Risk Management Decisions - Essay Example

Risk Management Decisions Risk Management Decisions Introduction It is difficult to define the risk management process. There are no universally accepted definitions. The definition can be changed based on the circumstances and the amount of risk involved in an incident such as natural disasters or fires, accidents, ergonomics, death and lawsuits, Financial risk management, etc. Most of the government organizations and private business sector have their own well structures risk management policies. Such policies will help them in dealing with unexpected risks. Most of the governments have action forces or commandoes to deal with the unexpected natural calamities or the terrorist attacks. At the time of writing this essay the Indian government is facing a terrorist attack at Mumbai and the military and commandos still trying to rescue the affected persons. In business sector also we are facing the unexpected financial crunch all over the world. Those organizations who have the well defined risk management policies find it easy to tackle the present situations while the others are agonizingly facing the reality. So the importance of risk management is very clear when we consider these incidents. Abstract Risk management is a structured approach to managing uncertainty related to a threat, a sequence of human activities including: risk assessment, strategies development to manage it, and mitigation of risk using managerial resources. The risk management strategies include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, Risk Management Decisions 2 and accepting some or all of the consequences of a particular risk. Making a Risk Management Decision entails deciding which of a variety of options are the most appropriate to manage the site. The risk management plan should propose applicable and effective security controls for managing the risks. The objective of risk management is to reduce different risks related to a particular domain to the level accepted by society. Risk management should create value; it should be an integral part of organizational process; it should be a part of decision making; it should explicitly address uncertainty; it should be systematic and structured; it should be based on the best available information; it should consider human factors; it should be transparent; and it should be capable of continual improvement and enhancement. Risk Management strategies “A risk management decision should be derived directly from the Risk Characterization based on the question: Does the Risk Characterization indicate that adverse effects to receptors are likely?” The ultimate goal of risk management is to select a socially and environmentally acceptable and cost effective strategy that mitigates the threats to, and provides protection for, human health, welfare and the environment as well as allowing, where possible, flexibility in future land uses (Risk Management Decisions). Some traditional risk managements are focused on risks causing from physical or legal causes. Financial risk management, on the other hand, focuses on risks that can be managed using traded financial instruments. Risk management goals generally fall into three broad categories: Public protection measures, Containment techniques, and Physical and chemical clean up techniques. Risk Management Decisions 3 “Risk management planning adaptation also relates to company risk management policies”. (Rita Mulcahy - Page 49). It is important to have a structured risk management policy for organizations. Since most of the risks occurred unexpectedly, such pre-defined policies will be helpful at the time of the occurrence of the risk. The Indian financial sector is an example. Since the Indian economy is a mixed economy and the financial sectors were not too much dependent on foreign organizations, the current economic crisis didn’t damage the Indian financial sector. Such precautions taken by the government and the financial sector are a best current example of pre-planned risk management. “Two of us looked at an event and made similar estimates of the likelihood of it recurring. However, one of us chose to accept the risk; the other, chose to mitigate it. Which of us was right?”(A Tale of Two Risk Management Decisions) For example, an observed high risk of computer viruses could be mitigated by acquiring and implementing antivirus software. A good risk management plan should contain a schedule for control implementation and responsible persons for those actions. “Risk management is often a multi criteria decision making process in which economic, health, legal, environmental, social, geo-political and other factors come into play. It is the risk manager’s responsibility, to appropriately weigh these factors and decide on a course of action” (Risk management decision criteria).. It may refer to numerous types of threats caused by environment, technology, humans, organizations and politics. On the other hand it involves all means available for humans, or in particular, for a risk management entity (person, staff, and organization). Once risks have been identified, they must then be assessed as to their potential severity of loss and to the probability of occurrence. Once risks have been identified, they must then be assessed as to their potential severity of loss and to Risk Management Decisions 4 the probability of occurrence. These quantities can be either simple to measure, in the case of the value of a lost building, or impossible to know for sure in the case of the probability of an unlikely event occurring. Therefore, in the assessment process it is critical to make the best