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Risk Management in Insurance Sector

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RISK MANAGEMENT
• Risk is felt everywhere in the environment • Be it an individual, society or an organization • Father will tell son- Don’t speed up the car; Don’t visit Srinagar or northeast for Holidays ! WHY ? • Risk – – Immediately we relate it to uncertainty in the outcome of an event. The outcome may not be favorable – What does it imply ? – It implies lack of knowledge about the future and the possibility of some adverse consequence
Tragic events arouse emotions Fire loss Sickness Car acdt.
Risk…….. • Risk is a threat or probability, which can be of the following types: – Physical damage to the property – Death or injury to self/family members/employees – Public liability arising out of the activities carried out • Risk– Uncertainty about the outcome of a situation – The possibility of outcome will be unfavorable Risk is the probability of any outcome different from the one expected (unfavorable)
Risk…….. • Risk is a threat or probability, which can be of the following types: – Physical damage to the property – Death or injury to self/family members/employees – Public liability arising out of the activities carried out
Risk……. • • • • Risk is the chance of a loss Risk is the possibility of a loss Risk is uncertainty Risk is the dispersion of actual from the expected results • Risk is the probability of any outcome different from the one expected (unfavorable)
Risk- Defined • Definition of Risk• 1. Risk is defined as the combination of the probability of an event and its consequences • 2. Risk is a condition in which there is a possibility of an adverse deviation from a desired outcome that is expected or hoped for. – There seems to be a possibility of loss – Between zero and one; zero- no possibility and one - certainty • The individual hopes that adversity will not occur, like we don’t want our house to be burnt or motor car to be damaged, etc. But it may or may not happen.
Relationship of Uncertainty to Risk • Uncertainty refers to a state of mind characterized by doubt what will or will not happen in future (Certainty is opposite mental state). • Uncertainty is a psychological reaction to the absence of knowledge about the future • There is a chance of loss or no loss. • The possibility of loss is the risk. • An asset shall depreciate in value with its use and time is certain but it will be damaged in an accidental fire is uncertain
Degree of Risk• Degree of Risk- We use terms like: • More risk or less risk – High Probability or low probability – The higher the probability of an event shall happen, the greater is the likelihood of a deviation from the desired outcome • The probability of death at the age of 75 is higher than that at 50; so the degree of risk at the age of 75 is higher
Degree of Risk• Zero probability mean impossible to happen and 01 means certain to happen • Therefore the probability of loss is between zero and one e.g. as the number of bullets in a revolver increases, so the probability of loss increases. If all the six bullets placed in the bullet, there is no hope of favorable result.
Degree of Risk…… • Large no. of exposures over a period sets a trend which can be estimated. • Predictions can be made out of these estimates – Suppose from the past experience, an insurer found that one out of 1000 houses would burnt. – If the Co. insures 100,000 houses, it is unlikely that 100 houses would burn. – The actual result will be different- may be less or may be more. – But these houses are insured, The possibility of loss of more than 100 houses is Insurer’s risk.
Peril, Hazard • Peril is a cause of a loss, Fire, theft, flood, storm, etc. • Hazard is condition that may create or increase the chance of a loss arising from a given peril. Sickness is a hazard for premature death – Physical hazard- physical properties, e.g. poor construction, property near a river, etc. – Moral hazard- dishonest tendencies in the character of the insured person that may increase probability of loss – Morale hazard- indifferent attitude towards insured property, careless attitude towards preventing losses
How does a risk arise ? Physical HAZARDS Moral/ Morale Contribute to PERIL Causes POSSIBILITY OR PROBABILITY OF LOSS Creates RISK Possible LOSS
Classification of Risk • • • • • Financial and Non Financial Risks Static and Dynamic Risks Fundamental and Particular Risks Pure and Speculative Risks In speculative risk- there is a situation in which there is possibility of loss and also there is possibility of gain, e.g., gambling • Pure risk- there may be a situation in which there is possibility of loss or no loss. A motor car may face and accidental damage or may not be damaged.
Classification of Risks • Dynamic Risks Changes in the economy Changes in the consumer tastes Changes in the price level Change or advancement in Technology • Pure Risks Result of an eventLike Fire, Accdt., etc. No change in situation or Causes loss • Fundamental Risks Impersonal in nature- caused By economic, social and Political phenomenon War, flood, EQ, Terrorism, etc. Static Risks No change in economy Natural calamities Dishonesty of individuals, Fire, Accidents, etc. Speculative Risks Result of an eventGambling, etc Gain/Loss Particular Risks Personal in nature affecting the IndividualsBurglary, Fire in a house Infidelity of an employee, etc
Financial risk • Financial Risk is often defined as the unexpected variability or volatility of returns. • Actual return on an Investment will be different than expected. This includes the possibility of losing some or all of the original investment – Credit risk- default in making payments as promised because of cash flow/collection from buyers problem – Market risk- product price (market conditions), stock price, interest rate, currency rate, etc. – Operational risk- risk of running a business, goodwill, Legal risk, etc. – Liquidity risk- Trading of a security or asset quickly in the market, etc.
Classification of Pure Risk • Personal Risks– – – – – Premature death Old age or risk of insufficient income during retirement Accident Sickness or disability or poor health Unemployment • Property Risks– Direct loss or physical loss to the propertyFire damage to a house – Indirect or consequential loss- additional expenses for alternative accommodation • Liability Risks– Legal liability arising out of Negligently causing bodily injury or loss/damage to others or their property; Legal defense cost • Risk Arising out of failure of others– When the other person could not perform or carry out his obligation to provide services as expected
Pure Risk Pure Risks Physical effects of Nature Social effects Personal effects Technical effects Storm E. Q. Flood Theft Fraud Negligence Riot MBD Failure of safety Device Haz.Process Death Sickness Injury
Costs incurred during a loss-producing event • Loss producing event involves both direct and indirect costs Direct costs - as a result of damage to the property - as a result of injuries to Self, family members and employees -as a result of loss in production - for Accident investigation expenses Indirect costs -Liability costs associated with a loss Producing event -Loss of market, goodwill or reputation -Effect on the morale of the workers Costs due to the existence of the risks -Maintenance Costs- costs incurred while taking an AMC, preventive maintenance -Costs incurred to prevent liability losses such as effluent treatment, wastewater treatment, disposal of wastes etc. -Costs to meet the statutory requirements
Private and social costs ------• Private costs ----those costs incurred by an individual or corporate firm engaged in a particular activity • Social costs --- Costs arising out of activity of an individual or a firm , but shared by the society as a whole indirectly • Burden of Risk on Society— • Size of emergency fund must be increased- to pay the unexpected losses • Society is deprived of certain goods and services- due to risk of liability lawsuit manufacturer may discontinue manufacturing certain product, like medicines, vaccines, etc. • Worry and fear are present- accident and its consequences
Acceptability of a Risk • A decision in regard to acceptance or nonacceptance of a risk depends upon • The retaining capacity of the organization or the individual • The attitude of a person taking the decision • Size of the loss • Probability of the loss • Time • Cost of handling the risk Size-> Small Big Low Low Small Low Big High High Small High Big Probability v
Risk Management Risk management decisions need to be made prior to knowing what the actual outcomes of unknown perils shall be. It is the study of : -all probable causes -affecting business and -probabilities of all those outcomes and then…………………
Risk Management • Risk Management is to reduce the adverse impact of uncertain events – Uncertainties may be related to Business risks (speculative) or Pure risks – Some times it is difficult to separate the two risks as in case of introduction of new process in a factory • A risk manager therefore adopt a unified approach to deal with all types of risk. • Pure risk can be controlled by Physical control and financial control
Risk Management • Risk Analysis – Risks identification/anticipation/perception – Evaluation/measurement – Grading • Risk Treatment Techniques – Avoidance/elimination – Reduction/control – Transfer • Risk Financing – Excess/deductible – Self insurance/coinsurance • Monitoring results/Review
Benefits of Managing risk • Minimize the negative impact of risks • Saving resources- assets, property, people, time • Goodwill • Reduction in legal liabilities and expenses • Increasing stability in the operations of orgn. • Ability to face the different circumstances • Protecting environment • To know insurance requirement • RM is only a part of Strategic Management
Impact of (why) Risk Management • Survival of the organisation • Reduced expenses/losses • Improvement in Profitability– – – – – Peace of mind and confidence Bold decision and risk taking ability Stability- less fluctuations in profit and cash flow Goodwill- retaining the customers and vendors Little or no interruption of operations • Peace of mind and confidence shall help in Sound management decisions & continued growth • Safety of Organisation, employees, image
Risk Management…… • Different risk management approaches are adopted by different organizations – depending upon the kind of risks they are exposed to, – the type and size of the organizations and – their financial situation • The likely impact of different risks shall be different, – some of which may be retained, – other may require reduction/prevention and – some may require to be transferred to insurance
Role of Risk Manager in Risk Management • RM has to be specialised person to forecast & plan RM • RM should have knowledge and skills To deal with the risks that an organization may face • RM has to cooperate and communicate with various sections or department heads of the orgn. to find the different risks and • Coordinate with the persons handling the risks. • To suggest the approach/alternatives to manage such risks with minimum cost, choose best one to implement. • Risk management should have approval of top Management so that plans, activities and controls are established & adhered to in the organization properly
Risk Management Process - Risk Identification Risk Analysis Evaluate Risk Avoidance Physical control Selection of technique Implementation Risk Financing Transfer-Insurance Monitoring & Review
Risk identification • Risk can be assessed/evaluated, controlled or financed only after have been identified • Objective is to find maximum number of risks • Missing a risk can have disastrous consequences • One or more method may be used to identify Risks which my further differ from Industry to Industry • Consultation with heads of various departments of the organisation shall provide valuable inputs • The risk identified should be loss producing one and proper record of the same should be maintained • The past experience of the orgainsation and that of the RM shall also help in perceiving potential risks
Identification of Risk • Identification of areas of vulnerability and specific hazards which can interfere with achieving business targets. • Areas to be looked into: – Knowledge about the organization – Market in which it operates – Business environment – Financial strengths and weaknesses – Vulnerability to unplanned losses – Manufacturing process – Management system • Out of so many methods of risk identification, a combination of best possible methods are applied • The process of risk identification can be discussed as under: – Perception of the Risk – Identification of the operative causes and perils along with their likely results
Risk Identification- Perception of Risk • Perception of Risk – Ability to perceive an exposure – Identification of possible causes or perils – The likely result • Cause/Source: – Type of business and nature of activities carried – Production method or processing – Place of activity, at own premises or service to be provided at clients Environment- in which the organization is working: – Legal environment : laws related to its activity, like public liability, WC Act, – Physical conditions : nearby river, earthquake zone, – Social and political situations, etc. • Role of risk manager is to adopt risk finding techniques which shall be result producing and cost effective
Factory- what are risks? • - Production unit Stores, Assembly, Fin. Goods, Admn. Block.
Techniques to Risk Identification: • • • • Study & Enquiry Information Sources and documents: Annual reports, Accounts (Balance sheet, etc.) Agreements and Contracts Leases agreements- responsibility of damages or losses to building or other assets or property under lease • Contracts : – Construction or other works: their terms in regard to liabilities of organization like injuries to workmen and physical damages – Purchase and sale : conditions about liability for the damages and injury • Guarantees/Warranties: After sale service records, expenses so incurred, replacements, etc.
Perception of Risk….. • Accounting records shall reveal: • Exposure: Value of Stocks and assets like – – building, plant and machinery, Furniture Fixtures, office equipments, etc. • Interdependencies between different parts of organization, – like production and sale; dependencies on major suppliers and customers • Organization's financial arrangements and its own financial position • Past experience about losses and expenditure incurred on them; frequency of such exposures • What shall be the duration of business interruption and size of loss
Survey • Site Inspection:• First hand information to understand the operations and functions to ascertain – – Safety or maintenance of the plants/operations – Different Risks in different sites or operations and their likely impact safety & maintenance – Risk handling capacity available there – Consultation with plant people will develop rapport to appreciate the controlling of risks – Risk management technique required there • Time consuming and may be treated as interference
How to Perceive Risk…… • Organization Charts shall reveal: • Nature and extent of the organ. Activities, – its products, – its size, – its subsidiaries • Inter relationship and inter dependencies between its various parts/units • Splitting the organization into individual units to examine them as profit and cost centers • Decision making and implementing persons; technical persons • Organization’s weakness which may be cause of a risk
Perception of Risk…… • Flow chart: Process layout • Manufacturing process involved from flow of raw material, different production stages uptill final customer. • It shall reveal the valuation of produce at each stage • Accumulation of stock in different stages, like at final stage in warehouse • Raw material required and sources and dependencies on the supplier
Perception of Risk…… • Flow chart: Process layout……. • Stage which is critical in the process, any machine which is very important, causes of damage like breakdown, wear and tear, lack of maintenance and its alternative • In house repair facility or nearby workshop capable of repairs in emergency • Source of power or energy required for production • Possible period of repair of machinery in worst circumstances • What shall be potential loss or damage to property and to gross profit
FLOW CHART • SUPPLIERS OFFICE R & D • MATERIALS FINISHED GOODS STORE TIMBER STORE SHEET METAL & PARTS STORE WOOD MACHINEING PRESSING & METAL MACHINING PACKING SECTION PAINT SHOP FINISHED PARTS STORE MAIN ASSEMBLY HEAT TREATMENT PARTS ASSEMBLY
Risks/Perils-Risk exposure analysis • Check list: simple in nature & inexpensive • Each peril shall be considered, whether a potential threat or not to business operation • Like fire- what can be source of fire; type of construction of the building housing the business, process involvedhazardous or non hazardous, power used; fire alarm system, fire fighting system, nearby fire station • flood and inundation- proximity to river, nalah and level of ground of factory • Earthquake- type of construction, seismic zone • Riot Strike and Terrorism- law and order situation, political, social environment • Liability arising out of possible exposures- like pollution, product defect.
Threat Analysis • Threat analysis: An alternative approach to check list • Listing of potential threats to business and possible causes • Riot, strike resulting to damage to property and partial closure of business; • Picketing- disrupting the business totally by trade union dissuading workers from working • Choking of drainage system leading to inundation • Floods due to nearby river • Epidemics leading to absence and shortage of workers • Blocking of road, due to subsidence or collapse of building • Disruption of supplies- water, power, supplies of raw material etc. due to damage to supply line
Event Analysis • Event Analysis: Possible loss producing events • Natural – Heavy rains, storm, floods, earthquake, subsidence • Man made- Fire, explosion, Bursting of pipes, Malicious Act, Impact damage, Aircraft damage, closure of roads, closure of various supplies like raw material, water, power • The reasons for above possible events are to be identified to find the remedial measures to be under taken • The imagination and prudence of the risk manager is very relevant to prepare a Hazard Logic trees. To find hazards which may cause operation of a peril. • His coordination with relevant persons of the organization and outside organization shall play a vital role to find mitigating factors
Fault tree analysis • Widely used method of conducting a detailed quantitative hazard assessment. • Fault tree is a graphical representation of the logistic relation between a particular accident or other undesirable event- top event and the primary cause event. • Top event is the loss producing event. • Top event is developed down the branches to the intermediate fault events, which in turn are developed into the primary failures • Output exists only when all the input exist. • Output exists only when any of the input exist
Fault Tree Analysis - Explosion in Paint spraying booth Source of ignition Paint vapors Concentration Failure of Exhaust fan Continued Flow of paint Breakdown Of fan Failure of Electric supply Electric spark Failure of Earthing Flames Near booth worker Cigarette/ beeri in or near booth outsider
Cause and Consequence DiagramsNielson • This method incorporates features of bothfault tree analysis as well as event analysis. • Define a critical event- boiler explosion • Define both the possible causes and the possible effects
Cause and Consequence Diagrams • An event like- a cause and consequence diagram for boiler explosion FAILURE OF PRIMARY PUMP SCALE FORMATION SHORTAGE OF WATER PHYSICAL DAMAGE TO BOILER BOILER EXPLOSION DAMAGE TO OWNER’S SURROUNDING PROPERTY DAMAGE TO THIRD PARTY DEATH/INJURY TO EMPLOYEES
Hazard and Operability Studies • Hazard identification studies are carried out at the planning stage of a new plant on the basis of a plant lay out, flow diagram/ process flow sheet etc. • Also carried at various construction stages of the project • To ensure that any changes if required, can be made as a result of the studies undertaken • During the studies, full description of the process is understood and attempts are made to find out possible deviations which may result into adverse consequences (losses). • Proper risk handling decision can be taken on the basis of such analysis
HAZOP Studies • Raw material Chemical A and B are transferred by pump to a reactor where they will react to form the final product- C • A + B ------- C • Condition: If the flow of B exceeds than that of A then it can lead to an explosion Supply tank of A is empty Effect-Pump fails • Intention: Transfer A Explosion due -Isolation valve is closed To excess of B • Deviation: Don’t transfer A -Leakage from pipe • To design appropriate risk handling method ? Chemical A Reactor Chemical B Final product-C
Input output analysis • The use of process lay out of where chain of process/sections are involved from input of material to output of a final product • Example is a manufacturing unit having A,B,C,D,E Section to • • A • 50% 100% B 100% C 100% D SALE D 50% E • Contribution by each section in total sale/revenue • Interdependencies among the sections in a process
Safety Audit • Safety audit subjects every area of the organization's activities to a systematic critical examination with the objective of minimizing the losses. • It examines and assesses in detail the standard of all facets of a particular activity • It extends from Complex technical operations, emergency procedures to clearance certificates, job descriptions, housekeeping and attitudes, Industrial relations, etc. • Elements of safety audit: – Identification of possible loss producing situations – Assessment of potential losses associated with these risks – Selection of measures to minimise losses – Implementation of these measures within the organization – Monitoring the changes • Internal Audits • External Audits
Identification of operative causes and perils • Interrelationship of the terms hazard, peril and loss producing event Effect of loss producing Event Peril(s) Hazard(s) Different techniques are adopted to find hazards involved, in different organizations Analysis is necessary at each stage of chain: Cause- Risk- Effect
Risk Evaluation • For proper risk handling, it is necessary to calculate the potential impact of the risks identified, on the organisation • A comparison of Potential impact in financial terms by each risk can be analysed through: – Frequency of its likely occurrence – Probability of loss or damage – Severity of the effects of a loss – Perception of the probability of loss and its effects
Risk evaluation……. • The risk assessment- to analyze the loss exposure, which require informations – The information in quantitative form is known as data, which is collected, analysed and interpreted – frequency of loss producing risk; – severity of loss; – premium and other costs. • For this we need to Examine statistical data on– The particular operation/company – The Industry – The country – Regionally and worldwide relevant data available
Risk evaluation….. • Data related to all the aspects of the organisation in question are examined, like – – – – – process, Management, Loss control, turnover, strength of manpower, etc. • Constraints of Statistical method– – – – Only historical data is available Cause of risk cannot be related Data can be manipulated Effects of environmental changes not taken into account
Risk evaluation… • Adjustments/corrections are also required to be made for– Volume fluctuation- growth or decline trend – Inflation- cost shall be more than the data under study – Increase in Exposure- Increase in the working hours-24 hrs., diversification or additions – Special circumstances- Change in legislation or change in insurance coverage – Influence of the Environment- Economic, social, political, operational changes • The result of statistical assessment shall help the management assess their impact on the organization in relation to– – – – Property/assets- Building, plant Machinery, computers, etc. Financial assets- money, debts, insurance, etc Manpower- employees, boar members, other stakeholders Liability- public, product liability, directors’ liability, pollution liability, etc.
