Raising Entrepreneurial Capital

STEP 4—S ELECTION AND IMPLEMENTATION OF RISK TREATMENT

METHODS

The fourth step in the risk management process is selection of appropriate

risk management methods for the exposures that have been identified. Risk

management methods are divided into risk control methods and risk finan-

cing methods . Risk control methods are those activities that affect the fre-

quency or severity of loss. Risk control methods include avoidance, loss

reduction, and loss prevention. Risk financing methods are the strategies

that are employed to pay for the losses that do occur. The fundamental risk

financing methods are retention and insurance. These risk control and

risk financing methods will be covered in more detail in a later section of

the chapter.

STEP 5—ADMINISTRATION OF THE RISK MANAGEMENT PROGRAM

Administration of the risk management program involves review and

evaluation of the risk control and risk management methods that were

chosen. In reviewing and evaluating risk treat ment methods, there are two

key questions. First, we want to know if the chosen procedures worked. Did

they have the desired effect (i.e., did they reduce losses)? Second, we will

determine whether they were cost-effective. In this step, the risk management

objectives will also be reviewed periodically. Remediation, correction, and

general monitoring of the risk management activities will be the emphases of

this step in the risk management process.

SOME CORE RISK MANAGEME NT PRINCIPLES

In the formulation and admini stration of a risk management program for

any economic entity, there are several core principles. These can be guides to

effective risk management practice. One of those—‘‘Do not risk more than

you can afford to lose’’—has already been stated. Following are several

others that have proven to be useful over time.

RISK MANAGEMENT ISA PROCESS,NOT AN EVENT

The use of the word process indicates that risk management is an ongoing

activity. Some entities have used the classic ‘‘muddle through’’ method of

risk management. When a loss occurred, they added that exposure to their

Essentials of Risk Management 335

listing and began to treat that exposure. This works fine—unless a severe

loss occurs before sufficient resources are in place to offset that loss. To be

truly effective, risk management must be incorporated into the planning and

budgeting processes.

EXPOSURE IDENTIFICATION IS THE KEY TO SUCCESSFUL RISK

MANAGEMENT

One of the classic truisms of risk management practice is that you cannot

treat a loss exposure that has not been identified. This principle prompts us

to find various methods for exposure identification. Some of those were

mentioned earlier, and it is common to use a combination of identification

methods to accomplish this task. One method is clearly superior to the

others, the periodic inspection of the entity’s facilities and operati ons.

More and more it is common practice to involv e employees in the exposure

identification process. They often are closer to the sources of incidents and

accidents, and they often have wisdom about causation and preven tion. The

key is to allow them to report conditions in a ‘‘blame-free’’ environment to

encourage them to do so freely.

LOSS CONTROL EFFORTS WILL PAY FOR THEMSELVES

Loss control (prevention and reduction of losses) is often the most cost-

effective approach to improving the overall risk management strategy of the

firm. Losses that never occur have savings that go beyond the direct costs of

the loss, such as personal injuries and lost product. Controlling losses in the

first place reduces indirect costs, such as supervisor time and time lost by

‘‘onlookers’’ at workpl ace incidents. These sometimes ‘‘hidden’’ costs are

often greater than the direct costs of the loss.

The most important reason for loss control, however, is that it can reduce

insurance premiums markedly. Insurance companies reward ‘‘good behav-

ior’’ in their premium structures. A place where this effect can be dramatic is

in workers’ compensation insurance. Insurance is normally required, and an

employer is given an experience premium modifier (often called simply the

MOD factor) that reflects recent experience. The standard premium, based

on employee job classifications, is multiplied by the MOD factor. With

medical cost inflation driving workers’ compensation premiums, losses that

are pr evented save not only the actual outlays but the ‘‘upcharge’’ from the

MOD factor as well.

336 Essentials of Risk Management