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<|ref|>title<|/ref|><|det|>[[268, 117, 794, 200]]<|/det|> # Risk Management Principles and Practices <|ref|>text<|/ref|><|det|>[[270, 232, 400, 255]]<|/det|> 3rd Edition <|ref|>text<|/ref|><|det|>[[270, 285, 365, 306]]<|/det|> Edited by <|ref|>text<|/ref|><|det|>[[270, 312, 440, 333]]<|/det|> Michael W. Elliott <|ref|>text<|/ref|><|det|>[[268, 570, 784, 615]]<|/det|> ARM™ A Risk Management Designation Program Powered by The Institutes
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<|ref|>text<|/ref|><|det|>[[266, 451, 730, 540]]<|/det|> Digitized by the Internet Archive in 2023 with funding from Kahle/Austin Foundation
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<|ref|>title<|/ref|><|det|>[[48, 97, 664, 183]]<|/det|> Risk Management Principles and Practices
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<|ref|>text<|/ref|><|det|>[[312, 83, 999, 150]]<|/det|> DME 2021/2022 2022/2023 2023/2024
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<|ref|>title<|/ref|><|det|>[[48, 100, 664, 184]]<|/det|> # Risk Management Principles and Practices <|ref|>text<|/ref|><|det|>[[48, 333, 430, 393]]<|/det|> Edited byMichael W. Elliott, CPCU, ARM, AIAF, MBA
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<|ref|>text<|/ref|><|det|>[[46, 168, 100, 183]]<|/det|> © 2018 <|ref|>text<|/ref|><|det|>[[46, 184, 500, 202]]<|/det|> American Institute For Chartered Property Casualty Underwriters <|ref|>text<|/ref|><|det|>[[46, 209, 640, 244]]<|/det|> All rights reserved. This book or any part thereof may not be reproduced without the written permission of the copyright holder. <|ref|>text<|/ref|><|det|>[[46, 250, 657, 353]]<|/det|> Unless otherwise apparent, examples used in The Institutes materials related to this course are based on hypothetical situations and are for educational purposes only. The characters, persons, products, services, and organizations described in these examples are fictional. Any similarity or resemblance to any other character, person, product, services, or organization is merely coincidental. The Institutes are not responsible for such coincidental or accidental resemblances. <|ref|>text<|/ref|><|det|>[[47, 360, 618, 428]]<|/det|> This material may contain internet website links external to The Institutes. The Institutes neither approve nor endorse any information, products, or services to which any external websites refer. Nor do The Institutes control these websites' content or the procedures for website content development. <|ref|>text<|/ref|><|det|>[[47, 434, 623, 486]]<|/det|> The Institutes specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. <|ref|>text<|/ref|><|det|>[[47, 493, 660, 579]]<|/det|> The Institutes materials related to this course are provided with the understanding that The Institutes are not engaged in rendering legal, accounting, or other professional service. Nor are The Institutes explicitly or implicitly stating that any of the processes, procedures, or policies described in the materials are the only appropriate ones to use. The advice and strategies contained herein may not be suitable for every situation. <|ref|>text<|/ref|><|det|>[[47, 585, 647, 688]]<|/det|> Information which is copyrighted by and proprietary to Insurance Services Office, Inc. ("ISO Material") is included in this publication. Use of the ISO Material is limited to ISO Participating Insurers and their Authorized Representatives. Use by ISO Participating Insurers is limited to use in those jurisdictions for which the insurer has an appropriate participation with ISO. Use of the ISO Material by Authorized Representatives is limited to use solely on behalf of one or more ISO Participating Insurers. <|ref|>text<|/ref|><|det|>[[47, 694, 633, 797]]<|/det|> This publication includes forms which are provided for review purposes only. These forms may not be used, in whole or in part, by any company or individuals not licensed by Insurance Services Office, Inc. (ISO) for the applicable line of insurance and jurisdiction to which this form applies. It is a copyright infringement to include any part(s) of this form within independent company programs without the written permission of ISO. <|ref|>text<|/ref|><|det|>[[47, 807, 336, 825]]<|/det|> 3rd Edition • 1st Printing • April 2018 <|ref|>text<|/ref|><|det|>[[47, 832, 401, 850]]<|/det|> Library of Congress Control Number: 2018938890 <|ref|>text<|/ref|><|det|>[[47, 857, 234, 874]]<|/det|> ISBN 978- 0- 89462- 209- 0
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<|ref|>sub_title<|/ref|><|det|>[[51, 108, 231, 144]]<|/det|> ## Foreword <|ref|>text<|/ref|><|det|>[[51, 203, 670, 293]]<|/det|> The Institutes are the trusted leader in delivering proven knowledge solutions that drive powerful business results for the risk management and propertycasualty insurance industry. For more than 100 years, The Institutes have been meeting the industry's changing professional development needs with customer- driven products and services. <|ref|>text<|/ref|><|det|>[[51, 300, 677, 391]]<|/det|> In conjunction with industry experts and members of the academic community, our Knowledge Resources Department develops our course and program content, including Institutes study materials. Practical and technical knowledge gained from Institutes courses enhances qualifications, improves performance, and contributes to professional growth- all of which drive results. <|ref|>text<|/ref|><|det|>[[51, 397, 675, 435]]<|/det|> The Institutes' proven knowledge helps individuals and organizations achieve powerful results with a variety of flexible, customer- focused options: <|ref|>text<|/ref|><|det|>[[51, 441, 678, 567]]<|/det|> Recognized Credentials- The Institutes offer an unmatched range of widely recognized and industry- respected specialty credentials. The Institutes' Chartered Property Casualty Underwriter (CPCU®) professional designation is designed to provide a broad understanding of the property- casualty insurance industry. Depending on professional needs, CPCU students may select either a commercial insurance focus or a personal risk management and insurance focus and may choose from a variety of electives. <|ref|>text<|/ref|><|det|>[[51, 574, 666, 612]]<|/det|> In addition, The Institutes offer certificate or designation programs in a variety of disciplines, including these: <|ref|>text<|/ref|><|det|>[[58, 624, 656, 812]]<|/det|> Claims Management Commercial underwriting Marine insurance Fidelity and surety bonding Personal insurance General insurance Premium auditing Insurance accounting and finance Quality insurance services Insurance information technology Reinsurance Insurance production and agency Risk management management Surplus lines Insurance regulation and compliance
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<|ref|>text<|/ref|><|det|>[[270, 94, 930, 224]]<|/det|> Ethics—Ethical behavior is crucial to preserving not only the trust on which insurance transactions are based, but also the public's trust in our industry as a whole. All Institutes designations now have an ethics requirement, which is delivered online and free of charge. The ethics requirement content is designed specifically for insurance practitioners and uses insurance- based case studies to outline an ethical framework. More information is available in the Programs section of our website, TheInstitutes.org. <|ref|>text<|/ref|><|det|>[[270, 232, 923, 324]]<|/det|> Flexible Online Learning—The Institutes have an unmatched variety of technical insurance content covering topics from accounting to underwriting, which we now deliver through hundreds of online courses. These cost- effective self- study courses are a convenient way to fill gaps in technical knowledge in a matter of hours without ever leaving the office. <|ref|>text<|/ref|><|det|>[[270, 332, 931, 405]]<|/det|> Continuing Education—A majority of The Institutes' courses are filed for CE credit in most states. We also deliver quality, affordable, online CE courses quickly and conveniently through CEU. Visit CEU.com to learn more. CEU is powered by The Institutes. <|ref|>text<|/ref|><|det|>[[270, 413, 927, 506]]<|/det|> College Credits—Most Institutes courses carry college credit recommendations from the American Council on Education. A variety of courses also qualify for credits toward certain associate, bachelor's, and master's degrees at several prestigious colleges and universities. More information is available in the Student Services section of our website, TheInstitutes.org. <|ref|>text<|/ref|><|det|>[[270, 514, 936, 570]]<|/det|> Custom Applications—The Institutes collaborate with corporate customers to use our trusted course content and flexible delivery options in developing customized solutions that help them achieve their unique organizational goals. <|ref|>text<|/ref|><|det|>[[270, 578, 936, 652]]<|/det|> Insightful Analysis—Our Insurance Research Council (IRC) division conducts public policy research on important contemporary issues in property- casualty insurance and risk management. Visit www.Insurance- Research.org to learn more or purchase its most recent studies. <|ref|>text<|/ref|><|det|>[[270, 660, 899, 734]]<|/det|> The Institutes look forward to serving the risk management and property- casualty insurance industry for another 100 years. We welcome comments from our students and course leaders; your feedback helps us continue to improve the quality of our study materials. <|ref|>text<|/ref|><|det|>[[270, 742, 465, 797]]<|/det|> Peter L. Miller, CPCU President and CEO The Institutes
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<|ref|>sub_title<|/ref|><|det|>[[50, 108, 198, 144]]<|/det|> ## Preface <|ref|>text<|/ref|><|det|>[[50, 204, 673, 278]]<|/det|> Risk Management Principles and Practices is the assigned textbook for the ARM 54 course in The Institutes' Associate in Risk Management (ARM) designation program. This text provides learners with a broad understanding of risk management and the risk management process. <|ref|>text<|/ref|><|det|>[[50, 285, 673, 445]]<|/det|> The course starts with an overview of the role of technology and data in risk management, including data capture, data storage and processing, and data analytics. It then discusses risk management from an enterprise- wide perspective by applying risk management concepts to four major categories of risk: hazard (insurable), operational, financial, and strategic. The enterprise- wide risk management process is contrasted with the traditional risk management process, which applies solely to insurable risk. Risk identification and analysis tools and techniques, including risk registers and risk mapping, are discussed in detail. <|ref|>text<|/ref|><|det|>[[50, 453, 666, 543]]<|/det|> The text describes global risk management standards and guidelines, including ISO 31000 Risk Management—Guidelines, developed by the International Organization for Standardization, and COSO Enterprise Risk Management—Integrating With Strategy and Performance, developed by the Committee of Sponsoring Organizations of the Treadway Commission. <|ref|>text<|/ref|><|det|>[[50, 550, 655, 621]]<|/det|> The latter part of the course covers big data and data analytics, as well as financial risk, including financial leverage, liquidity risk, and capital investment risk. Risk oversight, monitoring, and assurance are discussed from the perspectives of governance and internal control. <|ref|>text<|/ref|><|det|>[[50, 629, 661, 718]]<|/det|> The Institutes are grateful to the insurance professionals who contributed to this text. Their assistance during the review and development stages helped ensure that the text reflects current industry practices. We are particularly grateful to Kristina Narvaez, MBA, and Kathleen J. Robison, CPCU, AU, ARM, AIC, CPIW. <|ref|>text<|/ref|><|det|>[[50, 726, 664, 798]]<|/det|> We are also grateful to the individual members of the Risk and Insurance Management Society (RIMS) and the Public Risk Management Association (PRIMA) who gave us feedback on the relative importance of various topics included in the course. <|ref|>text<|/ref|><|det|>[[50, 806, 671, 860]]<|/det|> For more information about The Institutes' programs, please call our Customer Success Department at (800) 644- 2101, email us at CustomerSuccess@TheInstitutes.org, or visit our website at TheInstitutes.org. <|ref|>text<|/ref|><|det|>[[50, 870, 202, 887]]<|/det|> Michael W. Elliott
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<|ref|>image<|/ref|><|det|>[[0, 0, 999, 1005]]<|/det|>
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<|ref|>sub_title<|/ref|><|det|>[[45, 108, 281, 145]]<|/det|> ## Contributors <|ref|>text<|/ref|><|det|>[[45, 205, 675, 245]]<|/det|> The Institutes acknowledge with deep appreciation the contributions made to the content of this text by the following persons: <|ref|>text<|/ref|><|det|>[[45, 250, 546, 435]]<|/det|> Michael M. Barth, PhD, CPCU, AU Richard Berthelsen, JD, CPCU, AIC, ARM, AU, ARe, MBA Pamela J. Brooks, MBA, CPCU, AIM, AAM, AIS, AINS Susan Crowe, CPCU, MBA, AIC, ARe, ARM, API Doug Froggatt, CPCU, AINS Beth Illian, CPCU, AINS, AIS Laura J. Partsch, JD
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<|ref|>text<|/ref|><|det|>[[0, 0, 997, 997]]<|/det|> .
