract
• Insurance
• hedging

11
Frequency or Severity Reductions?

• segregation of exposures
• duplication of records
• sprinkler system
• health/country club memberships
• warning signs

12
Financial theory approach

• objective is to maximize value of the firm
• identify
• measure direct costs
• look at investment decisions
• replacement?
• Select financing sources insurance, capital
  markets, cost savings

13
Financial theory approach (cont.)

• measure impact on financial performance of the
  firm
• develop strategy

14
Questions?

• Thank you!