Risk evaluation…. • Now the risks are to be prioritized as per impact into to handle the risks properly– Small and insignificant- retained or ignored – Small size but frequent- may be retained but may also be significant if aggregated on annual basis – Medium sized but irregular- may be controllable – Catastrophe- large losses my occur rarely but devastating OR another method: Risk Mapping – HH- High Frequency and High Severity LH- Low Frequency and High Severity HL- High Frequency and Low Severity LL- Low Frequency and Low Severity
Presentation of Data • Collect all the relevant data, e.g. number and size of fire losses suffered by a firm during one year • Collate the data- arrange in order of increasing size to understand the trend • Group the losses of different sizes and number of events in each class and record it (class frequency). • The total range of the data is usually sub-divided into between six and twenty equal class intervals, depending upon volume of data • The total range of the observations in the example next slide is from Rs. 00 to Rs.600, subdivided into 6 number of equal intervals or width of Rs. 100 • This table is known as frequency distribution
Fire losses occurring during 1980 (Rs.) 99.0 170.5 7.5 199.5 400.0 396.5 102.5 270.0 298.5 390.0 15.0 99.5 330.0 75.0 495.0 230.0 130.5 296.0 2.10 97.5 10.0 260.0 120.0 105.0 520.0 35.0 12.5 20.0 110.0 198.0 20.0 380.0 110.0 55.5 105.0 20.0 5.0 110.0 250.5 290.5
Fire material damages losses for 1980 (Rs.) arranging in ascending order 5.0 102.5 210.0 330.0 400.0 7.5 105.0 230.0 380.0 495.0 10.0 110.0 250.5 390.0 12.5 110.0 260.0 396.5 15.0 110.0 270.0 20.0 130.5 290.5 20.0 298.5 35.0 170.5 55.5 198.0 75.0 199.5 97.5 99.0 99.5 520.0
Frequency distribution for fire material damage losses for 1980 Class interval Class frequency Rs. Mid- point of class interval Rs. 0- 99.5 14 49.75 100- 199.5 11 149.75 200- 299.5 8 249.75 300- 399.5 4 349.75 400- 499.5 2 449.75 500- 599.5 1 40 549.75 Over 80% of all fire losses are less than Rs.300 and that 35% lie between Rs. 0—Rs.99.5 The value lying mid-way between the upper and lower class limit is known as the class mid-point, to be used for further statistical analysis
Graphical representation of Data • Graphs and diagrams are among the most impressive modes of presenting the data • Bar Diagram: can be vertical or horizontal parallel bars of equal width and of lengths proportional to the frequency of the particular classes • Specimen bar diagram is given in the next slide drawn from the data provided
Company Y’s annual results before and after the introduction of a risk management programme Year Profits/losses (Rs. 000) 1970 1971 1972 1973 1974 1975 -10 -20 -30 -40 -50 -30 (Risk Management Programme started 1st January 1975) 10 20 40 40 50 1976 1977 1978 1979 1980
Rs. 50 40 30 20 10 1970 1971 0 1972 1973 1974 1975 1976 1977 1978 -10 -20 -30 -40 -50 Bar diagram Risk Management Programme Introduced 1979 1980 Year
Pie diagram Non Skilled 40% Semi Skilled 20% Supervisions 12% Skilled Manual 16%
Histogram • The area of each rectangle representing the frequency. • Height of each rectangle equals the frequency of the class interval divided by the class width
Fire material damage loss data Class interval Class frequency Rs. Class Width Rs. Height of histogram rectangle 0-99.5 14 100 14/100=.14 units 100-199.5 11 100 11/100=.11 units 200-299.5 8 100 8/100=.081 units 300-399.5 4 100 4/100=.04 units 400-499.5 2 100 2/100=.02 units 500-599.5 1 100 1/100=.01 units
Frequency Class Width 14 0.14 11 0.12 0.10 8 0.08 4 0.06 0.04 2 0.02 1 99.75 199.75 299.75 399.75 499.75 599.75 Loss Size Rs.
Frequency Polygon (curve) • Drawing straight line connecting the mid-points of each class interval along the top of the rectangles
Frequency Class Width 0.14 0.12 0.10 0.08 0.06 0.04 0.02 49.75 149.75 249.75 349.75 449.75 549.75 Loss Size Rs.
(a) Frequency Curves Frequency (b) Frequency Size of employers Liability Loses (Rs.) (c) No. of Defective goods produced in a week (d) Frequency Frequency (Damage to individual property within a 5 mile radius of scale earthquake expressed as % of total value) Size of employers Liability Loses (Rs.) Size of earthquake Losses (Rs.)
Cumulative Frequency Distribution Fire loss data : A fire insurance company incurred 46 incidents last year distributed by claims cost as follows: Size of fire loss Rs. Class frequency Cumulative frequency 0-99.5 14 14 100-199.5 11 25 200-299.5 10 35 300-399.5 06 41 400-499.5 03 44 500-599.5 02 46 46
Frequency Class Width 40 30 Cumulative Frequency 20 (Number of Losses) 10 99.75 199.75 299.75 399.75 499.75 599.75 Size of Loss Rs.
Workmen’s compensation payment probability Total Claims per year (f) Likelihood Probability Rs. 0 150 0.150 Rs. 500 430 0.430 Rs. 1,000 250 0.250 Rs. 2,500 100 0.100 Rs. 5,000 45 0.045 Rs. 10,000 20 0.020 Rs. 25,000 04 0.004 Rs. 50,000 01 0.001 1000 Total 1.000 The probability distribution indicates that most likely losses remained around Rs.500 which can be expected 43% of the population
Number of days it takes to settle a house hold insurance theft claim . Time taken to Frequency settle claim in days (f) (x) 20 10 30 20 40 30 10 40 4 50 Total 104 fx 200 600 1200 400 200 2600 Mean= 2600/104 or 25 days is the average time taken to settle a house hold insurance claim
Days lost due to machinery breakdown at a factory in last 13 Years Year Days Lost 1 2 7 23 3 0 4 10 5 34 6 47 Mode 7 18 Median 8 0 9 9 10 11 11 29 12 15 13 20 Total 223 Mean=223/13=17.5 The above data is not sufficient to develop a detailed probability distribution
Central tendency ( Clustering) • Most probability distributions tend to cluster around a particular value, which may be middle of the range of the possible values the distribution covers • Mean, Median and Mode are used to identify such values • Arithmetic mean is the average out of the number of days lost- 223/13=17.5; median is middle number-18; mode is the number most repeated • The arithmetic mean of a probability distribution is computed much like the arithmetic mean , the only difference is that instead of dividing by the number of items, each item in the probability distribution is multiplied by its respective probability and sum of these products is divided by the sum of the probabilities
The arithmetic mean of a probability distribution- Workmen compensation Total Claims per year (X) Probability Cumulative frequency (P) (PX) Rs. 0 0.150 Rs. 0 Rs. 500 0.430 215 Rs. 1,000 0.250 250 Rs. 2,500 0.100 250 Rs. 5,000 0.045 225 Rs. 10,000 0.020 200 Rs. 25,000 0.004 100 Rs. 50,000 0.001 50 Total1.000 ∑ PX Rs. 1,290 /1 = Arith. Mean The expected annual total of workmen’s compensation claim for the given firm is Rs. 1290 (EXPECTED VALUE)
Expected value • Arithmetic mean represents long-run average expectations • Arithmetic mean of a probability distribution usually referred to as the expected value of that distribution • Expected value of a probability distribution provides information about where the outcomes tend to occur, on average. It is expected loss in the example. • In the given example on an average the workmen compensation claims are Rs. 1290 per annum. It shall help the risk manager to pay premium price for any year. • Median of a distribution is the value in the middle, when the numbers are arranged in ascending order • Mode of distribution is the single value which is most likely to occur
Dispersion ( variability) • Should the mean be treated as a guide to understand the probability of loss in future ? Or further studied to find out the correctness of the decision by analysing how far the losses that took place were near to mean • The study of probability distribution indicate two characteristics– – Central tendency or clustering – Dispersion or variability (from the point around which the distribution clusters)
Dispersion ( variability)….. • The less the dispersion around the expected value of a distribution, the greater the likelihood that actual results will fall within a given range of the expected value. • The less the dispersion or variance, there is less risk in prediction • Variance measures the probable variation in outcomes around the expected value. • A high variance implies that outcomes are difficult to predict. • Measure of dispersion or variance- Standard deviation of the distribution and other is the coefficient of variation
Year Days Lost Difference Square of from Mean Difference (variance) 1 7 -10 100 2 23 6 36 3 0 0 0 4 10 -7 49 5 34 17 289 6 47 30 900 7 18 1 1 8 0 17 289 9 9 -8 64 10 11 -6 36 11 29 12 144 12 15 -2 4 13 20 3 9 223/13= 17 (Mean) Standard Deviation = 1,921/(13-1) Variation is very high. 1,921 = sum of squared differences = 160.083 = 12.6 days approx.
Standard deviation • The variance of a probability distribution provides information about the likelihood and magnitude by which a particular outcome from the distribution will differ from the expected value. • The more is the variance, the more is the uncertainty about the expected value • Square root of variance is called Standard deviation
Claims (X) Rs. Probability (P) (X-E*) (X-E)2 P(X-E)2 Rs. 0 0.150 -1,290 1,664,100 249,615 500 0.430 -790 624,100 2,683,630 1,000 0.100 1,210 13,764,100 619,384.5 2,500 0.100 1,210 1,464,100 146,410 5,000 0.045 3,710 13,764,100 619,384.5 10,000 0.020 8,710 75,864,100 1,517,282 25,000 0.004 23,710 562,164,100 11,243,282 50,000 0.001 48,710 2,372,664,100 2,372,664.1 *Expected Value= 1290 Standard Deviation = 18,853,272.6 = Rs.4,342 approx. & over Standard deviation provide a measure of the variability of these distributions Totals 1.000 18,853,272.6 Coefficient of variation = Standard Deviation/ Arithmetic mean
Application • Severity is very important, a single cat loss could wipe out the firm. • Maximum possible loss- worst loss that could happen to the firm during its life time • Maximum probable loss- worst loss that is likely to happen • Risk manager has to analyze cost effectiveness while using any RM technique. For examples: • While taking a policy: – – – – Premium cost Service charges by Ins. Co./Broker Probable average loss Possible variance • While opting for voluntary deductible – Premium saving exceeds the average loss • While investing on loss preventive measures, like– purchase cost of Fire Fighting equipment and – the saving in premium in consequence thereof.
Probable Maximum Loss • An estimate of the monetary loss which is likely be suffered by the insurer on a single risk at any one point of time , e.g. as a result of a single fire or explosion
Probable Maximum Loss • • 1. 2. It is more of a subjective phenomenon. Depends upon: Technical info about the risk. Contribution made by each block to the gross profit of the org. 3. Type of coverage given by the insurers. 4. Past loss experience. 5. Physical inspection of risk.
Probable Maximum Loss Advantages of PML 1. Placement of reinsurance contract. 2. Whether to retain or transfer. Disadvantages of PML 1. Subjective phenomenon 2. Requires experts 3. Requires periodic revision.
Risk management decisions • To decide over the probability of loss in future with the help of stat-analysis • What shall be the cost of loss control measures to be adopted and to what extent the average loss shall be reduced • What is the cost of premium and related costs in comparison to average loss • What shall be the capacity of business to sustain a loss by self to decide about the excess applied by Insurance or voluntary excess to be adopted
Decision taking under conditions of Risk and Uncertainty • Risk manager has to take a decision from the various decisions/options • A decision can have more than one outcome, the result are not known (uncertainty) • Manager may also unable to find out various outcomes • Decision theory is based on various techniques adopted by the manager to deal with different categories of uncertainty – Pure uncertainty – Risk – Competitive uncertainty
Decision taking under Pure Uncertainty • Pure uncertainty • When all possible outcomes to a decision are known (probability is not known) • But knowledge of which one will occur is absent • Risk • When outcomes are known and probability of each occurring can be assessed • Risk comes in selecting the strategy/ scheme • Competitive uncertainty • Decisions after knowing that Rivals using strategy to minimise the gains
Decision making under Pure Uncertainty….. • Pure uncertainty exists when the manager can specify all the possible outcomes of different strategies but has uncertainty of which one will occur (probability of the outcomes is not certain) • Manager has to decide about the various options or strategies and the outcomes as resultant of those strategies • Cost of 3 Risk Retention Scheme – Pay-Off Matrix(Rs.000) Risk Retention Scheme Claims Experience in next 5 yrs- Expected (Rs.000) High Medium Low A 26 7 0 B 15 14 6 C 10 10 10
Minimax criterion • Decision criteria which may be applied depending upon manager’s attitude towards retention of risk • A pessimist or risk averter will assume worst possible result would occur or highest cost in this case • He shall choose scheme A expecting a high claim experience costing Rs.26,000 • Minimax criterion- minimum out of Max. – • As per the High claim experience table given below, the manager shall choose scheme C with minimum cost Rs.10000 in minimax criterion Scheme High A 26 B 15 C 10 Cost of Rs. 000s
Minimum Criteria • An optimistic manager who can take a risk, would always expect the best to happen and shall opt for the low claim experience • He would choose scheme A with minimum cost under minimin criterion Scheme Low A 0 B 6 C Cost of 000s 10 Shortcomings in both the criterions: • It is assumed that the risk attitude of the manager is either risk averse or risk preferer • The intermediate or medium values of the pay off (claims) was ignored
Coefficient of Optimization • Out of those shortcomings, the first one about extreme attitude of risk manager can be overcome by taking weighted average of the results •A decision maker shall choose a number between 0 to 1 indicating his risk attitude •An optimistic manager shall choose higher coefficient as .80 or 4/5 and thereby the expected pay offs for each strategy shall be as under: Scheme Minimu m cost Maximu m cost Expected Pay-Off Rs. ‘000 A 0X4/5 + 26X1/5 = 5.2 B 6X4/5 + 15X1/5 = 7.8 C 10X4/5 + 10X1/5 = 10.0 The optimistic manager would choose scheme A which has the lowest expected cost
Insufficient Reason Criterion The second criticism of ignoring intermediate values of the pay offs. • In the absence of knowledge about the probability of each event, all the events from high to low claim experience in all strategies, shall be deemed to happen •The payoff for each scheme is then the average payoff in each row as calculated under: Medium Scheme High Low Expected PayOff Rs. ‘000 A 26 X 1/3 + 7 X 1/3 + 0 X 1/3 = 11.00 B 15 X 1/3 + 14 X 1/3 + 6 X 1/3 = 11.67 C 10 X 1/3 + 10 X 1/3 + 10 X 1/3 = 10.00 In this case scheme C would be chosen. This method takes no account of decision maker’s risk attitude.
Minimax Regret Criterion The risk manager does not want to regret on the choice of scheme he has opted, and therefore examine the results of another choice. Regret is measured as the absolute difference between the pay-off for chosen strategy and the pay-off for the most effective strategy with the same state of nature Risk Retention Scheme Claims Experience Rs.000 High Medium Low A 26-10=16 7-7= 0 0 B 15-10= 5 14-7= 7 6 C 10-10= 0 10-7= 3 10 Scheme Cost of 000s A 16 B 7 C 10
Decision making Under Risk Risk Retention Scheme Claims Experience (probability is known) High Probability 0.5 Medium Probability 0.3 Low Probability 0.2 A 30 10 50 B 40 30 20 C 20 20 30 The expected Value of each scheme is as follows: Scheme A : 30X0.5 + 10X0.3 + 50X0.2 = Rs. 28,000 Scheme B : 40X0.5 + 30X0.3 + 20X0.2 = Rs. 33,000 Scheme C : 20X0.5 + 20X0.3 + 30X0.2 = Rs. 22,000 Here B should be chosen for having highest expected value.