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<|ref|>sub_title<|/ref|><|det|>[[48, 108, 219, 142]]<|/det|> ## Contents <|ref|>text<|/ref|><|det|>[[45, 202, 290, 410]]<|/det|> Assignment 1 Introduction to Risk Management 1.1 The Risk Management Environment 1.3 Risk Management Benefits 1.7 Risk Management Objectives and Goals 1.13 Basic Risk Measures 1.18 Risk Classifications and Categories 1.21 Enterprise Risk Management 1.27 Summary <|ref|>text<|/ref|><|det|>[[45, 428, 287, 670]]<|/det|> Assignment 2 Risk Management Standards and Frameworks 2.1 Introduction to Risk Management Standards and Frameworks 2.3 ISO 31000 Risk Management— Guidelines 2.6 COSO Enterprise Risk Management—Integrating With Strategy and Performance 2.10 Solvency II and Basel Regulatory Standards 2.15 Summary 2.17 <|ref|>text<|/ref|><|det|>[[45, 688, 298, 813]]<|/det|> Assignment 3 Hazard Risk 3.1 The Nature of Hazard Risk 3.3 Loss Exposures 3.8 Commercial Insurance Policies 3.11 Summary 3.20 <|ref|>text<|/ref|><|det|>[[383, 203, 631, 430]]<|/det|> Assignment 4 Operational, Financial, and Strategic Risk 4.1 Operational Risk 4.3 Operational Risk Indicators 4.7 Financial Risk 4.12 Value at Risk and Earnings at Risk 4.18 Regulatory Capital 4.20 Economic Capital 4.27 Strategic Risk 4.33 Summary 4.36 <|ref|>text<|/ref|><|det|>[[383, 448, 620, 680]]<|/det|> Assignment 5 Risk Management Framework and Process 5.1 Modeling an Enterprise Risk Management Framework and Process 5.3 Designing and Implementing an Enterprise Risk Management Framework and Process 5.7 Comparing the Enterprise- Wide Risk Management Process With the Traditional Risk Management Process 5.13 <|ref|>text<|/ref|><|det|>[[383, 682, 620, 755]]<|/det|> Applying the Enterprise Risk Management Framework and Process 5.20 Summary 5.29
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<|ref|>text<|/ref|><|det|>[[266, 93, 930, 112]]<|/det|> Assignment 6 Assignment 10 <|ref|>text<|/ref|><|det|>[[266, 111, 930, 130]]<|/det|> Risk Identification 6.1 Capital Investment and Financial <|ref|>text<|/ref|><|det|>[[266, 131, 930, 150]]<|/det|> Introduction to Risk Identification 6.3 Risk 10.1 <|ref|>text<|/ref|><|det|>[[266, 155, 930, 174]]<|/det|> Team Approaches to Risk Present Value and Discounting 10.3 <|ref|>text<|/ref|><|det|>[[266, 175, 930, 194]]<|/det|> Identification 6.8 Present Value of an Annuity 10.5 <|ref|>text<|/ref|><|det|>[[266, 197, 930, 215]]<|/det|> Risk Registers 6.12 Present Value of Unequal <|ref|>text<|/ref|><|det|>[[266, 217, 930, 236]]<|/det|> Risk Maps 6.16 Payments 10.7 <|ref|>text<|/ref|><|det|>[[266, 238, 930, 257]]<|/det|> Identifying Loss Exposures 6.20 Net Present Value 10.9 <|ref|>text<|/ref|><|det|>[[266, 260, 930, 279]]<|/det|> Identifying Risk 6.24 Evaluating Capital Investment <|ref|>text<|/ref|><|det|>[[266, 280, 930, 299]]<|/det|> Proposals 10.11 <|ref|>text<|/ref|><|det|>[[266, 300, 930, 319]]<|/det|> Summary 6.30 Evaluating Cash Flows From <|ref|>text<|/ref|><|det|>[[266, 320, 930, 339]]<|/det|> Treating Hazard Risk 10.17 <|ref|>text<|/ref|><|det|>[[266, 340, 930, 359]]<|/det|> Risk Analysis 7.1 Using Call Options to Limit <|ref|>text<|/ref|><|det|>[[266, 360, 930, 379]]<|/det|> Financial Risk 10.23 <|ref|>text<|/ref|><|det|>[[266, 380, 930, 399]]<|/det|> Probability Analysis 7.5 Summary 10.27 <|ref|>text<|/ref|><|det|>[[266, 402, 930, 421]]<|/det|> Characteristics of Probability Assignment 11 <|ref|>text<|/ref|><|det|>[[266, 422, 930, 441]]<|/det|> Distributions 7.11 Monitoring and Reporting on Risk 11.1 <|ref|>text<|/ref|><|det|>[[266, 443, 930, 462]]<|/det|> Regression Analysis 7.18 Board Risk Oversight 11.3 <|ref|>text<|/ref|><|det|>[[266, 464, 930, 483]]<|/det|> Analyzing Event Consequences 7.24 Internal Controls Support to Risk <|ref|>text<|/ref|><|det|>[[266, 485, 930, 504]]<|/det|> Analyzing Loss Exposures 7.28 Monitoring 11.9 <|ref|>text<|/ref|><|det|>[[266, 506, 930, 525]]<|/det|> Summary 7.35 Internal Audit Support to Risk <|ref|>text<|/ref|><|det|>[[266, 526, 930, 545]]<|/det|> Monitoring 11.16 <|ref|>text<|/ref|><|det|>[[266, 548, 930, 567]]<|/det|> Risk Assessment to Evaluate Risk <|ref|>text<|/ref|><|det|>[[266, 568, 930, 587]]<|/det|> Risk Treatment 8.1 Management Performance 11.20 <|ref|>text<|/ref|><|det|>[[266, 589, 930, 608]]<|/det|> Risk Treatment 8.3 Risk Management Monitoring and <|ref|>text<|/ref|><|det|>[[266, 610, 930, 628]]<|/det|> Introduction to Risk Financing 8.6 Reporting 11.24 <|ref|>text<|/ref|><|det|>[[266, 630, 930, 650]]<|/det|> Summary 8.10 Summary 11.27 <|ref|>text<|/ref|><|det|>[[266, 670, 930, 690]]<|/det|> Big Data Analytics for Managing Risk 9.1 Index 1 <|ref|>text<|/ref|><|det|>[[266, 691, 930, 710]]<|/det|> Big Data Characteristics and Sources 9.3 <|ref|>text<|/ref|><|det|>[[266, 711, 930, 730]]<|/det|> Data- Driven Decision Making 9.7 <|ref|>text<|/ref|><|det|>[[266, 732, 930, 750]]<|/det|> Training and Evaluating a Predictive Model 9.13 <|ref|>text<|/ref|><|det|>[[266, 752, 930, 771]]<|/det|> Training and Evaluating a Predictive Model 9.13 <|ref|>text<|/ref|><|det|>[[266, 772, 930, 791]]<|/det|> Overview of Big Data Analysis Techniques 9.19 <|ref|>text<|/ref|><|det|>[[266, 792, 930, 811]]<|/det|> Overview of Big Data Analysis Techniques 9.19 <|ref|>text<|/ref|><|det|>[[266, 813, 930, 832]]<|/det|> Using Classification Tree Analysis in Claims Assignment 9.27 <|ref|>text<|/ref|><|det|>[[266, 833, 930, 852]]<|/det|> Using Classification Tree Analysis in Claims Assignment 9.27 <|ref|>text<|/ref|><|det|>[[266, 854, 930, 872]]<|/det|> Using Classification Tree Analysis in Claims Assignment 9.27 <|ref|>text<|/ref|><|det|>[[266, 874, 930, 892]]<|/det|> Summary 9.34
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<|ref|>sub_title<|/ref|><|det|>[[45, 120, 255, 160]]<|/det|> ## Segment A <|ref|>text<|/ref|><|det|>[[45, 241, 365, 289]]<|/det|> Assignment 1 Introduction to Risk Management <|ref|>text<|/ref|><|det|>[[45, 315, 485, 362]]<|/det|> Assignment 2 Risk Management Standards and Frameworks <|ref|>text<|/ref|><|det|>[[45, 388, 186, 432]]<|/det|> Assignment 3 Hazard Risk <|ref|>text<|/ref|><|det|>[[45, 460, 437, 508]]<|/det|> Assignment 4 Operational, Financial, and Strategic Risk
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<|ref|>text<|/ref|><|det|>[[0, 0, 997, 997]]<|/det|> .
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<|ref|>sub_title<|/ref|><|det|>[[46, 120, 430, 160]]<|/det|> Direct Your Learning <|ref|>sub_title<|/ref|><|det|>[[46, 240, 562, 273]]<|/det|> Introduction to Risk Management <|ref|>sub_title<|/ref|><|det|>[[60, 312, 265, 330]]<|/det|> Educational Objectives <|ref|>text<|/ref|><|det|>[[46, 352, 570, 371]]<|/det|> After learning the content of this assignment, you should be able to: <|ref|>text<|/ref|><|det|>[[78, 385, 560, 403]]<|/det|> Explain how the risk management environment is evolving. <|ref|>text<|/ref|><|det|>[[78, 410, 633, 446]]<|/det|> Explain how risk management benefits both an organization and the economy. <|ref|>text<|/ref|><|det|>[[78, 454, 666, 472]]<|/det|> Summarize various objectives and goals for organizations to manage risk. <|ref|>text<|/ref|><|det|>[[78, 479, 610, 497]]<|/det|> Explain how basic risk measures apply to the management of risk. <|ref|>text<|/ref|><|det|>[[78, 505, 679, 540]]<|/det|> Explain how classifying and categorizing risk help an organization meet its risk management goals. <|ref|>text<|/ref|><|det|>[[78, 548, 670, 583]]<|/det|> Compare the concepts of enterprise risk management and traditional risk management. <|ref|>sub_title<|/ref|><|det|>[[730, 312, 800, 328]]<|/det|> Outline <|ref|>text<|/ref|><|det|>[[732, 350, 818, 397]]<|/det|> The Risk Management Environment <|ref|>text<|/ref|><|det|>[[732, 408, 864, 439]]<|/det|> Risk Management Benefits <|ref|>text<|/ref|><|det|>[[732, 450, 864, 497]]<|/det|> Risk Management Objectives and Goals <|ref|>text<|/ref|><|det|>[[732, 509, 810, 539]]<|/det|> Basic Risk Measures <|ref|>text<|/ref|><|det|>[[732, 550, 872, 581]]<|/det|> Risk Classifications and Categories <|ref|>text<|/ref|><|det|>[[732, 592, 844, 622]]<|/det|> Enterprise Risk Management <|ref|>text<|/ref|><|det|>[[732, 634, 806, 649]]<|/det|> Summary
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<|ref|>image<|/ref|><|det|>[[0, 0, 999, 1005]]<|/det|>
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<|ref|>sub_title<|/ref|><|det|>[[45, 113, 675, 156]]<|/det|> ## Introduction to Risk Management <|ref|>sub_title<|/ref|><|det|>[[45, 237, 586, 265]]<|/det|> ## THE RISK MANAGEMENT ENVIRONMENT <|ref|>text<|/ref|><|det|>[[45, 269, 672, 430]]<|/det|> Risk management can be the difference between an invisible threat that vanishes before we are even aware of it and one that causes a loss whose gravity can imperil a global corporation and its customers. Imagine a rogue microbe that stows away in a food distributor's lettuce supply. As the bacteria multiply, the tainted greens hitch rides on tractors, trucks, and cargo planes throughout the unwitting supplier's network. But the ramifications are not apparent until clusters of consumers begin reporting salmonella symptoms: widespread sickness, accusatory headlines, and potential lawsuits for any company implicated in the produce's fateful trip from farm to table. <|ref|>text<|/ref|><|det|>[[45, 437, 678, 599]]<|/det|> Traditional risk management may have prevented this scenario from unfolding. For example, the distributor could have developed safe food- handling techniques, or downstream users could have imposed standards on suppliers. And it may have mitigated some of the consequences, as insurance could have covered a business's liability, continuity plans may have guided a company's reputation rehabilitation, and so forth. Ultimately, though, these measures would have been undermined by uncertainty—whether about the outbreak's true origin, its scope, its severity, or any number of additional factors that simply could not be known. <|ref|>text<|/ref|><|det|>[[44, 605, 670, 821]]<|/det|> However, today's risk management environment is animated by increasingly potent combinations of inexpensive data- gathering technology and predictive analytic techniques that can transform data into more certainty about risk management decisions than ever before. The food distributor could have virtual eyes and ears at every step along the supply chain, with data about the journey recorded in an immutable electronic ledger accessible to every farm, store, and restaurant in its network—for example, in conjunction with the ability to immediately pinpoint conditions (such as a tainted water supply or ailing livestock) that could lead to a potential outbreak in real time before it spreads. Founded in traditional risk management, these kinds of innovations represent the next step in the evolution from merely reacting to a loss after it occurs to preventing it from happening in the first place. <|ref|>sub_title<|/ref|><|det|>[[44, 844, 585, 870]]<|/det|> ## The Evolution of Risk and Risk Management <|ref|>text<|/ref|><|det|>[[44, 874, 641, 928]]<|/det|> This transformation of the risk management environment has occurred in tandem with the evolution of how we think of risk and risk management itself. The traditional concept of risk, inherent in insurance, is that risk is
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<|ref|>text<|/ref|><|det|>[[300, 115, 920, 223]]<|/det|> a hazard posed to an individual or organization. For example, fire or wind could destroy a home or business. In this context, the homeowner or business owner views risk in a negative sense, a possibility of loss. Today's conception of risk also incorporates its potential positive consequences—the idea that taking risks is necessary for growth. In this context, a home or business could increase in value over time. <|ref|>text<|/ref|><|det|>[[300, 230, 907, 355]]<|/det|> Recent risk management theory also includes the concept of a holistic approach to risk management. Organizations now realize the importance of managing all their risks, not just those that are familiar or easy to quantify. Risks that may seem relatively harmless or unlikely do have the potential to create significant damage or opportunity when they interact with other events. This holistic view of risk helps identify the risks that truly matter to an organization and provides a full perspective of the identified risks. <|ref|>text<|/ref|><|det|>[[300, 361, 925, 451]]<|/det|> High- level categories of risk include hazard risks, operational risks, financial risks, and strategic risks. These categories can be broken down into subcategories, such as project risk, financial reporting risk, and process risk. Over time, all these risks become part of an organization's overall risk portfolio, which has its own individual risk profile. <|ref|>sub_title<|/ref|><|det|>[[90, 433, 163, 448]]<|/det|> ## Risk profile <|ref|>text<|/ref|><|det|>[[90, 452, 235, 499]]<|/det|> A set of characteristics common to all risks in a portfolio. <|ref|>sub_title<|/ref|><|det|>[[300, 469, 818, 515]]<|/det|> ## Technology and the Changing Risk Management Environment <|ref|>text<|/ref|><|det|>[[300, 518, 917, 608]]<|/det|> Traditional risk assessment techniques focus on root cause analysis (RCA), which identifies a loss's predominant cause. This approach's inherent weakness is obvious—RCA can only look backward. Plus, it might not identify all root causes and the related events that contribute to a loss and can only be performed periodically. <|ref|>text<|/ref|><|det|>[[90, 697, 191, 712]]<|/det|> Smart product <|ref|>text<|/ref|><|det|>[[90, 716, 258, 833]]<|/det|> An innovative item that uses sensors; wireless sensor networks; and data collection, transmission, and analysis to further enable the item to be faster, more useful, or otherwise improved. <|ref|>text<|/ref|><|det|>[[90, 838, 256, 889]]<|/det|> Internet of Things (IoT) A network of objects that transmit data to computers. <|ref|>text<|/ref|><|det|>[[300, 614, 928, 773]]<|/det|> Today, however, a universe of data about past events can empower decision making that is further refined through data about previously imperceptible risk factors. Examples may include a worker's dangerous package- lifting technique, the presence of a hazardous chemical in the air at a factory, or the catastrophic intersection of seemingly disconnected financial transactions as they unfold in real time. The ways that technology and risk management intersect to achieve this can seem complex, but the basics are simple: The big data revolution is fueled by the capture, storage, and analysis of data. See the exhibit "How Big Data Has Transformed the Risk Management Environment." <|ref|>sub_title<|/ref|><|det|>[[302, 795, 427, 815]]<|/det|> ## Data Capture <|ref|>text<|/ref|><|det|>[[300, 818, 920, 891]]<|/det|> Data capture is enabled primarily by smart products that sense their environment, process data, and communicate with other smart products and smart operations through the Internet of Things (IoT). These interactions generate the data to which advanced analytics can be applied. The availability and
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<|ref|>image<|/ref|><|det|>[[40, 110, 888, 362]]<|/det|> <|ref|>text<|/ref|><|det|>[[42, 366, 105, 380]]<|/det|> [DA12739] <|ref|>text<|/ref|><|det|>[[42, 394, 653, 431]]<|/det|> sophistication of smart products and the IoT's continued growth have led to an explosion of risk management innovation. Here are just a few examples: <|ref|>text<|/ref|><|det|>[[40, 437, 666, 725]]<|/det|> - Wearables, such as helmets that monitor fatigue or wristwatches that measure vital signs, can sense, monitor, report, and analyze workers' health or well-being and their surrounding environments. Data generated by wearables may be specific to one employee or aggregated for a project, team, or organization.- Drones can be used in surveillance and aerial photography; being unmanned and highly versatile makes them ideal for assessing conditions or risks in dangerous or unknown areas. The data generated by drones relies heavily on other technologies, such as computer vision, image recognition, and artificial intelligence, to mine the data collected and form conclusions about the objects they detect.- In addition to performing activities and capturing information from sensors in a workplace, robots can measure, respond to, and produce data for monitored hazards or changing environmental conditions. Sensors in conjunction with high-definition cameras can scan and inspect, for example, bridges for erosion or other unsafe conditions. <|ref|>sub_title<|/ref|><|det|>[[42, 749, 166, 768]]<|/det|> ## Data Storage <|ref|>text<|/ref|><|det|>[[39, 770, 664, 895]]<|/det|> The decision- making value of data produced by smart products, the IoT, and other data- capturing technology can be undermined by its volume, velocity, and veracity—more and faster is not necessarily better. Cloud computing enables the storage and sharing of vast amounts of data. But what if there was a way to ensure that the data used for risk management analysis was from a trusted source and independently verified? That is the premise underlying the data storage and sharing medium known as the blockchain. <|ref|>text<|/ref|><|det|>[[38, 902, 614, 940]]<|/det|> Think of the blockchain as a virtual distributed ledger that maintains a dynamically updated list of data records (blocks). These records are not <|ref|>sub_title<|/ref|><|det|>[[707, 808, 816, 822]]<|/det|> ## Cloud computing <|ref|>text<|/ref|><|det|>[[707, 826, 875, 930]]<|/det|> information, technology, and storage services contractually provided from remote locations, through the internet or another network, without a direct server connection.
