Download VTU (Visvesvaraya Technological University) MBA 4th Semester (Fourth Semester) 16MBAFM402-Risk Management and Insurance RMI Module 2 Important Lecture Notes (MBA Study Material Notes)
identification
MODULE 2
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
example
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
example
Solve?
?What is the expected value of
outcome if you win Rs 1 for heads
and lose Rs 1 for tails; in a coin
toss game?
?Calculate the sample mean and
sample standard deviation if the
game is played 5 times with the
following results: T,T,H,T,H
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
example
Solve?
?What is the expected value of
outcome if you win Rs 1 for heads
and lose Rs 1 for tails; in a coin
toss game?
?Calculate the sample mean and
sample standard deviation if the
game is played 5 times with the
following results: T,T,H,T,H
?EXPECTED VALUE = 1*0.5+(-1*0.5)
= 0
?Sample mean = 1*2/5 + (-1*3/5) =
-0.2
?Sample standard deviation =
root Summation pi(xi-mu)
2
?
=
ROOT OF 2/5(1-(-0.2))
2
+ 3/5 (-1-
(-0.2))
2
?Root 0.96 = 0.98
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
example
Solve?
?What is the expected value of
outcome if you win Rs 1 for heads
and lose Rs 1 for tails; in a coin
toss game?
?Calculate the sample mean and
sample standard deviation if the
game is played 5 times with the
following results: T,T,H,T,H
?EXPECTED VALUE = 1*0.5+(-1*0.5)
= 0
?Sample mean = 1*2/5 + (-1*3/5) =
-0.2
?Sample standard deviation =
root Summation pi(xi-mu)
2
?
=
ROOT OF 2/5(1-(-0.2))
2
+ 3/5 (-1-
(-0.2))
2
?Root 0.96 = 0.98
Skewness
?Skewness measures the symmetry of
a distribution. A normal distribution
has zero skewness and is symmetric.
Most of the risk management
distributions are skewed.
?If one assumes a symmetric
distribution then one would
underestimate the likelihood of very
large losses which can be very
harmful.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
example
Solve?
?What is the expected value of
outcome if you win Rs 1 for heads
and lose Rs 1 for tails; in a coin
toss game?
?Calculate the sample mean and
sample standard deviation if the
game is played 5 times with the
following results: T,T,H,T,H
?EXPECTED VALUE = 1*0.5+(-1*0.5)
= 0
?Sample mean = 1*2/5 + (-1*3/5) =
-0.2
?Sample standard deviation =
root Summation pi(xi-mu)
2
?
=
ROOT OF 2/5(1-(-0.2))
2
+ 3/5 (-1-
(-0.2))
2
?Root 0.96 = 0.98
Skewness
?Skewness measures the symmetry of
a distribution. A normal distribution
has zero skewness and is symmetric.
Most of the risk management
distributions are skewed.
?If one assumes a symmetric
distribution then one would
underestimate the likelihood of very
large losses which can be very
harmful.
Maximum probable loss
?Maximum possible Loss is the
maximum amount a firm may lose
given an incident. It is may be the
total value of the assets
?Maximum probable loss is the
expected loss given the most likely
probability of an event happening
eg: MPL at 5% is 20 million, MPL at
1% is 30 million
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
example
Solve?
?What is the expected value of
outcome if you win Rs 1 for heads
and lose Rs 1 for tails; in a coin
toss game?
?Calculate the sample mean and
sample standard deviation if the
game is played 5 times with the
following results: T,T,H,T,H
?EXPECTED VALUE = 1*0.5+(-1*0.5)
= 0
?Sample mean = 1*2/5 + (-1*3/5) =
-0.2
?Sample standard deviation =
root Summation pi(xi-mu)
2
?
=
ROOT OF 2/5(1-(-0.2))
2
+ 3/5 (-1-
(-0.2))
2
?Root 0.96 = 0.98
Skewness
?Skewness measures the symmetry of
a distribution. A normal distribution
has zero skewness and is symmetric.
Most of the risk management
distributions are skewed.
?If one assumes a symmetric
distribution then one would
underestimate the likelihood of very
large losses which can be very
harmful.
Maximum probable loss
?Maximum possible Loss is the
maximum amount a firm may lose
given an incident. It is may be the
total value of the assets
?Maximum probable loss is the
expected loss given the most likely
probability of an event happening
eg: MPL at 5% is 20 million, MPL at
1% is 30 million
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
example
Solve?
