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23 Cards in this Set
- Front
- Back
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Enterprise Risk Management |
- logical process used by firms to deal with multifaceted exposures to loss - Continuous process that identifies loss and how to deal with them efficiently - takes the issue of risk to the corporate boardroom |
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ERM vs. traditional corporate risk management |
- corporate deals with pure risks, uses insurance and non-insurance techniques - looks at all risks collectively (ERM) |
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Why we are concerned with risk |
- Catastrophic losses - Corporate Financial Failures - Shrinking employee benefit plans |
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What is risk? |
- cause financial loss for individuals or firms |
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Pure Risk |
- exposure can result in a loss or no change (two possible outcomes) - no opportunity for financial gain - terrorism, floods, earthquakes, fires, windstorms, wars, unemployment - Employee benefits protect against pure risks |
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Speculative Risks
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- exposure that can result in loss, no change or gain - investing in stock market, entrepreneurs starting up new business, introducing new product lines, interest rate changes, foreign currency price movements, changes in commodities |
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Systemic Risk
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- hard to diversify because it is market wide
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Diversifiable Risk |
- financial losses of a few members are spread across much larger number of the group "risk pooling" - uses law of large numbers - differentiating characteristic- generally firm-specific - most speculative risks are diversifiable |
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Non-Diversifiable Risk |
- cannot be spread but affects all members - most catastrophic events - private insurers rarely offer insurance b/c financial strength could be harmed if catastrophic loss occurred |
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Risk Aversion
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- firms and individuals prefer to take less risk rather than more, and willing to pay more to avoid risk - good way to approach most pure risks but not best way to approach speculative risks |
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Risk- Return Trade Off |
- if taking more risk, firms/individuals expecting higher return
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Benefits compared to no insurance
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- stability of families - aids planning ability for businesses - facilitates credit transactions - anti-monopoly device - reduces credit costs - increases capital efficiency |
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Protection from Risk- Retention |
- default strategy - retain possible loss; called passive retention when subject has not identified exposure or underestimates potential severity of exposure - better alternative is personal insurance protection
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Insurance |
- financial agreement in which individual pays premium to transfer financial consequences to risk pool
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Industrialized vs. Developing Economies and Insurance |
- little to no protection in developing b/c poor risk and insurance infrastructures - rely on humanitarian aid - industrialized fail to appreciate insurance, crucial to stabilizing economy |
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Social vs. Private Insurance and Employee Benefit Plans
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- social- administered and funded by governmental bodies - private- independently owned and operated - employee benefit plans protect against many pure risks such as health, disability, life and retirement
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Risk Management Process
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1. Establish risk management goals 2. Identify potential loss exposures 3. Measure potential loss 4. Choose risk handling techniques 5. Implement techniques and monitor effectiveness
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Establish risk management goals |
- make sure they are consistent with strategic goals of the firm - pre-loss: prevent loss, be cost effective - post-loss: survive, minimize disruptions
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Identify the potential loss exposures
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- Property- tangible and intangible - Liability- forms of monetary judgments owed to plaintiffs harmed financially by negligent acts of organization - Human resources- employee benefits, workers comp., loss of key employees - Indirect- business interruption |
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Measure potential loss |
- frequency- measures number of losses that might occur over given period of time - severity- measure of size of loss if loss is assumed to occur
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Choose risk-handling techniques |
- avoidance - loss control (loss reduction and prevention) - loss/risk transfer - loss/risk financing
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ERM- Integrated Framework |
- Top Down Corporate Focus (raise awareness to boardroom) - Broad Scope of loss exposures (pure, operational, strategic and financial risks) - Portfolio Perspective for Diversification Opportunities (putting together risks that cancel out each other) - Systematic Process of Risk identification, Assessment and Treatment ( model after risk management process)
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Types of ERM Exposures
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- Pure (property, liability, human resource, indirect) - Operational (supply/distribution chains) - Strategic (product development, brand value) - Financial (credit, interest, currency risk) |