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<|ref|>text<|/ref|><|det|>[[296, 112, 921, 185]]<|/det|> actually recorded in the ledger, however, until the veracity of data within them is confirmed and verified through a consensus process called mining. This verification process removes intermediary validation and establishes trust without the use of a centralized authority. <|ref|>text<|/ref|><|det|>[[296, 191, 911, 265]]<|/det|> After a block is confirmed and the data within it is verified through mining, the block is time stamped and added to the preexisting blocks in the chain—hence the term "blockchain." The blockchain is encrypted and protected against tampering and revision. <|ref|>text<|/ref|><|det|>[[296, 271, 914, 482]]<|/det|> The myriad risk management ramifications of the blockchain are a by- product of the medium's immutability, security, transparency, scalability, and ability to facilitate the sharing of verified, quality data. For example, a supply chain linking disparate entities across a continent could be connected through a blockchain- enabled database. This virtual ledger could record sensor- enhanced data about inventory levels, weather, labor conditions, and other data relevant to the welfare of the supplier's products collected from radio frequency identification (RFID) sensors and other sources at each link in the chain and shared among all participants. The supplier could use the data to not only monitor conditions in real time, potentially staving off losses, but also inform ongoing analysis of its products, processes, and employment practices to continually refine its management of supply chain and other risks. <|ref|>sub_title<|/ref|><|det|>[[298, 504, 434, 524]]<|/det|> ## Data Analytics <|ref|>text<|/ref|><|det|>[[296, 527, 920, 616]]<|/det|> The collection, storage, and sharing of data empowers real- time risk management for organizations that use data gleaned from sensors to react immediately to hazardous situations. For instance, sensors affixed to the clothing of an assembly line laborer might sense that worker's hydration level dropping to a dangerous level. <|ref|>text<|/ref|><|det|>[[296, 622, 904, 730]]<|/det|> Collected and stored data can also be used to reveal forward- thinking risk management strategies when that data is organized and analyzed through methods that use artificial intelligence, such as machine learning and data modeling. In short, insurers and risk managers can improve their business results through data- driven decision making in an ever- increasing variety of ways, such as these: <|ref|>sub_title<|/ref|><|det|>[[84, 783, 152, 797]]<|/det|> ## Telematics <|ref|>text<|/ref|><|det|>[[82, 800, 250, 918]]<|/det|> The use of technological devices in vehicles with wireless communication and GPS tracking that transmit data to businesses or government agencies; some return information for the driver. <|ref|>text<|/ref|><|det|>[[296, 737, 914, 920]]<|/det|> - Automating decision making for improved accuracy and efficiency—Many insurers provide online quotes for personal auto insurance based on a computer algorithm.- Organizing large volumes of new data—An insurer could organize data according to multiple characteristics, such as the information provided by telematics, which can include speed, braking patterns, left turns, and distance traveled.- Discovering new relationships in data—A risk manager could identify the characteristics of workers who have never had a workplace accident and use that information to identify how to improve safety for all workers.
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<|ref|>text<|/ref|><|det|>[[48, 108, 671, 308]]<|/det|> Exploring new sources of data—An insurer could use text mining to analyze claims adjusters' notes for various purposes, such as developing an automated system to predict a claim's severity, and assign the appropriate resources to those claims predicted to become severe. Developing new products—The increasingly accurate predictive modeling of hazards, particularly catastrophe modeling, enabled by sources of shared, comprehensive data about the complex interactions of contributing factors, has led to the innovation of products. One notable example is parametric insurance, coverage that pays a predetermined amount to the insured if a particular set of parameters occur, such as a hurricane's wind speed. <|ref|>sub_title<|/ref|><|det|>[[48, 375, 459, 402]]<|/det|> ## RISK MANAGEMENT BENEFITS <|ref|>text<|/ref|><|det|>[[47, 406, 652, 530]]<|/det|> Organizations have long recognized the benefits of risk management techniques related to hazard risks—primarily risk mitigation and risk transfer—that benefit not only the individual organization, but also the overall economy. For example, insurance can prevent a business failure and the resulting unemployment after a catastrophe. However, truly comprehensive risk management also should account for broader risks within organizations and systemic risk in the economy. <|ref|>text<|/ref|><|det|>[[46, 537, 656, 644]]<|/det|> A risk management strategy that looks beyond just hazard risk allows an organization to reduce the cost and deterrence effects of hazard risks while maximizing its profitability and ensuring its compliance with legal and regulatory risk management requirements. A holistic strategy also benefits the economy through waste reduction, the improved allocation of productive resources, and the reduction of systemic risk. <|ref|>sub_title<|/ref|><|det|>[[46, 667, 390, 692]]<|/det|> ## Benefits for an Organization <|ref|>text<|/ref|><|det|>[[45, 696, 658, 802]]<|/det|> All organizations face various risks simply by operating. Many risks result in a negative outcome only, such as the possibility of accidental loss, and could prevent an organization from meeting its objectives. Other risks can have either a positive or negative outcome, such as a new product or a financial investment, and could help an organization meet its objectives. There are various benefits to any organization in managing these risks. <|ref|>sub_title<|/ref|><|det|>[[45, 821, 346, 844]]<|/det|> ## Reduce Cost of Hazard Risk <|ref|>text<|/ref|><|det|>[[45, 848, 670, 885]]<|/det|> In risk management, an organization's cost of risk associated with a particular asset or activity is the total of these: <|ref|>text<|/ref|><|det|>[[45, 892, 644, 952]]<|/det|> Costs of accidental losses not reimbursed by insurance or other outside sources Insurance premiums or expenses incurred for noninsurance indemnity <|ref|>sub_title<|/ref|><|det|>[[715, 114, 790, 129]]<|/det|> ## Text mining <|ref|>text<|/ref|><|det|>[[715, 133, 848, 178]]<|/det|> Obtaining information through language recognition. <|ref|>sub_title<|/ref|><|det|>[[715, 512, 802, 527]]<|/det|> ## Systemic risk <|ref|>text<|/ref|><|det|>[[714, 531, 886, 590]]<|/det|> The potential for a major disruption in the function of an entire market or financial system. <|ref|>sub_title<|/ref|><|det|>[[714, 848, 788, 862]]<|/det|> ## Cost of risk <|ref|>text<|/ref|><|det|>[[714, 866, 888, 912]]<|/det|> The total cost incurred by an organization because of the possibility of accidental loss.
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<|ref|>text<|/ref|><|det|>[[299, 112, 922, 172]]<|/det|> - Costs of risk control techniques to prevent or reduce the size of accidental losses- Costs of administering risk management activities <|ref|>text<|/ref|><|det|>[[298, 179, 920, 304]]<|/det|> Risk management aims to reduce the long- term overall cost of risk for the organization without precluding or otherwise interfering with the organization's achieving its goals or engaging in its normal activities. The reduction in the overall cost of risk can increase the organization's profits (or, for a not- for- profit organization, reduce the budget it needs for a particular activity). Risk management also supports safety while minimizing the financial effect of safety measures on the organization's productivity. <|ref|>sub_title<|/ref|><|det|>[[299, 322, 756, 345]]<|/det|> ## Reduce Deterrence Effects of Hazard Risks <|ref|>text<|/ref|><|det|>[[298, 348, 922, 455]]<|/det|> The fear of possible future losses tends to make senior management reluctant to undertake activities they consider too risky. Consequently, the organization is deprived of potential benefits. Risk management reduces the deterrent effects of uncertainty about potential future accidental losses by making these losses less frequent, less severe, or more foreseeable. The resulting reduction in uncertainty benefits an organization in these ways: <|ref|>text<|/ref|><|det|>[[299, 461, 904, 592]]<|/det|> - Alleviates or reduces management's fears about potential losses, thereby increasing the feasibility of ventures that once appeared too risky- Increases profit potential by greater participation in investment or production activities- Makes the organization a safer investment and therefore more attractive to suppliers of investment capital through which the organization can expand <|ref|>text<|/ref|><|det|>[[298, 599, 919, 653]]<|/det|> Many new products and manufacturing processes have become attractive only after better ways of preventing and paying for accidental losses have reduced related uncertainty. <|ref|>text<|/ref|><|det|>[[298, 660, 920, 835]]<|/det|> Like an organization's senior managers, those who would provide the organization with funds seek assurances: stockholders or other investors seek assurance that their equity is safe and will generate future income; creditors seek assurance that the money they have loaned will be repaid on time with interest. The security sought by these sources of new capital rests, at least partly, on confidence that the organization will prosper despite any accidental losses that might befall it. Consequently, an organization's ability to attract willing investors depends to a significant degree on the effectiveness of its risk management program to protect investors' capital against the cost of accidental losses. <|ref|>sub_title<|/ref|><|det|>[[299, 855, 543, 877]]<|/det|> ## Reduce Downside Risk <|ref|>text<|/ref|><|det|>[[298, 881, 920, 935]]<|/det|> Downside risks, including losses and failures, are an inevitable aspect of any type of business or speculative risk. For example, a company has downside risk whenever it introduces a new product. A financial institution has downside
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<|ref|>text<|/ref|><|det|>[[44, 111, 667, 201]]<|/det|> risk every time it makes a loan or an investment. Operational risk is a part of an organization's processes, and the downside risks include delays, errors, cost increases, and the failure of any aspect of the operation. Reducing downside risk provides similar organizational benefits as reducing the deterrence effects of hazard risks. <|ref|>text<|/ref|><|det|>[[44, 208, 671, 386]]<|/det|> To reduce downside risks, organizations can use threshold limits, which can be applied to many types of risks. By monitoring risks with preset limits based on established risk criteria, triggers are in place to alert management when the threshold has been breached. This threshold might be a certain number of faulty manufactured items within a certain amount of time (operational risk), a certain variation in interest rates on investments (financial risk), or the number of serious accidents within a specified time frame (hazard risk). When these thresholds are breached, management can review the situation and discuss changes before the losses become more significant and much more difficult to manage. <|ref|>sub_title<|/ref|><|det|>[[45, 404, 370, 427]]<|/det|> ## Manage the Downside of Risk <|ref|>text<|/ref|><|det|>[[45, 429, 621, 483]]<|/det|> Although it cannot eliminate downside risk, risk management can help an organization meet its objectives. See the exhibit "Example of Risk Management Failure at Equifax." <|ref|>text<|/ref|><|det|>[[45, 490, 664, 563]]<|/det|> The risk management strategy an organization uses must be well thought out so that the strategy itself does not increase risk. Hedging is an example of a risk management technique that can be used to manage downside risk resulting from market volatility, but it must be well designed and executed. <|ref|>sub_title<|/ref|><|det|>[[46, 582, 280, 605]]<|/det|> ## Take Intelligent Risks <|ref|>text<|/ref|><|det|>[[45, 607, 664, 715]]<|/det|> Successful organizations usually take risks to grow and increase profit. This type of risk can create a positive or a negative outcome. Decisions regarding new opportunities should be based on the organization's risk appetite, which is "the total exposed amount that an organization wishes to undertake on the basis of risk- return trade- offs for one or more desired and expected outcomes." <|ref|>text<|/ref|><|det|>[[45, 722, 671, 846]]<|/det|> An important benefit of risk management is that it provides organizations with a framework to analyze and manage the risks associated with an opportunity. For example, when an organization considers whether to expand into a new product line, risk management can help it decide whether the potential rewards are greater than the downside risks. If the organization decides to go forward with the new product line, risk management can assist in designing a process to manage the associated risks. <|ref|>sub_title<|/ref|><|det|>[[45, 866, 283, 889]]<|/det|> ## Maximize Profitability <|ref|>text<|/ref|><|det|>[[45, 891, 670, 929]]<|/det|> Risk management can help an organization achieve the optimal risk- adjusted return on capital. If an organization does not take enough risk, its capital may