educated guesses possible in order to properly prioritize the implementation of the risk management plan. “A primer risk in the widest sense is not new to business” (Michel Crouhy, Dan Galai, Robert Mark-Page 37) There is always much risk associated with any kind of operations whether it is business or service. The smartest business man will foresee the chances of possible risks and will take necessary remedial measures to overcome it. Risk management involves methods that reduce the severity of the loss or the likelihood of the loss from occurring. The fundamental difficulty in risk assessment is determining the rate of occurrence since statistical information is not available on all kinds of past incidents. Furthermore, evaluating the severity of the consequences (impact) is often quite difficult for immaterial assets. . Asset valuation is another question that needs to be addressed. Thus, best educated opinions and available statistics are the primary sources of information. Nevertheless, risk assessment should produce such information for the management of the organization. In an ideal risk management, priority will be decided based on the seriousness of the incident. The risks with the greatest loss and the greatest probability of occurring are handled first, and risks with lower probability of occurrence and lower loss are handled in descending order. In practice the process can be very difficult, and balancing between risks with a high probability of occurrence Risk Management Decisions 5 but lower loss versus a risk with high loss but lower probability of occurrence can often be mishandled. Risk management also faces difficulties in allocating resources. Resources spent on risk management could have been spent on more profitable activities if the risk anticipation is proper. Unnecessary expenses can be avoided if the probability of risk identified at an early stages. Again, ideal risk management minimizes spending while maximizing the reduction of the negative effects of risks.”Certainly economic decision making is key to operating a ranch or farm operation, but it is the individual decision maker who guides the business and is responsible for whether the operation succeeds”(Randy R. Weigel) The flow chart of a typical risk management process is shown below What are the Hazards in this operation? How severe are the What is the probability Hazards of an accident What is the level of risk? High? Low? Medium? Is this level of risk acceptable? Risk Management Decisions 6 Yes No Continue operation Can the risk be eliminated Yes No Engineering action Can the risk be Reduced Yes No Procedural action Cancel the Personnel action operation (Risk Management decision tree) The above flow chart explains the method of a typical risk management. The hazards in the process are studied first. The probability and seriousness analyzed in this step. Secondly the level of the risk involved will be assessed. It will be rated as low, medium and high. Once the level of the risk identified then the risk management operation will be started. If it is not identified then decide up on whether the risk can be eliminated or not. If the answer is yes then the appropriate actions will be started. If the answer is no then the risk reduction possibilities will be studied. If there any chance of risk reduction then the actions will be taken Otherwise the entire risk management operation will be cancelled. Risk Management Decisions 7 The key risk management decisions “Disciplined collection of project metrics is essential for accurate estimation, better planning, and effective risk management”. (Tom Kendrick - Page 87). Because of the difficulties in making decisions the criteria for the decision making will be varied. The decision process will consider the cost benefit analysis, cost effectiveness analysis, risk benefit analysis, and comparative risk analysis etc. Cost benefit analysis Since we can’t do everything in the life, we have to select the actions from different choices available to us. Selection of one thing may reduce the priority of other things. The rejection of a low quality material in a manufacturing unit increases the quality of the final product. But at the same time this rejection may cause loss to the company. Her we have to decide up on the choices whether to select the material or to reject it. We are often willing to bear the cost because of the benefit associated with it. Consider the case of gold. We are ready to spend more on gold purchasing since we know that, in this era of world economic crisis gold provide us an attractive investment opportunity. It can be used as ornaments also and thus we have two benefits as far as gold purchasing is concerned. So people often will neglect the high cost of gold. People will not purchase iron and will keep it for long time as an investment since people know that iron will not survive long and also cost benefit of iron is less compared to that of gold. “Model risk market prices are normally the best indicators of the value of an asset”( Michel Crouhy, Dan Galai, Robert Mark - Page 347) Risk Management Decisions 8 The government decisions also can affect risk management decisions. Smoking and drinking of liquors are injurious to health. The government has enforced a warning slogan like “Cigarette smoking is injurious to health” on all cigarette packets. The responsibility of the government, finished there. It is the users to decide up on whether they have to make use of cigarettes? Or whether the smoking or drinking is cost effective? Cost benefit analysis is an analytical tool that can be used to answer the questions “Is it worth it?” of every government