?What is the expected value of
outcome if you win Rs 1 for heads
and lose Rs 1 for tails; in a coin
toss game?
?Calculate the sample mean and
sample standard deviation if the
game is played 5 times with the
following results: T,T,H,T,H
?EXPECTED VALUE = 1*0.5+(-1*0.5)
= 0
?Sample mean = 1*2/5 + (-1*3/5) =
-0.2
?Sample standard deviation =
root Summation pi(xi-mu)
2
?
=
ROOT OF 2/5(1-(-0.2))
2
+ 3/5 (-1-
(-0.2))
2
?Root 0.96 = 0.98
Skewness
?Skewness measures the symmetry of
a distribution. A normal distribution
has zero skewness and is symmetric.
Most of the risk management
distributions are skewed.
?If one assumes a symmetric
distribution then one would
underestimate the likelihood of very
large losses which can be very
harmful.
Maximum probable loss
?Maximum possible Loss is the
maximum amount a firm may lose
given an incident. It is may be the
total value of the assets
?Maximum probable loss is the
expected loss given the most likely
probability of an event happening
eg: MPL at 5% is 20 million, MPL at
1% is 30 million
Value-at-risk
? Value at risk is the value of the property at
risk for a givedescribes probability distribution
for the value of a firm/portfolio that is subject
to loss.
? Fig 3.9; 5 million is the value at risk for a
portfolio at 5% risk, the probability that the
firm will lose more than 5 million is 5%(area to
the left of 5 million is 0.05) similarly if 7.5 million
is the value at risk at 1% level, the probability
that the firm will lose > 7.5 million is 1%
? Firms use value at risk concept to measure
risk and rebalance portfolio by
selling/hedging.
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
example
Solve?
?What is the expected value of
outcome if you win Rs 1 for heads
and lose Rs 1 for tails; in a coin
toss game?
?Calculate the sample mean and
sample standard deviation if the
game is played 5 times with the
following results: T,T,H,T,H
?EXPECTED VALUE = 1*0.5+(-1*0.5)
= 0
?Sample mean = 1*2/5 + (-1*3/5) =
-0.2
?Sample standard deviation =
root Summation pi(xi-mu)
2
?
=
ROOT OF 2/5(1-(-0.2))
2
+ 3/5 (-1-
(-0.2))
2
?Root 0.96 = 0.98
Skewness
?Skewness measures the symmetry of
a distribution. A normal distribution
has zero skewness and is symmetric.
Most of the risk management
distributions are skewed.
?If one assumes a symmetric
distribution then one would
underestimate the likelihood of very
large losses which can be very
harmful.
Maximum probable loss
?Maximum possible Loss is the
maximum amount a firm may lose
given an incident. It is may be the
total value of the assets
?Maximum probable loss is the
expected loss given the most likely
probability of an event happening
eg: MPL at 5% is 20 million, MPL at
1% is 30 million
Value-at-risk
? Value at risk is the value of the property at
risk for a givedescribes probability distribution
for the value of a firm/portfolio that is subject
to loss.
? Fig 3.9; 5 million is the value at risk for a
portfolio at 5% risk, the probability that the
firm will lose more than 5 million is 5%(area to
the left of 5 million is 0.05) similarly if 7.5 million
is the value at risk at 1% level, the probability
that the firm will lose > 7.5 million is 1%
? Firms use value at risk concept to measure
risk and rebalance portfolio by
selling/hedging.
3.9
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
example
Solve?
?What is the expected value of
outcome if you win Rs 1 for heads
and lose Rs 1 for tails; in a coin
toss game?
?Calculate the sample mean and
sample standard deviation if the
game is played 5 times with the
following results: T,T,H,T,H
?EXPECTED VALUE = 1*0.5+(-1*0.5)
= 0
?Sample mean = 1*2/5 + (-1*3/5) =
-0.2
?Sample standard deviation =
root Summation pi(xi-mu)
2
?
=
ROOT OF 2/5(1-(-0.2))
2
+ 3/5 (-1-
(-0.2))
2
?Root 0.96 = 0.98
Skewness
?Skewness measures the symmetry of
a distribution. A normal distribution
has zero skewness and is symmetric.
Most of the risk management
distributions are skewed.
?If one assumes a symmetric
distribution then one would
underestimate the likelihood of very
large losses which can be very
harmful.