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<|ref|>sub_title<|/ref|><|det|>[[320, 130, 764, 152]]<|/det|> ## Example of Risk Management Failure at Equifax <|ref|>text<|/ref|><|det|>[[320, 154, 884, 270]]<|/det|> Equifax, one of the big three credit reporting companies, revealed that approximately 143 million Americans had their sensitive financial and personally identifiable information compromised by a security breach. Consumers learned that these thefts occurred months before the company notified them of the breach. And many of the affected consumers had not requested that their information be given to Equifax but assumed that credit reporting companies would manage and safeguard all private information in their possession. <|ref|>text<|/ref|><|det|>[[320, 272, 901, 323]]<|/det|> The fallout from this failure has affected not only Equifax but also the banks, credit card companies, and other institutions that were entrusted with Social Security numbers and other personal and financial information. <|ref|>text<|/ref|><|det|>[[320, 325, 870, 376]]<|/det|> This incident is an example of ineffective risk management—a corporate failure to manage risks effectively—from the organization itself all the way to vendors and anyone else entrusted with valuable consumer information. <|ref|>text<|/ref|><|det|>[[320, 378, 888, 508]]<|/det|> In addition to the public outrage, Equifax will be exposed to lawsuits, investigations, and financial penalties. Banks and other institutions that report to the credit reporting agencies will experience negative responses from consumers who believe that these institutions were also culpable. Despite these setbacks, the most damaging fallout for Equifax may result from reputational risk. This is, at least in part, because this breach affected so many people and because all the details of its occurrence and the extent of the damage may be far worse than predicted. This security breach will be in the spotlight for a long time; consumers will not soon forget it. <|ref|>text<|/ref|><|det|>[[320, 511, 892, 594]]<|/det|> Equifax did not perform its due diligence regarding what it was entrusted to do, and it did not have the appropriate or sufficiently updated systems in place to fulfill its corporate responsibility to its customers. This incident underscores the need to establish and continually monitor effective practices to manage an organization's risks and maintain the trust of its stakeholders. <|ref|>text<|/ref|><|det|>[[298, 611, 357, 625]]<|/det|> [DA12692] <|ref|>text<|/ref|><|det|>[[297, 640, 900, 678]]<|/det|> be underutilized. However, if an organization takes on too much risk, it may exceed its capability to withstand potential losses. <|ref|>text<|/ref|><|det|>[[296, 684, 918, 826]]<|/det|> Risk management provides an organization with information to evaluate the potential risk- adjusted return on its activities and to manage the risks associated with those activities. For example, an organization may consider whether to increase its dividend to shareholders versus investing in a new product. Although the same amount of capital may be considered for each option, the risk- adjusted return will not be the same. Risk managers can help the organization evaluate the risks and potential return of each option and their effects on the organization's meeting its objectives. <|ref|>sub_title<|/ref|><|det|>[[297, 844, 671, 868]]<|/det|> ## Practice Holistic Risk Management <|ref|>text<|/ref|><|det|>[[296, 870, 918, 926]]<|/det|> Traditional risk management was conducted in silos within an organization. For example, a manufacturing organization would typically have the risk management function manage hazard risk; the finance function manage financial
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<|ref|>text<|/ref|><|det|>[[45, 113, 666, 202]]<|/det|> risks, such as credit and exchange- rate risk; the operations function manage operational risks, such as equipment failures; and the information technology function manage cyber risk. This fragmented approach can miss critical risks to the organization and fails to provide senior management with a picture of the organization's risk portfolio and profile. <|ref|>text<|/ref|><|det|>[[45, 209, 670, 334]]<|/det|> In the example of the manufacturing organization, the risk management function may not be aware of the age and condition of equipment in the plants if this equipment is not insured. Operations may not be aware of the risks presented by some of the older equipment, and its request to senior management for a capital expenditure for new equipment may be turned down. In that scenario, a piece of machinery could then malfunction and cause a fire, rendering the plant unusable for a year and delaying production. <|ref|>text<|/ref|><|det|>[[45, 340, 675, 466]]<|/det|> An integrated, holistic approach that manages risk across all levels and functions within an organization presents a more complete picture of an organization's risk portfolio and profile. This picture allows for better decisions by and improved outcomes for senior management. In the example of the manufacturing organization, if there were a complete understanding of the risks the equipment presented, senior management may have allocated capital to replacing the equipment instead of making a different investment. <|ref|>sub_title<|/ref|><|det|>[[45, 483, 574, 508]]<|/det|> ## Comply With Legal and Regulatory Requirements <|ref|>text<|/ref|><|det|>[[45, 509, 675, 686]]<|/det|> Because of the failure of large organizations and the ensuing financial crisis, subsequent U.S. legislation and regulations require public companies to use and report on risk management. The Securities and Exchange Commission approved a rule requiring corporate disclosure about risk. The Sarbanes- Oxley Act requires both the management of public companies and their auditors to assess and report on financial risk and controls. The Dodd- Frank Act requires that financial bank holding companies and certain other public companies have a risk committee, and at least one member of the committee must be a risk management expert. Basel III and Solvency II in Europe also have risk management requirements for financial firms and insurers. <|ref|>text<|/ref|><|det|>[[45, 693, 660, 766]]<|/det|> One of the benefits of effective risk management is that organizations will be able to comply with these regulatory requirements. Additionally, external auditors will be able to report on these risk management processes to satisfy the reporting requirements. <|ref|>sub_title<|/ref|><|det|>[[45, 789, 354, 813]]<|/det|> ## Benefits for the Economy <|ref|>text<|/ref|><|det|>[[44, 816, 675, 925]]<|/det|> The economy at both local and national levels incurs certain costs associated with risk and its management, as well as uncertainty about future losses. For example, a major hurricane can have widespread effects on the national economy, not just on individual organizations. Beyond a single loss occurrence like a hurricane, the cumulative effect of many smaller losses also adversely affects the national and local economies. For example, many retail stores in
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<|ref|>text<|/ref|><|det|>[[294, 112, 917, 220]]<|/det|> a shopping mall would suffer reduced sales if one of the anchor stores were closed because of an accidental loss. Depending on the magnitude of the loss and the length of time required for the anchor store to recover, the local community may sustain lost jobs, reduced tax revenue, and an overall reduction in the quality of life that was enjoyed when the mall was fully operational and thriving. <|ref|>text<|/ref|><|det|>[[294, 227, 912, 368]]<|/det|> An economy's cost of risk management includes the resources consumed by or devoted to combating losses. For example, uncertainty throughout the economy causes organizations to be more risk averse. This in turn causes allocation of the economy's resources away from assets or activities that seem to be too risky so that the economy is not as productive as it might otherwise be. Consequently, average living standards can be reduced. Risk management benefits the entire economy by reducing waste of resources, improving allocation of productive resources, and reducing systemic risk. <|ref|>sub_title<|/ref|><|det|>[[295, 387, 605, 410]]<|/det|> ## Reduced Waste of Resources <|ref|>text<|/ref|><|det|>[[295, 413, 914, 501]]<|/det|> Any economy possesses a given quantity of resources with which to produce goods and services. If an accidental loss reduces those resources, such as when a fire or an earthquake demolishes a factory or destroys a highway, that economy's overall productive resources are reduced. Risk management prevents or minimizes the waste of these productive resources. <|ref|>text<|/ref|><|det|>[[295, 508, 919, 598]]<|/det|> Whenever there is a risk that accidental losses may occur, some portion of the economy's resources must be devoted to risk management. Allocating such resources is a cost because the resources cannot be used for other purposes that could promote growth. However, without such resources the economy would suffer even more in the event of an accidental loss. <|ref|>sub_title<|/ref|><|det|>[[295, 617, 775, 641]]<|/det|> ## Improved Allocation of Productive Resources <|ref|>text<|/ref|><|det|>[[295, 643, 916, 800]]<|/det|> Risk management also improves the allocation of productive resources because when economic uncertainty is reduced for individual organizations, productive resources are better allocated. Risk management makes those who own or run an organization more willing to undertake formerly risky activities because they are better protected against the downside of risk. That greater willingness frees senior managers, workers, and suppliers of financial capital to pursue activities that maximize profits, returns on investments, and ultimately wages. Such a shift increases overall productivity within an economy and, on balance, improves everyone's average standard of living. <|ref|>sub_title<|/ref|><|det|>[[295, 819, 546, 842]]<|/det|> ## Reduced Systemic Risk <|ref|>text<|/ref|><|det|>[[295, 845, 919, 916]]<|/det|> The Dodd- Frank Act, Solvency II, and Basel III are all intended to reduce systemic risk. If a systemically important organization does not have an effective risk management program, that organization's risks can result in failure for not only the organization but also the economy.
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<|ref|>text<|/ref|><|det|>[[48, 109, 675, 234]]<|/det|> Not only did the financial crisis of 2008- 09 cause widespread negative consequences, such as recessions and high unemployment, it also caused many organizations to become risk averse and therefore afraid to invest their capital because of uncertainty. The benefits of risk management programs at systemically important organizations include reducing systemic risk and reassuring investors and the public about reasonable risk taking that can provide economic growth. <|ref|>sub_title<|/ref|><|det|>[[50, 257, 263, 279]]<|/det|> ## Apply Your Knowledge <|ref|>text<|/ref|><|det|>[[50, 281, 470, 299]]<|/det|> State the benefits of risk management for an insurer. <|ref|>text<|/ref|><|det|>[[49, 307, 676, 450]]<|/det|> Feedback: Insurers, which are in the risk business, can provide benefits to their organizations and their clients by developing methods to reduce the cost of hazard risk and by providing cost- effective risk transfer mechanisms. By employing risk management, insurers can make optimal use of their capital through new opportunities and prudent risk taking. Holistic risk management allows an insurer to gain perspective on its entire risk portfolio. Additionally, insurers need effective risk management programs to meet regulatory requirements. <|ref|>sub_title<|/ref|><|det|>[[50, 514, 660, 542]]<|/det|> ## RISK MANAGEMENT OBJECTIVES AND GOALS <|ref|>text<|/ref|><|det|>[[50, 546, 668, 583]]<|/det|> A structured, logical, and appropriate program is the foundation on which an organization's entire risk management effort rests. <|ref|>text<|/ref|><|det|>[[50, 590, 678, 679]]<|/det|> The support of an organization's senior management is essential to an effective risk management program. To gain that support, a risk management professional should design a program with objectives and goals that align with the organization's overall objectives. In some circumstances, a trade- off will be necessary between organizational objectives and risk management goals. <|ref|>sub_title<|/ref|><|det|>[[50, 703, 405, 728]]<|/det|> ## Risk Management Objectives <|ref|>text<|/ref|><|det|>[[49, 732, 650, 875]]<|/det|> Each organization should align its risk management objectives with its overall objectives. Common objectives for risk management are balancing risk and reward and supporting decision- making. These objectives should reflect the organization's risk appetite and the organization's internal and external context. Objectives can emphasize certain goals, such as business continuity, protection of reputation, or growth. See the exhibit "Example of an Organization's Risk Management Objectives: Zurich's Enterprise Risk Management." <|ref|>text<|/ref|><|det|>[[48, 882, 671, 937]]<|/det|> Risk management objectives can emphasize certain goals in order to align the risk management program with the organization's risk philosophy and to help the organization meet its overall objectives.
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<|ref|>sub_title<|/ref|><|det|>[[318, 130, 870, 172]]<|/det|> ## Example of an Organization's Risk Management Objectives: Zurich's Enterprise Risk Management <|ref|>sub_title<|/ref|><|det|>[[319, 176, 637, 193]]<|/det|> ## Mission and Objectives of Risk Management <|ref|>text<|/ref|><|det|>[[319, 197, 888, 279]]<|/det|> The mission of Zurich's Enterprise Risk Management is to promptly identify, measure, manage, report and monitor risks that affect the achievement of our strategic, operational and financial objectives. This includes adjusting the risk profile in line with the Group's stated risk tolerance to respond to new threats and opportunities in order to optimize returns. <|ref|>text<|/ref|><|det|>[[319, 283, 700, 300]]<|/det|> Our major Enterprise Risk Management objectives are to: <|ref|>text<|/ref|><|det|>[[319, 304, 894, 450]]<|/det|> Protect the capital base by monitoring that risks are not taken beyond the Group's risk tolerance Enhance value creation and contribute to an optimal risk- return profile by providing the basis for an efficient capital deployment Support the Group's decision- making processes by providing consistent, reliable and timely risk information Protect our reputation and brand by promoting a sound culture of risk awareness and disciplined and informed risk taking <|ref|>text<|/ref|><|det|>[[298, 483, 515, 497]]<|/det|> \(①\) Zurich Insurance Company [DA08642] <|ref|>sub_title<|/ref|><|det|>[[298, 512, 590, 537]]<|/det|> ## Risk Management Goals <|ref|>text<|/ref|><|det|>[[297, 540, 911, 612]]<|/det|> The risk management program should have goals to manage the risks that an organization will face. These goals should be incorporated into the risk management framework and the process designed to meet a particular organization's objectives. These are typical risk management goals: <|ref|>text<|/ref|><|det|>[[297, 618, 655, 787]]<|/det|> Tolerable uncertainty Legal and regulatory compliance Survival Business continuity Earnings stability Profitability and growth Social responsibility Economy of risk management operations <|ref|>sub_title<|/ref|><|det|>[[297, 806, 524, 828]]<|/det|> ## Tolerable Uncertainty <|ref|>text<|/ref|><|det|>[[296, 832, 912, 939]]<|/det|> A typical risk management goal is tolerable uncertainty, which means aligning risks with the organization's risk appetite ("the total exposed amount that an organization wishes to undertake on the basis of risk- return trade- offs for one or more desired and expected outcomes"). Managers want to be assured that whatever might happen will be within the bounds of what was anticipated and will be effectively addressed by the risk management program.
