ENTERPRISE RISK MANAGEMENT RAMONA G. COLANNAY, MSBA, LPT ENTERPRISE RISK MANAGEMENT 1. Enterprise risk management (ERM) is a firm-wide strategy to identify and prepare for hazards with a company's finances, operations, and objectives. · 2. RISK MANAGEMENT IS AN ORGANIZED STRATEGY FOR CONTROLLING FINANCIAL LOSS FROM PURE RISK AND INSURABLE RISK. RISK MANAGEMENT IS A PROCESS. WHILE YOU CANNOT ELLIMINATE RISK, YOU CAN MANAGE IT SO THAT A LOSS DOES NOT BECOME FINANCIALLY DEVASTATING. 3. Enterprise risk management (ERM) is the process of planning, organizing, directing and controlling the activities of an organization to minimize the harmful effects of risk on its capital and earnings. 4. Enterprise risk management (ERM) is a firm-wide strategy to identify and prepare for hazards with a company's finances, operations, and objectives. ERM allows managers to shape the firm's overall risk position by mandating certain business segments engage with or disengage from particular activities. What is an example of ERM? An example of enterprise risk management would be a company deciding to hire extra employees to carry out product quality control. By doing this, the company reduces the risk of its product violating relevant regulations. MANAGING PURE RISK EXPOSURES HAS DEVELOPED INTO ITS OWN NICHE ARE OF STUDY RISK MANAGEMENT. RISK MANAGERS INCLUDE THOSE RESPONSIBLE FOR MANAGING PURE RISK EXPOSURES WITHIN THE ORGANIZATION. ALL ORGANIZATIONS HAVE PURE RISK EXPOSURES. MORE THAN BUYING INSURANCE. (niche-a comfortable or suitable position in life or employment. "he is now a partner at a leading law firm and feels he has found his niche") 1. IDENTIFYING LOSS EXPOSURES, PREVENTING LOSS, REDUCING LOSS, LOSS FINANCING, EDUCATING OTHER CORPORATE MANAGERS AND ACTING AS A RESOURCE TO OTHER MANAGERS. 2. MAJOR DECISION SHOULD BE SUPORTED BY SENIOR MANAGEMENT. 3. RISK MANAGERS AND PRODUCERS MUST HAVE A GOOD WORKING RELATIONSHIP. 4. THE PRODUCER MUST FIRST UNDERSTAND THE BASICS OF THE RISK MANAGEMENT PROCESS AND PROVIDE THE CLIENT WITH THE BEST SERVICE. TYPES OF RISK 1. PURE RISK IS A CHANCE OF LOSS WITH NO CHANCE FOR GAIN. PURE RISKS ARE RANDOM AND RESULT IN LOSS. PURE RISKS ARE RANDOM OR CAN HAPPEN TO ANYONE AND RESULT IN LOSS (NOT GAIN). EXAMPLES OFPURE RISK INCLUDE THE FOLLOWING: • ACCIDENTS RESULTING IN PHYSICAL INJURY AND DAMAGE TO PROPERTY. • ILLNESSES THAT PEOPLE GET THOUGHOUT LIFE, AS A PART OF AGING. • ACTS OF NATURE, RESULTING IN DAMAGE TO PERSONS AND PROPERTIES. 2. SPECULATIVE RISK MAY GAIN RESULT IN EITHER GAIN OR LOSS. BECAUSE SPECULATIVE RISK IS NOT RANDOM OR ACCIDENTAL, AND MAY RESULT IN EITHER GAIN OR LOSS, YOU CANNOT PROTECT YOURSELF FROM LOSSES IN A TRADITIONAL MANNER. WHILE HEDGING OR MAKING AN INVESTMENT TO HELP OFFSET AGAINST LOSS IS A TECHNIQUE USED O HELP REDUCE LOSSES FROM SUCH RISKY ACTS, IT DOES NOT REDUCE THE RISK ITSELF. 3. ECONOMIC RISK MAY RESULT IN GAIN OR LOSS BECAUSE OF CHANGING ECONOMIC CONDITIONS. FOR EXAMPLE, WHEN THE BUSINESS CYCLE IS IN A PERIOD OF RECOVERY OR GROWTH, MOST PEOPLE AND BSINESSES ARE REALIZING GAINS IN THEIR FINANCIAL POSITION. HOWEVER, THE ECONOMY CAN SLOW DOWN. DURING THIS TIME, PEOPLE LOSE JOBS AND ARE UNABLE TO BUY GOODS AND SERVICES. AS A RESULT, MANY BUSINESSES FIND HEMSELVES UNABLE TO MEET THEIR DEBTS. 