Maximum probable loss
?Maximum possible Loss is the
maximum amount a firm may lose
given an incident. It is may be the
total value of the assets
?Maximum probable loss is the
expected loss given the most likely
probability of an event happening
eg: MPL at 5% is 20 million, MPL at
1% is 30 million
Value-at-risk
? Value at risk is the value of the property at
risk for a givedescribes probability distribution
for the value of a firm/portfolio that is subject
to loss.
? Fig 3.9; 5 million is the value at risk for a
portfolio at 5% risk, the probability that the
firm will lose more than 5 million is 5%(area to
the left of 5 million is 0.05) similarly if 7.5 million
is the value at risk at 1% level, the probability
that the firm will lose > 7.5 million is 1%
? Firms use value at risk concept to measure
risk and rebalance portfolio by
selling/hedging.
3.9
Normal distribution and VAR
?Probability of VAR (mu+/-1.64
sigma) = 0.05
?Probability of VAR (mu+/- 2.33
sigma) = 0.01
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
example
Solve?
?What is the expected value of
outcome if you win Rs 1 for heads
and lose Rs 1 for tails; in a coin
toss game?
?Calculate the sample mean and
sample standard deviation if the
game is played 5 times with the
following results: T,T,H,T,H
?EXPECTED VALUE = 1*0.5+(-1*0.5)
= 0
?Sample mean = 1*2/5 + (-1*3/5) =
-0.2
?Sample standard deviation =
root Summation pi(xi-mu)
2
?
=
ROOT OF 2/5(1-(-0.2))
2
+ 3/5 (-1-
(-0.2))
2
?Root 0.96 = 0.98
Skewness
?Skewness measures the symmetry of
a distribution. A normal distribution
has zero skewness and is symmetric.
Most of the risk management
distributions are skewed.
?If one assumes a symmetric
distribution then one would
underestimate the likelihood of very
large losses which can be very
harmful.
Maximum probable loss
?Maximum possible Loss is the
maximum amount a firm may lose
given an incident. It is may be the
total value of the assets
?Maximum probable loss is the
expected loss given the most likely
probability of an event happening
eg: MPL at 5% is 20 million, MPL at
1% is 30 million
Value-at-risk
? Value at risk is the value of the property at
risk for a givedescribes probability distribution
for the value of a firm/portfolio that is subject
to loss.
? Fig 3.9; 5 million is the value at risk for a
portfolio at 5% risk, the probability that the
firm will lose more than 5 million is 5%(area to
the left of 5 million is 0.05) similarly if 7.5 million
is the value at risk at 1% level, the probability
that the firm will lose > 7.5 million is 1%
? Firms use value at risk concept to measure
risk and rebalance portfolio by
selling/hedging.
3.9
Normal distribution and VAR
?Probability of VAR (mu+/-1.64
sigma) = 0.05
?Probability of VAR (mu+/- 2.33
sigma) = 0.01
3.10
FirstRanker.com - FirstRanker's Choice
Risk
identification
MODULE 2
Risk identification
?Critical aspect of risk management.
Failure to identify risk exposures will lead
to huge losses. There is no scientific
method to identify risks and sometimes
they may even be unknown. It is usually
done on the basis of what is insurable
and on the basis of past experience.
??Risk identification is the process by
which a business systematically and
continuously identifies property, liability
and personal exposures as soon as or
before they emerge? ?. Williams and
Heins
Risk identification
Risk
identification
Business risk
exposures
Individual risk
exposures
Identifying business risk
exposures
1
?Physical assets/property
2
?Financial assets
3
?Legal liability
4
?Human assets/personnel
5
?External economic forces
Types of property loss exposure
? Direct loss: direct loss happening to the property either partly
or wholly on coming in contact with the incident . Eg: building,
P&M
? Indirect loss: indirect loss occuring while the direct damage is
on some other property. Eg: factory being torn down to
facilitate rebuilding
? Net income loss: refers to reduction in net income(revenue-
expenses)
? Decrease in revenue may be because of loss of rent,
interruption of operation, contingent business interruption
(losses occuring because a loss eg loss of records)
? Increase in expenses: owing to spending extra money on the
wake of a damage. Eg: spending extra money to hire a
house/hotel room, spending extra money to continue running
the operation ./3P production.
Value of exposures of physical
assets
? Property insurance policies indemnifies the
insured on the basis of either? or?
? Actual Cash Value (ACV) : cost to replace or
repair damaged property less value of physical
depreciation and obsolescence.