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<|ref|>text<|/ref|><|det|>[[46, 110, 670, 201]]<|/det|> Risk management programs should use measurements that align with the organization's overall objectives and take into account the risk appetite of senior management. For example, value at risk (VaR) can be used to analyze various financial portfolios with different assets and risk factors. VaR can be calculated quickly and easily to determine risk factor returns on a portfolio. <|ref|>sub_title<|/ref|><|det|>[[46, 220, 412, 243]]<|/det|> ## Legal and Regulatory Compliance <|ref|>text<|/ref|><|det|>[[46, 245, 650, 298]]<|/det|> An important goal for risk management programs is to ensure that the organization's legal obligations are satisfied. Such legal obligations are typically based on these items: <|ref|>text<|/ref|><|det|>[[48, 306, 620, 368]]<|/det|> Standard of care that is owed to others Contracts entered into by the organization Federal, state, provincial, territorial, and local laws and regulations <|ref|>text<|/ref|><|det|>[[48, 375, 667, 413]]<|/det|> A risk management professional has an essential role in helping the organization manage regulatory risk and the potential for liability. <|ref|>sub_title<|/ref|><|det|>[[48, 432, 139, 453]]<|/det|> ## Survival <|ref|>text<|/ref|><|det|>[[48, 457, 669, 616]]<|/det|> For risk management purposes, an organization can be viewed as a structured system of resources such as financial assets, machinery and raw materials, employees, and managerial leadership. The organization generates income for its employees and owners by producing goods or services that meet others' needs. Many risks can threaten the survival of an organization. Traditionally, hazard risk, which could destroy an organization's facilities or cause injury to employees or customers, was viewed as the major threat to an organization's survival. Risk management professionals use techniques such as loss control and risk transfer to manage hazard risks. <|ref|>text<|/ref|><|det|>[[48, 623, 675, 765]]<|/det|> However, the risks that organizations face are much broader than hazard risk. These risks include financial risks such as the value of assets (for example, the organization's stock value), competition, supply- chain risks, and technology (vulnerability to computer attacks and ability to keep pace with technological developments). Survival of an organization depends on identifying as many risks as possible that could threaten the organization's ability to survive and managing those risks appropriately. It also depends on anticipating and recognizing emerging risks, such as those related to climate change. <|ref|>sub_title<|/ref|><|det|>[[48, 785, 264, 808]]<|/det|> ## Business Continuity <|ref|>text<|/ref|><|det|>[[46, 810, 675, 936]]<|/det|> Continuity of operations is a key goal for many private organizations and an essential goal for all public entities. Although survival requires that no risk occurrence (no matter how severe) permanently shut down an organization, the goal of continuity of operations is more demanding. To be resilient, an organization cannot interrupt its operations for any appreciable time. When an organization's senior management sets business continuity as a goal, its risk management professionals must have a clear, detailed understanding of the
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<|ref|>text<|/ref|><|det|>[[297, 112, 905, 150]]<|/det|> specific operations for which continuity is essential and the maximum tolerable interruption interval for each operation. <|ref|>text<|/ref|><|det|>[[298, 157, 920, 195]]<|/det|> These are the steps an organization should take to provide business continuity and, therefore, resiliency: <|ref|>text<|/ref|><|det|>[[299, 201, 914, 320]]<|/det|> Identify activities whose interruptions cannot be tolerated Identify the types of accidents that could interrupt such activities Determine the standby resources that must be immediately available to counter the effects of those accidents Ensure the availability of the standby resources at even the most unlikely and difficult times <|ref|>sub_title<|/ref|><|det|>[[299, 340, 488, 364]]<|/det|> ## Earnings Stability <|ref|>text<|/ref|><|det|>[[299, 365, 907, 472]]<|/det|> Earnings stability is a goal of some organizations. Rather than strive for the highest possible level of current profits (or, for not- for- profit organizations, surpluses) in a given period, some organizations emphasize earnings stability over time. Striving for earnings stability requires precision in forecasting fluctuations in asset values; liability values; and risk management costs, such as costs for insurance. <|ref|>sub_title<|/ref|><|det|>[[300, 491, 553, 514]]<|/det|> ## Profitability and Growth <|ref|>text<|/ref|><|det|>[[300, 516, 918, 673]]<|/det|> An organization's senior management might have established a minimum amount of profit (or surplus) that no event should reduce. To achieve that minimum amount, risk management professionals must identify the risks that could prevent this goal from being reached, as well as the risks that could help achieve this goal within the context of the organization's overall objectives. For example, an organization concerned that a disaster preventing a key supplier from delivering parts will cause a supply- chain risk could develop a backup plan that might not only avoid this risk but also provide an opportunity to sell the backup parts to other companies. <|ref|>text<|/ref|><|det|>[[300, 680, 915, 752]]<|/det|> An organization might measure profitability for its various units on a risk- adjusted basis. For example, high- risk investments require higher expected profits to account for the risk involved. By measuring profit on a risk- adjusted basis, the organization can efficiently deploy its capital. <|ref|>text<|/ref|><|det|>[[300, 758, 920, 936]]<|/det|> Most organizations set goals for growth. Emphasizing growth—for example, enlarging an organization's market share, the size and scope of its activities or products, or its assets—might have two distinctly opposing effects on its risk management program: the reduction of the potentially negative consequences of risk versus supporting the organization's entrepreneurial risk- taking. Those effects depend on managers' and owners' tolerance for uncertainty. It is essential that risk managers understand growth goals in the context of senior management's risk appetite. Risk managers should also advise senior management of the potential risk in different growth strategies that the organization considers. For example, before the financial crisis, many financial
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<|ref|>text<|/ref|><|det|>[[44, 110, 661, 166]]<|/det|> organizations became highly leveraged in order to achieve growth. Although this strategy provided significant short- term growth, it ultimately caused the failure of several prominent firms. <|ref|>sub_title<|/ref|><|det|>[[44, 184, 272, 208]]<|/det|> ## Social Responsibility <|ref|>text<|/ref|><|det|>[[44, 210, 671, 352]]<|/det|> Social responsibility is a goal for many organizations. It includes the organization's ethical conduct as well as the philanthropic commitments that the owners of the organization have made to the community and society as a whole. Beyond the altruistic interests of the organization's owners, many organizations justify pursuing the objective of social responsibility because such activities enhance the organization's reputation. Risk management professionals should consider an organization's societal commitments when developing its risk management program. <|ref|>sub_title<|/ref|><|det|>[[44, 370, 496, 395]]<|/det|> ## Economy of Risk Management Operations <|ref|>text<|/ref|><|det|>[[44, 397, 636, 469]]<|/det|> Risk management should operate economically and efficiently; that is, an organization generally should not incur substantial costs for slight benefits gained. Risk management programs should be operated economically and efficiently. <|ref|>text<|/ref|><|det|>[[42, 476, 653, 670]]<|/det|> One way to measure the economy of a risk management program is through benchmarking, in which an organization's risk management costs are compared with those of similar organizations. The Risk and Insurance Management Society (RIMS), a global organization of risk management professionals, conducts an annual benchmarking survey, in partnership with Advisen, that organizations can use to compare their cost of hazard risk with other organizations in their industry. The benchmark survey combines expenditures for risk assessment, risk control, and risk financing, as well as the administrative costs of risk management programs. These costs are then related to revenue so that comparisons can be made between organizations and industry sectors. <|ref|>sub_title<|/ref|><|det|>[[44, 692, 343, 718]]<|/det|> ## Trade-Offs Among Goals <|ref|>text<|/ref|><|det|>[[42, 721, 660, 935]]<|/det|> Although an organization's risk management objectives and goals are interrelated, sometimes they are not consistent with one another. For example, to obtain tolerable uncertainty, the risk management professional may have to advise senior management that a growth goal may not be achievable without adjusting either the risk appetite or the growth strategy. Legality and social responsibility goals may conflict with the economy of operations goal. Some externally imposed legal obligations, such as safety standards dictated by building codes, are nonnegotiable. Therefore, costs associated with these obligations are unavoidable. Other nonlegal obligations, such as charitable contributions, may be negotiable. However, while meeting social responsibility may raise costs in the short term, it can have worthwhile long- term benefits that make the costs acceptable.
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<|ref|>text<|/ref|><|det|>[[298, 112, 912, 202]]<|/det|> In working with others regarding the trade- offs among organizational goals, a risk management professional must consider the likely effects of alternative risk treatment techniques and the costs and benefits of each. The interests and concerns of the various groups affected by an organization's risk management program should also be considered. <|ref|>text<|/ref|><|det|>[[298, 210, 910, 283]]<|/det|> The way in which a risk management department is structured, how it cooperates with other departments, and how it handles communication of information are all relevant in enabling risk management professionals to respond to the goals and concerns of the organization and of affected parties. <|ref|>sub_title<|/ref|><|det|>[[298, 309, 612, 336]]<|/det|> ## BASIC RISK MEASURES <|ref|>text<|/ref|><|det|>[[298, 340, 900, 412]]<|/det|> The physicist Lord Kelvin said, "To measure is to know" and "If you cannot measure it, you cannot improve it." Risk management requires measures of risk in order to both know the nature of risks and manage them to help an organization meet its objectives. <|ref|>text<|/ref|><|det|>[[298, 419, 911, 509]]<|/det|> Although it is not possible to measure all the risks that could potentially affect an organization's ability to meet its objectives, quantifying those risks that can be measured should form the basis of risk assessment. Additionally, ongoing measurement provides benchmarks to monitor and evaluate the success of an organization's risk management program. <|ref|>text<|/ref|><|det|>[[298, 516, 780, 536]]<|/det|> These are the basic measures that apply to risk management: <|ref|>text<|/ref|><|det|>[[298, 543, 448, 666]]<|/det|> Exposure Volatility Likelihood Consequences Time horizon Correlation <|ref|>sub_title<|/ref|><|det|>[[86, 678, 145, 692]]<|/det|> ## Exposure <|ref|>text<|/ref|><|det|>[[85, 696, 250, 755]]<|/det|> Any condition that presents a possibility of gain or loss, whether or not an actual loss occurs. <|ref|>text<|/ref|><|det|>[[297, 675, 920, 921]]<|/det|> Exposure provides a measure of the maximum potential damage associated with an occurrence. Generally, the risk increases as the exposure increases, assuming the risk is nondiversifiable. For example, if a bank underwrites mortgages to subprime borrowers, the credit risk increases as the amount of subprime mortgages increases because the exposure to default increases. An insurer that writes homeowners policies in coastal areas increases its exposure to windstorms as its coastal book of business increases. In these examples, the exposure can be quantified based on the amount of mortgages or policy coverage issued. Other exposures, such as the risk of a data breach or reputational risk, are not as easily quantified. However, even if an exposure cannot be readily quantified, there should be an attempt to qualitatively measure its effect on the organization to effectively manage the risk. For example, the effect of reputational risk could be measured in terms of its potential influence on an organization's stock price, customer loyalty, and employee turnover.
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<|ref|>text<|/ref|><|det|>[[44, 110, 672, 306]]<|/det|> Volatility provides a basic measure that can be applied to risk. Generally, risk increases as volatility increases. Volatility can often be quantified. For example, VIX, the Chicago Board Options Exchange Market Volatility Index, provides a measure of stock market volatility. The volatility of energy prices, for example, is a major risk for many organizations. Utility companies, airlines, trucking companies, and other types of organizations that are highly dependent on fuel use strategies such as hedging to manage the risk associated with volatility in the price of oil. However, organizations that may be only indirectly affected by energy price volatility, such as retailers whose customers have less disposable income when gas prices rise, may also want to assess and manage this risk through inventory and pricing adjustments. <|ref|>text<|/ref|><|det|>[[44, 312, 666, 455]]<|/det|> The likelihood of an occurrence is a key measure in risk management. The ability to determine the probability of an event mathematically is the foundation of insurance and risk management.3 The term "likelihood" is used rather than "probability" because probability analysis relies on the law of large numbers. Although insurers and some other organizations can use the law of large numbers to accurately determine the probability of various risks, most organizations need to determine the likelihood of an occurrence without the benefit of a probability analysis of large numbers. <|ref|>text<|/ref|><|det|>[[42, 460, 670, 690]]<|/det|> For example, a bank can probably determine and quantify the likelihood of default on a loan based on credit scores and other factors in the bank's extensive data. However, it would be more difficult for the bank to determine the likelihood of a cyber attack in which customer data are taken, resulting in liability. It would be even more difficult for the bank to predict the likelihood of a terrorist attack that could be catastrophic. Similarly, it is easier to determine the likelihood that certain risks undertaken to improve an organization's performance will have a positive outcome than it is for others. If a bank decides to issue credit to borrowers with slightly lower credit scores than its current borrowers, the bank probably has sufficient data to determine the likelihood of a positive outcome. However, if the bank decides to expand into a new and unfamiliar region, it may be more difficult to predict the likelihood of a successful outcome. <|ref|>text<|/ref|><|det|>[[42, 696, 668, 788]]<|/det|> The relationship between likelihood and consequences is critical for risk management in assessing risk and deciding whether and how to manage it. Therefore, organizations must determine to the extent possible the likelihood of an event and then determine the potential consequences if the event occurs. <|ref|>text<|/ref|><|det|>[[41, 793, 666, 920]]<|/det|> Consequences are the measure of the degree to which an occurrence could positively or negatively affect an organization. The greater the consequences, the greater the risk. In assessing the level of risk, the risk management professional must understand to the extent possible both the likelihood and the consequences. If there is a low likelihood of an occurrence with minor consequences, it may not be necessary for an organization to actively manage the risk. For example, a bank may decide that the likelihood of employees taking <|ref|>sub_title<|/ref|><|det|>[[713, 115, 770, 130]]<|/det|> ## Volatility <|ref|>text<|/ref|><|det|>[[713, 134, 879, 164]]<|/det|> Frequent fluctuations, such as in the price of an asset. <|ref|>sub_title<|/ref|><|det|>[[713, 368, 850, 382]]<|/det|> ## Law of large numbers <|ref|>text<|/ref|><|det|>[[712, 386, 875, 504]]<|/det|> A mathematical principle stating that as the number of similar but independent exposure units increases, the relative accuracy of predictions about future outcomes (losses) also increases.
