Risk Management Techniques in the Financial Sector - Research Proposal Example

Risk Management Techniques in the Financial Sector Table of Contents 0 Introduction 4 1.1 Background 4 1.2 Statement of problem 4 1.3 Purpose of the Study 4 1.4 Objective of the Study 4 2.0 Research Questions 5 2.1 Significance of Study 5 3.0 Literature Review 5 3.1 Introduction 5 3.2 Conceptual Framework 5 3.3 Techniques of Risk Management 6 3.3.1 Loss Financing 6 3.3.2 Risk Avoidance 6 3.3.3 Loss Prevention and Control 7 3.4 Financial Performance of Companies 7 3.4.1 Underwriting Ratio as a Measure of Financial Performance 7 3.4.2 Profitability Ratio as a Measure of Financial Performance 7 3.5 Relationship between Risk Management Techniques and Financial Performance 7 4.0 Research Methodology 8 4.1 Research Design 8 4.2 Data Collection Instruments 8 4.3 Research Approach Adopted 8 5.0 Data Collection and Analysis 8 5.1 Factor Analysis 8 5.2 To Determine the Relationship between Applied Risk Management Techniques and Financial Performance 9 6.0 Conclusion 9 7.0 Reference List 10 1.0 Introduction 1.1 Background Risk management is defined as a method of identifying the loss exposures which is faced by the companies and choosing the most suitable practice for treating such exposure (Rejda, 2003). There are several techniques available to manage the risk prevailing in the financial sector such as companies. These comprise of loss deterrence and control, avoidance of risk, and loss financing (Meredith, 2004). Management of risk is a significant factor on which the companies must focus if they want to attain the financial performance. The companies are categorized by low degrees of loss deterrence and control, and low threat/risk transfers, and are not neglecting extremely insurable risks. The loss ratios have been continuously increasing in the financial sector and therefore hampering financial performance. 1.2 Statement of problem Companies are continuously registering unacceptable financial performance. This is due to the fact that they might be not correctly applying techniques accessible for controlling risks for example loss financing, risk avoidance, and loss prevention/deterrence and control. Insufficient utilization of such risk management technique could lead to augmented loss exposure that ultimately results in increase in the loss ratios and therefore deprived financial performance. 1.3 Purpose of the Study The rationale behind this study is to scrutinize the connection between applied techniques of risk management and the financial performance of companies. 1.4 Objective of the Study The research objectives are summarized below: To institute the use of risk management methods of companies. To scrutinize the financial or economic performance of companies. To observe the connection between applied techniques of risk management and the financial or economic performance of companies. 2.0 Research Questions How do companies in the financial sector such as the companies apply techniques of risk management? What is the economic performance of companies? What is the connection between applied techniques of risk management and the financial or economic performance of the companies? 2.1 Significance of Study The study will provide knowledge on the utilization of different techniques of risk management in the companies. It will also offer knowledge of the financial sector on the connection between methods of risk management and financial or economic performance in the companies. 3.0 Literature Review 3.1 Introduction Financial sector includes the banks, real estate, and the financial companies. The study will be carried out on the companies. The insurance company is defined as a corporation which is mainly engaged in giving insurance cover to the public as well as sale contracts of the insurance. Risk management is defined as a method of recognizing loss exposures that is faced by the companies as well as choosing the most suitable technique or method for treating the loss exposures (Dorfman, 1997). 3.2 Conceptual Framework (Source: Rejda, 2003) Components of risk management methods or techniques include risk avoidance, loss financing, and loss deterrence and control. Financial measures which are considered for the companies include profitability and underwriting ratios (Naik, 2003). The techniques of risk management have an immense effect on the financial performance of the companies. If the companies fail to apply these techniques then it could result in the increase in the costs of insurance, which will consequently affect profitability and loss ratios. 3.3 Techniques of Risk Management 3.3.1 Loss Financing It is mainly concerned with guarantying the accessibility of finances in case of loss. There are various methods of loss financing such as risk transfer, risk retention and diversification that can be used in the companies (Naik, 2003). Risk transfer: The companies employ this technique in order to shift the loss exposure to another entity or person that can be capable to bear the loss. Companies generally transfer risks by way of re-insurance and insurance hedging and diversification. This reduces the loss of original/new insurer and thus improves the financial performance (Naik, 2003). Risk retention: It is defined as a method of keeping the probability of loss without any effort to transfer the loss to other party. This technique is suitable when the loss exposure or the threat of loss is excessively small with little or no impact on companies. Diversification: This technique is employed to diffuse or spread the risk exposure. It is one of the common risk management techniques that attempt to lower the risk by mingling exposures which are not connected to each other (Naik, 2003). 3.3.2 Risk Avoidance It implies that a definite risk exposure is under no circumstances acquired or a prevailing loss exposure is neglected. If the companies remain unsuccessful to avoid the risks then they may become bankrupt. Therefore, these companies apply strategies and policies to neglect the threat of bankruptcy. They can avoid risks through selling the small policies in spite of one comprehensive policy (Naik, 2003). 3.3.3 Loss Prevention and Control It implies to the method that minimize the occurrence of a definite loss such as measures that minimize truck accidents or stringent enforcement of the protection rules. Companies can install an automatic sprinkler method that quickly extinguishes fire as well as separation of the exposure divisions so that a particular loss cannot concurrently damage entire exposure divisions such as including warehouse with the inventories at various locations (Naik, 2003). 