action intervention and policy that can affect the safety of the citizens. When the impact of the of the government action identified we can say that the cost benefit analysis is successful where is as in other case we can say that it is a failure. Consider a case in which you are offered with $ 50 per hour for an emergency job which has to be finished in the night. If you say yes to the overtime you have implicitly determined that the things you consumed with the income you earned from the overtime provide you greater utility than a sleep would have provided you. If you say no to the overtime you have implicitly determined that the night sleep is worth more than the overtime income. Consider another case of purchasing a car. Some people will go for luxurious cars which may not be fuel efficient and the resale value may not be good. Some other people will purchase economic cars with greater fuel efficiency and resale value. Thus we can see that the cost benefit analysis may be different from person to person. The decision of government in importing commodities may always consider the influence of the commodity on society. It is government’s duty to keep the citizen’s interest in tact while taking such decisions. For example in India like countries, the import of rubber Risk Management Decisions 9 from other countries will be regulated based on the internal production to ensure better earnings for the rubber farmers in India. The government will compare the benefits of the import with the impact of the import on the farmers before taking such decisions. Cost benefit analysis is not an answer, but a systematic analytical technique that informs decisions. It acts as an aid like providing useful information to decision making. Each cost benefit analysis is unique in nature. But at times some of them may recur. Cost effectiveness analysis It is a technique that identifies the least cost, way of meeting a specific goal. Once the goal is set, the risk analyst review the range of alternative approaches for reaching this goal and will choose the least costly method. In this approach, the benefit of achieving goal overweighs the cost of achieving the goal. Cost effectiveness differs from the cost benefit analysis in two ways. First, there is a specified level of goal achievement. Second, benefits are not explicitly estimated. I all the other ways both of the analysis are almost the same. The procedures of cost benefit analysis can be applied to cost effectiveness also. Risk Benefit analysis It is a kind of study between risks and benefits. Driving a car and climbing a mountain, both involve the risk factors. But driving enable us to work in different places and we can keep the timing also. The purpose of driving may be for the livelihood. But climbing a mountain, involve too much risk elements though it may give some psychological satisfactions. It is not necessary for the livelihood. For psychological satisfactions we can choose many other activities Risk Management Decisions 10 which may possess less risk factor. Consumption of alcohol though may provide temporary happiness; there is high risk elements involved in it. So we have to consider the risk elements as well as the benefits when we analyze such things. Risk benefit analysis is not at all concerned with the cost of the action; it concentrates only on the risk elements and the benefit elements. We know that in order to make the fruits more attractive and to keep them for longer period, fruit merchants uses chemicals which may harmful to the health. Their motives only rest on their profits rather than the health of the public. It is government’s duty to analyze such things and take necessary actions to sustain the pople’s interests. Comparative risk analysis This is a process in to identify which safety problems pose most risk to human health and quality of life. Some consider it as a communication device in which analyst compare the unknown risk elements with the known risk elements. For example, compare the risk in taking bath in a slippery bathroom with floor tiles and taking bath in a river. The aim of the risk assessment process is to evaluate and rank the magnitude of risks associated with problem areas on the basis of the best available scientific information and judgment. These ranking will remain as a key to the risk management process. These ranking will help to select the appropriate risk management options when dealing with risky situations Risk Management Decisions 11 The direct costs and benefit of risk management decisions “A key management requirement for risk/return optimisations is to integrate risk management in the business process of the company”.(James Lam - Enterprise Risk Management: From Incentives to Controls- Page 5) Risk management can prevent different types of risks at an early stage and also at the stage of occurrence of the risk. Risk management can avoid, reduce, retain, or transfer risk possibilities. Risk avoidance means, not performing an activity that could carry risk. An example would be not buying a property or business which has more liability. Another would be not touring a place where there are fears of terrorist attack. Avoidance is the best answer to all risks, but avoiding risks also means losing out on the opportunity to gain. Not entering a business to avoid the risk of loss also avoids the possibility of earning profits. Risk reduction means reduction of severity of the loss or the likelihood of the loss from occurring. An example for risk reduction is; we are closing the taps of the gas connection to the kitchen when we got sleep to avoid the possibility gas leakage and thereby the fire. The usage of