4. INSURABLE RISK IS A PURE RISK THAT IS FACED BY A LARGE NUMBER OF PEOPLE AND FOR WHICH THE AMOUNT OF THE LOSS CAN BE PREDICTED. INSURANCE COMPANIES CAN MAKE THESE PREDICTIONS BY EXAMINING THE AMOUNT OF LOSS INCCURED FROM PAST EVENTS, SUCH AS FLOODING. • TO PURCHASE INSURANCE, YOU MUST HAVE AN INSURABLE INTEREST TO PROTECT. • AN INSURABLE INTEREST IS ANY FINANCIAL INTEREST IN LIFE OR PROPERTY SUCH THAT, IF THE LIFE OR PROPERTY WERE LOST OR HARMED, THE INSURED WOULD SUFFER FINANCIALLY. INSURANCE IS A METHOD FOR SPREADING INDIVIDUAL RISK AMONG A LARGE GROUP OF PEOPLE TO MAKE LOSSES MORE AFFORDBLE FOR ALL. YOU CAN REDUCE NEGATIVE CONSEQUENCES OF A PURE RISK BY PURCHASING INSURANCE. THE THREE MAJOR INSURABLE RISKS: 1. PERSONAL RISK IS THE CHANCE OF LOSS INVOVING YOUR INCOME AND STANDARD OF LIVING. YOU CAN PROTECT YOURSELF FROM PERSONAL RISKS BY BUYING LIFE, HEALTH AND DISABILITY INSURANCE. IN ADDITION, INSURANCE AGAINST PERSONAL RISKS PROTECT OTHERS WHO ARE DEPENDING ON YOUR INCOME TO PROVIDE FOOD, CLOTHING, SHELTER AN THE COMFORTS OF LIFE. 2.PROPERTY RISK IS THE CHANCE OF LOSS OR HARM TO PERSONAL OR REAL PROPERTY IS CALLED PROPERTY RISK. FOR EXAMPLE, YOUR HOME, CAR AND OTHET POSSESSIONS COULD BE DAMAGED OR DESTROYED BY FIRE, THEFT, WIND, RAIN, ACCIDENT AND OTHER HAZARDS. TO PROTECT AGAINST SUCH RISK, YOU CAN BUY PROPERTY INSURANCE. 3.LIABILITY RISK IS THE CHANCE OF LOSS THAT MAY OCCUR WHEN YOUR ERRORS OR ACTIONS RESULT IN INJURIES TO OTHERS OR DAMAGES TO THEIR PROPERTY. FOR EXAMPLE, YOU COULD ACCIDENTALLY CAUSE INJURY OR DAMAGE TO OTHERS OR THEIR PROPERTY BY YOUR CONDUCT WHILE DRIVING A CAR. OR A PERSON COULD FALL BECAUSE OF YOUR HOME’S CRUMBLING FRONT STEPS AND BREAK AN ARM. LIABILITY INSURANCE WILL PROTECT YOU WHEN OTHERS SUE YOU FOR INJURING THEM OR DAMAGING THEIR PROPERTY. RISK ASSESSMENT RISK ASSESSMENT BEGINS WITH A SYSTEMATIC STUDY OF THERISK THAT YOU FACE. IT BEGINSW WITH RISK ASSESSMENT OR UNDERSTANDING THE TYPES OF RISK YOU WILL FACE AND THEIR POTENTIAL CONSEQUENCES. TECHNIQUES FOR HANDING RISKS RISK SHIFTING – ALSO CALLED RISK TRANSFER, OCCURS WHEN YOU BUY INSURANCE TO COVER FINANCIAL LOSSES CAUSED BY DAMAGING EVENTS, SUCH AS FIRE, INJURY OR DEATH. BY MAKING PREMIUM PAYMENTS, YOU SHIFT THE RISK OF MAJOR FINANCIAL LOSS TO THE INSURANCE COMPANY. RISK AVOIDANCE – LOWERS THE CHANCE FOR LOSS BY NOT DOING THE ACTIVITY THAT COULD RESULT IN LOSS. EXAMPLES: INSTEAD OF HAVING A PARTY AT YOUR HOUSE AND RISKING DAMAGE, YOU COULD RESERVE A SECTION OF A RESTAURANT. INSTEAD OF PARTICIPATING IN ADANGEROUS SPORT, YOU COULD GO CAMPING. RISK REDUCTION – LOWER THE CHANCE OF LOSS BY TAKING MEASURES TO LESSEN THE FREQUENCY OF LOSSES THAT MAY OCCUR. FOR EXAMPLE, YOU MAY PUT STUDDED SNOW TIRES ON YOUR CAR, INSTALL FIRE ALARMS OR SPRINKLERS IN YOUR HOME OR USE SEAT BELTS. ALL THESE STEPS WOULD LESSEN THE FINANCIAL RISK OF A POTENTIAL LOSSES. RISK ASSUMPTION – IS THE PROCESS OF ACCEPTING THE CONSEQUENCES OF RISK. TO HELP CUSHION YOUR FINANCIAL BURDEN, YOU COULD ESTABLISH A MONETARY FUN TO COVER COST OF LOSS. PEOPLE WHO SELF-INSURE PLAN TO ABSORB THE COSTS OF SOME RISKS THEMSELVES. THIS STRATEGY CAN REDUCE THE COST OF INSURANCE. ROLE OF RISK MANAGEMENT THE ROLE OF RISK MANAGEMENT IS TO IDENTIFY, MEASURE AND TREATING PROPERTY, LIABILITY, INCOME AND PERSONNEL EXPOSURES TO LOSS. PURPOSE OF RISK MANAGEMENT THE PURPOSE OF RISK MANAGEMENT IS TO IDENTIFY POTENTIAL PROBLEMS BEFORE THEY OCCUR SO THAT RISK-HANDLING ACTIVITIES MAY BE PLANNED AND INVOLKED AS NEEDED ACROSS THE LIFE OF THE WHOLE ORGANIZATION TO MITIGATE ADVERSE IMPACTS ON ACHIEVING GOALS. EVOLUTION OF THE DISCIPLINE OF RISK MANAGEMENT ANCIENT EGYPTIAN TIMES In ancient Egypt, the Nile River would yield a bountiful flow for 30 years in succession and then have two dry years in which all harvests failed. After surveying, studying and calculating this risk, ancient Egyptians were able to plan for the next