Subjective Probability • Decisions are based on the probabilities of outcomes, derived from statistical data • But it is not always possible to arrive at a decision due to lack of sufficient statistical data • A subjective decision is taken by risk manager depending upon the degree of confidence to judge probabilities of different events based on his experience and whatever historical data available
Subjective Probability…….. • According to the degree of belief for the possible occurrence of an event, the risk manager assigns a probability between 0 to 1 • The experience of similar firms or organizations my also be examined • All the available facts and data must be collected and expert opinions may be sought for by the risk manager
Risk Management Techniques . Risk Financing Risk Control/ Preventive measures -Avoidance -Prevention -Reduction -Segregation -Contractual By Retention -Operations -Fund/Reserves -Pool -Debt or equity -Credit -Pool By Transfer -Contract by Jobwork/AMC -Insurance
Other Risk Management Tools • RM information System(RMIS)- A computerized RM database stored & analysed by RMr to predict and attempt to control future loss levels. • RM intranets and Web sites- with search facilities, answering FAQs and having wealth of other information • Risk Maps- giving details of potential frequency and severity of the risks faced by the organization • Value at Risk(VAR) analysis – worst probable loss likely to occur in a given time period under regular market condition • Insurer can apply VAR to a portfolio of assets such as mutual fund or pension fund
Risk Management Techniques -Risk Control: Avoidance, Reduction • Purpose of Loss control ? • Any loss caused by a risk is a cost to individual, firm or society – Cost of injury or damage – Cost of handling and steering the loss – Cost of any risk control measures – Cost of financing a loss – Cost of arranging finance to recover loss (loss) • Loss control Management is to reduce such cost – Prevent losses, eliminate the cause of loss – Protect people and property from loss/damage – Limit the extent of loss, if it happens – To recover the most
Risk management techniques • Stage immediately after completion of the risk assessment phase consists of preparing a Risk Treatment Plan • The plan should document the decisions about how each of the identified risks should be handled by- • Avoidance (eliminate, withdraw from or not become involved) • Reduction/prevention (optimize - mitigate) • Retention (accept and budget) • Sharing (transfer - outsource or insure) • A combination of the above
Risk Management Techniques -Risk Control: Avoidance, Reduction • Risk avoidance: Drastic method of risk control • Abandon some activity or change the product • Change in existing operations or in the nature of activitiesuse of non hazardous or less hazardous raw material • Change the location of operations- shifting of factory • Such changes cause major inconvenience and disrupt the business • Incur substantial expenses, which may be direct or indirect cost- new machines or costly raw material; handsome income forgone by leaving the hazardous production • RM should be a Proactive approach: • It is therefore better to have a full risk appraisal conducted when a new project is coming up and risk control devices may prove cheaper than the modification at a later stage
Risk Reduction/Prevention • Reducing the probability of risk occurrence: • Prevention of accidents improve industrial relations—attracts skilful labour • Improvement in the quality of risk making it more acceptable – Proper maintenance enhances useful life of machines --indirect savings in cost and increase of productivity – Clearing of waste at more frequent intervals – Knowledge & Training- Sign boards, instruction • Advantage: Discounts in insurance premium – Choice of voluntary deductibles—step towards risk retention – Easier to get reinsurance support—for insurers
Risk Reduction • Risk reduction is also called as loss prevention measure – To reduce the probability of loss – To reduce the size of loss (impact) • By selecting appropriate scheme out of various options in relation to the cost involved/incurred • Arranging finance or funds the various scheme available • The cost involved in the activities related to loss prevention must be examined in relation to potential savings earned in future • Loss reduction schemes require: – Allocation of limited funds to different schemes – Various methods of risk financing • Risk/Earnings Ratio Study” of more than 500 multinational corporations finds clear correlation between good physical loss prevention and lower earnings volatility
Risk Reduction…… • • Classification or Nature of Loss Control/Reduction Measures: Pre Loss Reduction 1. 2. Avoidance - Eliminating the cause of loss: Avoiding the risk; use of non-hazardous material instead of Haz. Reduction - Reducing the probability of a loss occurring: Improving the risk; Loss controlling devices are kept in order On occurrence1. 2. Raising an alarm Measure to control it at source or not to allow it to spread Post Loss Reduction- Reducing the size of loss: 1. 2. 3. Protective or quasi-preventive- Protecting things or persons exposed to damage or injury; Minimizing- to limit loss to as small as possible; Salvaging- to preserve as much as possible of the value or damaged property or the rehabilitation of injured persons
Loss Control/Loss reduction…. • Loss Control/ Reduction Measures : • Passive Measures: Inbuilt • Which shall , limit the loss or facilitate recovery – Perfect party walls to segregate the blocks – Fire doors – Contingency plan • Proactive Measures: Taking steps to limit the loss or maximise the recovery: – Sprinklers, – Burglar alarms – Training of Salvage operations
Risk Reduction…… • Yet Another Classification of Loss Control/ Reduction Measures : • Reduce Probability of a loss-producing event– fitting of safety guards to dangerous machinery; safety valves in pressure vessels – removing potential sources of ignition, waste or bushes; – removal of obstacles, spillages and slippery surfaces from gangways, stairs, etc. – separation of pedestrian and vehicular traffic • Reduce Size of the loss expectancy- severity – Inundation – keep susceptible goods above floor level; - installation of fire fighting equipments- sprinkler systems and smoke vents; - provision of first-aid facilities; - Fittings against water- tight compartments in ships. And of fire Reducing both, Probability & Severity of Loss: – Education & Training to employees and use of non combustible walls and doors in buildings
Risk Reduction…… • Examples: • Minimizing measures: - Wearing helmets while driving or moving in the works or factory - Segregation of the sound stocks from the partially burnt or the completely burnt goods • Mixed measures: – Construction of fire proof doors and perfect party wall (14”)segregating a hazardous block from a nonhazardous block – Replacing combustible material of building or poor construction by non-combustible material – Education and Training
Probability of a fire in a factory • Evaluation of risk – Possible sources (identification) – Probability of fire (analysis & evaluation) Frequency Severity • Pre-loss control – Limiting the availability of flammable materials and oxygen – Limiting the spread of fire • Post-loss control – Salvage materials, stock, property(minimise Loss) – Use of protection devices such as FFE
Risk Factor Analysis Chart Activity P&M, Operations Hazards & loss Equipments involved experience Manufacturing -A -B Material Management R&D To ascertain: Loss control like-Method of risk control -Introduction of Protection system -Training & education -Any change or modification required -Financing of the risk control -Financing of the loss/damage Comments/ analysis
Loss Control Measures • Loss control measures are cost to the organ. • Cost is incurred so as to take benefit in future in – Reducing the probability of loss – Reducing the size of loss
Risk Reduction…… • 1. 2. 3. Yet Another classification: Education and training Procedural devices Physical devices
Who should be trained----• • • • Employees of the organization Contractors and sub contractors Suppliers, service providers Third party visitors
Why training: • Most of the losses or damages are the resultant of negligence, carelessness, lack of knowledge. • Human factor plays a major role in all this. • The Management of the Organization must be aware of the Risks and understand the need of Risk prevention
Education and training • The management of Education and training on loss prevention should be recognized at various stages. • Planning Stage: while designing the plant and product, concerned persons should be educated to ensure the – – Safety of employees – Safety of Bldg., Plant, Machinery and other assets – Safety of the final product and its safe use
Education and training….. • • • • Planning Stage….. Segregation of hazardous blocks Contingency / disaster planning Incorporation of safety measures in the plant design e.g fire resistant/ earthquake resistant structure • Planning for product safety—ensuring quality control
Education and training….. • Production Stage: Employees associated with production need to be educated on safety norms and loss prevention • Personal injuries- can be avoided by knowledge and carefulness by individuals • Workers safety and avoidance of congestion in work place • Security/ security checks • Knowledge of manuals for operation of Machinery • The prevention of major hazards call for the use of technical knowledge
Education and training….. • Good house keeping- Avoid smoking, loose wiring, proper storage facility for hazardous and non hazardous material, accumulation of waste material, Waste disposal procedure • Maintenance of plant and machinery- timely maintenance and repairs. Guarding/Casing of machinery to avoid personal accidents • Training to use Fire fighting installations • Final product- High Technical standards and Quality control in producing the final product for the safety of users • Education to visitors/ suppliers/ vendors
Education and training….. • After Sales service • Supply of goods to customers in sound condition • Proper labeling and clear instruction for use of the product • People associated with after sales service, transporter, servicing employees must be educated • Information system about the usefulness and defects must reach to management to make changes in design of the product or after sale services
Education and training….. • Security: • Security holds a very key position in the process of loss prevention and safety • Security of the organization, including its personnel and assets is very important • Other business risks are espionage, defalcation and credit risks which require special training and education programme.
Procedural Devices-Management Attitude • It is the responsibility Management to laid down the procedures to be followed by the people in the site during their operations and on happening of an event – To reduce the probability and severity of loss – Trained to use the safety equipments and also follow the instructions – To make aware about the safety procedures to fellow employees and outside agencies those are coming to the sites
Procedural Devices….. • Some examples procedural devices are: – Manning of works/factory entrances for security checks – Steps to be taken for easy and speedy communication – Evacuating the visitors and the third parties to safe places – Information to Fire fighting team and safety team – First aid facilities to injured – Instructions to operators to handle the plant and machinery and safety measures – Procedure for plant control, shutdown and maintenance – Movement of material and equipment to safe places – Periodic internal audit system; safety audits
Procedural --– No smoking sign – Minimum congestion at work places – Vehicles with spark arrestor to enter into premises where there are presence of flammable vapours – Flame proof electrical fittings in such areas – Adequate precautions to be taken at places where hot work is carried out – No storage of hazardous chemicals near machines - to avoid sparks arising out of static electricity falling on these
Management attitude--Procedural deviations:---• Non adherence to statutory requirements under Boiler Act/Factory’s Act • Smoking being allowed inside the premises • Relaxed security norms ---e.g. vehicles without spark arrestors entering inside refinery premises • No formal procedure for waste disposal • No formal training on fire fighting for employees
Contingency Planning • Risk Management is the concern of top management • Management awareness of risk should lead to the designing and adoption of contingency plans for unforeseen major or catastrophic losses • There can be instances when a small damage to property or critical machinery leads to prolonged stoppage of business • Planning should be such that while the salvaging operation following the loss are being carried, the business should also continue. • It is therefore must that the employees must be trained to deal with emergency situations
Contingency Planning…… • While preparing contingency plan to deal with major disaster, the management must consider the following: – Identify all potential sources of loss-producing events which may disrupt the normal operations – Determine the interdependencies between different parts of the organizations – Determine the dependencies upon the suppliers and customers – Identifying the alternative sources of supply or outlet to remove such dependencies
Contingency Planning…… • Find the means of reducing the impact of the potential hazards as identified, such as : – Availability of Spare plant or machineries related to the trade – To hold a larger stock of raw material or finished goods in different stores/places – Find another supplier or customer to avoid vulnerability of business to limited suppliers or customers
Contingency Planning…… • While adopting above means the extra cost involved should reasonable in regard to the potential risk – Making arrangements with other business organization in competition to produce the goods at the time of contingency to reduce the impact on business – Employees must be educated and trained to take initiative to act and handle the situation. Responsibilities should assigned to each employee who is part of the team handling contingency plan so that employee is supposed to know his role in time of contingency.
Training of Employees • Knowledge of hazards to which employees are exposed in course of their work and steps to be taken to minimise the risk of injury to them or fellow employees • Use of special clothes and use of equipments provided for their safety • Laid down procedure for all employees to take steps in emergencies, like fire, MB or breakdown of safety devices • Immediate relief or salvaging exercise until expert help arrives, like first-aid and fir fighting teams • Inculcating a sense of responsibility to safetyconsciousness in the employees
Contractors, Suppliers, Retailers and Service Agents • • • • • The outside agencies who are involved in the organisation’s operations may be given necessary technical training – say knowledge of hazards and steps to be taken, defects in the products, etc. Supplier- consequences of supplying defective components. Standards of quality control system and product must be mutually agreed Inward material if brought inside the site of work must in be informed to security to take necessary safeguard Identifying the transit hazards and taking control measures Cash carrying safety measures
Physical Devices • Wide range of physical devices are available to reduce the probability and severity of loss caused by various risks. Categories of physical devices : Active devices which continuously operate to reduce the probability of loss-producing event occurring, like • • – – – – – Close circuit TV Thermostats on boilers and refrigerating equipments, Guards on power presses and other machines, Overload and other warning devices Devices for detecting leakage
Physical Devices……. • Passive devices which come into operation on happening of an event, like – – – – – – – – – Security and alarm system, automatic fire doors and vents, Automatic switch off devices Portable fire extinguishing appliances Small bore hose reels Hydrants and sprinklers Water spray systems Carbon di oxide flooding systems First aid and salvaging equipments
Statutory and other requirements • Factories Act, 1948 and amendments; other safety regulations are to be complied in regard to: – Safety at work – Food and drink regulations – Transport regulations covering aircraft, ships and vehicles – Safety of persons in hotels, boarding houses and other premises to which the public has access – Safety of persons adjacent to premises in which dangerous processes are carried on
Statutory and other requirements Safety • Safety norms and implementing the statutory safety requirements are integral parts of any loss prevention system. • Moving and rotating part of machines like fan belt, conveyor belts etc. should be covered or fenced • Machines should operated by trained male workers, wearing tight fitting clothing • Lifts and hoists should be of good mechanical construction, and of sound material and maintained periodically • Examination and maintenance of lifting machine, chains, ropes and lifting tackles periodically
Statutory and other requirements- Safety………. • Workers are to be provided with screens or goggles for protection of their eyes where process involves risk of injury to the eyes, like dry grinding of metals by hand welding or cutting of metals use of electricity • Gas cylinders should be stored in enclosed area with asbestos roofing and preferably with wall thickness of two bricks with proper ventilating system
Statutory and other requirements…… • Electrical installations should be proper with no loose wiring, no open switchboards. Regular checking of wirings and switchboards • Installation of right type of Fire extinguishers at correct places • Proper training on safety aspects should be given to all the employees to ensure safe operations at the site • The safety instructions as well as the directions to safety exits should be prominently displayed at strategic locations within the factories
Physical hazards ----Storage • 1. Over stacking up to the roof Delay the operation of automatic sprinklers and even if they operate the distribution of water will be impaired 2. Touch the electrical installations • Highly congested storage area 1. Denial of access to fire fighters –reduce efficiency 2. Heat generation
Physical hazards ----Storage • Little or no space between high stacks --- create a flue effect drawing heat upwards to spread fire vertically • Locked warehouses with high stacks --- many a times small fires which go undetected develop into a large one (since warehouses are mostly unmanned ) • Storage in front of open switch boards , near transformers, adjacent to electrical installations --inception of fire as well as propagation • Storage in front of fire extinguishers -- denial of access to the fire fighting appliances
Spontaneous combustion---• Certain materials undergo rise in temperature without application of external source of heat • When stored in bulk or in close contact with other materials ---a chemical or physical reaction is initiated which results in spontaneous development of heat as a result of oxidation • Bacterial reaction in organic materials
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Physical hazards ----Electrical Installations • Overloading the circuit----current flowing through the main supply cables increases as additional current consuming appliances are introduced into the circuit . Heat generated in the circuit proportionately increases . H= I 2 R t • Loose electrical wirings/ temporary wiring ---increases probability of short circuit • Open switch boards ---- possibility of combustible materials settling in between the wires and igniting subsequently • Wooden switch boards
Faulty electrical wiring-------
Faulty electrical wiring------• High tension wires passing over storage in open • Main switch board inside a warehouse --- in case of emergency / electrical fire the connections cannot be discontinued • Non-industrial lighting in factories
Physical hazards-Housekeeping • Congestion in work place ---insufficient floor space • Accumulation of chemicals / wastes on the floor at the work place -- e.g. cut-pieces of cloth in a garment manufacturing unit • • Inadequate safety during hot work-- e.g. necessary precautions not being taken during welding operations
Poor housekeeping---
Loose wiring Poor housekeeping
Location and exposure hazards--• Hazardous surroundings---- dry bushes, hazardous operations in neighboring factories • No space for fire brigade – • Buildings in close proximity to each other – • Temporary sheds • Remote locations • Static electricity / frictions from machines ---e.g. belts passing over pulleys or rollers generating static sparks
Handling the sources of ignition-• Electrical installations---1. 2. 3. 4. 5. 6. 7. Wirings should be in metal conduits or in armoured PVC cables Non-combustible materials to be used for switch boards Closed switch boards Power cables in trenches or through bus bars No overloading of circuit Double earthing of machines No storage in front of switch boards/ inside panel rooms
Handling the sources of ignition- • Storage – 1. 2. 3. Proper stacking and orderly storing Clear space of one and half to two feet from the roof Preferably storage in pellets and clear space of one to two feet from walls No storage in gangways, staircase , in front of FEA Space between high stacks –ensure proper air circulation, space for movement of fire fighting personnel Main switch outside the storage areas for cutting off electric supply in case of fire 4. 5. 6.
Handling the sources of ignition• Spontaneous combustion— 1. Stacks should be spaced from each other as much as possible Regular inspection for over heating e.g. haystacks Stocks of coal should be upturned at regular intervals and kept away from main premises Freshly prepared charcoal should be kept exposed to air for adequate time before packing and storing Oily rags/ cleaning rags should be kept in metal bins and the bins should be kept away from main premises 2. 3. 4. 5.
Handling the sources of ignition• Waste disposal ---1. Periodic waste disposal should be carried out and there should be a formal procedure for the same 2. Wastes should be kept in separate warehouse away from main blocks 3. Segregation of wastes from other stocks 4. Install fire fighting extinguishers near waste storages
Fixing of Sum Insured • Sum insured represents the value for which the customer wishes to insure his asset/property • Sum insured represent the maximum liability of the insurance company in the event of an accident • Premium is charged by insurer on sum insured • Sum insured can represent: – Market value or – Reinstatement/replacement value
Fixing of Sum Insured……. • Market value is a depreciated value. New replacement cost less depreciation gives the depreciated market value as on date of taking a policy • Reinstatement value is the current market price of the plant and machinery or reinstatement value of the building • Policy year 1.4.2005 to 31.3.2006 • Original Capitalized cost of Machinery Rs.10,00,00,000 as on 1.4.1995 • Index for April- March 1994-1995 110 • Index for April-March 2004-2005 190 • Replacement cost of Machinery Rs.10,00,00,000x190/11 =Rs.17,27,27,280 • Deprecation e.g. @ 5% per year for 10 yrs. (-) Rs.8,63,63,640 • Depreciated Market value of Machinery on 1.4.2005 = Rs.8,63,63,640
Fixing of Sum Insured……. • The settlement of the loss shall be based upon the basis of sum insured opted for by the insured • If the sum insured is found less than market value or the reinstatement/replacement value as the case may be, underinsurance shall apply • Example: • • • • • Market value Reinstatement value Sum insured Rs.10,00,000 Rs.20,00,000 Value at time of loss Rs.15,00,000 Rs.30,00,000 Loss Rs.600,000; Loss payable 600000x10/15 600000x20/30 Rs.4,00,000 Rs. 4,00,000
Fixing of Sum Insured…… • Reinstatement/Replacement Value: • Large Plant, machineries, equipments: – Original capitalised cost as per books of accounts – Inflation/escalation factor up till inception of the insurance policy to be added to the value – This escalation/inflation is done on certain paramenteters like RBI Index published by RBI for various machineries and industries. This value represents the new replacement cost • For small machineries/equipments the current market price of new one at which they are available may be treated as replacement value
Fixing of Sum Insured… • Building: Either of the method can be adopted– Prevailing PWD rate per square meter can be applied to the total covered area of the building to get the new reinstatement value; or – The initial constructed cost is escalated/inflated on the basis of established parameters to arrive at the current replacement value – The improvements done during previous years need to be added further to the cost • Stocks: The maximum quantity of stocks at risk during the previous year is multiplied by prevailing market cost without profit
Fixing of Sum Insured…. • On Market value: • Plant, Machinery and equipments – – An average rate of depreciation ranging between 3% - 5% per year is applied to replacement value • Building– An average rate of depreciation ranging between 1.5% - 5% per year is applied to reinstatement value of the building
Fixing of sum insured…. • Project Insurance: • Sum insured represents the estimated complete constructed cost of the project • However, in case of long duration projects( 3 to 5 yrs) the correct project cost after completion may be difficult due to uncertain price inflation rate • To avoid such situation the project cost is declared for insurance with escalation provision – The insured gets the advantage of gradual increase in sum insured as per the percentage of escalation opted. – Estimated Project cost: Rs.10 crores – Escalation opted: 25% – Sum Insured available on last date of project insurance: Rs.12.50 crores
Relationship- Risk analysis, risk control & risk financing
Financial objectives • Risk/Earnings Ratio Study” of more than 500 multinational corporations finds clear correlation between good physical loss prevention and lower earnings-volatility • Risk control or technique is essential to– – – – Ensure stability in earning and steady growth Maximize profit and cash inflow To reduce the losses and reduce cash outflow Cost effective cash outflow on control measures
Risk Financing • Risk Cost: – Control measures- proactive approach – Payment of losses- post loss approach • Financing of risk-cost by: – – – – – Payment out of current expenses Funded or unfunded reserve Debt or equity financing Pre or post-loss credit Forming a captive, a trust, by pooling or through spread-loss plan
Risk financing….. • Probability and severity of possible losses – High probability and low severity – Less probability and high severity – High probability and high severity • Capacity to retain the losses – Cost of potential loss is low – Cost of the potential loss is large – Disaster if not managed proves counter productiveEarthquake, floods, storms, etc. • Transfer of the Risk- Insurance, etc. cost
Selection of best technique • Management Technique depends upon: – Impact of losses on the finance of the organization- frequency and severity of expected losses – Possible effects of the different techniques on frequency and severity – Cost analysis of such techniques • Most cost effective technique: – Effective to get desired objectives – Feasible to implement – Cost effective- balance between cost of control and cost of risk
Implementation of Management Technique • Best technique decided on the basis of – – Feasibility of implementation – Technical decisions – Managerial decisions . Monitoring and improvement – Achievements as per standard specified or expected results – Need for modification/change in the technique – to evaluate the possible risk level changes in the business environment.
