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The Management Of Risk

This article is provided to you independently of any insurance broker, company, or lobbyist. We believe in democratizing knowledge to our readers through a complete independent lens. For more learning around commercial insurance and risk management, visit our classroom.

The Management Of Risk

The management of risk is the practice of discovering, analyzing, controlling, transferring, and exploiting possible loss scenarios. For business and investors, this can translate into much higher returns over the long term. In fact, investors who evaluate in detail various solutions to address exposures within a business-acceptable tolerance level are known to outperform their peers consistently. Therefore, the management of risk is an essential practice for business and investors to adopt in order to keep growing without having to stop or fall back at any point in time.

Origins Of The Management Of Risk

The management of risk has been a strategic tool that early civilizations such as the Pharaohs and the Babylonians used. Insurance is also one of the oldest known forms of risk management, and yet it remains in practice today because of its mathematical effectiveness with respect to protecting against certain types of losses. In fact, commercial insurance is becoming more and more important within the management of risk as it can now be structured, independently of brokers and insurers, to transfer the financial consequences of specific events from the person or entity involved to an insurance company with a much higher degree of confidence than previous.

Process Of The Management Of Risk

All risk management systems are based on the same principles even if they differ in style or approach, which is to allow business and investors to effectively and efficiently manage uncertainty and potential disruptions so that they are able to smooth out their performance over a long time horizon and maximize risk-adjusted returns. While some scholars advocate the use of Enterprise Risk Management as the main process for managing risk, we advocate the use of Operational Risk Management instead given that Operational Risk is the nucleus of all business risks. In any event, the following steps should be implemented within the management of risk:

1. Determining an organization's risks.

The first stage in the process of managing risk is to identify and analyze the details of any hazards, risks, or loss scenarios to your organization. Risk management techniques such as risk assessments and risk reviews can help in identifying and recording loss scenarios of concern.

2. Assessing the impact of identified risks.

The probability and outcome of every risk or loss scenario are decided within the second step of the risk management process. By analyzing each risk mathematically, it is possible to evaluate its potential impact on the business and its investors. A risk register is a useful risk management tool for keeping track of and scoring loss scenarios. This will also help an organization determine which risks are too dangerous and should be avoided or transferred fully through insurance. Deciding which risks are unacceptable should be done in relation to an organization's goals and readiness. While acceptable risks should be assessed and evaluated on a regular basis, undesirable risks should be avoided, minimized, or transferred.

3. Reducing or transferring any risks that are undesirable.

Risks that are undesirable and that cannot be avoided should be minimized or moved to an appropriate risk tolerance level for the business. Executives should also think about transferring unacceptable risks off their balance sheet through commercial insurance to reduce the amount of exposure.

4. Disaster planning.

This phase of the process of managing risk deals with risks that cannot be controlled or transferred through insurance. What is an organization's backup plan if its first attempt to manage a risk fails? For example, what are the procedures to successfully respond to and limit the consequences of a cyber breach after the incident has occurred and in the event there is no good cyber insurance in place? These are the types of questions to think about and around which a formal disaster planning and business continuity protocol should be formalized.

5. Monitoring, reviewing, and updating regularly.

Continuously monitoring, assessing, and reporting on risks to your organization is one of the most dynamic phases of the risk management process and should be done based on the evolution of the operations at hand. However, the risk management framework does not end with the identification, analysis, and control of risks. New and developing risks will continue to threaten a business and its investors. Hence, the management of risk needs evolve accordingly.

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