3.4 Financial Performance of Companies Financial institutions like banks and financial companies have different methods of reporting the financial information. The financial or monetary performance of companies can be assessed by means of profitability and underwriting ratios. 3.4.1 Underwriting Ratio as a Measure of Financial Performance Loss Ratio: It is calculated by dividing the adjusted expenses of loss by the premium earned. It indicates what proportion of the payouts will be settled with receivers or recipients (Bishop, 2009). Lower loss ratio is preferable. A high loss ratio signifies that the insurance company might need better techniques of risk management to protect against the future probable insurance payouts. 3.4.2 Profitability Ratio as a Measure of Financial Performance Return on Equity Ratio: If the companies are capable to check their performance then they should observe their levels of profitability. Return on Equity is one of the frequently used ratio in defining the financial performance and profitability of an institution. The high value of return on equity means that the organization is competent in generating earnings on the new investment. 3.5 Relationship between Risk Management Techniques and Financial Performance The financial companies should use sound techniques of risk management when settings plan for the upcoming moments so as not to reduce the company’s assets. The companies cannot continue to exist with increased expense and loss ratios. Averting losses by adopting appropriate method is considered as a main component in minimizing risks and a main driver of profitability. 4.0 Research Methodology 4.1 Research Design Convenient sampling will be used to choose the sample for conducting the primary research. It will be simpler to use because it involves choosing respondents based on their vicinity to the researcher. This facilitates the researcher to avoid complexities related to the random sampling method (Patton, 2002). A sampling method will be used by taking the sample size of 20 supervisory and management officers. They will be selected due to the reason that they deal with the policy formulation as well as supervising policy execution (Bailey, 1994). 4.2 Data Collection Instruments Primary data: Primary data based on the applicability of the techniques of risk management will be obtained from supervisory and management officers by means of a closed questionnaire. Secondary data: Secondary data on the economic performance of the forms or companies will be acquired from the annual reports of the companies. It has also been collected in order to provide robustness to the outcomes that will be obtained from the analysis of secondary data (Connaway and Powell, 2010). 4.3 Research Approach Adopted Deductive approach has been deemed appropriate to conduct this research study because it initiates with the development of relevant theories. This approach serves as a solid foundation based on which a thorough conclusion is reached (Gratton and Jones, 2010). The reason behind the execution of deductive approach is that this study involves testing soundness of theories that have been used through a wide range of literature to determine the connection between the research variables (Mukherji and Albon, 2009). 5.0 Data Collection and Analysis 5.1 Factor Analysis Factor analysis will be used in order to extract the most significant aspect that measures the techniques of risk management by using the principle component technique. This involves employing the analysis of multiple linear regressions and the Pearson correlation analysis in order to determine the level of relationship among the variables and the expectedness of risk management methods (McDonald, 1985). 5.2 To Determine the Relationship between Applied Risk Management Techniques and Financial Performance The level of relationship will be determined by the correlation coefficient of Pearson and the expectedness of company’s performance will be determined by the regression analysis. The relationship or connection between the techniques of risk management and the financial performance will be established by using risk avoidance, loss financing, loss deterrence and control, loss ratio, and ratio on return on equity. Correlation coefficients will be obtained by using applied techniques of risk management and the latest year data for the financial performance. 6.0 Conclusion The main purpose of this study was to inspect the relationship among applied techniques of risk management and the financial performance of companies. Main objectives of this study was to institute the use of risk management methods of companies and to observe the connection between applied techniques of risk management and the financial or economic performance of companies. The financial companies should implement enterprise risk management method that is presently the best standard. The strategies of risk transfer can also be executed in order to minimize the rate of hedging unwanted risks and also to improve the organization’s capabilities towards originating desirable though concentrated risks. 7.0 Reference List Bailey, K.D., 1994. Methods of Social Research. 4th ed. New York: Macmillan Inc. Bishop, A., 2009. How to calculate Claims Loss Ratio example. [online] Available at: [Accessed 27 Jan 2015]. Connaway, L. S. and Powell, R. R., 2010. Basic research methods for librarians. California: ABC-CLIO. Dorfman, M., 1997. Introduction to risk management and insurance. New Delhi: Pearson Prentice Hall. Gratton, C. and Jones, I., 2010. Research Methods for Sports Studies. United Kingdom: Taylor & Francis. McDonald, R.P., 1985. Factor Analysis and Related Methods. United Kingdom: Psychology Press. Meredith, L., 2004. The ultimate risk manager. Boston: CUSP Communications Group Inc. Mukherji, P. and Albon, D., 2009. Research Methods in Early Childhood: An Introductory Guide. London: SAGE Publication. Naik, K.L., 2003. Theory and practice of Re-insurnace. Journal on business insurance management, 2(1). Patton, M. Q., 2002. Qualitative research and evaluation methods. London: Sage Publication. Rejda, E.G., 2003. Principles of Risk Management and Insurance. New York: Pearson Education Inc. Read More