Alternatives to Reinsurance or ART • Alternative risk financing market- other than Insurance Market(traditional reinsurance) Or other techniques to finance the risks • Most of these techniques permit investors in the capital markets to take a more direct role in providing insurance and reinsurance protection, and as such the broad field of ART is said to be bringing about a Convergence of insurance and financial markets. • Need for ART came about when no reinsurance cover is made available or the risk are not insurable • Why ART ? – Tailored to specific client’s requirement – Spread of risk over time and over many investors – Risk assumption by non-insurer or reinsurer, capital market, financers, etc.
ART • • • Another area of covergence is the emergence of pure insurance risk hedge funds such as Nephila, Fermat, Securis, Coriolis, Pentalia, Goldman Catastrophe Fund, Stark Catastrophe Fund, Acuance, Soldidum, various Zurich-based funds managed by [Clariden Leu] Bank and Banque [AIG] and other such funds. These function economically like fully collaterallized reinsurers (and some of them operate through reinsurance vehicles, such as Nephila's Posiden Re and Goldman's Steamboat Re), but take the form of hedge funds. A more specialized version is Gamut Re, a tranched collaterallized risk obligation managed by Nephila. Life insurance companies have developed a very extensive battery of ART approaches including Life Insurance Securitisation, full recourse reserve funding, funded letters of credit, surplus relief reinsurance, administrative reinsurance and related approaches. Because life reinsurance is more "financial" to begin with, there is less separation between the conventional and alternative risk transfer markets than in the property & casualty sector. Emerging areas of alternative risk transfer include intellectual property insurance, automobile insurance securitization and Life Settlements. It should be possible to adapt these instruments to other contexts. Professor Lawrence A Cunningham of George Washington University suggests adapting cat bonds to the risks that large auditing firms face in cases asserting massive securities law damages. Professor Cunningham has proposed other innovative ways to transfer financial risks using alternative risk transfer mechanisms.
ART Market • Risk takers and investors like reinsurer, life insurer, banks, traders, capital market investors • Intermediaries like insurance brokers, investment bankers
• Key market participants • Banks, notably JPMorgan Chase, Goldman Sachs, Bank of America and Citibank. • Insurers, including AIG, Zurich, USAA and XL Capital • Reinsurers, notably Munich Re, Hannover Re and Swiss Re both directly and through their capital markets subsidiaries. • Brokers including Artex Risk Solutions, Willis, Marsh, Aon Corporation, Aon Benfield, BB&T Insurance Services and RK Carvill. • Consultants, notably AIR Worldwide Corp, EQECAT, Milliman International, Patterson Martin, Planalytics, Inc., Risk Management Solutions, Inc, Tillinghast, Lane Financial,Navigation Advisors LLC, BB&T Assurance Company, Ltd., ABS Consulting, Belmont Risk Solutions Ltd, The Taft Companies, Capstone Associated, Mercer (consulting firm) andWatson Wyatt. • Turnkey service providers include notably for mid market companies, Capstone Associatied Services, Ltd.
Major benefits of ART • To increase underwriting capacity and capital for insurer • Protection from catastrophic risks for the society at large • Broader choice of coverage and earning stability for corporate • Opportunity to enter into transactions otherwise outside the regulatory guidelines for insurance business • Protection of the balance sheet from credit risk
Alternative risk transfer and financing techniques • Finite risk insurance • Integrated risk management and insuratization • Insurance securitization and insurance derivatives • Contingent capital
ART- Finite Risk Reinsurance • The reinsurance arrangement is in the form of package with the limits of liability, aggregate loss coverage (Enterprise wide Risk Management), long term contract • The client has a programme tailored to its own claims experience • It is a multi-year programme, say 5 yrs., so the insurer is not tied into annual price negotiations • The client is assured not only of the availability of the product but also that is not subject to the volatility of price • The projected investment income from the premiums is explicitly brought into the calculation of the premium. • If cover runs loss free during the multi-year term, 80% of premiums as paid are returnable to the policyholder with interest
ART-Insurance linked Securities loss capacity An alternative to catastrophe excess of • • Establishes a catastrophe excess of loss market with greater price stability • Extend capacity for coverage for a particular territorial area and/or peril beyond that already available from the traditional market • Insurance linked securities appear to be financial instruments to investors and reinsurance contracts to insurance companies • Insurance companies buy cover, or additional cover in different market places.
ART- Securitization • In catastrophic losses there are constraints in insurance market. Alternatively Insurer/Reinsurer or even banks could sponsor a cat bond, which would pass the risk on to investors. • Securitisation brings about convergence of the insurance and capital market • The main form of securitisation is the Catastrophe bond which range from one year to ten year • The operation of the peril may put either the principal amount or the interest on the bond at risk, or both • the more risk that is brought into the bond, the higher the pricing for the insurer • Catastrophe bonds have been bought by banks and other related institutions and by insurance and reinsurance companies as risk bearers or financial institutions
Alternate to Reinsurance • Pooling • Orgainsations with a common purpose will self-insure through pooling arrangements. Like in USA Municipalities and trade associations pooling for similar exposers among members, example workmen compensation – Large number of small risks, where individual premiums inadequate to cover individual losses
• Self Insurance: • Reinsurance purchase reduces Insurer’s profit as there were either no claim or marginal claims • Where the insurer feel the loss experience is predictable over a period of time • The insurer can emphasis on risk management and exercise control over the claims • Self-Insurance can be an alternative • LIC retaining life business, Mediclaim business being managed by few Non-life Insurance Cos.
ART- Captives • In a group of companies the parent company forms a captive insurance company to insure the risks of all the group companies • The captive company can retain all the risks or purchase reinsurance protection, it can also provide reinsurance to other insurance companies • The premium is invested in the captive company to meet future losses.
Disaster management and Business continuity Plan • Any unexpected interruption to a critical business process, loss of revenue or market share or damage to reputation and brand, could have a significant impact on an organisation and, in extreme cases, the survival of business may even be threatened. • A Business Continuity Plan is a roadmap for continuing operations under adverse conditions (i.e. interruption from natural or man-made hazards).
Disaster Risk Management • Disaster Risk Management aims to reduce human suffering and economic losses caused by natural and technological disasters. • It is a strategic and rapid response to disasters and • promoting the integration of disaster prevention and mitigation efforts • into the range of development activities.
Disaster Risk Management… • Disaster arises by– An increase in extreme natural events, primarily due to climatic change and man made events. – Increased vulnerability of populations to these natural events ( damage to life and property) • Definition of Disaster by Disaster Management Act 2005– Disaster is an event of natural or manmade causes that leads to sudden disruption of normalcy within society, causing damage to life and property to such an extent that is beyond the capacity of normal social and economic mechanism to cope with. There are various definitions of BCP in the book
• Natural hazards: environmental disaster Earthquake, volcanic eruption, mass movement (landslide, debris flow, avalanche), windstorm (including tropical cyclone, tornado, blizzard etc.), flood, tsunami, drought, forest fire. • Manmade or organized hazards: – Act of: Terrorism, Sabotage, War, Theft, Arson, Labour disputes • Technological hazards: Industrial pollution, nuclear activities and radioactivity, toxic wastes, dam failures; transport, industrial or technological accidents (explosions, fires, spills). – Industrial disaster- caused by chemical, mechanical, civil, electrical or other process failures due to accident, negligence or incompetence, in industrial plant which may spill over to the areas outside the plant causing damage to life and property – Chemical Disaster- occurrences of emission, fire or explosion involving one or more hazardous chemicals in the course of industrial activity or storage or transportation, etc. causing loss of life, property and environment
• Results of disaster - high severity of loss – Substantial loss of life; - High value property damage; – Long interruption periods; - Other associated effects • Second Generation effects: – Children born with genetic defects; - Growth retardation in children – Hormonal chaos among girls; - Ground water contamination – Skin and gastro-intestinal diseases; - Accumulation of toxins in vegetables and breast milk • Emergency: an unplanned event that significantly– – – – Disrupts normal operations, or Pose serious threat to persons and property Cannot be managed by routine response; Requires a quick and coordinated response across multiple department or divisions
Major Disasters Triangle Factory Fire New York 1911: 100 garment workers died in fire
Minamata Mercury Disaster (Japan) 1932- 68 3000 people suffered from mercury poisoning
Seveso Dioxin Disaster (Italy) 1976 3000 animals died and 70,000 slaughtered
Tsunami in South East Asia, Dec. 26, 2004
Hurricane Katrina in North America, August 2005
Bhopal Gas Tragedy- Dec. 3-4,1984 - 40 tones of methyl iso-cyanate (MIC) gas released from Union Carbide plant for ignoring safety standards -15000 killed, over 500,000 affected. - People are suffering from Cancer, Tuberculosis, blindness, trauma, abortion, genetic defects, etc.
Features of disaster • • • • • Disaster shall create losses/damages A disaster can happen at any time It is always unpredictable Extent of loss caused cannot be estimated There is no way to know : – When it will happen – What form it will take • How much impact or damage it will cause – Total destruction of property/persons – Partial damage – No damage but destabilization, evacuation, etc
Business operation disruption • A Business can be adversely affected- short term or long term by: • Natural disaster • Terrorist attack • Cyber crime • Fund mismanagement • Simple malfunction • Proactive approach: To combat all these events, we need to have Business Continuity Plan.
Business Continuity Plan (BCP) • A disaster can seriously disrupts usual operations or processes of a business and can have long term impact on your normal way of life or that of your organizations. It could cause severe financial losses and even threaten survival of business. A disaster can affect any kind of business activity and its resources • BCP is: • A process to minimize the impact of a major disruption to normal operations • A process to enable restoration of critical assets/systems
Business Continuity Plan (BCP)… • Contd…… • A process to restore normalcy to Business as soon as possible after a crisis. • It is not just a recovery of information technology resources • It is the phase of crisis management that follows the immediate actions taken to protect life and property and contain the event • It is a plan to take actions before, during and after a disaster. But preparedness is the key.
Why to have a BCP ? • BCP is aimed to minimize the disruption of operations and ensure early recovery after disaster. Its objectives are: – – – – – To provide stability To provide sense of security To provide reliability of standby systems To provide a standard for testing the plan To ensure plan to work effectively during a disaster and minimize new decision making • Commitment of the management and all the stakeholders towards the Business Continuity plan is essential.
Impact of hazards Network Operations Disruptions Power Hardware Assessment of risks to the organization which could result in disaster or emergency situations
Purpose of BCP • To manage the risk which could prove disastrous • To minimize the likelihood of a disaster occurring • To reduce the time taken to recover when an incident occurs • To minimize the risks involved in the recovery process by making critical decisions in advance in stress free conditions and not at the time of crisis
Features of B.C. Planning • 1. Risk Reduction- Risk identification and assessment • 2. Emergency Plan- Prevention/mitigation so that it could not prove disastrous. Example- evacuation of staff, preserving important objects and data, etc. • 3. Business continuity plan- efficient resumption of business by quick recovery directions and combined team actions. Key elements for this are continuity of: • Office services- premises, furniture, stationery, etc. • Information technology- communication and computer • Human and other resources- ensure that staff: – Are aware of alternative arrangements – Have resources they need – Are productively employed
Business Continuity Plan- key tasks • Identify which operations and supporting activities need to be restarted after a disaster • The maximum acceptable time limits by which they must restart, and the resources needed to restart them • Identify contingencies for the required resources • Select a cost-effective strategy for restarting operations • Develop the BCP to guide and direct restart of operations • Test the BCP, train staff in how to use it, and keep it up to date
Strategy for BCP development • It is necessary to know the damage and impact of the event on the business before devising a strategy • Plans should be developed to deal with different phases of disaster, they may differ from organ. to organ.: • Crisis phase- first few hours after an event. Incident Control team to handle • Emergency phase- potentially threatening situation, need to monitor the events and take proactive measures • Recovery phase- after the disaster, may last from few days to several months—the need is to start essential operations by one or more recovery teams • Restoration phase- assessment of damage, repairs/ replacement till normal operation starts. • Combination of disaster phases my also be applied depending upon the situations
BCP Process should meet the objectives: • Business Continuity planning is about maintaining, resuming and recovering the business, not just the recovery of IT • Planning process should be conducted on an enterprisewide basis • Business impact analysis and risk assessment are foundation of an effective BCP • The effectiveness of BCP can only be validated through testing or practical application • The BCP and test results should be subjected to an audit and reviewed by board of directors • BCP should be periodically updated to respond to the changes
Development of BCP • It should be• Written so as various groups/teams can implement when the need arise • Specific- regarding situations and conditions under which it should be implemented • Specific regarding the steps to be taken during disruption • Flexible to respond to unanticipated threats and conditions
Cost effectiveness of BCP planning & Management • • • • AttitudeTop management Criticalitywhat are critical systems/areas Risks evaluation- which risks to be handled Investment cost benefit analysis before implementation of a system • Downtime for various systems • Recovery recovery operation using printed documents and backup taps • Implementation- Technical team shall decide and operation team shall carry out implementation
Assess Loss Exposure Definition. of loss exposure: "Any condition or situation that presents a possibility of loss, regardless of whether loss actually occurs.― • In order to manage the potential risk, the business must first identify the loss exposures: Property(ies) and causes of loss; then •Measure the impact each exposure can have on the business. •The strategies to control the risk are developed around those measurements.
Assess loss exposure…… • While building these strategies, the business may elect to retain some of the risks rather than insure or finance the exposure. • The retained losses are then paid directly by the business as they occur. • For instance, a business may elect to eliminate collision coverage from certain vehicles on its business auto policy. • The elimination of the coverage is an acknowledgement that the business will absorb the potential costs incurred in vehicle accidents. •
Assessing Loss Exposures . Fire, EQ, etc. Values Exposed Perils causing losses loss to– ppty., Income, persons, liab. Financial Consequences Impact of risks on property, net-income, liability and personnel
Kinds of loss exposures to be examined • • • • Loss to property Net income loss and consequential loss Liability Loss to personnel
Identifying and assessing loss exposure • Methods• Standardized checklist and questionnaire • Loss history • Financial statements • Flow charts • Inspection reports • Other records • Expert – knowledge and experience Frequency and severity of each exposure
Property Loss Exposure • Types of - Property & Losses: • Locate those things or those properties which have value and are exposed to loss. • Class of property affected- Real and personal • Cause of loss • Whether loss is direct or indirect • Nature of the Organization's interest in the property
Property Loss exposure • Real property- assets attached to land – Real estate including land, building , other infrastructure. • Personal property- moveable (Tangible & Intangible) Tangible- Items contained in the bldg. or otherwise like: – – – – – – Money & Securities Inventory- Raw material, finished goods, etc Machinery, Furniture, Officer stationery, office equipments, etc Data processing hardware, software Records, books of accounts, documents Automobile, other mobile items, etc Intangible Items- like Goodwill, copyrights, patents, trademarks etc. For risk managers valuing intangible assets on the basis of their extra earning power is much difficult and complicated.
Causes of loss • General classification of perils-the next step is to identify the perils causing loss • Natural perils- Acts of God like EQ, Floods, Tsunami, lightning, rockslide, landslide, volcanic eruption, drought, hailstorm, etc • Manmade perils- error or omission by human, terrorism, pollution, chemical explosion, nuclear fission, explosion, fraud, forgery, burglary, dishonesty, etc. • Economic perils- change in consumer taste and behaviour, exchange rate, inflation, recession, technological changes, obsolescence, consequences of war, strike, etc.
Financial/Monetary impact • Monetary impact/effect is – Analysing and valuing the exposures in monetary terms • Identify the property and identify the perils that may operate • Evaluate the potential loss to property by a peril • Loss can be direct or indirect: • Direct loss – Occurs when there is damage to property • Indirect loss – consequential losses – Occurs when a direct loss causes expenses to increase or revenues to decline (consequential losses)
Financial/Monetary impact -Valuation Methods • There are various valuation standards• Original purchase cost- no depreciation or inflation, trend or technical changes • Original cost less book deprecation- not accounting inflation, trend or technical changes • Market Value- demand and supply • Tax appraisal value- taxable value • Economic or use value- income produced by it • Reproduction cost- reconstruction or replacing same property • New Replacement Cost- replacing with new property • New replacement cost less physical depreciation
Net Income Loss exposure • Net income=Revenue minus expenses. Loss shall be, when: – Revenue is reduced ;or – expenses increased • Reduction in Revenue: Reasons– – – – – – – – Property damaged, lost, destroyed- source is lost Business interruption or adversely affected Reduction in revenue due to reduction in turnover(sales) Loss due records of debtors/receivable get destroyed Interruption in operations/production Contingent business interruption- supplier/customer Loss of profit on damaged finished goods Loss of rent to owner • Increase in expenses – Additional Loss in hiring alternate site (rental value) – Extra expenses incurred to continue business operations
Net Income Loss- Consequential losses • • • • Calculation of net Income Loss: Fixed cost- salaries, rent, insurance, accountancy costs. Variable cost- Material, daily wages, overtime, fuel, etc. Overhead costs- depreciation on Mach. & Bldg, indirect labour in manufacturing unit, Quality assurance cost. • Gross profit= Sales- (V.C.+ F.C.+ Overheads) • Net contribution or Non variable cost= Sale –(gross profit +V.C.) • Net contribution of each unit and each product group shall be determined
Liability Loss exposure • Legal liability- property damage or personal injuries to others • Liability arises due to responsibility of care towards others • LL arises under: – Common law – Statute Law- laws framed by Parliament – Contract Law • An organization has to therefore also manage the legal risks and ensure that it– Operates within law – Fulfill its legal obligations – Recognize and handle legal threats
Liability Loss exposure…. • • • • Sources of legal liability: Ownership of property and its use Property or goods held in trust or control vehicles • Business activity- manufacturing, sale and distribution of its products or services – – – – Public liability including pollution liab. Product liability Professional activities Employers liability
Risk Management in Insurance Sector
Risk Management in Insurance Sector
Risk Management in Insurance Sector
Risk Management in Insurance Sector

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Risk Management in Insurance Sector

  • 2. • Risk is felt everywhere in the environment • Be it an individual, society or an organization • Father will tell son- Don’t speed up the car; Don’t visit Srinagar or northeast for Holidays ! WHY ? • Risk – – Immediately we relate it to uncertainty in the outcome of an event. The outcome may not be favorable – What does it imply ? – It implies lack of knowledge about the future and the possibility of some adverse consequence
  • 3. Tragic events arouse emotions Fire loss Sickness Car acdt.