? Replacement Cost : cost to replace or repair
damaged property with same or like-kind
property WITHOUT any value of physical
depreciation and obsolescence. Also called re
-instatement cost.
? Value by second method is always higher.
Types of exposure to financial
assets
? Risk of loss of financial assets like
? 1. credit exposure: debtors or accounts receivables fail
to pay or delay payments. Bad-debts can lead to heavy
losses. Delayed payments lead to loss of money owing
to interest cost .
? 2. currency exposure: involves losses in adverse
movement of exchange rates. It affects companies
which are in international trade. Indirectly it also affects
companies which have competitions from abroad.
? 3. country exposure: arising out of problems in the
country of opeartion. Comprises of political risk,
regulatory risk and economic risk.
? 4. Liquidity exposure: this refers to the risk of a financial
asset like bond, debentures going illiquid.
Features of financial asset
exposure
? Financial asset exposure depends upon its financial
structure
? If the capital structure makes earnings unstable the
company may fail
? When company raises funds to finance its growth it will
have impact on future earnings and stability
? Debt financing offers a low cost source of funds to the
company and financial leverage to stock holders
? Large amounts of debt increases variabilty of returns to
the stock holders thereby increasing their risk
? Variability in returns is for shareholders is more in leveraged
firms than in unleveraged firms.
Types of legal liability exposure
? Arising out of ownership/use/possession: this
puts onus to keep it risk free. And safe
? Arising from manufacture/distribution/sale:
owing to breach of warranty, defective
product. May lead to penal provisions
? Arising from fiduciary relations: failure to
discharge duty towards shareholders by the
directors
? Employers? liability: for job related injuries and
compensation to workmen. Usually discharged
by workmen compensation policies.
Legal wrong
? A legal wrong is a violation of a person?s legal rights, or
a failure to perform legal duty towards another person
or society.
? There are 3 broad categories of legal wrongs:
- a crime is a legal wrong against society and is
punishable by fines, imprisonment, death.
- a breach of contract is another legal wrong
- a tort is a legal wrong for which the remedy is in the
form of money damages. It is a personal injury law.
Torts are of 3 types: intentional torts, absolute/strict
liability and negligence.
? A person who is harmed (plaintiff, claimant) can sue
for damages from the defendant or tortfeasor.
Categories of legal liability
?Criminal liability: comes under IPC,
generally directed at wrongs against
the society. Police begins the legal
procedure and the court will impose
penalty and/or imprisonment.
?Civil liability: directed at wrongs against
individuals/organisations where one
party files a liability suit against another.
Penalty in the form of indemnity for losses
or punitive damages may be levied by
the court.
Exposure of human assets/personnel
?Exposure when employees/people die,
get injured, reach old age, fall ill or lose
jobs. Companies manage these
exposures either due to legal strictures or
as part of compensation/motivation to
employees.
?Employers resort to provisioning to PF,
pension, gratuity, life and health
insurance cover and disability benefits.
?A special kind of risk is a key person?s
death or disability . Keyman insurance is
available for this purpose.
Exposure from external economic
forces
Losses arise from factors outside
the firm like,
?Changes in input/output prices,
changes in exchange rate, and
financial distress experienced by
important suppliers/buyers.
Identifying personal risk exposures
1
?Personal loss/injury
exposures
2
?Property loss exposures
3
?Legal liability loss exposures
Personal loss/injury exposures
?Loss of income to the family
because of death of the family
head
?Huge medical bills and loss of
earnings during disability
?Insufficient income/assets during
retirement
?Loss of income from unemployment
?Identity theft
Property loss exposures
? Direct physical damage to home/personal
property because of fire, lightning, flood,
earthquake, etc
? Indirect expenses arising out of above direct
physical loss like expenses for hotel, travel
during period of reconstruction, loss of rent loss
of use of the building etc
? Theft of valuable personal property including
money, securities, jewellery, electronics etc
? Direct physical damage to cars, Bykes, etc
from collision and non-collision reasons
? Theft of cars, bykes, and other vehicles
Legal liability loss exposure
Legal liability arising out of:
?Personal acts that cause bodily
injury to others
?Libel, slander, defamation of
character and similar exposures
?Negligent operation of vehicles
?Business or professional activities
?Payment of attorney fees and other
legal defense costs
Probability and Statistics - concepts
? Random Variable ? A variable whose outcome is
uncertain. Eg: head or tail in a coin flip is
uncertain.