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<|ref|>text<|/ref|><|det|>[[298, 113, 907, 151]]<|/det|> office supplies for personal use is low, and the consequences if this occurs are minor. Therefore, the bank may decide not to manage this risk. <|ref|>text<|/ref|><|det|>[[298, 158, 921, 281]]<|/det|> Risks with high likelihood and minor consequences should usually be managed through an organization's routine business procedures. For example, there is a significant likelihood that a customer will be a few days late in making a loan payment. The consequences of payments that are a few days late are relatively minor. However, the bank should manage this risk through normal business procedures such as late charges or sending reminder notices if the payment is not received by the due date. <|ref|>text<|/ref|><|det|>[[298, 289, 920, 414]]<|/det|> Risks with potentially major consequences should be managed even if the likelihood of their occurrence is low. For example, the risk of a fire at a bank, although unlikely, must be managed. Risks with significant likelihood and major consequences require significant, continuous risk management. For example, an international bank faces exchange rate risk that is likely and that could result in considerable losses. The bank may use hedging strategies and other techniques to modify this type of risk. <|ref|>text<|/ref|><|det|>[[86, 422, 203, 456]]<|/det|> Time horizon Estimated duration. <|ref|>text<|/ref|><|det|>[[298, 420, 919, 577]]<|/det|> The time horizon of an exposure is another basic measure that is applied in risk management. A risk's time horizon can be measured in various ways. The time horizon associated with an investment risk, such as a stock or bond, can be determined by specified bond duration or by how quickly a stock can be traded. Longer time horizons are generally riskier than shorter ones. For example, a thirty- year mortgage is usually riskier for a bank than a fifteen- year mortgage. A business strategy that involves purchase of real estate and building new structures is not as easily reversed as one that involves only a new advertising campaign and is therefore riskier. <|ref|>text<|/ref|><|det|>[[297, 585, 921, 760]]<|/det|> Although an organization may have little or no control over the time horizon of a risk, the organization should evaluate and manage this risk just as it would manage other risks over which it has no control, such as weather- related risks. For example, diversification in financial investments can help manage the risks associated with the time horizon of those investments. An insurance company that matches the durations of its assets (investments) and liabilities (loss reserves) neutralizes the risks associated with time horizon. When real estate prices are highly volatile, an organization may defer an expansion strategy that involves a long time horizon, such as purchasing or building new facilities. <|ref|>text<|/ref|><|det|>[[85, 768, 223, 817]]<|/det|> Correlation A relationship between variables. <|ref|>text<|/ref|><|det|>[[297, 768, 918, 928]]<|/det|> Correlation is a measure that should be applied to the management of an organization's overall risk portfolio. If two or more risks are similar, they are usually highly correlated. The greater the correlation, the greater the risk. For example, if a bank makes mortgage loans primarily to the employees of a local manufacturer and business loans primarily to that same manufacturer, the bank's loan risks are highly correlated. The failure of the manufacturing business would likely be catastrophic for the bank's entire loan book of business. If a manufacturer contracts with three major suppliers in the same earthquake- prone region in Asia, the manufacturer's supply- chain risks are highly
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<|ref|>text<|/ref|><|det|>[[42, 112, 655, 149]]<|/det|> correlated. Diversification is a risk management strategy that can reduce the risk of correlation.⁴ <|ref|>text<|/ref|><|det|>[[42, 156, 671, 350]]<|/det|> Risk management professionals should evaluate all of these measures and their overall effect on an organization's risk portfolio. Highly correlated risks with a high likelihood, major consequences, high volatility, and significant exposure over a long time horizon should be a key focus of risk management. The global financial crisis that started in 2007 resulted in part from the failure to recognize or address this type of risk. Subprime mortgages represented highly correlated risk to the same types of risky borrowers, large exposure with major consequences, high volatility due to fluctuations in their market value (and in the market value of the underlying real estate collateral), and a long time horizon because of their duration. Therefore, it is essential that organizations apply these basic measures when assessing their risk. <|ref|>sub_title<|/ref|><|det|>[[45, 372, 258, 393]]<|/det|> ## Apply Your Knowledge <|ref|>text<|/ref|><|det|>[[44, 396, 674, 468]]<|/det|> An insurer decides to achieve growth in its auto insurance line by offering a discount to its homeowners insurance customers who also purchase auto insurance. Which of the following risk measures is or are likely to increase as a result of this business decision? Select all that apply. <|ref|>text<|/ref|><|det|>[[44, 476, 188, 559]]<|/det|> a. Exposure b. Volatility c. Time horizon d. Correlation <|ref|>text<|/ref|><|det|>[[44, 566, 671, 673]]<|/det|> Feedback: a. and d. The insurer increases its exposure to its existing customer base by offering discounted auto insurance to its homeowners customers. The insurer also increases its risk correlation because it insures the same customers for both the homeowners and auto lines. Presumably, the insurer can manage its risk volatility through diversification, and its time horizon for risk is largely limited by the length of the auto and homeowners policy terms. <|ref|>sub_title<|/ref|><|det|>[[44, 737, 601, 766]]<|/det|> ## RISK CLASSIFICATIONS AND CATEGORIES <|ref|>text<|/ref|><|det|>[[44, 770, 667, 825]]<|/det|> Classifying the various types of risk can help an organization understand and manage its risks. The categories should align with an organization's objectives and risk management goals. <|ref|>text<|/ref|><|det|>[[44, 831, 666, 940]]<|/det|> Classification can help with assessing risks, because many risks in the same classification have similar attributes. It also can help with managing risk, because many risks in the same classification can be managed with similar techniques. Finally, classification helps with the administrative function of risk management by helping to ensure that risks in the same classification are less likely to be overlooked.
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<|ref|>text<|/ref|><|det|>[[298, 113, 819, 133]]<|/det|> These classifications of risk are some of the most commonly used: <|ref|>text<|/ref|><|det|>[[299, 141, 832, 225]]<|/det|> Pure and speculative risk- Subjective and objective risk- Diversifiable and nondiversifiable risk- Quadrants of risk (hazard, operational, financial, and strategic) <|ref|>text<|/ref|><|det|>[[298, 231, 886, 268]]<|/det|> These classifications are not mutually exclusive and can be applied to any given risk. <|ref|>sub_title<|/ref|><|det|>[[298, 291, 616, 317]]<|/det|> ## Pure and Speculative Risk <|ref|>text<|/ref|><|det|>[[85, 323, 250, 371]]<|/det|> Pure riskA chance of loss or no loss, but no chance of gain. <|ref|>text<|/ref|><|det|>[[298, 320, 919, 444]]<|/det|> Pure riskA pure risk is a chance of loss or no loss, but no chance of gain. For example, the owner of a commercial building faces the risk associated with a possible fire loss. The building will either burn or not burn. If the building burns, the owner suffers a financial loss. If the building does not burn, the owner's financial condition is unchanged. Neither of the possible outcomes would produce a gain. Because there is no opportunity for financial gain, pure risks are always undesirable. See the exhibit "Classifications of Risk." <|ref|>image<|/ref|><|det|>[[100, 512, 900, 728]]<|/det|> <|ref|>text<|/ref|><|det|>[[85, 735, 145, 750]]<|/det|> [DA02396] <|ref|>text<|/ref|><|det|>[[84, 780, 237, 829]]<|/det|> Speculative riskA chance of loss, no loss, or gain. <|ref|>text<|/ref|><|det|>[[296, 780, 920, 888]]<|/det|> Speculative riskIn comparison, speculative risk involves a chance of gain. As a result, it can be desirable, as evidenced by the fact that every business venture involves speculative risks. For example, an investor who purchases an apartment building to rent to tenants expects to profit from this investment, so it is a desirable speculative risk. However, the venture could be unprofitable if rental price controls limit the amount of rent that can be charged.
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<|ref|>text<|/ref|><|det|>[[40, 114, 512, 133]]<|/det|> Certain businesses involve speculative risks, such as these: <|ref|>text<|/ref|><|det|>[[40, 140, 668, 266]]<|/det|> - Price risk—Uncertainty over the size of cash flows resulting from possible changes in the cost of raw materials and other inputs (such as lumber, gas, or electricity), as well as cost-related changes in the market for completed products and other outputs.- Credit risk—Although a credit risk is particularly significant for banks and other financial institutions, it can be relevant to any organization with accounts receivable. <|ref|>text<|/ref|><|det|>[[40, 275, 666, 312]]<|/det|> Financial investments, such as the purchase of stock shares, involve a distinct set of speculative risks. See the exhibit "Speculative Risks in Investments." <|ref|>sub_title<|/ref|><|det|>[[60, 356, 377, 377]]<|/det|> ## Speculative Risks in Investments <|ref|>image<|/ref|><|det|>[[60, 390, 650, 710]]<|/det|> <|ref|>text<|/ref|><|det|>[[40, 755, 664, 828]]<|/det|> Insurance deals primarily with risks of loss, not risks of gain; that is, with pure risks rather than speculative risks. However, the distinction between these two classifications of risk is not always precise—many risks have both pure and speculative aspects. <|ref|>text<|/ref|><|det|>[[40, 835, 670, 943]]<|/det|> Distinguishing between pure and speculative risks is important because those risks must often be managed differently. For example, although a commercial building owner faces a pure risk from causes of loss such as fire, he or she also faces the speculative risk that the market value of the building will increase or decrease during any one year. Similarly, although an investor who purchases an apartment building to rent to tenants faces speculative risk because rental
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<|ref|>text<|/ref|><|det|>[[298, 113, 897, 151]]<|/det|> income may produce a profit or loss, the investor also faces a pure risk from causes of loss such as fire. <|ref|>text<|/ref|><|det|>[[298, 158, 925, 265]]<|/det|> To properly manage these investments, the commercial building owner and the apartment owner must consider both the speculative and the pure risks. For example, they may choose to manage the pure risk by buying insurance or taking other measures to address property loss exposures. The speculative risk might be managed by obtaining a favorable mortgage and maintaining the property to enhance its resale value. <|ref|>sub_title<|/ref|><|det|>[[298, 287, 657, 313]]<|/det|> ## Subjective and Objective Risk <|ref|>text<|/ref|><|det|>[[298, 316, 912, 388]]<|/det|> When individuals and organizations must make a decision that involves risk, they usually base it on the individual's or organization's assessment of the risk. The assessment can be based on opinions, which are subjective, or facts, which are objective. <|ref|>sub_title<|/ref|><|det|>[[87, 398, 180, 413]]<|/det|> ## Subjective risk <|ref|>text<|/ref|><|det|>[[87, 417, 258, 461]]<|/det|> The perceived amount of risk based on an individual's or organization's opinion. <|ref|>sub_title<|/ref|><|det|>[[87, 465, 175, 480]]<|/det|> ## Objective risk <|ref|>text<|/ref|><|det|>[[87, 484, 254, 528]]<|/det|> The measurable variation in uncertain outcomes based on facts and data. <|ref|>text<|/ref|><|det|>[[298, 395, 909, 484]]<|/det|> Because it is based on opinion rather than fact, subjective risk may be quite different from the actual underlying risk that is present. In fact, subjective risk can exist even where objective risk does not. The closer an individual's or organization's subjective interpretation of risk is to the objective risk, the more effective its risk management plan will likely be. <|ref|>text<|/ref|><|det|>[[298, 491, 912, 528]]<|/det|> The reasons that subjective and objective risk can differ substantially include these: <|ref|>text<|/ref|><|det|>[[298, 536, 919, 875]]<|/det|> - Familiarity and control—For example, although many people consider air travel (over which they have no control) to carry a high degree of risk, they are much more likely to suffer a serious injury when driving their cars, where the perception of control is much greater.- Consequences over likelihood—People often have two views of low-likelihood, high-consequence events. The first misconception is the "It can't happen to me" view, which assigns a probability of zero to low-likelihood events such as natural disasters, murder, fires, accidents, and so on. The second misconception is overstating the probability of a low-likelihood event, which is common for people who have personally been exposed to the event previously. If the effect of a particular event can be severe, such as the potentially destructive effects of a hurricane or earthquake, the perception of the likelihood of deaths resulting from such an event is heightened. This perception may be enhanced by the increased media coverage given to high-severity events.- Risk awareness—Organizations differ in terms of their level of risk awareness and, therefore, perceive risks differently. An organization that is not aware of its risks would perceive the likelihood of something happening as very low. <|ref|>text<|/ref|><|det|>[[298, 882, 920, 936]]<|/det|> Both risk management and insurance depend on the ability to objectively identify and analyze risks. However, subjectivity is also necessary because facts are often not available to objectively assess risk.
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<|ref|>sub_title<|/ref|><|det|>[[42, 111, 519, 137]]<|/det|> ## Diversifiable and Nondiversifiable Risk <|ref|>text<|/ref|><|det|>[[42, 140, 666, 265]]<|/det|> Diversifiable risk is not highly correlated and can be managed through diversification, or spread, of risk. An example of a diversifiable risk is a fire, which is likely to affect only one or a small number of businesses. For instance, an insurer can diversify the risks associated with fire insurance by insuring many buildings in several different locations. Similarly, business investors often diversify their holdings, as opposed to investing in only one business, hoping those that succeed will more than offset those that fail. <|ref|>text<|/ref|><|det|>[[42, 272, 670, 414]]<|/det|> Examples of nondiversifiable risks include inflation, unemployment, and natural disasters such as hurricanes. Nondiversifiable risks are correlated- that is, their gains or losses tend to occur simultaneously rather than randomly. For example, under certain monetary conditions, interest rates increase for all firms at the same time. If an insurer were to insure firms against interest rate increases, it would not be able to diversify its portfolio of interest rate risks by underwriting a large number of insureds, because all of them would suffer losses at the same time. <|ref|>text<|/ref|><|det|>[[42, 420, 670, 580]]<|/det|> Systemic risks are generally nondiversifiable. For example, if excess leverage by financial institutions causes systemic risk resulting in an event that disrupts the financial system, this risk will have an effect on the entire economy and, therefore, on all organizations. Because of the global interconnections in finance and industry, many risks that were once viewed as nonsystemic (affecting only one organization) are now viewed as systemic. For instance, many economists view the failure of Lehman Brothers in early 2008 as a trigger event: highlighting the systemic risk in the banking sector that resulted in the financial crisis. <|ref|>sub_title<|/ref|><|det|>[[42, 601, 647, 656]]<|/det|> ## Quadrants of Risk: Hazard, Operational, Financial, and Strategic <|ref|>text<|/ref|><|det|>[[42, 658, 668, 696]]<|/det|> Although no consensus exists about how an organization should categorize its risks, one approach involves dividing them into risk quadrants: <|ref|>text<|/ref|><|det|>[[42, 702, 660, 910]]<|/det|> Hazard risks arise from property, liability, or personnel loss exposures and are generally the subject of insurance. Operational risks fall outside the hazard risk category and arise from people or a failure in processes, systems, or controls, including those involving information technology. Financial risks arise from the effect of market forces on financial assets or liabilities and include market risk, credit risk, liquidity risk, and price risk. Strategic risks arise from trends in the economy and society, including changes in the economic, political, and competitive environments, as well as from demographic shifts. <|ref|>sub_title<|/ref|><|det|>[[712, 144, 819, 158]]<|/det|> ## Diversifiable risk <|ref|>text<|/ref|><|det|>[[712, 162, 886, 206]]<|/det|> A risk that affects only some individuals, businesses, or small groups. <|ref|>sub_title<|/ref|><|det|>[[712, 275, 844, 289]]<|/det|> ## Nondiversifiable risk <|ref|>text<|/ref|><|det|>[[712, 293, 866, 337]]<|/det|> A risk that affects a large segment of society at the same time. <|ref|>sub_title<|/ref|><|det|>[[712, 731, 784, 745]]<|/det|> ## Market risk <|ref|>text<|/ref|><|det|>[[712, 750, 868, 825]]<|/det|> Uncertainty about an investment's future value because of potential changes in the market for that type of investment. <|ref|>sub_title<|/ref|><|det|>[[712, 829, 794, 843]]<|/det|> ## Liquidity risk <|ref|>text<|/ref|><|det|>[[712, 847, 858, 905]]<|/det|> The risk that an asset cannot be sold on short notice without incurring a loss.