  • 4. Risk…….. • Risk is a threat or probability, which can be of the following types: – Physical damage to the property – Death or injury to self/family members/employees – Public liability arising out of the activities carried out • Risk– Uncertainty about the outcome of a situation – The possibility of outcome will be unfavorable Risk is the probability of any outcome different from the one expected (unfavorable)
  • 5. Risk…….. • Risk is a threat or probability, which can be of the following types: – Physical damage to the property – Death or injury to self/family members/employees – Public liability arising out of the activities carried out
  • 6. Risk……. • • • • Risk is the chance of a loss Risk is the possibility of a loss Risk is uncertainty Risk is the dispersion of actual from the expected results • Risk is the probability of any outcome different from the one expected (unfavorable)
  • 7. Risk- Defined • Definition of Risk• 1. Risk is defined as the combination of the probability of an event and its consequences • 2. Risk is a condition in which there is a possibility of an adverse deviation from a desired outcome that is expected or hoped for. – There seems to be a possibility of loss – Between zero and one; zero- no possibility and one - certainty • The individual hopes that adversity will not occur, like we don’t want our house to be burnt or motor car to be damaged, etc. But it may or may not happen.
  • 8. Relationship of Uncertainty to Risk • Uncertainty refers to a state of mind characterized by doubt what will or will not happen in future (Certainty is opposite mental state). • Uncertainty is a psychological reaction to the absence of knowledge about the future • There is a chance of loss or no loss. • The possibility of loss is the risk. • An asset shall depreciate in value with its use and time is certain but it will be damaged in an accidental fire is uncertain
  • 9. Degree of Risk• Degree of Risk- We use terms like: • More risk or less risk – High Probability or low probability – The higher the probability of an event shall happen, the greater is the likelihood of a deviation from the desired outcome • The probability of death at the age of 75 is higher than that at 50; so the degree of risk at the age of 75 is higher
  • 10. Degree of Risk• Zero probability mean impossible to happen and 01 means certain to happen • Therefore the probability of loss is between zero and one e.g. as the number of bullets in a revolver increases, so the probability of loss increases. If all the six bullets placed in the bullet, there is no hope of favorable result.
  • 11. Degree of Risk…… • Large no. of exposures over a period sets a trend which can be estimated. • Predictions can be made out of these estimates – Suppose from the past experience, an insurer found that one out of 1000 houses would burnt. – If the Co. insures 100,000 houses, it is unlikely that 100 houses would burn. – The actual result will be different- may be less or may be more. – But these houses are insured, The possibility of loss of more than 100 houses is Insurer’s risk.
  • 12. Peril, Hazard • Peril is a cause of a loss, Fire, theft, flood, storm, etc. • Hazard is condition that may create or increase the chance of a loss arising from a given peril. Sickness is a hazard for premature death – Physical hazard- physical properties, e.g. poor construction, property near a river, etc. – Moral hazard- dishonest tendencies in the character of the insured person that may increase probability of loss – Morale hazard- indifferent attitude towards insured property, careless attitude towards preventing losses
  • 13. How does a risk arise ? Physical HAZARDS Moral/ Morale Contribute to PERIL Causes POSSIBILITY OR PROBABILITY OF LOSS Creates RISK Possible LOSS
  • 14. Classification of Risk • • • • • Financial and Non Financial Risks Static and Dynamic Risks Fundamental and Particular Risks Pure and Speculative Risks In speculative risk- there is a situation in which there is possibility of loss and also there is possibility of gain, e.g., gambling • Pure risk- there may be a situation in which there is possibility of loss or no loss. A motor car may face and accidental damage or may not be damaged.
  • 15. Classification of Risks • Dynamic Risks Changes in the economy Changes in the consumer tastes Changes in the price level Change or advancement in Technology • Pure Risks Result of an eventLike Fire, Accdt., etc. No change in situation or Causes loss • Fundamental Risks Impersonal in nature- caused By economic, social and Political phenomenon War, flood, EQ, Terrorism, etc. Static Risks No change in economy Natural calamities Dishonesty of individuals, Fire, Accidents, etc. Speculative Risks Result of an eventGambling, etc Gain/Loss Particular Risks Personal in nature affecting the IndividualsBurglary, Fire in a house Infidelity of an employee, etc
  • 16. Financial risk • Financial Risk is often defined as the unexpected variability or volatility of returns. • Actual return on an Investment will be different than expected. This includes the possibility of losing some or all of the original investment – Credit risk- default in making payments as promised because of cash flow/collection from buyers problem – Market risk- product price (market conditions), stock price, interest rate, currency rate, etc. – Operational risk- risk of running a business, goodwill, Legal risk, etc. – Liquidity risk- Trading of a security or asset quickly in the market, etc.
  • 17. Classification of Pure Risk • Personal Risks– – – – – Premature death Old age or risk of insufficient income during retirement Accident Sickness or disability or poor health Unemployment • Property Risks– Direct loss or physical loss to the propertyFire damage to a house – Indirect or consequential loss- additional expenses for alternative accommodation • Liability Risks– Legal liability arising out of Negligently causing bodily injury or loss/damage to others or their property; Legal defense cost • Risk Arising out of failure of others– When the other person could not perform or carry out his obligation to provide services as expected
  • 18. Pure Risk Pure Risks Physical effects of Nature Social effects Personal effects Technical effects Storm E. Q. Flood Theft Fraud Negligence Riot MBD Failure of safety Device Haz.Process Death Sickness Injury
  • 19. Costs incurred during a loss-producing event • Loss producing event involves both direct and indirect costs Direct costs - as a result of damage to the property - as a result of injuries to Self, family members and employees -as a result of loss in production - for Accident investigation expenses Indirect costs -Liability costs associated with a loss Producing event -Loss of market, goodwill or reputation -Effect on the morale of the workers Costs due to the existence of the risks -Maintenance Costs- costs incurred while taking an AMC, preventive maintenance -Costs incurred to prevent liability losses such as effluent treatment, wastewater treatment, disposal of wastes etc. -Costs to meet the statutory requirements
  • 20. Private and social costs ------• Private costs ----those costs incurred by an individual or corporate firm engaged in a particular activity • Social costs --- Costs arising out of activity of an individual or a firm , but shared by the society as a whole indirectly • Burden of Risk on Society— • Size of emergency fund must be increased- to pay the unexpected losses • Society is deprived of certain goods and services- due to risk of liability lawsuit manufacturer may discontinue manufacturing certain product, like medicines, vaccines, etc. • Worry and fear are present- accident and its consequences
  • 21. Acceptability of a Risk • A decision in regard to acceptance or nonacceptance of a risk depends upon • The retaining capacity of the organization or the individual • The attitude of a person taking the decision • Size of the loss • Probability of the loss • Time • Cost of handling the risk Size-> Small Big Low Low Small Low Big High High Small High Big Probability v
  • 22. Risk Management Risk management decisions need to be made prior to knowing what the actual outcomes of unknown perils shall be. It is the study of : -all probable causes -affecting business and -probabilities of all those outcomes and then…………………
  • 23. Risk Management • Risk Management is to reduce the adverse impact of uncertain events – Uncertainties may be related to Business risks (speculative) or Pure risks – Some times it is difficult to separate the two risks as in case of introduction of new process in a factory • A risk manager therefore adopt a unified approach to deal with all types of risk. • Pure risk can be controlled by Physical control and financial control
  • 24. Risk Management • Risk Analysis – Risks identification/anticipation/perception – Evaluation/measurement – Grading • Risk Treatment Techniques – Avoidance/elimination – Reduction/control – Transfer • Risk Financing – Excess/deductible – Self insurance/coinsurance • Monitoring results/Review
  • 25. Benefits of Managing risk • Minimize the negative impact of risks • Saving resources- assets, property, people, time • Goodwill • Reduction in legal liabilities and expenses • Increasing stability in the operations of orgn. • Ability to face the different circumstances • Protecting environment • To know insurance requirement • RM is only a part of Strategic Management
  • 26. Impact of (why) Risk Management • Survival of the organisation • Reduced expenses/losses • Improvement in Profitability– – – – – Peace of mind and confidence Bold decision and risk taking ability Stability- less fluctuations in profit and cash flow Goodwill- retaining the customers and vendors Little or no interruption of operations • Peace of mind and confidence shall help in Sound management decisions & continued growth • Safety of Organisation, employees, image
  • 27. Risk Management…… • Different risk management approaches are adopted by different organizations – depending upon the kind of risks they are exposed to, – the type and size of the organizations and – their financial situation • The likely impact of different risks shall be different, – some of which may be retained, – other may require reduction/prevention and – some may require to be transferred to insurance
  • 28. Role of Risk Manager in Risk Management • RM has to be specialised person to forecast & plan RM • RM should have knowledge and skills To deal with the risks that an organization may face • RM has to cooperate and communicate with various sections or department heads of the orgn. to find the different risks and • Coordinate with the persons handling the risks. • To suggest the approach/alternatives to manage such risks with minimum cost, choose best one to implement. • Risk management should have approval of top Management so that plans, activities and controls are established & adhered to in the organization properly
  • 29. Risk Management Process - Risk Identification Risk Analysis Evaluate Risk Avoidance Physical control Selection of technique Implementation Risk Financing Transfer-Insurance Monitoring & Review
  • 30. Risk identification • Risk can be assessed/evaluated, controlled or financed only after have been identified • Objective is to find maximum number of risks • Missing a risk can have disastrous consequences • One or more method may be used to identify Risks which my further differ from Industry to Industry • Consultation with heads of various departments of the organisation shall provide valuable inputs • The risk identified should be loss producing one and proper record of the same should be maintained • The past experience of the orgainsation and that of the RM shall also help in perceiving potential risks
  • 31. Identification of Risk • Identification of areas of vulnerability and specific hazards which can interfere with achieving business targets. • Areas to be looked into: – Knowledge about the organization – Market in which it operates – Business environment – Financial strengths and weaknesses – Vulnerability to unplanned losses – Manufacturing process – Management system • Out of so many methods of risk identification, a combination of best possible methods are applied • The process of risk identification can be discussed as under: – Perception of the Risk – Identification of the operative causes and perils along with their likely results
  • 32. Risk Identification- Perception of Risk • Perception of Risk – Ability to perceive an exposure – Identification of possible causes or perils – The likely result • Cause/Source: – Type of business and nature of activities carried – Production method or processing – Place of activity, at own premises or service to be provided at clients Environment- in which the organization is working: – Legal environment : laws related to its activity, like public liability, WC Act, – Physical conditions : nearby river, earthquake zone, – Social and political situations, etc. • Role of risk manager is to adopt risk finding techniques which shall be result producing and cost effective
  • 33. Factory- what are risks? • - Production unit Stores, Assembly, Fin. Goods, Admn. Block.
  • 34. Techniques to Risk Identification: • • • • Study & Enquiry Information Sources and documents: Annual reports, Accounts (Balance sheet, etc.) Agreements and Contracts Leases agreements- responsibility of damages or losses to building or other assets or property under lease • Contracts : – Construction or other works: their terms in regard to liabilities of organization like injuries to workmen and physical damages – Purchase and sale : conditions about liability for the damages and injury • Guarantees/Warranties: After sale service records, expenses so incurred, replacements, etc.
  • 35. Perception of Risk….. • Accounting records shall reveal: • Exposure: Value of Stocks and assets like – – building, plant and machinery, Furniture Fixtures, office equipments, etc. • Interdependencies between different parts of organization, – like production and sale; dependencies on major suppliers and customers • Organization's financial arrangements and its own financial position • Past experience about losses and expenditure incurred on them; frequency of such exposures • What shall be the duration of business interruption and size of loss
  • 36. Survey • Site Inspection:• First hand information to understand the operations and functions to ascertain – – Safety or maintenance of the plants/operations – Different Risks in different sites or operations and their likely impact safety & maintenance – Risk handling capacity available there – Consultation with plant people will develop rapport to appreciate the controlling of risks – Risk management technique required there • Time consuming and may be treated as interference
  • 37. How to Perceive Risk…… • Organization Charts shall reveal: • Nature and extent of the organ. Activities, – its products, – its size, – its subsidiaries • Inter relationship and inter dependencies between its various parts/units • Splitting the organization into individual units to examine them as profit and cost centers • Decision making and implementing persons; technical persons • Organization’s weakness which may be cause of a risk
  • 38. Perception of Risk…… • Flow chart: Process layout • Manufacturing process involved from flow of raw material, different production stages uptill final customer. • It shall reveal the valuation of produce at each stage • Accumulation of stock in different stages, like at final stage in warehouse • Raw material required and sources and dependencies on the supplier
  • 39. Perception of Risk…… • Flow chart: Process layout……. • Stage which is critical in the process, any machine which is very important, causes of damage like breakdown, wear and tear, lack of maintenance and its alternative • In house repair facility or nearby workshop capable of repairs in emergency • Source of power or energy required for production • Possible period of repair of machinery in worst circumstances • What shall be potential loss or damage to property and to gross profit
  • 40. FLOW CHART • SUPPLIERS OFFICE R & D • MATERIALS FINISHED GOODS STORE TIMBER STORE SHEET METAL & PARTS STORE WOOD MACHINEING PRESSING & METAL MACHINING PACKING SECTION PAINT SHOP FINISHED PARTS STORE MAIN ASSEMBLY HEAT TREATMENT PARTS ASSEMBLY
  • 41. Risks/Perils-Risk exposure analysis • Check list: simple in nature & inexpensive • Each peril shall be considered, whether a potential threat or not to business operation • Like fire- what can be source of fire; type of construction of the building housing the business, process involvedhazardous or non hazardous, power used; fire alarm system, fire fighting system, nearby fire station • flood and inundation- proximity to river, nalah and level of ground of factory • Earthquake- type of construction, seismic zone • Riot Strike and Terrorism- law and order situation, political, social environment • Liability arising out of possible exposures- like pollution, product defect.
  • 42. Threat Analysis • Threat analysis: An alternative approach to check list • Listing of potential threats to business and possible causes • Riot, strike resulting to damage to property and partial closure of business; • Picketing- disrupting the business totally by trade union dissuading workers from working • Choking of drainage system leading to inundation • Floods due to nearby river • Epidemics leading to absence and shortage of workers • Blocking of road, due to subsidence or collapse of building • Disruption of supplies- water, power, supplies of raw material etc. due to damage to supply line
  • 43. Event Analysis • Event Analysis: Possible loss producing events • Natural – Heavy rains, storm, floods, earthquake, subsidence • Man made- Fire, explosion, Bursting of pipes, Malicious Act, Impact damage, Aircraft damage, closure of roads, closure of various supplies like raw material, water, power • The reasons for above possible events are to be identified to find the remedial measures to be under taken • The imagination and prudence of the risk manager is very relevant to prepare a Hazard Logic trees. To find hazards which may cause operation of a peril. • His coordination with relevant persons of the organization and outside organization shall play a vital role to find mitigating factors
  • 44. Fault tree analysis • Widely used method of conducting a detailed quantitative hazard assessment. • Fault tree is a graphical representation of the logistic relation between a particular accident or other undesirable event- top event and the primary cause event. • Top event is the loss producing event. • Top event is developed down the branches to the intermediate fault events, which in turn are developed into the primary failures • Output exists only when all the input exist. • Output exists only when any of the input exist
  • 45. Fault Tree Analysis - Explosion in Paint spraying booth Source of ignition Paint vapors Concentration Failure of Exhaust fan Continued Flow of paint Breakdown Of fan Failure of Electric supply Electric spark Failure of Earthing Flames Near booth worker Cigarette/ beeri in or near booth outsider
  • 46. Cause and Consequence DiagramsNielson • This method incorporates features of bothfault tree analysis as well as event analysis. • Define a critical event- boiler explosion • Define both the possible causes and the possible effects
  • 47. Cause and Consequence Diagrams • An event like- a cause and consequence diagram for boiler explosion FAILURE OF PRIMARY PUMP SCALE FORMATION SHORTAGE OF WATER PHYSICAL DAMAGE TO BOILER BOILER EXPLOSION DAMAGE TO OWNER’S SURROUNDING PROPERTY DAMAGE TO THIRD PARTY DEATH/INJURY TO EMPLOYEES
  • 48. Hazard and Operability Studies • Hazard identification studies are carried out at the planning stage of a new plant on the basis of a plant lay out, flow diagram/ process flow sheet etc. • Also carried at various construction stages of the project • To ensure that any changes if required, can be made as a result of the studies undertaken • During the studies, full description of the process is understood and attempts are made to find out possible deviations which may result into adverse consequences (losses). • Proper risk handling decision can be taken on the basis of such analysis
  • 49. HAZOP Studies • Raw material Chemical A and B are transferred by pump to a reactor where they will react to form the final product- C • A + B ------- C • Condition: If the flow of B exceeds than that of A then it can lead to an explosion Supply tank of A is empty Effect-Pump fails • Intention: Transfer A Explosion due -Isolation valve is closed To excess of B • Deviation: Don’t transfer A -Leakage from pipe • To design appropriate risk handling method ? Chemical A Reactor Chemical B Final product-C
  • 50. Input output analysis • The use of process lay out of where chain of process/sections are involved from input of material to output of a final product • Example is a manufacturing unit having A,B,C,D,E Section to • • A • 50% 100% B 100% C 100% D SALE D 50% E • Contribution by each section in total sale/revenue • Interdependencies among the sections in a process
  • 51. Safety Audit • Safety audit subjects every area of the organization's activities to a systematic critical examination with the objective of minimizing the losses. • It examines and assesses in detail the standard of all facets of a particular activity • It extends from Complex technical operations, emergency procedures to clearance certificates, job descriptions, housekeeping and attitudes, Industrial relations, etc. • Elements of safety audit: – Identification of possible loss producing situations – Assessment of potential losses associated with these risks – Selection of measures to minimise losses – Implementation of these measures within the organization – Monitoring the changes • Internal Audits • External Audits
  • 52. Identification of operative causes and perils • Interrelationship of the terms hazard, peril and loss producing event Effect of loss producing Event Peril(s) Hazard(s) Different techniques are adopted to find hazards involved, in different organizations Analysis is necessary at each stage of chain: Cause- Risk- Effect
  • 53. Risk Evaluation • For proper risk handling, it is necessary to calculate the potential impact of the risks identified, on the organisation • A comparison of Potential impact in financial terms by each risk can be analysed through: – Frequency of its likely occurrence – Probability of loss or damage – Severity of the effects of a loss – Perception of the probability of loss and its effects
  • 54. Risk evaluation……. • The risk assessment- to analyze the loss exposure, which require informations – The information in quantitative form is known as data, which is collected, analysed and interpreted – frequency of loss producing risk; – severity of loss; – premium and other costs. • For this we need to Examine statistical data on– The particular operation/company – The Industry – The country – Regionally and worldwide relevant data available
  • 55. Risk evaluation….. • Data related to all the aspects of the organisation in question are examined, like – – – – – process, Management, Loss control, turnover, strength of manpower, etc. • Constraints of Statistical method– – – – Only historical data is available Cause of risk cannot be related Data can be manipulated Effects of environmental changes not taken into account
  • 56. Risk evaluation… • Adjustments/corrections are also required to be made for– Volume fluctuation- growth or decline trend – Inflation- cost shall be more than the data under study – Increase in Exposure- Increase in the working hours-24 hrs., diversification or additions – Special circumstances- Change in legislation or change in insurance coverage – Influence of the Environment- Economic, social, political, operational changes • The result of statistical assessment shall help the management assess their impact on the organization in relation to– – – – Property/assets- Building, plant Machinery, computers, etc. Financial assets- money, debts, insurance, etc Manpower- employees, boar members, other stakeholders Liability- public, product liability, directors’ liability, pollution liability, etc.