? Discrete variable v/s continuous variable.
? All the possible outcome in a random variable and
their probabilities is identified in a probability
distribution. This can be represented tabular or
graphical. (propability of head and probability of
tail ccuring)
? In a graphical representation, you put outcome
on the X axis and probability on the Y axis.
Possible outcome for X probability
$1 0.5 or 50%
-$1 0.5 or 50%
Another example
? Probability distribution for
damages to your car.
Damages Probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
Characteristics of a probability
distribution
?In order to compare and analyse
different probability distributions the
following characteristics may be
used:
?Expected value
?Variance and standard deviation
?Skewness
?Correlation
Expected value
? Expected value of an outcome tells where the
outcome tends to average
? Expected value
? = average
? = add up all (outcome*probability)
? = x1p1+x2p2+x3p3+???..
? = Summation xipi (Sigma xipi)
? Graphically expected value = Mean can be
easily identified visually if the graph is
symmetric.
? If not, it is a bit difficult.
?
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability
0 0.5
500 0.3
1000 0.1
5000 0.06
10000 0.04
What is the expected value of
damages?
Possible outcomes for
damage (Rs)
probability xipi
0 0.5 0
500 0.3 150
1000 0.1 100
5000 0.06 300
10000 0.04 400 total=950
What is the expected liability loss?
?5000000 with probability of 0.004
?1500000 0.025
?Loss of 500000 0.030
?0 0.941
What is the expected liability loss?
?5000000 * 0.004 = 20000
?1500000 * 0.025 = 37500
? 500000 * 0.030 = 15000
? 0 * 0.941 = 0
?EXPECTED LIABILITY = 72500
Variance & standard deviation
? Variance of a probability distribution provides
information about the likelihood and magnitude
by which a particular outcome will differ from
the expected value (or average)
? A low variance means that an actual outcome
is very close to the expected value and a high
variance means that the actual outcome is far
from the expected value.
? Variance = Sigma pi (xi-mu)
2
? It is mathematically more convenient to work
with the square root of variance which is called
standard deviation.
example
Solve?
?What is the expected value of
outcome if you win Rs 1 for heads
and lose Rs 1 for tails; in a coin
toss game?
?Calculate the sample mean and
sample standard deviation if the
game is played 5 times with the
following results: T,T,H,T,H
?EXPECTED VALUE = 1*0.5+(-1*0.5)
= 0
?Sample mean = 1*2/5 + (-1*3/5) =
-0.2
?Sample standard deviation =
root Summation pi(xi-mu)
2
?
=
ROOT OF 2/5(1-(-0.2))
2
+ 3/5 (-1-
(-0.2))
2
?Root 0.96 = 0.98
Skewness
?Skewness measures the symmetry of
a distribution. A normal distribution
has zero skewness and is symmetric.
Most of the risk management
distributions are skewed.
?If one assumes a symmetric
distribution then one would
underestimate the likelihood of very
large losses which can be very
harmful.
Maximum probable loss
?Maximum possible Loss is the
maximum amount a firm may lose
given an incident. It is may be the
total value of the assets
?Maximum probable loss is the
expected loss given the most likely
probability of an event happening
eg: MPL at 5% is 20 million, MPL at
1% is 30 million
Value-at-risk
? Value at risk is the value of the property at
risk for a givedescribes probability distribution
for the value of a firm/portfolio that is subject
to loss.
? Fig 3.9; 5 million is the value at risk for a
portfolio at 5% risk, the probability that the
firm will lose more than 5 million is 5%(area to
the left of 5 million is 0.05) similarly if 7.5 million
is the value at risk at 1% level, the probability
that the firm will lose > 7.5 million is 1%
? Firms use value at risk concept to measure
risk and rebalance portfolio by
selling/hedging.
3.9
Normal distribution and VAR
?Probability of VAR (mu+/-1.64
sigma) = 0.05
?Probability of VAR (mu+/- 2.33
sigma) = 0.01
3.10
Correlation
?Correlation measures the relationship
between random variables.
?If the correlation between two random
variables is zero then they are not
correlated. I means that knowing value
of one will not reveal the value of the
other. Eg: liability claims for an auto
company and steel prices. They are
independent or uncorrelated.
? on the other hand, demand for new cars
and steel prices are correlated.
FirstRanker.com - FirstRanker's Choice
This post was last modified on 18 February 2020