The Key Risk Management Decisions - Research Paper Example

A. What are the key risk management decisions? Risk management represents the process of weighing policy options inconsideration of the outcomes of risk assessment and, if necessitated, choosing and implementing suitable control options such as regulatory measures. An optimal definition of risk management incorporates risk management processes such as risk evaluation, implementation of management decision, risk management, and monitoring and review. Risk management represents the process of highlighting, analyzing, and communication risk and embracing averting, transferring, or managing risk to an acceptable degree taking into account the associated costs and benefits for any actions undertaken. The purpose of risk management centres not in eliminating risk, but to comprehend risk so that the organization can take advantage of the upside and reduce the downside. Risk management cannot be considered as an end in and of itself, but rather forms part of sound organizational practices detailing planning, program appraisal, process improvement, preparedness, and budget priority development. The core principles guiding effective risk management entail transparency, effectiveness, urgency, flexibility, adaptability, practicality, customization, robustness, synergy, and transparency. The key areas in risk management include fund (governance risk); strategy (asset allocation risk); implementation (manager risk and Implementation risk), and review (monitoring risk). Discussion Given the uncertainties connected to estimating the costs and benefits, the function of risk management strongly connected to process rather than outcome. Cost benefit analysis is a useful tool for structuring, appraising, and presenting the cost and benefits, as well as the pros and cons on interventions. This demands a coherent methodological, especially in data-restricted environments. In the context of risk management, two prominent issues deserve close attention when undertaking risk management: assessment of risk, whereby the analysis should be undertaken in a “stochastic way so as to account for the nature of exposure impacts” (Moller 2011, p.2). Second, the assessment of averted risks, whereby benefits represent risks avoided. The core benefits derived from investment in risk management centres on the minimization of future impacts and losses. Risk management plans may detail set functions, areas, activities, projects or processes that are consistent with the organization’s risk management strategy. In order to manage risk, companies should first comprehend the risks that they may be exposed to, which necessitates the development of a risk profile that features immediate risks (from either market changes or competition), as well as the indirect impacts of macroeconomic forces. Companies scan protect themselves from the risks by utilizing several approaches such as hedging against certain risks, adjusting the manner in which entities fund asset minimize risk exposure, or purchasing insurance. The categorization of risks can be regarded as the first step in determining what the company should do about the risk: Market versus firm-specific risks; operating versus financial risks; catastrophic versus smaller risks; and, continuous versus event risks. B. Direct costs and benefits of these risk management decisions Direct costs represent costs that can be traced easily and conveniently to a set cost element/object. Directs costs emanate from a direct contact with the risk (immediate effect) while indirect costs emanate from the direct impacts and are usually ranging from medium to long term. The monitoring of risk drivers and increased risk awareness can lead to the processes of event identification and assessment, investment flexibility, and risk management spending, which in turn, paves way for improved cost control, business continuity, improved reputation, greater sales, and improved productivity. Risk manager has an opportunity to substantiate their decision-making based on quantifiable measures. Quantifiable risk analysis avail improved data collection and highly robust modelling software and techniques. Portfolio risk analysis measures can be gauged against enterprise risk management mode of benchmark including risk bearing capacity. This form of depth analysis enables clients to explore the range of the total portfolio hazard risk outcomes against the company’s risk tolerance levels, as well as their capacity to absorb risk. The valuation on the anticipated loss can be employed as the foundation of detailed analysis on the value based on risk management efforts in an organization, loss of alleviation scenario testing, decision tree modelling, and variability of the total cost of risk. A detailed simulation analysis can be undertaken and benchmarked against the organization forecasts and risk tolerance levels (Dezfuli, Youngblood, and Reinert, 2007). Cost estimate captures the entire cost of every alternative over its whole life-cycle and its summation of all pertinent cost elements. Benefits, on the other hand, represent the outcomes anticipated in return for costs incurred in a certain alternative. Benefits can be quantitative and qualitative improvements anticipated or emanating from the implementation of an alternative. The value of the minimization of economic constant derived from the costs linked to the control measures. The estimation of the benefits can also be based on valuation methods based on how entities “trade-off costs and benefits” (Berg 2010, p.79). The objective, in this case, rests on the availability of data and statistical tools that can be employed to estimate the economic costs and benefits of risks. Risk management decision can deliver a number of direct benefits such as reduced costs of penalties or prosecution, an increase in shareholder value, and increased savings in costs. The other direct benefit of risk management decisions draw from improved