  • 57. Risk evaluation…. • Now the risks are to be prioritized as per impact into to handle the risks properly– Small and insignificant- retained or ignored – Small size but frequent- may be retained but may also be significant if aggregated on annual basis – Medium sized but irregular- may be controllable – Catastrophe- large losses my occur rarely but devastating OR another method: Risk Mapping – HH- High Frequency and High Severity LH- Low Frequency and High Severity HL- High Frequency and Low Severity LL- Low Frequency and Low Severity
  • 58. Presentation of Data • Collect all the relevant data, e.g. number and size of fire losses suffered by a firm during one year • Collate the data- arrange in order of increasing size to understand the trend • Group the losses of different sizes and number of events in each class and record it (class frequency). • The total range of the data is usually sub-divided into between six and twenty equal class intervals, depending upon volume of data • The total range of the observations in the example next slide is from Rs. 00 to Rs.600, subdivided into 6 number of equal intervals or width of Rs. 100 • This table is known as frequency distribution
  • 59. Fire losses occurring during 1980 (Rs.) 99.0 170.5 7.5 199.5 400.0 396.5 102.5 270.0 298.5 390.0 15.0 99.5 330.0 75.0 495.0 230.0 130.5 296.0 2.10 97.5 10.0 260.0 120.0 105.0 520.0 35.0 12.5 20.0 110.0 198.0 20.0 380.0 110.0 55.5 105.0 20.0 5.0 110.0 250.5 290.5
  • 60. Fire material damages losses for 1980 (Rs.) arranging in ascending order 5.0 102.5 210.0 330.0 400.0 7.5 105.0 230.0 380.0 495.0 10.0 110.0 250.5 390.0 12.5 110.0 260.0 396.5 15.0 110.0 270.0 20.0 130.5 290.5 20.0 298.5 35.0 170.5 55.5 198.0 75.0 199.5 97.5 99.0 99.5 520.0
  • 61. Frequency distribution for fire material damage losses for 1980 Class interval Class frequency Rs. Mid- point of class interval Rs. 0- 99.5 14 49.75 100- 199.5 11 149.75 200- 299.5 8 249.75 300- 399.5 4 349.75 400- 499.5 2 449.75 500- 599.5 1 40 549.75 Over 80% of all fire losses are less than Rs.300 and that 35% lie between Rs. 0—Rs.99.5 The value lying mid-way between the upper and lower class limit is known as the class mid-point, to be used for further statistical analysis
  • 62. Graphical representation of Data • Graphs and diagrams are among the most impressive modes of presenting the data • Bar Diagram: can be vertical or horizontal parallel bars of equal width and of lengths proportional to the frequency of the particular classes • Specimen bar diagram is given in the next slide drawn from the data provided
  • 63. Company Y’s annual results before and after the introduction of a risk management programme Year Profits/losses (Rs. 000) 1970 1971 1972 1973 1974 1975 -10 -20 -30 -40 -50 -30 (Risk Management Programme started 1st January 1975) 10 20 40 40 50 1976 1977 1978 1979 1980
  • 65. Pie diagram Non Skilled 40% Semi Skilled 20% Supervisions 12% Skilled Manual 16%
  • 66. Histogram • The area of each rectangle representing the frequency. • Height of each rectangle equals the frequency of the class interval divided by the class width
  • 67. Fire material damage loss data Class interval Class frequency Rs. Class Width Rs. Height of histogram rectangle 0-99.5 14 100 14/100=.14 units 100-199.5 11 100 11/100=.11 units 200-299.5 8 100 8/100=.081 units 300-399.5 4 100 4/100=.04 units 400-499.5 2 100 2/100=.02 units 500-599.5 1 100 1/100=.01 units
  • 69. Frequency Polygon (curve) • Drawing straight line connecting the mid-points of each class interval along the top of the rectangles
  • 71. (a) Frequency Curves Frequency (b) Frequency Size of employers Liability Loses (Rs.) (c) No. of Defective goods produced in a week (d) Frequency Frequency (Damage to individual property within a 5 mile radius of scale earthquake expressed as % of total value) Size of employers Liability Loses (Rs.) Size of earthquake Losses (Rs.)
  • 72. Cumulative Frequency Distribution Fire loss data : A fire insurance company incurred 46 incidents last year distributed by claims cost as follows: Size of fire loss Rs. Class frequency Cumulative frequency 0-99.5 14 14 100-199.5 11 25 200-299.5 10 35 300-399.5 06 41 400-499.5 03 44 500-599.5 02 46 46
  • 74. Workmen’s compensation payment probability Total Claims per year (f) Likelihood Probability Rs. 0 150 0.150 Rs. 500 430 0.430 Rs. 1,000 250 0.250 Rs. 2,500 100 0.100 Rs. 5,000 45 0.045 Rs. 10,000 20 0.020 Rs. 25,000 04 0.004 Rs. 50,000 01 0.001 1000 Total 1.000 The probability distribution indicates that most likely losses remained around Rs.500 which can be expected 43% of the population
  • 75. Number of days it takes to settle a house hold insurance theft claim . Time taken to Frequency settle claim in days (f) (x) 20 10 30 20 40 30 10 40 4 50 Total 104 fx 200 600 1200 400 200 2600 Mean= 2600/104 or 25 days is the average time taken to settle a house hold insurance claim
  • 76. Days lost due to machinery breakdown at a factory in last 13 Years Year Days Lost 1 2 7 23 3 0 4 10 5 34 6 47 Mode 7 18 Median 8 0 9 9 10 11 11 29 12 15 13 20 Total 223 Mean=223/13=17.5 The above data is not sufficient to develop a detailed probability distribution
  • 77. Central tendency ( Clustering) • Most probability distributions tend to cluster around a particular value, which may be middle of the range of the possible values the distribution covers • Mean, Median and Mode are used to identify such values • Arithmetic mean is the average out of the number of days lost- 223/13=17.5; median is middle number-18; mode is the number most repeated • The arithmetic mean of a probability distribution is computed much like the arithmetic mean , the only difference is that instead of dividing by the number of items, each item in the probability distribution is multiplied by its respective probability and sum of these products is divided by the sum of the probabilities
  • 78. The arithmetic mean of a probability distribution- Workmen compensation Total Claims per year (X) Probability Cumulative frequency (P) (PX) Rs. 0 0.150 Rs. 0 Rs. 500 0.430 215 Rs. 1,000 0.250 250 Rs. 2,500 0.100 250 Rs. 5,000 0.045 225 Rs. 10,000 0.020 200 Rs. 25,000 0.004 100 Rs. 50,000 0.001 50 Total1.000 ∑ PX Rs. 1,290 /1 = Arith. Mean The expected annual total of workmen’s compensation claim for the given firm is Rs. 1290 (EXPECTED VALUE)
  • 79. Expected value • Arithmetic mean represents long-run average expectations • Arithmetic mean of a probability distribution usually referred to as the expected value of that distribution • Expected value of a probability distribution provides information about where the outcomes tend to occur, on average. It is expected loss in the example. • In the given example on an average the workmen compensation claims are Rs. 1290 per annum. It shall help the risk manager to pay premium price for any year. • Median of a distribution is the value in the middle, when the numbers are arranged in ascending order • Mode of distribution is the single value which is most likely to occur
  • 80. Dispersion ( variability) • Should the mean be treated as a guide to understand the probability of loss in future ? Or further studied to find out the correctness of the decision by analysing how far the losses that took place were near to mean • The study of probability distribution indicate two characteristics– – Central tendency or clustering – Dispersion or variability (from the point around which the distribution clusters)
  • 81. Dispersion ( variability)….. • The less the dispersion around the expected value of a distribution, the greater the likelihood that actual results will fall within a given range of the expected value. • The less the dispersion or variance, there is less risk in prediction • Variance measures the probable variation in outcomes around the expected value. • A high variance implies that outcomes are difficult to predict. • Measure of dispersion or variance- Standard deviation of the distribution and other is the coefficient of variation
  • 82. Year Days Lost Difference Square of from Mean Difference (variance) 1 7 -10 100 2 23 6 36 3 0 0 0 4 10 -7 49 5 34 17 289 6 47 30 900 7 18 1 1 8 0 17 289 9 9 -8 64 10 11 -6 36 11 29 12 144 12 15 -2 4 13 20 3 9 223/13= 17 (Mean) Standard Deviation = 1,921/(13-1) Variation is very high. 1,921 = sum of squared differences = 160.083 = 12.6 days approx.
  • 83. Standard deviation • The variance of a probability distribution provides information about the likelihood and magnitude by which a particular outcome from the distribution will differ from the expected value. • The more is the variance, the more is the uncertainty about the expected value • Square root of variance is called Standard deviation
  • 85. Application • Severity is very important, a single cat loss could wipe out the firm. • Maximum possible loss- worst loss that could happen to the firm during its life time • Maximum probable loss- worst loss that is likely to happen • Risk manager has to analyze cost effectiveness while using any RM technique. For examples: • While taking a policy: – – – – Premium cost Service charges by Ins. Co./Broker Probable average loss Possible variance • While opting for voluntary deductible – Premium saving exceeds the average loss • While investing on loss preventive measures, like– purchase cost of Fire Fighting equipment and – the saving in premium in consequence thereof.
  • 86. Probable Maximum Loss • An estimate of the monetary loss which is likely be suffered by the insurer on a single risk at any one point of time , e.g. as a result of a single fire or explosion
  • 87. Probable Maximum Loss • • 1. 2. It is more of a subjective phenomenon. Depends upon: Technical info about the risk. Contribution made by each block to the gross profit of the org. 3. Type of coverage given by the insurers. 4. Past loss experience. 5. Physical inspection of risk.
  • 88. Probable Maximum Loss Advantages of PML 1. Placement of reinsurance contract. 2. Whether to retain or transfer. Disadvantages of PML 1. Subjective phenomenon 2. Requires experts 3. Requires periodic revision.
  • 89. Risk management decisions • To decide over the probability of loss in future with the help of stat-analysis • What shall be the cost of loss control measures to be adopted and to what extent the average loss shall be reduced • What is the cost of premium and related costs in comparison to average loss • What shall be the capacity of business to sustain a loss by self to decide about the excess applied by Insurance or voluntary excess to be adopted
  • 90. Decision taking under conditions of Risk and Uncertainty • Risk manager has to take a decision from the various decisions/options • A decision can have more than one outcome, the result are not known (uncertainty) • Manager may also unable to find out various outcomes • Decision theory is based on various techniques adopted by the manager to deal with different categories of uncertainty – Pure uncertainty – Risk – Competitive uncertainty
  • 91. Decision taking under Pure Uncertainty • Pure uncertainty • When all possible outcomes to a decision are known (probability is not known) • But knowledge of which one will occur is absent • Risk • When outcomes are known and probability of each occurring can be assessed • Risk comes in selecting the strategy/ scheme • Competitive uncertainty • Decisions after knowing that Rivals using strategy to minimise the gains
  • 92. Decision making under Pure Uncertainty….. • Pure uncertainty exists when the manager can specify all the possible outcomes of different strategies but has uncertainty of which one will occur (probability of the outcomes is not certain) • Manager has to decide about the various options or strategies and the outcomes as resultant of those strategies • Cost of 3 Risk Retention Scheme – Pay-Off Matrix(Rs.000) Risk Retention Scheme Claims Experience in next 5 yrs- Expected (Rs.000) High Medium Low A 26 7 0 B 15 14 6 C 10 10 10
  • 93. Minimax criterion • Decision criteria which may be applied depending upon manager’s attitude towards retention of risk • A pessimist or risk averter will assume worst possible result would occur or highest cost in this case • He shall choose scheme A expecting a high claim experience costing Rs.26,000 • Minimax criterion- minimum out of Max. – • As per the High claim experience table given below, the manager shall choose scheme C with minimum cost Rs.10000 in minimax criterion Scheme High A 26 B 15 C 10 Cost of Rs. 000s
  • 94. Minimum Criteria • An optimistic manager who can take a risk, would always expect the best to happen and shall opt for the low claim experience • He would choose scheme A with minimum cost under minimin criterion Scheme Low A 0 B 6 C Cost of 000s 10 Shortcomings in both the criterions: • It is assumed that the risk attitude of the manager is either risk averse or risk preferer • The intermediate or medium values of the pay off (claims) was ignored
  • 95. Coefficient of Optimization • Out of those shortcomings, the first one about extreme attitude of risk manager can be overcome by taking weighted average of the results •A decision maker shall choose a number between 0 to 1 indicating his risk attitude •An optimistic manager shall choose higher coefficient as .80 or 4/5 and thereby the expected pay offs for each strategy shall be as under: Scheme Minimu m cost Maximu m cost Expected Pay-Off Rs. ‘000 A 0X4/5 + 26X1/5 = 5.2 B 6X4/5 + 15X1/5 = 7.8 C 10X4/5 + 10X1/5 = 10.0 The optimistic manager would choose scheme A which has the lowest expected cost
  • 96. Insufficient Reason Criterion The second criticism of ignoring intermediate values of the pay offs. • In the absence of knowledge about the probability of each event, all the events from high to low claim experience in all strategies, shall be deemed to happen •The payoff for each scheme is then the average payoff in each row as calculated under: Medium Scheme High Low Expected PayOff Rs. ‘000 A 26 X 1/3 + 7 X 1/3 + 0 X 1/3 = 11.00 B 15 X 1/3 + 14 X 1/3 + 6 X 1/3 = 11.67 C 10 X 1/3 + 10 X 1/3 + 10 X 1/3 = 10.00 In this case scheme C would be chosen. This method takes no account of decision maker’s risk attitude.
  • 97. Minimax Regret Criterion The risk manager does not want to regret on the choice of scheme he has opted, and therefore examine the results of another choice. Regret is measured as the absolute difference between the pay-off for chosen strategy and the pay-off for the most effective strategy with the same state of nature Risk Retention Scheme Claims Experience Rs.000 High Medium Low A 26-10=16 7-7= 0 0 B 15-10= 5 14-7= 7 6 C 10-10= 0 10-7= 3 10 Scheme Cost of 000s A 16 B 7 C 10
  • 98. Decision making Under Risk Risk Retention Scheme Claims Experience (probability is known) High Probability 0.5 Medium Probability 0.3 Low Probability 0.2 A 30 10 50 B 40 30 20 C 20 20 30 The expected Value of each scheme is as follows: Scheme A : 30X0.5 + 10X0.3 + 50X0.2 = Rs. 28,000 Scheme B : 40X0.5 + 30X0.3 + 20X0.2 = Rs. 33,000 Scheme C : 20X0.5 + 20X0.3 + 30X0.2 = Rs. 22,000 Here B should be chosen for having highest expected value.
