CHAPTER 2

RISK MANAGEMENT
 SYLLABUS CONTENT

CODE CHAPTER WEEK

Ppt 01 Nature of risks 1
Ppt 02 Risk Management; Concept and Processes 2&3
Ppt 03 Nature of Insurance 4
Ppt 04 Principles of insurance 5&6
Ppt 05 Underwriting and claims procedures 7&8
Ppt 06 The insurance marketplace 9
Ppt 07 Insurance regulations and consumer protection 10
Ppt 08 Life assurance products 11 & 12
Ppt 09 General insurance products 13 & 14
LEARNING OBJECTIVES

Upon completion of the chapter, you should be able to:

➢Define some common terminology
➢Explain the importance of risk management to individuals and organization
➢Describe the objectives of risk management
➢Explain the risk management process
➢Identify the best risk management techniques to be used for different category of risk
➢Define the risk management from Islamic perspective
DEFINITION AND EVOLUTION OF RISK
MANAGEMENT
Risk management is now considered crucial for survival of the
organization

Climate changes, political uncertainties, economic forces are

among external factors of emerging needs of risk management in
an organization.

As a systematic approach to identifying, measuring and controlling

risks that can threaten assets and earnings of oneself, a business or
the organization.

The purpose of risk management is to enable an organization to

progress toward its goal and objectives (mission) in the most direct,
efficient, and effective path
OBJECTIVES OF RISK MANAGEMENT

Objectives of
Risk
Management

Pre loss Post loss

objectives occurs
Pre Loss-Objectives
Reduce
impact of loss

Reduce fear
and worry

Required by
law
Post Loss Objectives
Survival of organization – organization still able to continue operations

Stability of earnings – business operations do not have to stop and the

organizations can concentrate on their business activities as usual.

Reduce impact of losses to organization and society – when a loss occurs not only
will the organization suffer but the loss has to be burdened by society as well.
Employees may have to be retrenched and some departments may have to be
closed down.
RISK MANAGEMENT PROCESS

Examining Selecting and Evaluating,

Identifying alternative Implementing reviewing
Evaluating
existing and risk risk and
potential risks
potential risks management management controlling
techniques program the program
1. IDENTIFYING EXISTING AND POTENTIAL
LOSSES

Risk identification is the

process by which an
organization is able to Identification techniques are
learn of the areas in which designed to develop
it is exposed to risk. information on sources of risk,
hazards, risk factors, perils and
exposures to loss.
Direct damage Indirect damage Liability (court Loss of Key
(damage to (loss of profits due award to 3rd party Employees (key
building) to business since fire was employees such as
interruption caused by general
negligence of the manager/CEO/Rese
owner of building) archer)
Risk Identification Tools

Risk Analysis Exposure Insurance

Orientation
Questionnaires checklists Policy checklist

Financial
Flowchart Inspections Interviews
Statements

Combination
approach
2. EVALUATING POTENTIAL LOSSES

Risk measurement evaluates the likelihood of loss and the value of loss in
terms of frequency and severity.

The measurement process may take the form of a qualitative assessment

(using %)

This step involves two important aspects of loss exposures

Frequency
Severity
How can you determine and estimate the
impact of losses

Frequency Severity
Referring to the Referring to the
number of maximum size
times the loss of loss
occurs exposures
 Identifying and determining the
loss exposures alone is not
sufficient

Estimating the frequency and

severity for each type of loss
exposure and ranked it according to
their relative importance. High loss
exposure will be given priority.

Estimating relative frequency and

severity of each loss exposure as
the selection of appropriate
technique will depend on this.
3. EXAMINING ALTERNATIVE RISK
MANAGEMENT TECHNIQUES
❖Two main ways to classify the risk management techniques

1.Risk Control
▪Risk avoidance 2. Risk Financing
▪Loss control ▪Retention/Assumption
•Loss prevention
▪Captive insurer
•Loss reduction
▪Separation ▪Insurance
▪Contractual Transfer
Risk Control

Methods seek to alter an

organization’s exposure to risk.

Risk control efforts help organization

avoid a risk, prevent loss, lessen the
amount of damage if a loss occurs or
reduce undesirable effects of risk on
an organization.
Risk Avoidance

Risk is proactively avoided or If someone is afraid of risks,

abandoned after rational the best way to deal with it is
consideration. to avoid it completely.