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<|ref|>text<|/ref|><|det|>[[299, 113, 919, 151]]<|/det|> Hazard and operational risks are classified as pure risks, and financial and strategic risks are classified as speculative risks. <|ref|>text<|/ref|><|det|>[[298, 158, 923, 335]]<|/det|> The focus of the risk quadrants is different from the risk classifications previously discussed. Whereas the classifications of risk focus on some aspect of the risk itself, the four quadrants of risk focus on the risk source and who traditionally manages it. For example, the chief financial officer traditionally manages financial risk, and the risk manager traditionally manages hazard risk. Just as a particular risk can fall into more than one classification, a risk can also fall into multiple risk quadrants. For example, embezzlement of funds by an employee can be considered both a hazard risk, because it is an insurable pure risk, and an operational risk, because it involves a failure of controls. See the exhibit "Risk Quadrants." <|ref|>image<|/ref|><|det|>[[100, 350, 920, 777]]<|/det|> <|ref|>text<|/ref|><|det|>[[97, 784, 148, 799]]<|/det|> [DA08677] <|ref|>text<|/ref|><|det|>[[296, 826, 919, 934]]<|/det|> Organizations define types of risk differently. Some organizations consider legal risks as operational risk, and some may characterize certain hazard risks as operational risk. Financial institutions generally use the categories of market, credit, and operational risk (defined as all other risk, including hazard risk). Each organization should select categories that align with its objectives and processes.
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<|ref|>sub_title<|/ref|><|det|>[[44, 112, 258, 134]]<|/det|> ## Apply Your Knowledge <|ref|>text<|/ref|><|det|>[[42, 137, 668, 227]]<|/det|> The New Company manufactures electronic consumer products. The company's manufacturing plant is highly automated and located in the United States. However, it purchases components from three companies in Asia. The majority of its sales are in the U.S., but European sales represent a growing percentage. <|ref|>text<|/ref|><|det|>[[42, 232, 655, 270]]<|/det|> Describe the types of risk New Company would have in each of the four risk quadrants. <|ref|>text<|/ref|><|det|>[[42, 276, 649, 350]]<|/det|> Feedback: In the hazard risk quadrant, New Company would have property damage risks to its plant and equipment resulting from fire, storms, or other events. It would also have risk of injury to its employees and liability risks associated with its products. <|ref|>text<|/ref|><|det|>[[42, 355, 653, 429]]<|/det|> In the operational risk quadrant, New Company would have risks from employee turnover or the inability to find skilled employees. It would also have business process risk related to how it manages its supply chain and information technology risk related to its automated manufacturing process. <|ref|>text<|/ref|><|det|>[[42, 433, 656, 490]]<|/det|> In the financial risk quadrant, New Company would have exchange rate risk related to its European sales. It would also have price risk for raw materials and supplies. <|ref|>text<|/ref|><|det|>[[42, 495, 647, 552]]<|/det|> Strategic risks include competition, economic factors that could affect consumer demand, and the political risk arising from countries in which the company's component suppliers are located. <|ref|>sub_title<|/ref|><|det|>[[42, 616, 492, 645]]<|/det|> ## ENTERPRISE RISK MANAGEMENT <|ref|>text<|/ref|><|det|>[[42, 648, 655, 703]]<|/det|> The concept of enterprise risk management (ERM) was developed as a way to manage all of an organization's risks, including operational, financial, and strategic risk. <|ref|>text<|/ref|><|det|>[[42, 709, 655, 765]]<|/det|> Traditional risk management is concerned with an organization's pure risk, primarily hazard risk. In practice, there is no clear dividing line between risk management and ERM, with the terms often used interchangeably. <|ref|>sub_title<|/ref|><|det|>[[42, 788, 239, 812]]<|/det|> ## ERM Definitions <|ref|>text<|/ref|><|det|>[[41, 815, 670, 925]]<|/det|> The evolving similarity of the concepts of risk management and ERM is demonstrated in the International Organization for Standardization (ISO) definition of risk management in ERM terms: "coordinated activities to direct and control an organization with regard to risk." The ISO definition of risk as "the effect of uncertainty on objectives" also reflects an ERM approach to risk and risk management. <|ref|>sub_title<|/ref|><|det|>[[710, 650, 803, 680]]<|/det|> ## Enterprise risk management <|ref|>text<|/ref|><|det|>[[710, 683, 880, 802]]<|/det|> An approach to managing all of an organization's key business risks and opportunities with the intent of maximizing shareholder value. Also known as enterprise- wide risk management.
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<|ref|>text<|/ref|><|det|>[[297, 114, 923, 204]]<|/det|> There are many similar definitions of ERM, including one from the Committee of Sponsoring Organizations of the Treadway Commission: "the culture, capabilities, and practices, integrated with strategy- setting and performance, that organizations rely on to manage risk in creating, preserving, and realizing value."<sup>16</sup> <|ref|>text<|/ref|><|det|>[[298, 211, 925, 284]]<|/det|> The various definitions of ERM all include the concept of managing an organization's risks to help that organization meet its objectives. This link between management of an organization's risks and its objectives is a key driver in deciding how to assess and treat risks. <|ref|>sub_title<|/ref|><|det|>[[299, 306, 520, 331]]<|/det|> ## Theoretical Pillars <|ref|>text<|/ref|><|det|>[[298, 335, 920, 390]]<|/det|> Whether the source of a risk is financial, hazardous, operational, or strategic, risks managed separately are not the same as they are when managed together. Three main theoretical concepts explain how ERM works: <|ref|>text<|/ref|><|det|>[[299, 397, 470, 458]]<|/det|> Interdependency Correlation Portfolio theory <|ref|>text<|/ref|><|det|>[[299, 465, 910, 590]]<|/det|> The silo type of management that is typical of traditional risk management ignores any interdependencies and assumes that a financial risk is unrelated to a hazard risk. Events are statistically independent if the probability of one event occurring does not affect the probability of a second event occurring. However, the traditional assumption of independence may not always be valid—and when it is not, the result may be inefficient treatment of an organization's portfolio of risks. <|ref|>text<|/ref|><|det|>[[299, 596, 905, 651]]<|/det|> For example, mortgage loans in different geographical regions may seem independent. But the 2008 financial crisis revealed that there was actually a significant interdependency. <|ref|>text<|/ref|><|det|>[[299, 657, 915, 730]]<|/det|> Correlation increases risk, while uncorrelated risks can provide a balance or hedge. For example, if all of an organization's suppliers are located in an earthquake- prone region in Asia, there is a significant correlation among suppliers in the organization's supply- chain risk. <|ref|>text<|/ref|><|det|>[[299, 736, 915, 912]]<|/det|> The third concept that makes ERM work well is the portfolio theory. In an ERM context, a portfolio is a combination of risks. The portfolio theory assumes that risk includes both individual risks and their interactions. For example, an airline may experience an increased portfolio risk from increased fuel prices. This increase may affect not only the airline's costs but also consumer demand. The effect of rising gas prices on consumers' available disposable income could reduce the demand for air travel and constrict the airline's ability to offset its higher costs with higher prices. An airline that successfully hedged against rising oil prices may be able to take advantage of these circumstances to increase its market share.
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<|ref|>sub_title<|/ref|><|det|>[[38, 112, 393, 140]]<|/det|> ## Organizational Relationships <|ref|>text<|/ref|><|det|>[[37, 141, 647, 268]]<|/det|> Under the traditional risk management organizational model, there is a risk manager and a risk management department to manage hazard risk. This traditional function mainly provides risk transfer, such as insurance, for the organization. Larger organizations typically include a claims management function. Many organizations include safety and loss prevention in the risk management department. See the exhibit "Example of a Traditional Risk Management Department." <|ref|>image<|/ref|><|det|>[[35, 270, 670, 610]]<|/det|> <|ref|>text<|/ref|><|det|>[[37, 612, 100, 626]]<|/det|> [DA01662] <|ref|>text<|/ref|><|det|>[[36, 653, 646, 727]]<|/det|> In ERM, the responsibility of the risk management function is broader and includes all of an organization's risks, not just hazard risk. Additionally, the entire organization at all levels becomes responsible for risk management as the ERM framework encompasses all stakeholders. <|ref|>text<|/ref|><|det|>[[35, 733, 658, 895]]<|/det|> The board of a public company has the ultimate responsibility for oversight of the organization's risks. The Dodd- Frank Act requires that certain types of financial companies appoint board risk committees. A board risk committee may consist of the full board, the audit committee, or a dedicated risk committee. In addition, some public companies have formed an executive- level risk committee to assist the board in its risk oversight function. The executive- level committee might be chaired by a chief risk officer (CRO), who reports to both the chief executive officer (CEO) and the board risk committee. See the exhibit "Example of an ERM Governance Model." <|ref|>text<|/ref|><|det|>[[35, 901, 648, 940]]<|/det|> As facilitator, the CRO engages the organization's management in a continual conversation that establishes risk strategic goals in relationship to the
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<|ref|>image<|/ref|><|det|>[[296, 116, 930, 526]]<|/det|> <|ref|>image_caption<|/ref|><|det|>[[299, 530, 360, 543]]<|/det|> <center>[DA08658] </center> <|ref|>text<|/ref|><|det|>[[298, 556, 923, 628]]<|/det|> organization's strengths, weaknesses, opportunities, and threats (SWOT). The stakeholders in the organization include employees, management, the board of directors, and shareholders. External stakeholders include customers, regulators, and the community. <|ref|>text<|/ref|><|det|>[[298, 635, 925, 741]]<|/det|> The CRO's responsibility includes helping the enterprise to create a risk culture in which managers of the organization's divisions and units, and eventually individual employees, become risk owners. In the fully integrated ERM organization, identifying and managing risk become part of every job description and project. Successful risk management of strategic objectives becomes a measure on all evaluations. <|ref|>sub_title<|/ref|><|det|>[[299, 765, 490, 789]]<|/det|> ## Implementation <|ref|>text<|/ref|><|det|>[[298, 793, 920, 917]]<|/det|> It is essential to have senior management's commitment in a midsize to large organization to successfully implement an ERM program. The risk management professionals must have access to data from all organizational areas and levels to identify and assess the organization's risks. The risk management process to manage those risks must be integrated throughout the organization. To accomplish this, risk managers must have authority to make and enforce necessary changes, often against significant resistance.