  • 99. Subjective Probability • Decisions are based on the probabilities of outcomes, derived from statistical data • But it is not always possible to arrive at a decision due to lack of sufficient statistical data • A subjective decision is taken by risk manager depending upon the degree of confidence to judge probabilities of different events based on his experience and whatever historical data available
  • 100. Subjective Probability…….. • According to the degree of belief for the possible occurrence of an event, the risk manager assigns a probability between 0 to 1 • The experience of similar firms or organizations my also be examined • All the available facts and data must be collected and expert opinions may be sought for by the risk manager
  • 101. Risk Management Techniques . Risk Financing Risk Control/ Preventive measures -Avoidance -Prevention -Reduction -Segregation -Contractual By Retention -Operations -Fund/Reserves -Pool -Debt or equity -Credit -Pool By Transfer -Contract by Jobwork/AMC -Insurance
  • 102. Other Risk Management Tools • RM information System(RMIS)- A computerized RM database stored & analysed by RMr to predict and attempt to control future loss levels. • RM intranets and Web sites- with search facilities, answering FAQs and having wealth of other information • Risk Maps- giving details of potential frequency and severity of the risks faced by the organization • Value at Risk(VAR) analysis – worst probable loss likely to occur in a given time period under regular market condition • Insurer can apply VAR to a portfolio of assets such as mutual fund or pension fund
  • 103. Risk Management Techniques -Risk Control: Avoidance, Reduction • Purpose of Loss control ? • Any loss caused by a risk is a cost to individual, firm or society – Cost of injury or damage – Cost of handling and steering the loss – Cost of any risk control measures – Cost of financing a loss – Cost of arranging finance to recover loss (loss) • Loss control Management is to reduce such cost – Prevent losses, eliminate the cause of loss – Protect people and property from loss/damage – Limit the extent of loss, if it happens – To recover the most
  • 104. Risk management techniques • Stage immediately after completion of the risk assessment phase consists of preparing a Risk Treatment Plan • The plan should document the decisions about how each of the identified risks should be handled by- • Avoidance (eliminate, withdraw from or not become involved) • Reduction/prevention (optimize - mitigate) • Retention (accept and budget) • Sharing (transfer - outsource or insure) • A combination of the above
  • 105. Risk Management Techniques -Risk Control: Avoidance, Reduction • Risk avoidance: Drastic method of risk control • Abandon some activity or change the product • Change in existing operations or in the nature of activitiesuse of non hazardous or less hazardous raw material • Change the location of operations- shifting of factory • Such changes cause major inconvenience and disrupt the business • Incur substantial expenses, which may be direct or indirect cost- new machines or costly raw material; handsome income forgone by leaving the hazardous production • RM should be a Proactive approach: • It is therefore better to have a full risk appraisal conducted when a new project is coming up and risk control devices may prove cheaper than the modification at a later stage
  • 106. Risk Reduction/Prevention • Reducing the probability of risk occurrence: • Prevention of accidents improve industrial relations—attracts skilful labour • Improvement in the quality of risk making it more acceptable – Proper maintenance enhances useful life of machines --indirect savings in cost and increase of productivity – Clearing of waste at more frequent intervals – Knowledge & Training- Sign boards, instruction • Advantage: Discounts in insurance premium – Choice of voluntary deductibles—step towards risk retention – Easier to get reinsurance support—for insurers
  • 107. Risk Reduction • Risk reduction is also called as loss prevention measure – To reduce the probability of loss – To reduce the size of loss (impact) • By selecting appropriate scheme out of various options in relation to the cost involved/incurred • Arranging finance or funds the various scheme available • The cost involved in the activities related to loss prevention must be examined in relation to potential savings earned in future • Loss reduction schemes require: – Allocation of limited funds to different schemes – Various methods of risk financing • Risk/Earnings Ratio Study” of more than 500 multinational corporations finds clear correlation between good physical loss prevention and lower earnings volatility
  • 108. Risk Reduction…… • • Classification or Nature of Loss Control/Reduction Measures: Pre Loss Reduction 1. 2. Avoidance - Eliminating the cause of loss: Avoiding the risk; use of non-hazardous material instead of Haz. Reduction - Reducing the probability of a loss occurring: Improving the risk; Loss controlling devices are kept in order On occurrence1. 2. Raising an alarm Measure to control it at source or not to allow it to spread Post Loss Reduction- Reducing the size of loss: 1. 2. 3. Protective or quasi-preventive- Protecting things or persons exposed to damage or injury; Minimizing- to limit loss to as small as possible; Salvaging- to preserve as much as possible of the value or damaged property or the rehabilitation of injured persons
  • 109. Loss Control/Loss reduction…. • Loss Control/ Reduction Measures : • Passive Measures: Inbuilt • Which shall , limit the loss or facilitate recovery – Perfect party walls to segregate the blocks – Fire doors – Contingency plan • Proactive Measures: Taking steps to limit the loss or maximise the recovery: – Sprinklers, – Burglar alarms – Training of Salvage operations
  • 110. Risk Reduction…… • Yet Another Classification of Loss Control/ Reduction Measures : • Reduce Probability of a loss-producing event– fitting of safety guards to dangerous machinery; safety valves in pressure vessels – removing potential sources of ignition, waste or bushes; – removal of obstacles, spillages and slippery surfaces from gangways, stairs, etc. – separation of pedestrian and vehicular traffic • Reduce Size of the loss expectancy- severity – Inundation – keep susceptible goods above floor level; - installation of fire fighting equipments- sprinkler systems and smoke vents; - provision of first-aid facilities; - Fittings against water- tight compartments in ships. And of fire Reducing both, Probability & Severity of Loss: – Education & Training to employees and use of non combustible walls and doors in buildings
  • 111. Risk Reduction…… • Examples: • Minimizing measures: - Wearing helmets while driving or moving in the works or factory - Segregation of the sound stocks from the partially burnt or the completely burnt goods • Mixed measures: – Construction of fire proof doors and perfect party wall (14”)segregating a hazardous block from a nonhazardous block – Replacing combustible material of building or poor construction by non-combustible material – Education and Training
  • 112. Probability of a fire in a factory • Evaluation of risk – Possible sources (identification) – Probability of fire (analysis & evaluation) Frequency Severity • Pre-loss control – Limiting the availability of flammable materials and oxygen – Limiting the spread of fire • Post-loss control – Salvage materials, stock, property(minimise Loss) – Use of protection devices such as FFE
  • 113. Risk Factor Analysis Chart Activity P&M, Operations Hazards & loss Equipments involved experience Manufacturing -A -B Material Management R&D To ascertain: Loss control like-Method of risk control -Introduction of Protection system -Training & education -Any change or modification required -Financing of the risk control -Financing of the loss/damage Comments/ analysis
  • 114. Loss Control Measures • Loss control measures are cost to the organ. • Cost is incurred so as to take benefit in future in – Reducing the probability of loss – Reducing the size of loss
  • 115. Risk Reduction…… • 1. 2. 3. Yet Another classification: Education and training Procedural devices Physical devices
  • 116. Who should be trained----• • • • Employees of the organization Contractors and sub contractors Suppliers, service providers Third party visitors
  • 117. Why training: • Most of the losses or damages are the resultant of negligence, carelessness, lack of knowledge. • Human factor plays a major role in all this. • The Management of the Organization must be aware of the Risks and understand the need of Risk prevention
  • 118. Education and training • The management of Education and training on loss prevention should be recognized at various stages. • Planning Stage: while designing the plant and product, concerned persons should be educated to ensure the – – Safety of employees – Safety of Bldg., Plant, Machinery and other assets – Safety of the final product and its safe use
  • 119. Education and training….. • • • • Planning Stage….. Segregation of hazardous blocks Contingency / disaster planning Incorporation of safety measures in the plant design e.g fire resistant/ earthquake resistant structure • Planning for product safety—ensuring quality control
  • 120. Education and training….. • Production Stage: Employees associated with production need to be educated on safety norms and loss prevention • Personal injuries- can be avoided by knowledge and carefulness by individuals • Workers safety and avoidance of congestion in work place • Security/ security checks • Knowledge of manuals for operation of Machinery • The prevention of major hazards call for the use of technical knowledge
  • 121. Education and training….. • Good house keeping- Avoid smoking, loose wiring, proper storage facility for hazardous and non hazardous material, accumulation of waste material, Waste disposal procedure • Maintenance of plant and machinery- timely maintenance and repairs. Guarding/Casing of machinery to avoid personal accidents • Training to use Fire fighting installations • Final product- High Technical standards and Quality control in producing the final product for the safety of users • Education to visitors/ suppliers/ vendors
  • 122. Education and training….. • After Sales service • Supply of goods to customers in sound condition • Proper labeling and clear instruction for use of the product • People associated with after sales service, transporter, servicing employees must be educated • Information system about the usefulness and defects must reach to management to make changes in design of the product or after sale services
  • 123. Education and training….. • Security: • Security holds a very key position in the process of loss prevention and safety • Security of the organization, including its personnel and assets is very important • Other business risks are espionage, defalcation and credit risks which require special training and education programme.
  • 124. Procedural Devices-Management Attitude • It is the responsibility Management to laid down the procedures to be followed by the people in the site during their operations and on happening of an event – To reduce the probability and severity of loss – Trained to use the safety equipments and also follow the instructions – To make aware about the safety procedures to fellow employees and outside agencies those are coming to the sites
  • 125. Procedural Devices….. • Some examples procedural devices are: – Manning of works/factory entrances for security checks – Steps to be taken for easy and speedy communication – Evacuating the visitors and the third parties to safe places – Information to Fire fighting team and safety team – First aid facilities to injured – Instructions to operators to handle the plant and machinery and safety measures – Procedure for plant control, shutdown and maintenance – Movement of material and equipment to safe places – Periodic internal audit system; safety audits
  • 126. Procedural --– No smoking sign – Minimum congestion at work places – Vehicles with spark arrestor to enter into premises where there are presence of flammable vapours – Flame proof electrical fittings in such areas – Adequate precautions to be taken at places where hot work is carried out – No storage of hazardous chemicals near machines - to avoid sparks arising out of static electricity falling on these
  • 127. Management attitude--Procedural deviations:---• Non adherence to statutory requirements under Boiler Act/Factory’s Act • Smoking being allowed inside the premises • Relaxed security norms ---e.g. vehicles without spark arrestors entering inside refinery premises • No formal procedure for waste disposal • No formal training on fire fighting for employees
  • 128. Contingency Planning • Risk Management is the concern of top management • Management awareness of risk should lead to the designing and adoption of contingency plans for unforeseen major or catastrophic losses • There can be instances when a small damage to property or critical machinery leads to prolonged stoppage of business • Planning should be such that while the salvaging operation following the loss are being carried, the business should also continue. • It is therefore must that the employees must be trained to deal with emergency situations
  • 129. Contingency Planning…… • While preparing contingency plan to deal with major disaster, the management must consider the following: – Identify all potential sources of loss-producing events which may disrupt the normal operations – Determine the interdependencies between different parts of the organizations – Determine the dependencies upon the suppliers and customers – Identifying the alternative sources of supply or outlet to remove such dependencies
  • 130. Contingency Planning…… • Find the means of reducing the impact of the potential hazards as identified, such as : – Availability of Spare plant or machineries related to the trade – To hold a larger stock of raw material or finished goods in different stores/places – Find another supplier or customer to avoid vulnerability of business to limited suppliers or customers
  • 131. Contingency Planning…… • While adopting above means the extra cost involved should reasonable in regard to the potential risk – Making arrangements with other business organization in competition to produce the goods at the time of contingency to reduce the impact on business – Employees must be educated and trained to take initiative to act and handle the situation. Responsibilities should assigned to each employee who is part of the team handling contingency plan so that employee is supposed to know his role in time of contingency.
  • 132. Training of Employees • Knowledge of hazards to which employees are exposed in course of their work and steps to be taken to minimise the risk of injury to them or fellow employees • Use of special clothes and use of equipments provided for their safety • Laid down procedure for all employees to take steps in emergencies, like fire, MB or breakdown of safety devices • Immediate relief or salvaging exercise until expert help arrives, like first-aid and fir fighting teams • Inculcating a sense of responsibility to safetyconsciousness in the employees
  • 133. Contractors, Suppliers, Retailers and Service Agents • • • • • The outside agencies who are involved in the organisation’s operations may be given necessary technical training – say knowledge of hazards and steps to be taken, defects in the products, etc. Supplier- consequences of supplying defective components. Standards of quality control system and product must be mutually agreed Inward material if brought inside the site of work must in be informed to security to take necessary safeguard Identifying the transit hazards and taking control measures Cash carrying safety measures
  • 134. Physical Devices • Wide range of physical devices are available to reduce the probability and severity of loss caused by various risks. Categories of physical devices : Active devices which continuously operate to reduce the probability of loss-producing event occurring, like • • – – – – – Close circuit TV Thermostats on boilers and refrigerating equipments, Guards on power presses and other machines, Overload and other warning devices Devices for detecting leakage
  • 135. Physical Devices……. • Passive devices which come into operation on happening of an event, like – – – – – – – – – Security and alarm system, automatic fire doors and vents, Automatic switch off devices Portable fire extinguishing appliances Small bore hose reels Hydrants and sprinklers Water spray systems Carbon di oxide flooding systems First aid and salvaging equipments
  • 136. Statutory and other requirements • Factories Act, 1948 and amendments; other safety regulations are to be complied in regard to: – Safety at work – Food and drink regulations – Transport regulations covering aircraft, ships and vehicles – Safety of persons in hotels, boarding houses and other premises to which the public has access – Safety of persons adjacent to premises in which dangerous processes are carried on
  • 137. Statutory and other requirements Safety • Safety norms and implementing the statutory safety requirements are integral parts of any loss prevention system. • Moving and rotating part of machines like fan belt, conveyor belts etc. should be covered or fenced • Machines should operated by trained male workers, wearing tight fitting clothing • Lifts and hoists should be of good mechanical construction, and of sound material and maintained periodically • Examination and maintenance of lifting machine, chains, ropes and lifting tackles periodically
  • 138. Statutory and other requirements- Safety………. • Workers are to be provided with screens or goggles for protection of their eyes where process involves risk of injury to the eyes, like dry grinding of metals by hand welding or cutting of metals use of electricity • Gas cylinders should be stored in enclosed area with asbestos roofing and preferably with wall thickness of two bricks with proper ventilating system
  • 139. Statutory and other requirements…… • Electrical installations should be proper with no loose wiring, no open switchboards. Regular checking of wirings and switchboards • Installation of right type of Fire extinguishers at correct places • Proper training on safety aspects should be given to all the employees to ensure safe operations at the site • The safety instructions as well as the directions to safety exits should be prominently displayed at strategic locations within the factories
  • 140. Physical hazards ----Storage • 1. Over stacking up to the roof Delay the operation of automatic sprinklers and even if they operate the distribution of water will be impaired 2. Touch the electrical installations • Highly congested storage area 1. Denial of access to fire fighters –reduce efficiency 2. Heat generation
  • 141. Physical hazards ----Storage • Little or no space between high stacks --- create a flue effect drawing heat upwards to spread fire vertically • Locked warehouses with high stacks --- many a times small fires which go undetected develop into a large one (since warehouses are mostly unmanned ) • Storage in front of open switch boards , near transformers, adjacent to electrical installations --inception of fire as well as propagation • Storage in front of fire extinguishers -- denial of access to the fire fighting appliances
  • 142. Spontaneous combustion---• Certain materials undergo rise in temperature without application of external source of heat • When stored in bulk or in close contact with other materials ---a chemical or physical reaction is initiated which results in spontaneous development of heat as a result of oxidation • Bacterial reaction in organic materials
  • 143. -
  • 144. Physical hazards ----Electrical Installations • Overloading the circuit----current flowing through the main supply cables increases as additional current consuming appliances are introduced into the circuit . Heat generated in the circuit proportionately increases . H= I 2 R t • Loose electrical wirings/ temporary wiring ---increases probability of short circuit • Open switch boards ---- possibility of combustible materials settling in between the wires and igniting subsequently • Wooden switch boards
  • 146. Faulty electrical wiring------• High tension wires passing over storage in open • Main switch board inside a warehouse --- in case of emergency / electrical fire the connections cannot be discontinued • Non-industrial lighting in factories
  • 147. Physical hazards-Housekeeping • Congestion in work place ---insufficient floor space • Accumulation of chemicals / wastes on the floor at the work place -- e.g. cut-pieces of cloth in a garment manufacturing unit • • Inadequate safety during hot work-- e.g. necessary precautions not being taken during welding operations
  • 150.
  • 151. Location and exposure hazards--• Hazardous surroundings---- dry bushes, hazardous operations in neighboring factories • No space for fire brigade – • Buildings in close proximity to each other – • Temporary sheds • Remote locations • Static electricity / frictions from machines ---e.g. belts passing over pulleys or rollers generating static sparks
  • 152. Handling the sources of ignition-• Electrical installations---1. 2. 3. 4. 5. 6. 7. Wirings should be in metal conduits or in armoured PVC cables Non-combustible materials to be used for switch boards Closed switch boards Power cables in trenches or through bus bars No overloading of circuit Double earthing of machines No storage in front of switch boards/ inside panel rooms
  • 153. Handling the sources of ignition- • Storage – 1. 2. 3. Proper stacking and orderly storing Clear space of one and half to two feet from the roof Preferably storage in pellets and clear space of one to two feet from walls No storage in gangways, staircase , in front of FEA Space between high stacks –ensure proper air circulation, space for movement of fire fighting personnel Main switch outside the storage areas for cutting off electric supply in case of fire 4. 5. 6.
  • 154. Handling the sources of ignition• Spontaneous combustion— 1. Stacks should be spaced from each other as much as possible Regular inspection for over heating e.g. haystacks Stocks of coal should be upturned at regular intervals and kept away from main premises Freshly prepared charcoal should be kept exposed to air for adequate time before packing and storing Oily rags/ cleaning rags should be kept in metal bins and the bins should be kept away from main premises 2. 3. 4. 5.
  • 155. Handling the sources of ignition• Waste disposal ---1. Periodic waste disposal should be carried out and there should be a formal procedure for the same 2. Wastes should be kept in separate warehouse away from main blocks 3. Segregation of wastes from other stocks 4. Install fire fighting extinguishers near waste storages
  • 156. Fixing of Sum Insured • Sum insured represents the value for which the customer wishes to insure his asset/property • Sum insured represent the maximum liability of the insurance company in the event of an accident • Premium is charged by insurer on sum insured • Sum insured can represent: – Market value or – Reinstatement/replacement value
  • 157. Fixing of Sum Insured……. • Market value is a depreciated value. New replacement cost less depreciation gives the depreciated market value as on date of taking a policy • Reinstatement value is the current market price of the plant and machinery or reinstatement value of the building • Policy year 1.4.2005 to 31.3.2006 • Original Capitalized cost of Machinery Rs.10,00,00,000 as on 1.4.1995 • Index for April- March 1994-1995 110 • Index for April-March 2004-2005 190 • Replacement cost of Machinery Rs.10,00,00,000x190/11 =Rs.17,27,27,280 • Deprecation e.g. @ 5% per year for 10 yrs. (-) Rs.8,63,63,640 • Depreciated Market value of Machinery on 1.4.2005 = Rs.8,63,63,640
  • 158. Fixing of Sum Insured……. • The settlement of the loss shall be based upon the basis of sum insured opted for by the insured • If the sum insured is found less than market value or the reinstatement/replacement value as the case may be, underinsurance shall apply • Example: • • • • • Market value Reinstatement value Sum insured Rs.10,00,000 Rs.20,00,000 Value at time of loss Rs.15,00,000 Rs.30,00,000 Loss Rs.600,000; Loss payable 600000x10/15 600000x20/30 Rs.4,00,000 Rs. 4,00,000
  • 159. Fixing of Sum Insured…… • Reinstatement/Replacement Value: • Large Plant, machineries, equipments: – Original capitalised cost as per books of accounts – Inflation/escalation factor up till inception of the insurance policy to be added to the value – This escalation/inflation is done on certain paramenteters like RBI Index published by RBI for various machineries and industries. This value represents the new replacement cost • For small machineries/equipments the current market price of new one at which they are available may be treated as replacement value
  • 160. Fixing of Sum Insured… • Building: Either of the method can be adopted– Prevailing PWD rate per square meter can be applied to the total covered area of the building to get the new reinstatement value; or – The initial constructed cost is escalated/inflated on the basis of established parameters to arrive at the current replacement value – The improvements done during previous years need to be added further to the cost • Stocks: The maximum quantity of stocks at risk during the previous year is multiplied by prevailing market cost without profit
  • 161. Fixing of Sum Insured…. • On Market value: • Plant, Machinery and equipments – – An average rate of depreciation ranging between 3% - 5% per year is applied to replacement value • Building– An average rate of depreciation ranging between 1.5% - 5% per year is applied to reinstatement value of the building
  • 162. Fixing of sum insured…. • Project Insurance: • Sum insured represents the estimated complete constructed cost of the project • However, in case of long duration projects( 3 to 5 yrs) the correct project cost after completion may be difficult due to uncertain price inflation rate • To avoid such situation the project cost is declared for insurance with escalation provision – The insured gets the advantage of gradual increase in sum insured as per the percentage of escalation opted. – Estimated Project cost: Rs.10 crores – Escalation opted: 25% – Sum Insured available on last date of project insurance: Rs.12.50 crores
  • 163. Relationship- Risk analysis, risk control & risk financing
  • 164. Financial objectives • Risk/Earnings Ratio Study” of more than 500 multinational corporations finds clear correlation between good physical loss prevention and lower earnings-volatility • Risk control or technique is essential to– – – – Ensure stability in earning and steady growth Maximize profit and cash inflow To reduce the losses and reduce cash outflow Cost effective cash outflow on control measures
  • 165. Risk Financing • Risk Cost: – Control measures- proactive approach – Payment of losses- post loss approach • Financing of risk-cost by: – – – – – Payment out of current expenses Funded or unfunded reserve Debt or equity financing Pre or post-loss credit Forming a captive, a trust, by pooling or through spread-loss plan
  • 166. Risk financing….. • Probability and severity of possible losses – High probability and low severity – Less probability and high severity – High probability and high severity • Capacity to retain the losses – Cost of potential loss is low – Cost of the potential loss is large – Disaster if not managed proves counter productiveEarthquake, floods, storms, etc. • Transfer of the Risk- Insurance, etc. cost
  • 167. Selection of best technique • Management Technique depends upon: – Impact of losses on the finance of the organization- frequency and severity of expected losses – Possible effects of the different techniques on frequency and severity – Cost analysis of such techniques • Most cost effective technique: – Effective to get desired objectives – Feasible to implement – Cost effective- balance between cost of control and cost of risk
  • 168. Implementation of Management Technique • Best technique decided on the basis of – – Feasibility of implementation – Technical decisions – Managerial decisions . Monitoring and improvement – Achievements as per standard specified or expected results – Need for modification/change in the technique – to evaluate the possible risk level changes in the business environment.
