Chapter 1: Introduction to Risk Management - Review (Part 1) Flashcards
(24 cards)
How is today’s risk management environment different from the traditional environment?
Combinations of inexpensive data-gathering technology and predictive analytic techniques can trqansoform data into mor certainty about risk management decisions than in the past
Traditional concept of risk in insurance
Risk is a hazard posed to an individual or organization (ex. fire or wind destroying a home or business)
Two ways that today’s concept of risk differ from the traditional concept
- It incorporates positive consequences - the idea that taking risks is necessary for growth (ex. a home or business growing in value over time)
- Includes concept of holistic approach to risk management (i.e. managing all risks, not just those that are familiar or easy to quanitfy), which helps identify risks that truly matter and provide better perspective
High level categories of risk (4)
Hazard risks
Operational risks
Financial risks
Strategic risks
What is root cause analysis and what is its weakness?
Root cause analysis (RCA) identifies a loss’s predominant cause. RCA is weak because it can only look backward, and may not identify all root causes or related events that contributed to a loss
Three technological factors that influence risk management (i.e. the “big data revolution”)
Data capture
Data storage
Data analytics
What is data capture and how does it influence risk management?
Data capture is enabled by smart products that sense their environment, process data, and communicate with other smart products through the Internet of Things (IoT)
Three examples of data capture innovations in risk management
- Data generated by wearables, such as helmets that monitor fatigue or watches that measure vital signs
- Drones used for surveillance and photography; can assess conditions in dangerous or unknown areas
- Robots can measure, respond to, and produce data for monitored hazards or changing environmental conditions
How can the blockchain benefit risk management through data storage?
- Volume of data produced by data capture technology can undermine effectiveness
- Blockchain is a distributed ledger that maintains a dynamically updated list of data records (blocks)
- Blocks on the chain are verified, encryupted and protected against tampering and revisions
- Medium is immutable, secure, transparent, scalable, and facilitates sharing of verified, quality data
Five ways that data analytics can help insurers and risk managers improve business results
- Automating decision making for improved accuracy and efficiency (ex. online quoting tools based on algorithms)
- Organizing large volumes of new data (ex. sorting telematics data into categories)
- Discovering new relationships in data (ex. characteristics of workers never involved in an accident can be used to improve safety)
- Exploring new sources of data (ex. text mining of claims adjusters’ notes to predict claim severity)
- Developing new products (ex. parametric insurance, which pays a predetermined amount when a specific situation occurs, such as winds over a certain speed)
Eight benefits of risk management for an organization
(Important)
- Reduce cost of hazard risk
- Reduce deterrence effects of hazard risks
- Reduce downside risk
- Manage the downside of risk
- Take intelligent risks
- Maximize profitability
- Practice holistic risk management
- Comply with legal and regulatory requirements
Reduce the cost of hazard risk
(Benefits of risk management to an organization)
Risk management reduces long-term overall cost of risk without interfering with the organization’s ability to achieve its goal or engage in normal activities
Cost of risk is a total of these four things
- Costs of accidental losses not reimbursed by insurance
- Insurance premiums or expenses incurred for noninsurance indmenity
- Costs of risk control techniques to prevent or reduce the size of accidental losses
- Costs of adminstering risk management activities
Reduce deterrence effects of hazard risks
(Benefits of risk management to an organization)
Fear of possible future losses makes management reluctant to undertake activities they deem too risky. Risk management reduces uncertainty, providing these benefits:
- Alleviates management’s fear about potential losses, thereby increasing feasibility of ventures that once appeared to risky
- Increases profit potential by greater participation in investment or production activities
- Makes the organization a safer investment and more attractive to suppliers of investment capital
Reduce downside risk
(Benefits of risk management to an organization)
- Downside risks include losses and failures
- Ex. a new product not doing well, or a financial institution making a bad loan or investment
- Operational risk is part of any organization’s process and includes delays, errors, cost increases, etc.
- Risk management can monitor risks with “threshold limits,” which warn management when the threshold is breached
- Ex. a certain number of faulty products manufactured in a given time (operational risk), variance in interest rates or investments (financial risk), or a certain number of serious accidents in a given time (hazard risk)
Manage the downside of risk
(Benefits of risk management to an organization)
Risk management strategy cannot eliminate downside risk, but it can help the organization achieve its objectives. Must we well thought out so as not to increase risk
Take intelligent risks
(Benefits of risk management to an organization)
Organizations need to take risks in order to grow and increase profit. Risk management provides a framework to analyze and manage risks associated with an opportunity (ex. the potential rewards and downside risks of exploring a new product)
Maximize profitability
(Benefits of risk management to an organization)
Risk management frameworks help an organization achieve risk-adjusted return on capital. Need to take risk to maximize capital, but too much risk can exceed capacity to absorb losses.
Practice holistic risk management
(Benefits of risk management to an organization)
- Traditional risk management doncuted in silos within an organization
- Ex. at a manufacturer, risk managers would monitor hazard risk; finance function would manage financial risks; operations function would manage operational risks etc.
- Fragmented approach which can miss risks to organization (ex. risk managers might not be aware of age of equipment if it is not insured, and operations managers might not be aware of the risk this older equipment could pose)
- A holistic approach manages risk across all levels to provide a more complete picture of the risk portfolio and profile,w hcih allows for better management decisions and improved outcomes
Comply with legal and regulatory requirements
(Benefits of risk management to an organization)
Failure of large organizations lead to financial crises, resulting in regulation (ex. SEC requires corporate disclosure about risk). Risk management ensures organizations comply with these requirements.
Three overall economic benefits of risk management
- Reduced waste of resources
- Improved allocation of productive resources
- Reduced systemic risk
Reduced waste of resources
(Economic benefits of risk management)
Economies posess a given quantity of resources to provide people with goods and services. Reduction in these resources (ex. a fire or earthquake that destroys a factory), overall productive resources are also reduced. Risk management prevents or minimizes waste of productive resources.
Improved allocation of productive resources
(Economic benefits of risk management)
When economic uncertainty is reduced for an individual organization, productive resources are better allocated. Organizations can undertake formerly risky activities because they are protected from downside of risk.
Reduced systemic risk
(Economic benefits of risk management)
If a systemically important organization does not manage risks effectively, its failure can result in failure for the economy overall (ex. 2008 financial crisis)