However, some risks are

unavoidable although risk
Example; a manufacturer may
avoidance may be chosen as
stop production of a defective
an option in handling certain
products to avoid a lawsuit.
risks, the exposures of losses
cannot be eliminated entirely.
Loss Control

Loss control is designed to reduce both the

frequency and severity of losses by changing the
characteristics of the exposure so that it is more
acceptable to the firm. Divided into:
Loss prevention
Loss reduction
Loss Control
❖Loss Prevention ❖Loss Reduction
• Seek to reduce the number of • Designed to reduce or lower the
losses (frequency) of losses severity of losses, should it occur.
• Is used when the benefits • Since some risks are unavoidable,
the other alternative is to reduce
outweigh the costs involved.
its impact.
• Either imposed by law or • Can be used in two
imposed by companies and circumstances: before a loss, e.g.
factories to fence dangerous installation of fire alarm or after a
machinery to reduce the loss e.g. salvage efforts in the
chances of employees being restoration of a building burnt
injured. down by fire.
Separation

Involves the dispersal of the firm’s assets in several

locations instead of confining it to one major area.

This measure will reduce the impact of losses

should a major disaster occurs.

Example, separation of head quarters and

assembly plant in automobile industry.
Contractual Transfer

Risk transfer mechanism. Refers to the various methods

other than insurance by which
a pure risk and its potential
financial consequences can be
transferred to other party.
 Leasing contracts Hedging
An agreement to buy or sell
An agreement where the
a commodity at a certain
owner or landlord transfers
price to avoid losses due to
the risks to the tenants
price increase or decrease.

Hold-harmless
Incorporation agreements
An agreement between a
The owner of the company retailer and a manufacturer
transfers the risks to whereby the later agrees to
corporation by registering bear losses due to the
the company. manufacturer of defective
Contractual products thus relieving the
retailer of any liability.
Transfer
Contractual Transfer
❖Advantages ❖Disadvantages

• Can transfer potential losses • If the party to whom the loss is

that are commercially transferred is unable to pay
uninsurable the loss the firm is still
• Often cost less than insurance responsible
• Potential loss shifted to a party • Not necessarily cheaper than
who is in a better position to insurance if discounts are
exercise control taken into consideration
• Ambiguity in contracts drafted
may not hold in court.
Risk Financing

Self
insurance
Retention Insurance
and captive
insurer
Retention

Retention – the company will bear the consequences of

the loss

Risk or loss exposed are normally assumed or retained

when their impact and consequences are not too great
or in cases when or other methods seem feasible.

In an organization, the ability to assume a risk depends

on one’s financial ability.
Self insurance & Captive Insurer

Self insurance implies tat the organization sets up a pool of

fund to retain its loss exposures.

Adequate financial agreement has to be made in

advance of the occurrence of losses.

The number of loss exposures must be large enough to

ensure the mechanism of insurance to be operative.
Self insurance & Captive Insurer

A captive insurance company is an entity to write

insurance arrangement for its parent company.

The captive’s parent may be one company,

several companies or an entire industry.

Example; Sime Darby Group is the parent

company of Sime AXA Assurance Sdn Bhd
Self insurance & Captive Insurer
❖Advantages ❖Disadvantages

• Cash flow advantages • Possible higher losses

• Safe money • Possible higher expenses
• Lower expenses
• Encourage loss prevention
Insurance
Risk financing method of Transferring the risks to another
transferring the financial party involves a contractual
consequences of potential agreement whereby the other
accidental losses from an party assumes the risks and is
insured firm or family to an liable for the loss in the event of
insurer loss.

In an insurance contract, the

In return, the insurance
party exposed to the risks (the
company agrees to pay a stated
proposer/insured) pays the
sum on the happening of certain
premium to the insurance
risks specified in the contract.
company.
4. SELECTION AND IMPLEMENTATION OF THE
RISK MANAGEMENT PROCESS

Non-
Financial
financial Whether it affects the
criteria Whether it will affect
the organization's
criteria growth of the
organization,
profitability or rate of humanitarian aspects
return. and legal
requirements.
 F R E Q U E N C Y

LOW HIGH

S Risk assumption/Retention Loss Prevention

also; also;
E LOW
Loss prevention Loss reduction if cost can be justified
V Loss reduction if cost justifies the Assume risk if cost cant 'be justified
E benefits
R Insurance Risk Avoidance
HIGH
also; also;
I Risk transfer, loss reduction and loss Loss prevention and loss reduction if
T prevention possible
Y

SELECTION OF THE RISK MANAGEMENT TECHNIQUE

5. EVALUATION, REVIEW AND CONTROL

Evaluation and review

The risk management
The techniques that of the risk
program must be
were appropriate last management program
monitored and
year many not be the permits the manager
controlled
most advisable this to review decisions
systematically. It must
year, and constant and discover mistakes,
be periodically
attention is required it is hoped, before
reviewed
they become costly.
RISK MANAGEMENT IN ISLAMIC PERSPECTIVE
The ummah should anticipate the risks that will hinder the ultimate
goal of them which is to attain success in the world and here after.

Risk management in Islamic perspective should be aimed to reduce the

utilization of resources (financial and non-financial) and to minimize
the negative effects of risks or maximize the opportunities and goals.
The goals must be aligned with the Shariah
Thank you!
“Adventure without risk is Disneyland”
-Douglas Coupland-

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