  • 169. Alternatives to Reinsurance or ART • Alternative risk financing market- other than Insurance Market(traditional reinsurance) Or other techniques to finance the risks • Most of these techniques permit investors in the capital markets to take a more direct role in providing insurance and reinsurance protection, and as such the broad field of ART is said to be bringing about a Convergence of insurance and financial markets. • Need for ART came about when no reinsurance cover is made available or the risk are not insurable • Why ART ? – Tailored to specific client’s requirement – Spread of risk over time and over many investors – Risk assumption by non-insurer or reinsurer, capital market, financers, etc.
  • 170. ART • • • Another area of covergence is the emergence of pure insurance risk hedge funds such as Nephila, Fermat, Securis, Coriolis, Pentalia, Goldman Catastrophe Fund, Stark Catastrophe Fund, Acuance, Soldidum, various Zurich-based funds managed by [Clariden Leu] Bank and Banque [AIG] and other such funds. These function economically like fully collaterallized reinsurers (and some of them operate through reinsurance vehicles, such as Nephila's Posiden Re and Goldman's Steamboat Re), but take the form of hedge funds. A more specialized version is Gamut Re, a tranched collaterallized risk obligation managed by Nephila. Life insurance companies have developed a very extensive battery of ART approaches including Life Insurance Securitisation, full recourse reserve funding, funded letters of credit, surplus relief reinsurance, administrative reinsurance and related approaches. Because life reinsurance is more "financial" to begin with, there is less separation between the conventional and alternative risk transfer markets than in the property & casualty sector. Emerging areas of alternative risk transfer include intellectual property insurance, automobile insurance securitization and Life Settlements. It should be possible to adapt these instruments to other contexts. Professor Lawrence A Cunningham of George Washington University suggests adapting cat bonds to the risks that large auditing firms face in cases asserting massive securities law damages. Professor Cunningham has proposed other innovative ways to transfer financial risks using alternative risk transfer mechanisms.
  • 171. ART Market • Risk takers and investors like reinsurer, life insurer, banks, traders, capital market investors • Intermediaries like insurance brokers, investment bankers
  • 172. • Key market participants • Banks, notably JPMorgan Chase, Goldman Sachs, Bank of America and Citibank. • Insurers, including AIG, Zurich, USAA and XL Capital • Reinsurers, notably Munich Re, Hannover Re and Swiss Re both directly and through their capital markets subsidiaries. • Brokers including Artex Risk Solutions, Willis, Marsh, Aon Corporation, Aon Benfield, BB&T Insurance Services and RK Carvill. • Consultants, notably AIR Worldwide Corp, EQECAT, Milliman International, Patterson Martin, Planalytics, Inc., Risk Management Solutions, Inc, Tillinghast, Lane Financial,Navigation Advisors LLC, BB&T Assurance Company, Ltd., ABS Consulting, Belmont Risk Solutions Ltd, The Taft Companies, Capstone Associated, Mercer (consulting firm) andWatson Wyatt. • Turnkey service providers include notably for mid market companies, Capstone Associatied Services, Ltd.
  • 173. Major benefits of ART • To increase underwriting capacity and capital for insurer • Protection from catastrophic risks for the society at large • Broader choice of coverage and earning stability for corporate • Opportunity to enter into transactions otherwise outside the regulatory guidelines for insurance business • Protection of the balance sheet from credit risk
  • 174. Alternative risk transfer and financing techniques • Finite risk insurance • Integrated risk management and insuratization • Insurance securitization and insurance derivatives • Contingent capital
  • 175. ART- Finite Risk Reinsurance • The reinsurance arrangement is in the form of package with the limits of liability, aggregate loss coverage (Enterprise wide Risk Management), long term contract • The client has a programme tailored to its own claims experience • It is a multi-year programme, say 5 yrs., so the insurer is not tied into annual price negotiations • The client is assured not only of the availability of the product but also that is not subject to the volatility of price • The projected investment income from the premiums is explicitly brought into the calculation of the premium. • If cover runs loss free during the multi-year term, 80% of premiums as paid are returnable to the policyholder with interest
  • 176. ART-Insurance linked Securities loss capacity An alternative to catastrophe excess of • • Establishes a catastrophe excess of loss market with greater price stability • Extend capacity for coverage for a particular territorial area and/or peril beyond that already available from the traditional market • Insurance linked securities appear to be financial instruments to investors and reinsurance contracts to insurance companies • Insurance companies buy cover, or additional cover in different market places.
  • 177. ART- Securitization • In catastrophic losses there are constraints in insurance market. Alternatively Insurer/Reinsurer or even banks could sponsor a cat bond, which would pass the risk on to investors. • Securitisation brings about convergence of the insurance and capital market • The main form of securitisation is the Catastrophe bond which range from one year to ten year • The operation of the peril may put either the principal amount or the interest on the bond at risk, or both • the more risk that is brought into the bond, the higher the pricing for the insurer • Catastrophe bonds have been bought by banks and other related institutions and by insurance and reinsurance companies as risk bearers or financial institutions
  • 178. Alternate to Reinsurance • Pooling • Orgainsations with a common purpose will self-insure through pooling arrangements. Like in USA Municipalities and trade associations pooling for similar exposers among members, example workmen compensation – Large number of small risks, where individual premiums inadequate to cover individual losses
  • 179. • Self Insurance: • Reinsurance purchase reduces Insurer’s profit as there were either no claim or marginal claims • Where the insurer feel the loss experience is predictable over a period of time • The insurer can emphasis on risk management and exercise control over the claims • Self-Insurance can be an alternative • LIC retaining life business, Mediclaim business being managed by few Non-life Insurance Cos.
  • 180. ART- Captives • In a group of companies the parent company forms a captive insurance company to insure the risks of all the group companies • The captive company can retain all the risks or purchase reinsurance protection, it can also provide reinsurance to other insurance companies • The premium is invested in the captive company to meet future losses.
  • 181. Disaster management and Business continuity Plan • Any unexpected interruption to a critical business process, loss of revenue or market share or damage to reputation and brand, could have a significant impact on an organisation and, in extreme cases, the survival of business may even be threatened. • A Business Continuity Plan is a roadmap for continuing operations under adverse conditions (i.e. interruption from natural or man-made hazards).
  • 182. Disaster Risk Management • Disaster Risk Management aims to reduce human suffering and economic losses caused by natural and technological disasters. • It is a strategic and rapid response to disasters and • promoting the integration of disaster prevention and mitigation efforts • into the range of development activities.
  • 183. Disaster Risk Management… • Disaster arises by– An increase in extreme natural events, primarily due to climatic change and man made events. – Increased vulnerability of populations to these natural events ( damage to life and property) • Definition of Disaster by Disaster Management Act 2005– Disaster is an event of natural or manmade causes that leads to sudden disruption of normalcy within society, causing damage to life and property to such an extent that is beyond the capacity of normal social and economic mechanism to cope with. There are various definitions of BCP in the book
  • 184. • Natural hazards: environmental disaster Earthquake, volcanic eruption, mass movement (landslide, debris flow, avalanche), windstorm (including tropical cyclone, tornado, blizzard etc.), flood, tsunami, drought, forest fire. • Manmade or organized hazards: – Act of: Terrorism, Sabotage, War, Theft, Arson, Labour disputes • Technological hazards: Industrial pollution, nuclear activities and radioactivity, toxic wastes, dam failures; transport, industrial or technological accidents (explosions, fires, spills). – Industrial disaster- caused by chemical, mechanical, civil, electrical or other process failures due to accident, negligence or incompetence, in industrial plant which may spill over to the areas outside the plant causing damage to life and property – Chemical Disaster- occurrences of emission, fire or explosion involving one or more hazardous chemicals in the course of industrial activity or storage or transportation, etc. causing loss of life, property and environment
  • 185. • Results of disaster - high severity of loss – Substantial loss of life; - High value property damage; – Long interruption periods; - Other associated effects • Second Generation effects: – Children born with genetic defects; - Growth retardation in children – Hormonal chaos among girls; - Ground water contamination – Skin and gastro-intestinal diseases; - Accumulation of toxins in vegetables and breast milk • Emergency: an unplanned event that significantly– – – – Disrupts normal operations, or Pose serious threat to persons and property Cannot be managed by routine response; Requires a quick and coordinated response across multiple department or divisions
  • 186. Major Disasters Triangle Factory Fire New York 1911: 100 garment workers died in fire
  • 187. Minamata Mercury Disaster (Japan) 1932- 68 3000 people suffered from mercury poisoning
  • 188. Seveso Dioxin Disaster (Italy) 1976 3000 animals died and 70,000 slaughtered
  • 189. Tsunami in South East Asia, Dec. 26, 2004
  • 190. Hurricane Katrina in North America, August 2005
  • 191. Bhopal Gas Tragedy- Dec. 3-4,1984 - 40 tones of methyl iso-cyanate (MIC) gas released from Union Carbide plant for ignoring safety standards -15000 killed, over 500,000 affected. - People are suffering from Cancer, Tuberculosis, blindness, trauma, abortion, genetic defects, etc.
  • 192. Features of disaster • • • • • Disaster shall create losses/damages A disaster can happen at any time It is always unpredictable Extent of loss caused cannot be estimated There is no way to know : – When it will happen – What form it will take • How much impact or damage it will cause – Total destruction of property/persons – Partial damage – No damage but destabilization, evacuation, etc
  • 193. Business operation disruption • A Business can be adversely affected- short term or long term by: • Natural disaster • Terrorist attack • Cyber crime • Fund mismanagement • Simple malfunction • Proactive approach: To combat all these events, we need to have Business Continuity Plan.
  • 194. Business Continuity Plan (BCP) • A disaster can seriously disrupts usual operations or processes of a business and can have long term impact on your normal way of life or that of your organizations. It could cause severe financial losses and even threaten survival of business. A disaster can affect any kind of business activity and its resources • BCP is: • A process to minimize the impact of a major disruption to normal operations • A process to enable restoration of critical assets/systems
  • 195. Business Continuity Plan (BCP)… • Contd…… • A process to restore normalcy to Business as soon as possible after a crisis. • It is not just a recovery of information technology resources • It is the phase of crisis management that follows the immediate actions taken to protect life and property and contain the event • It is a plan to take actions before, during and after a disaster. But preparedness is the key.
  • 196. Why to have a BCP ? • BCP is aimed to minimize the disruption of operations and ensure early recovery after disaster. Its objectives are: – – – – – To provide stability To provide sense of security To provide reliability of standby systems To provide a standard for testing the plan To ensure plan to work effectively during a disaster and minimize new decision making • Commitment of the management and all the stakeholders towards the Business Continuity plan is essential.
  • 197. Impact of hazards Network Operations Disruptions Power Hardware Assessment of risks to the organization which could result in disaster or emergency situations
  • 198. Purpose of BCP • To manage the risk which could prove disastrous • To minimize the likelihood of a disaster occurring • To reduce the time taken to recover when an incident occurs • To minimize the risks involved in the recovery process by making critical decisions in advance in stress free conditions and not at the time of crisis
  • 199. Features of B.C. Planning • 1. Risk Reduction- Risk identification and assessment • 2. Emergency Plan- Prevention/mitigation so that it could not prove disastrous. Example- evacuation of staff, preserving important objects and data, etc. • 3. Business continuity plan- efficient resumption of business by quick recovery directions and combined team actions. Key elements for this are continuity of: • Office services- premises, furniture, stationery, etc. • Information technology- communication and computer • Human and other resources- ensure that staff: – Are aware of alternative arrangements – Have resources they need – Are productively employed
  • 200.
  • 201. Business Continuity Plan- key tasks • Identify which operations and supporting activities need to be restarted after a disaster • The maximum acceptable time limits by which they must restart, and the resources needed to restart them • Identify contingencies for the required resources • Select a cost-effective strategy for restarting operations • Develop the BCP to guide and direct restart of operations • Test the BCP, train staff in how to use it, and keep it up to date
  • 202. Strategy for BCP development • It is necessary to know the damage and impact of the event on the business before devising a strategy • Plans should be developed to deal with different phases of disaster, they may differ from organ. to organ.: • Crisis phase- first few hours after an event. Incident Control team to handle • Emergency phase- potentially threatening situation, need to monitor the events and take proactive measures • Recovery phase- after the disaster, may last from few days to several months—the need is to start essential operations by one or more recovery teams • Restoration phase- assessment of damage, repairs/ replacement till normal operation starts. • Combination of disaster phases my also be applied depending upon the situations
  • 203. BCP Process should meet the objectives: • Business Continuity planning is about maintaining, resuming and recovering the business, not just the recovery of IT • Planning process should be conducted on an enterprisewide basis • Business impact analysis and risk assessment are foundation of an effective BCP • The effectiveness of BCP can only be validated through testing or practical application • The BCP and test results should be subjected to an audit and reviewed by board of directors • BCP should be periodically updated to respond to the changes
  • 204. Development of BCP • It should be• Written so as various groups/teams can implement when the need arise • Specific- regarding situations and conditions under which it should be implemented • Specific regarding the steps to be taken during disruption • Flexible to respond to unanticipated threats and conditions
  • 205. Cost effectiveness of BCP planning & Management • • • • AttitudeTop management Criticalitywhat are critical systems/areas Risks evaluation- which risks to be handled Investment cost benefit analysis before implementation of a system • Downtime for various systems • Recovery recovery operation using printed documents and backup taps • Implementation- Technical team shall decide and operation team shall carry out implementation
  • 206. Assess Loss Exposure Definition. of loss exposure: "Any condition or situation that presents a possibility of loss, regardless of whether loss actually occurs.― • In order to manage the potential risk, the business must first identify the loss exposures: Property(ies) and causes of loss; then •Measure the impact each exposure can have on the business. •The strategies to control the risk are developed around those measurements.
  • 207. Assess loss exposure…… • While building these strategies, the business may elect to retain some of the risks rather than insure or finance the exposure. • The retained losses are then paid directly by the business as they occur. • For instance, a business may elect to eliminate collision coverage from certain vehicles on its business auto policy. • The elimination of the coverage is an acknowledgement that the business will absorb the potential costs incurred in vehicle accidents. •
  • 208. Assessing Loss Exposures . Fire, EQ, etc. Values Exposed Perils causing losses loss to– ppty., Income, persons, liab. Financial Consequences Impact of risks on property, net-income, liability and personnel
  • 209. Kinds of loss exposures to be examined • • • • Loss to property Net income loss and consequential loss Liability Loss to personnel
  • 210. Identifying and assessing loss exposure • Methods• Standardized checklist and questionnaire • Loss history • Financial statements • Flow charts • Inspection reports • Other records • Expert – knowledge and experience Frequency and severity of each exposure
  • 211. Property Loss Exposure • Types of - Property & Losses: • Locate those things or those properties which have value and are exposed to loss. • Class of property affected- Real and personal • Cause of loss • Whether loss is direct or indirect • Nature of the Organization's interest in the property
  • 212. Property Loss exposure • Real property- assets attached to land – Real estate including land, building , other infrastructure. • Personal property- moveable (Tangible & Intangible) Tangible- Items contained in the bldg. or otherwise like: – – – – – – Money & Securities Inventory- Raw material, finished goods, etc Machinery, Furniture, Officer stationery, office equipments, etc Data processing hardware, software Records, books of accounts, documents Automobile, other mobile items, etc Intangible Items- like Goodwill, copyrights, patents, trademarks etc. For risk managers valuing intangible assets on the basis of their extra earning power is much difficult and complicated.
  • 213. Causes of loss • General classification of perils-the next step is to identify the perils causing loss • Natural perils- Acts of God like EQ, Floods, Tsunami, lightning, rockslide, landslide, volcanic eruption, drought, hailstorm, etc • Manmade perils- error or omission by human, terrorism, pollution, chemical explosion, nuclear fission, explosion, fraud, forgery, burglary, dishonesty, etc. • Economic perils- change in consumer taste and behaviour, exchange rate, inflation, recession, technological changes, obsolescence, consequences of war, strike, etc.
  • 214. Financial/Monetary impact • Monetary impact/effect is – Analysing and valuing the exposures in monetary terms • Identify the property and identify the perils that may operate • Evaluate the potential loss to property by a peril • Loss can be direct or indirect: • Direct loss – Occurs when there is damage to property • Indirect loss – consequential losses – Occurs when a direct loss causes expenses to increase or revenues to decline (consequential losses)
  • 215. Financial/Monetary impact -Valuation Methods • There are various valuation standards• Original purchase cost- no depreciation or inflation, trend or technical changes • Original cost less book deprecation- not accounting inflation, trend or technical changes • Market Value- demand and supply • Tax appraisal value- taxable value • Economic or use value- income produced by it • Reproduction cost- reconstruction or replacing same property • New Replacement Cost- replacing with new property • New replacement cost less physical depreciation
  • 216. Net Income Loss exposure • Net income=Revenue minus expenses. Loss shall be, when: – Revenue is reduced ;or – expenses increased • Reduction in Revenue: Reasons– – – – – – – – Property damaged, lost, destroyed- source is lost Business interruption or adversely affected Reduction in revenue due to reduction in turnover(sales) Loss due records of debtors/receivable get destroyed Interruption in operations/production Contingent business interruption- supplier/customer Loss of profit on damaged finished goods Loss of rent to owner • Increase in expenses – Additional Loss in hiring alternate site (rental value) – Extra expenses incurred to continue business operations
  • 217. Net Income Loss- Consequential losses • • • • Calculation of net Income Loss: Fixed cost- salaries, rent, insurance, accountancy costs. Variable cost- Material, daily wages, overtime, fuel, etc. Overhead costs- depreciation on Mach. & Bldg, indirect labour in manufacturing unit, Quality assurance cost. • Gross profit= Sales- (V.C.+ F.C.+ Overheads) • Net contribution or Non variable cost= Sale –(gross profit +V.C.) • Net contribution of each unit and each product group shall be determined
  • 218. Liability Loss exposure • Legal liability- property damage or personal injuries to others • Liability arises due to responsibility of care towards others • LL arises under: – Common law – Statute Law- laws framed by Parliament – Contract Law • An organization has to therefore also manage the legal risks and ensure that it– Operates within law – Fulfill its legal obligations – Recognize and handle legal threats
  • 219. Liability Loss exposure…. • • • • Sources of legal liability: Ownership of property and its use Property or goods held in trust or control vehicles • Business activity- manufacturing, sale and distribution of its products or services – – – – Public liability including pollution liab. Product liability Professional activities Employers liability