Ways to Manage Risk: Insurable and Uninsurable Risk

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  • 0:06 What Exactly Is Risk?
  • 0:45 Risk Identification
  • 1:24 Risk Assessment
  • 2:21 Risk Mitigation
  • 4:40 Insurable and…
  • 6:10 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
Risks abound in life and in business. However, most risks can be managed. In this lesson, you'll learn about ways to manage risks. You'll also learn the difference between insurable and uninsurable risks. A short quiz follows.

What Exactly Is Risk?

Meet Rene. She's the risk manager of a medium-sized manufacturing company that specializes in novelty items. The company has its own factory where it produces most of its products, but also outsources some production to Chinese manufacturers. Rene's company faces different types of risk on a daily basis.

Risk is the probability, or chance, that a negative event may occur, resulting in a financial loss. Part of Rene's job is to ensure that the company's risks are managed. Risk management involves the identification, assessment and mitigation of risk.

Risk Identification

In risk identification, Rene needs to determine the types of risks to which the company is exposed. For example, some of the company's products may contain substances that are dangerous to humans or defects that cause injuries. This can expose the company to lawsuits and damages from injuries.

The company faces fiscal risks if the economy tanks or new product lines fail to produce sales. Additionally, the company faces casualty risks, such as its factory being destroyed by a tornado or company vehicles damaged in auto accidents.

Risk Assessment

The next step is risk assessment. Rene will assess risks in terms of probability and magnitude of impact. Probability is the likelihood of an event occurring. Magnitude of impact refers to how much harm the event will cause if it happens.

Some risks have a high probability of occurring but a low magnitude of impact. For example, every so often, a product will be damaged on the assembly line, causing a small financial loss to the company. On the other hand, some risks involve a low probability of occurring but a very high magnitude of impact.

For example, it's unlikely that a tornado will level the company's factory, but if it happens, the impact would be devastating. Of course, risks can fall between these two extremes. Once a risk has been assessed, the next step is to determine how to mitigate, or manage, it.

Risk Mitigation

After the risks have been assessed, it's time to plan for risk mitigation, which is the means of reducing the exposure to the risk and the harm that can be created by it. Rene has four general options for managing her company's risk. She can try to avoid the risk, assume the risk, reduce the risk or transfer the risk. Let's look at each approach.

Rene may institute company policies or recommend courses of action that result in risk avoidance. The aim here is to decrease the probability of a harmful event. For example, Rene may have the company institute new safety protocols for handling dangerous cleaning solvents at the factory to reduce the chance of injury from spills and exposure to toxic chemicals. If the protocol is followed, the risk will be avoided.

Rene can also recommend assuming some risks. Risk assumption means that the company will accept the possibility of a risk and be willing and prepared to pay the cost of the loss if the risk occurs. For example, the company may decide to market a new product. The company assumes the risk of financial loss if the product fails at the marketplace.

Rene can also pursue risk reduction. This approach is about reducing the chance that loss will occur and reducing the cost if it does. A classic example is the installation of fire extinguishers and sprinklers. The fire extinguishers and sprinklers will not stop a fire from starting, but if a fire starts, the extinguishers and sprinklers will reduce the damage caused by a fire.

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