seat belt while driving to avoid major injuries if accident occurs; is another example of risk reduction. Modern software development methodologies reduce risk by developing and delivering software incrementally. Early methodologies suffered from the fact that they only delivered software in the final phase of development; any problems encountered in earlier phases Risk Management Decisions 12 meant costly rework and often jeopardized the whole project. By developing in iterations, software projects can limit effort wasted to a single iteration. Risk retention is a viable strategy for small risks where the cost of insuring against the risk would be greater over time than the total losses sustained. All risks that are not avoided or transferred are retained by default. This includes risks that are so large or catastrophic that they either cannot be insured against or the premiums would be infeasible. War is an example since most property and risks are not insured against war, so the loss attributed by war is retained by the insure Many sectors have for long time regarded insurance as a transfer of risk. This is not correct. Insurance is a post event compensatory mechanism. That is, even if an insurance policy has been effected this does not mean that the risk has been transferred. For example, a personal injuries insurance policy does not transfer the risk of a car accident to the insurance company. The risk still lies with the policy holder namely the person who has been in the accident. The insurance policy simply provides that if an accident (the event) occurs involving the policy holder then some compensation may be payable to the policy holder that is commensurate to the suffering/damage. The indirect costs and benefits of risk management decisions If the probability of risk involved in a domain is less, then the reliability of the domain and hence the image of the domain will be boosted. For example; the reliability of the organizations which stood up with the current financial crunch will be immensely improved. The Risk Management Decisions 13 brand or product image will be increased a lot as more and more people will approach such organizations or services. The Indian banking and insurance sector stood up in tackling the dip in world economy. This will improve the confidence of people in Indian financial sector. Conclusion Risk analysis and management is an essential part of any kind of organizations. Risk analysis and pre planning of strategies will help the governments or organizations to tackle the threats caused by unexpected risks. The anticipation of risk probabilities will be a key to the success of any organizations. The management of risk involves lot of steps. It is better to avoid risks before it is happening. Once it is happened then the priority should be given in managing it based on the seriousness of the causalities. Careful analysis is required to study the risks and the probabilities. The expenditure on risk management should be allocated after the careful examination of the risk and its probabilities. There are direct and indirect costs and benefits for the risk management. The risk management decision process will consider the cost benefit analysis, cost effectiveness analysis, risk benefit analysis, and comparative risk analysis etc. The best way of managing a risk is try to avoid it before it is happening. “One of the fundamental goals of financial risk management is to avoid the type of disasters that can threaten the viability of a firm”.( Steve L. Allen- Page 49) Risk Management Decisions 14 Sources 1. Risk Management decision tree Retrieved on 27/11/08 http://www.iawg.cap.gov/safety/RiskManagementDecisionTree.PDF 2. Risk management decision criteria Retrieved on 27/11/08 http://www.foodrisk.org/risk_analysis/RM/RM_Decision_Criteria.pdf 3. Randy R. Weigel- The influence of personality on risk management decisions. Retrieved on 27/11/08 http://agecon.uwyo.edu/RnRinAg/RnR%20Section%206/RnR%20Influence%20of%20Personality.pdf 4. Risk Management Decisions Retrieved on 27/11/08 http://contamsites.landcareresearch.co.nz/risk_management_decisions.htm 5. A Tale of Two Risk Management Decisions Retrieved on 27/11/08 http://www.riskythinking.com/articles/article2.php 6. Michel Crouhy, Dan Galai, Robert Mark -The Essentials of Risk Management Page 347 Publisher: McGraw-Hill; 1 edition (December 14, 2005) http://www.amazon.com/Essentials-Risk-Management-Michel-Crouhy/dp/0071429662/ref=sr_1_1?ie=UTF8&s=books&qid=1227861664&sr=1-1 Risk Management Decisions 15 7. James Lam - Enterprise Risk Management: From Incentives to Controls Page 5 -Publisher: Wiley; 1st edition (May 16, 2003) http://www.amazon.com/Enterprise-Risk-Management-Incentives-Controls/dp/0471430005/ref=sr_1_3?ie=UTF8&s=books&qid=1227861664&sr=1-3 8. Steve L. Allen- Page 49 Financial Risk Management: A Practitioners Guide to Managing Market and Credit Risk (with CD-ROM) Publisher: Wiley (February 14, 2003) http://www.amazon.com/Financial-Risk-Management-Practitioners-Managing/dp/0471219770/ref=sr_1_4?ie=UTF8&s=books&qid=1227864640&sr=1-4 9. Tom Kendrick - Identifying and Managing Project Risk: Essential Tools for Failure-Proofing Your Project (Hardcover) - Page 87 -Publisher: AMACOM (April 25, 2003) http://www.amazon.com/Identifying-Managing-Project-Risk-Failure-Proofing/dp/0814407617/ref=sr_1_6?ie=UTF8&s=books&qid=1227864640&sr=1-6 10. Rita Mulcahy - Page 49 Risk Management, Tricks of the Trade for Project Managers (Paperback)- Publisher: RMC Publications, Inc. (September 15, 2003) http://www.amazon.com/Management-Tricks-Trade-Project-Managers/dp/0971164797/ref=sr_1_8?ie=UTF8&s=books&qid=1227864640&sr=1-8 Read More