corporate reputation, which may be accompanied by an increase in sales from existing and new clients, improved employee retention, and improved recruitment. This may come at direct costs associated with cost of risk reporting, potential costs related to competitors given that risk information can aid competitors to improve their competitive position. Risk management decision must be supported by data; as such, organizations incur costs in gathering data, analysis, and reporting. Other costs include possible costs related to investors who may withdraw their capital. Moreover, risk management decisions may herald “bargaining disadvantage with both customers and suppliers” (Epstein and Buhovac 2006, p.32). In the event that risk manifests overtime as time changes in value and earnings, companies can assess a firm’s exposure to risks by probing the firm’s history. Alternatively, the firm can arrive at estimates on risk exposure by looking at firms within the sector where the firm operate, especially their sensitivity to alterations in risk measures. Three approaches can be outlined to estimate the costs, namely: economic-engineering analysis approach, the cost survey analysis approach, and econometric estimations of cost. In the economic-engineering approach, the cost of control programs can be approximated for each procedure required in the implementation of the program. Economic-engineering approach allows for the “efficiency analysis via approximation of cost functions” and also fosters transparency (MacDaniels and Gregory 2004, p.1921). In the econometric approach, costs approximations can be undertaken by deriving econometrically approximated costs functions based on a dataset that is representative of a set group of producers. In this approach, several econometric approach modelling approaches with diverse underpinning assumptions can be employed. C. Indirect costs and benefits Risk analysis has grown to become a critical decision making tool. The assessment of risks aids in the determination of appropriate policies that the organization should adopt so as to mitigate the highlighted risk. The analysis of risks mainly encompasses a probability statement detailing how likely the events will occur. The other significant consideration in the estimation of costs and benefits centres on the consequences of an event. Risk management represents decision making process that encompasses risk assessment, economic impacts, technological feasibility, economic impacts, legal requirements, and pubic concerns (Herrinton, 2012). The risk estimates seeks to guarantee that the absence of complete knowledge does not yield to an underestimation of the risk. Indirect costs represent costs that cannot be traced readily/easily to a cost object/element. Risk management decision may herald reduced earnings volatility, which leads to an increase in shareholder value. Ultimately, risk management decision plays a big role in increasing revenues and containing costs in the organization. The concerted effort on risk management leads to enhanced organizational success and shareholder value. Internal risk disclosure can play a big role in ensuring that the organization comply with regulation, enhanced operational decision-making, improved working environment, improved resource allocation, and enhanced strategic decision-making. Ultimately, risk management decision may herald “indirect benefits evidenced by reduced cost of capital,” which in turn, plays a big role in enhancing savings in costs of equity financing (Epstein and Buhovac 2006, p.33). Estimating risk and the costs and benefits of risk management in intrinsically complex given that the consequences, costs, and benefits to risk management are probabilistic and emanate only in event occurring. Accordingly, benefits should be appraised in terms of probability multiplied by the consequences, yielding to an estimate of risk as the outcome of exposure and vulnerability. When appraising risk management decision, risk manager can utilize a range of approaches that have proven to be effective decision support tools (Tonello, 2012). Risks and benefits, when minimized, transferred or averted, can be measured based on quantitative cost-benefit analysis. Cost-benefit analysis represents an established tool for determining the economic efficiency of developing interventions. Cost-benefit analysis compares the costs of undertaking such decisions with their benefits and calculates the net benefits or efficiency (Mechler and The Risk to Resilience Study Team, 2008). The benefits generated by the interventions, as well as the additional benefits emanating from improvement in the infrastructure. In risk management, the benefits represent the averted or minimized potential damages and losses occasioned by the implementation of risk management decisions. Conclusion Risk management, by definition centres on making a decision regarding balancing risks; nevertheless, risk management framework avail minimal direction as to making a multi-objective choice that feature value-based trade-offs. Risk management represents the culture, processes, and structures designed to deliver opportunities and create value while managing adverse impacts. Recently, there has been growing interest in risk management as a chance to apply new thinking and tools. Risk management seeks to appraise the uncertainty of the future with the main of making best possible decision today. Risk management plays a critical role in leading to better decisions, enhanced planning, effectiveness, and performance. References List Berg, H. (2010). ‘Risk management: Procedures, methods and experiences’, RT & A, 2 (17), pp.79-95. [Online]. Available at: http://gnedenko-forum.org/Journal/2010/022010/RTA_2_2010-09.pdf [Accessed 21 November 2013]. 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Available at http://blogs.law.harvard.edu/corpgov/2012/08/23/strategic-risk-management-a-primer-for-directors/ [Accessed 21 November 2013]. Read More