drought well in advance. WORL WAR II The modern terms for managing risk arose after World War II, but the discipline mostly began as a study using insurance to manage risk. The formative years from World War II to the mid-1960s led to the creation of new risk, aggravated old ones and, compelled by risk managers’ responses to the risk management evolved rapidly and gained its and a core definition. Committee of Sponsoring Organizations of the Treadway Commission (COSO) 1985 With advancement in economic activity and growth in business, there was a rise in questionable practices of financing corporate political campaigns and corrupt foreign practice in the mid-1970s. As a joint initiative to combat corporate fraud. The COSO framework covered 4 categories of risk – strategy, operations, reports and compliance. FAILURES OF FORTUNE 1000 COMPANIES From 1993 through 2003, more than one-third of Fortune 1000 companies – only a fraction which were in volatile high-technology industries – lost at least 60% of their value in a single year. 90% of the cases were categorised under causes that represented strategic and operational failures as the primary reasons for the stock drops. ENRON SCANDAL 2001 This led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas and the de-facto dissolution of Arthur Andersen which was of the five largest audit and accountancy partnerships in the world. FINANCIAL CRISIS OF 2007 TO 2008 The financial crisis of 2007 to 2008 exposed the limitations of bank’s risk management. The guidelines were re-analysed and worked so that the financial industry could be better managed in the future. In recent years, much attention is given to the expansion of risk management to compass a wide range of business risk including enterprise risk, many of which are uninsurable and traditionally out of the risk manager’s purview. COVID-19 PANDEMIC The global financial crisis was a watershed moment that made the world, including India; put some serious thought into risk literacy with a newfound appreciation for crisis and business continuity planning within the private sector and government. India, too, has its fair scams and scandals; the outcome resulting in plausible changes made on the legal and compliance front. In the present scenario, the COVID-19 pandemic escalated the field back into prominence as businesses have to deal with safety issues along digital risks, reputation risks, market and credit risks. The role of qualified risk professionals and chief risk officers has come to the fore. Companies are now responding to the new risk committees and emphasizing more on crisis experience in director recruitment. These committees are focusing on how to avoid operative risk, navigate through the new normal through crisis planning and create a risk-based culture and riskbased decision making process. BENEFITS OF RIKS MANAGEMENT IT HELPS THE ORGANIZATION UNDERSTAND AND DESCRIBE ITS RISKS. KEEP THE ORGANIZATION ON TRACK TO ACHIEVE ITS STRATEGY AND GOALS. HELP THE WHOLE ORGANIZATION UNDERSTAND ITS PRIORITIES AND CHALLENGES. TAKE OPPORTUNITIES AS WELL AS TRYING TO AVOID THE NEGATIVES. IT HELPS THE ORGANIZATION FOCUS ON HOW IT WILL RESPOND TO RISKS. MAKE INFORED DECISIONS. OTHER BENEFITS INCLUDE: ENABLES FIRM TO ATTAIN ITS PRE-LOSS AND POST-LOSS OBJECTIVES MORE EASILY. A RISK MANAGEMENT PROGRAM CAN REDUCE A FIRM’S COST OF RISK. REDUCTION IS PURE LOSS EXPOSURES ALLOWS A FIRM TO ENACT AN ENTERPRISE RISK MANAGEMENT PROGRAM TO TREAT BOTH PURE AND SPECULATIVE LOSS EXPOSURES. SOCIETY BENEFITS BECAUSE BOTH DIRECT AND INDIRECT LOSSES ARE REDUCED.
