Chapter 9: Risk Management

Chapter 9: Risk Management

Speculate risk – involves loss and gain but in uncertain amounts, ex. Common shares or lottery tickets, investments; you choose to accept the risk rather than those you encounter because of circumstance

Pure risk – possibility of loss only, ex. Early death, disability, theft; generally happen without us having made a conscious choice to seek them out

Risk management Process

• Step 1: Identifying the Risks

• Three general categories:

• Personal/life and health – risk: disability/death, possible losses: extra expenses, family duties and income
• Property – risk: theft, damage or destruction, possible losses: cost of finding other accommodation, repair, replacement
• Liability to other persons for our actions that affect them – unincorporated business risk or property risk – risk: liability to second/third party, possible losses: amount lost by other parties, and legal costs

• Torts: legal wrongs or injuries on person causes another (ie if you hit someone with your car you may be liable to pay for the present value of their lifetime earnings) – court will not find you responsible for someone else’s losses as long as you take reasonable care
• Limited companies are not responsible beyond the amount of money paid for the investment whereas unincorporated businesses and professionals are personally liable without limit for all losses they cause (could be to their customers/creditors = second party/contractual liability

• Step 2: Evaluating the Risks

• We evaluate the risk using two criteria: i) the size of the potential loss and ii) the frequency or probability of occurrence
• Which risks you wish to avoid and which you can live with is a personal decision but the basic rule is that a risk is insupportable if it materially affects the family’s standard of living

• Step 3: Controlling the Risks

• One method is avoidance: ie avoid risk of injury in dangerous sport by not engaging it
• Second method: separation: parents who travel on different airplanes will not be killed in the same accent living the children without support, or parents who work for the same company increase the severity of risk of job loss since they both might lose employment at same time (this method only applies in a few situations, more useful for large organizations)
• Prevention or reduction of frequency: most widely applicable method, reduce risk of disability or premature death w/ good nutrition, regular exercise and preventive medicines, protect property with smoke detectors, bolt looks and preventive maintenance, reduce likelihood of being sued for negligence by driving carefully and incorporating the family business
• Size and probability of loss will dictate amount of time and money you will spend to control it, another factor is availability of a means to finance a risk (if you cant finance it you will do more to control it)