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<|ref|>text<|/ref|><|det|>[[37, 111, 666, 323]]<|/det|> Effective communication is essential to a successful ERM program. The CEO should meet with the senior managers of each organizational function to discuss the purpose and goals of ERM and the importance of management support. A task force composed of representatives from each function to work with the CRO and/or risk professionals can help achieve buy- in from key stakeholders. It is important for risk professionals to communicate with representatives from the various functions as well as receive communication from them. For example, operations managers may want more information about various types of risks, including hazard risks, such as employee injuries, or opportunity risks, such as communities with high growth rates. It is also essential to find out the type of information the CEO and other senior managers need to understand the organization's risk portfolio. <|ref|>text<|/ref|><|det|>[[38, 330, 666, 455]]<|/det|> An organization with a fully integrated ERM program develops a communication matrix that moves information throughout the organization. Communications include dialogue and discussions among the different units and levels within the organization. The establishment of valid metrics and the continuous flow of cogent data are a critical aspect to this communication process. The metrics are carefully woven into reporting structures that engage the entire organization, including both internal and external stakeholders. <|ref|>sub_title<|/ref|><|det|>[[39, 477, 202, 503]]<|/det|> ## Impediments <|ref|>text<|/ref|><|det|>[[38, 505, 664, 595]]<|/det|> An impediment to successfully adopting ERM is technological deficiency. For ERM to succeed, people have to receive relevant information. Management needs information on all organizational risks in a timely and concise manner- for example, a dashboard highlighting the critical risks affecting the organization's ability to meet its objectives. <|ref|>text<|/ref|><|det|>[[37, 602, 660, 693]]<|/det|> Some risk management functions are able to use existing internet technology systems to produce this information, while others require new systems. The risk management information system (RMIS) of a broker or insurer could provide a starting point for a system to be tailored to the organization's ERM program. <|ref|>text<|/ref|><|det|>[[36, 699, 664, 875]]<|/det|> Perhaps the single largest impediment to successful implementation of ERM is the organizational culture of entrenched silos. The risk management function traditionally purchased insurance and had claims oversight. The human resource function typically managed employee benefits and absences. The financial function managed prices; credit; investments, including hedges; and exchange rates. The operations function managed the core business operations, such as manufacturing or distribution. The safety function was separate or part of either risk management or operations. Information technology was a separate function or part of finance. Each of these functions typically had its own management structure. <|ref|>text<|/ref|><|det|>[[36, 883, 664, 937]]<|/det|> In the new ERM culture, risk management is integrated throughout the organization. In many organizations, this involves operations managers taking responsibility for risk management within their areas of responsibility. For
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<|ref|>text<|/ref|><|det|>[[298, 111, 920, 272]]<|/det|> example, a bank branch manager would assume responsibility for speculative risk involved in growing the business and for financial risk, such as credit risk associated with the loans written by the branch. In large organizations, there may be a risk committee or task force headed by the CRO that includes representatives of each major function within the organization. To achieve accountability, many organizations charge back the gains and costs associated with risk management to the responsible function. For example, an operating division would be charged for the cost of hazard insurance and claims and also receive credit for new business or production improvements. <|ref|>sub_title<|/ref|><|det|>[[300, 294, 508, 315]]<|/det|> ## Apply Your Knowledge <|ref|>text<|/ref|><|det|>[[299, 317, 924, 424]]<|/det|> An organization, with locations throughout the U.S., provides oxygen and related supplies to customers who need oxygen for medical reasons. Oxygen is an oxidizer that, although not a flammable gas, makes other substances around it more likely to burn faster and hotter. Therefore, there is a risk of fire and explosion at these locations. Describe a traditional risk management approach to this risk, versus an ERM approach. <|ref|>text<|/ref|><|det|>[[299, 430, 923, 589]]<|/det|> Feedback: A traditional risk management approach would be to procure property, liability, and workers compensation insurance for this risk. Additionally, risk management might include the safety function to help prevent the occurrence and to provide an analysis of the cause if the event occurs. An ERM approach, in addition to risk transfer and safety, would assess additional risks such as those associated with the ability to provide a necessary medical product to customers, the organization's reputational risks in communities, the effect of demographics on the future of the business, and the ability to continue operations after a disaster. <|ref|>sub_title<|/ref|><|det|>[[298, 655, 441, 680]]<|/det|> ## SUMMARY <|ref|>text<|/ref|><|det|>[[298, 685, 894, 774]]<|/det|> Grounded in traditional risk management techniques, today's risk management environment is animated by increasingly potent combinations of inexpensive data- gathering and storage technology and predictive analytic techniques that can transform data into more certainty about risk management decisions than ever before. <|ref|>text<|/ref|><|det|>[[298, 781, 919, 888]]<|/det|> An effective risk management program provides benefits to an organization in meeting its goals and complying with regulations. Such programs also benefit the economy as a whole by helping to prevent business failures. Additionally, regulators who apply risk management principles in their functions can help address systemic risk to ensure that risk provides economic benefits rather than negative consequences. <|ref|>text<|/ref|><|det|>[[297, 895, 900, 932]]<|/det|> A risk management program provides a framework for planning, organizing, leading, and controlling the resources and activities of an organization to
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<|ref|>text<|/ref|><|det|>[[37, 112, 653, 185]]<|/det|> achieve the organization's objectives. The risk management program's goals should be aligned with those objectives. Because there may be inconsistency at times between an organization's objectives and risk management goals, trade- offs may be necessary to achieve the desired results. <|ref|>text<|/ref|><|det|>[[37, 192, 658, 264]]<|/det|> Effective risk management should quantify risks and the results of risk management efforts to the extent possible. The basic measures that are applied to risk management include exposure, volatility, likelihood, consequences, time horizon, and correlation. <|ref|>text<|/ref|><|det|>[[37, 272, 652, 361]]<|/det|> Classifying the various types of risk can help organizations manage risk. Some of the most commonly used classifications are pure and speculative risk, subjective and objective risk, and diversifiable and nondiversifiable risk. An organization's risks can also be categorized into quadrants as hazard risk, operational risk, financial risk, and strategic risk. <|ref|>text<|/ref|><|det|>[[37, 368, 644, 476]]<|/det|> Traditional risk management took responsibility for hazard risk, typically arranging for risk transfer. ERM identifies operational, financial, and strategic risks in addition to hazard risks; develops an understanding of their relationships; and evaluates the potential effect of the risk portfolio on an organization's ability to achieve its objectives. ERM seeks to optimize a risk management strategy that is integrated into the entire organization. <|ref|>sub_title<|/ref|><|det|>[[39, 502, 320, 529]]<|/det|> ## ASSIGNMENT NOTES <|ref|>text<|/ref|><|det|>[[37, 532, 666, 783]]<|/det|> 1. "Exploring Risk Appetite and Risk Tolerance," Risk and Insurance Management Society, 2012, www.rims.org/resources/ERM/Documents/RIMS_Exploring_Risk_Appetite_Risk_Tolerance_0412.pdf (accessed November 11, 2017). 2. "Exploring Risk Appetite and Risk Tolerance," RIMS Executive Report, Risk and Insurance Management Society, 2012, www.rims.org/resources/ERM/Documents/RIMS_Exploring_Risk_Appetite_Risk_Tolerance_0412.pdf (accessed June 1, 2012). 3. Peter L. Bernstein, Against the Gods: The Remarkable Story of Risk (New York: John Wiley & Sons, Inc., 1998), p. 3. 4. James Lam, Enterprise Risk Management: From Incentives to Controls (Hoboken, N.J.: John Wiley & Sons, Inc., 2003), p. 26. 5. International Organization for Standardization, ISO 31000: 2018 (Geneva, Switzerland: International Organization for Standardization, 2018), p. 2. 6. ©Risk and Insurance Management Society, Inc.—used with permission.
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<|ref|>text<|/ref|><|det|>[[0, 0, 997, 997]]<|/det|> .
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<|ref|>sub_title<|/ref|><|det|>[[33, 123, 420, 170]]<|/det|> Direct Your Learning <|ref|>sub_title<|/ref|><|det|>[[33, 246, 483, 313]]<|/det|> Risk Management Standards and Frameworks <|ref|>sub_title<|/ref|><|det|>[[50, 353, 252, 371]]<|/det|> Educational Objectives <|ref|>text<|/ref|><|det|>[[35, 392, 558, 410]]<|/det|> After learning the content of this assignment, you should be able to: <|ref|>text<|/ref|><|det|>[[35, 422, 631, 457]]<|/det|> - Describe the general characteristics and elements of risk management standards and frameworks. <|ref|>text<|/ref|><|det|>[[35, 465, 597, 500]]<|/det|> - Explain how an organization can apply ISO 31000 to enhance its performance. <|ref|>text<|/ref|><|det|>[[35, 508, 666, 543]]<|/det|> - Explain how an organization can apply the COSO enterprise risk management framework to enhance its performance. <|ref|>text<|/ref|><|det|>[[35, 552, 639, 586]]<|/det|> - Explain how insurers and banks apply Solvency II and Basel regulatory standards. <|ref|>sub_title<|/ref|><|det|>[[720, 353, 784, 370]]<|/det|> Outline <|ref|>text<|/ref|><|det|>[[720, 392, 850, 455]]<|/det|> Introduction to Risk Management Standards and Frameworks <|ref|>text<|/ref|><|det|>[[720, 465, 831, 513]]<|/det|> ISO 31000 Risk Management—Guidelines <|ref|>text<|/ref|><|det|>[[720, 523, 832, 616]]<|/det|> COSO Enterprise Risk Management—Integrating With Strategy and Performance <|ref|>text<|/ref|><|det|>[[720, 627, 841, 675]]<|/det|> Solvency II and Basel Regulatory Standards <|ref|>text<|/ref|><|det|>[[720, 685, 792, 700]]<|/det|> Summary
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<|ref|>image<|/ref|><|det|>[[0, 0, 999, 1005]]<|/det|>
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<|ref|>sub_title<|/ref|><|det|>[[38, 121, 664, 206]]<|/det|> ## Risk Management Standards and Frameworks <|ref|>sub_title<|/ref|><|det|>[[38, 243, 568, 303]]<|/det|> ## INTRODUCTION TO RISK MANAGEMENT STANDARDS AND FRAMEWORKS <|ref|>text<|/ref|><|det|>[[38, 307, 667, 362]]<|/det|> How can an organization mitigate the negative consequences of risk while also leveraging its potential opportunities? The most effective way is to embed risk management into the organization's strategy, objectives, and operations. <|ref|>text<|/ref|><|det|>[[38, 368, 664, 458]]<|/det|> This can be accomplished through the application of a risk management standard (also sometimes referred to as a risk management framework). Various international organizations have developed risk management standards and frameworks through working- group discussions and compilations of best practices. <|ref|>text<|/ref|><|det|>[[38, 464, 657, 572]]<|/det|> Using a voluntary standard allows an organization to evaluate a product or process and provides a common language to use in external discussions. Although standards are developed by recognized authorities, organizations follow them voluntarily. A standard that becomes a mandatory requirement of a governmental agency is a regulation. See the exhibit "Risk Management Standards and Frameworks." <|ref|>sub_title<|/ref|><|det|>[[38, 594, 667, 647]]<|/det|> ## Characteristics of Risk Management Standards and Frameworks <|ref|>text<|/ref|><|det|>[[38, 650, 655, 740]]<|/det|> Although risk management standards and frameworks are developed by recognized authorities, they are voluntary. When an organization complies with a risk management standard or framework, it demonstrates that it is following best practices. This voluntary compliance helps organizations prepare for aspects of risk management that are or may become compulsory. <|ref|>text<|/ref|><|det|>[[38, 746, 667, 801]]<|/det|> All the standards share a common purpose of helping organizations assess and manage risk. However, they differ in approach and emphasis. For example, the definition of risk varies between two major standards. <|ref|>text<|/ref|><|det|>[[38, 807, 664, 899]]<|/det|> The Committee of Sponsoring Organizations' (COSO's) enterprise risk management (ERM) framework emphasizes the close ties between risk and strategy, as does the ISO 31000 definition. Both definitions reflect more recent thinking about risk, which encompasses the potential for both positive and adverse results. <|ref|>text<|/ref|><|det|>[[706, 370, 880, 464]]<|/det|> Risk management standard A document published by a recognized authority that includes principles, criteria, and best practices for risk management.
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<|ref|>sub_title<|/ref|><|det|>[[108, 152, 538, 172]]<|/det|> ## Risk Management Standards and Frameworks <|ref|>table<|/ref|><|det|>[[115, 180, 890, 780]]<|/det|> <table><tr><td>Risk Management Standard or Framework</td><td>Description</td></tr><tr><td>ISO 31000:2018</td><td>Provides an international standard for risk management as well as a generic approach to risk management applicable within any industry sector.<br>Consists of three major parts:<br>Principles—rooted in risk management and designed to generate value and continuously scan and react to the environment<br>Framework—elements based on program design, implementation, and monitoring<br>Processes—emphasis on deliberative communication, context, risk assessment and treatment, and follow-up</td></tr><tr><td>COSO ERM 2017</td><td>Developed by The Committee of Sponsoring Organizations of the Treadway Commission (COSO)<br>Encourages organizations to select and refine an adaptive risk management strategy that applies across all organizational functions, levels, and departments<br>Five core components are governance and culture; strategy and objective setting; performance; review and revision; and information, communicating, and reporting.</td></tr><tr><td>BS 31100</td><td>Published by British Standards Institution (BSI) as a code of practice for risk management<br>Provides recommendations for the model, framework, process, and implementation of risk management<br>Four primary goals:<br>· Ensuring that an organization achieves its objectives<br>· Ensuring that risks are managed in specific areas or activities<br>· Overseeing risk management in an organization<br>· Providing “reasonable assurance” on an organization’s risk management</td></tr><tr><td>FERMA 2002</td><td>Adopted by Federation of European Risk Management Associations (FERMA)<br>Recognizes that risk has both an upside and a downside<br>Standard has these elements:<br>· Establishment of consistent terminology<br>· Process by which risk management can be executed<br>· Organized risk management structure<br>· Risk management goals</td></tr><tr><td>OCEG Red Book</td><td>The Open Compliance and Ethics Group approach includes integration of governance, risk, and compliance processes.<br>Relies on an integrated technology platform to identify and assess risk.</td></tr></table>
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<|ref|>text<|/ref|><|det|>[[35, 111, 424, 131]]<|/det|> The definitions also share these characteristics:1 <|ref|>text<|/ref|><|det|>[[35, 138, 664, 312]]<|/det|> Based on an enterprise approach Emphasis on value creation Integration of ERM with existing processes Emphasis on cultural factors Stress the importance of defining risk appetite Require risk documentation when assessing risks Stress the importance of risk communication throughout the organization Require monitoring <|ref|>sub_title<|/ref|><|det|>[[35, 331, 593, 384]]<|/det|> ## Monitoring Adherence to Standards: The Risk Maturity Model <|ref|>text<|/ref|><|det|>[[35, 387, 666, 513]]<|/det|> Risk management is an ongoing process of identifying and monitoring all the risk an organization faces. For this process to be effective, an organization should conduct periodic self- assessments using an objective and consistent measurement tool with best practices elements and standards. The Risk and Insurance Management Society (RIMS) has developed a Risk Maturity Model (RMM) to provide such a tool. The RMM is not a standard, a prescribed process, or a framework. It focuses on seven essential attributes: <|ref|>text<|/ref|><|det|>[[36, 518, 375, 667]]<|/det|> ERM- based approach ERM process management Risk appetite management Root cause discipline Uncovering risks Performance management Business resiliency and sustainability <|ref|>text<|/ref|><|det|>[[35, 674, 654, 747]]<|/det|> Key drivers of each attribute are analyzed and measured to establish maturity level. The organization bases its self- assessment on maturity levels assigned to each attribute, based on five maturity levels, ranging from ad hoc to leadership. <|ref|>sub_title<|/ref|><|det|>[[36, 769, 250, 790]]<|/det|> ## Apply Your Knowledge <|ref|>text<|/ref|><|det|>[[35, 791, 654, 847]]<|/det|> An insurer has implemented an ERM program and would like to assess its effectiveness using an objective measurement tool. Which one of the following should it use? <|ref|>text<|/ref|><|det|>[[34, 854, 178, 937]]<|/det|> a. ISO 31000 b. COSO ERM c. BS 31100 d. RIMS RMM
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<|ref|>text<|/ref|><|det|>[[298, 112, 925, 238]]<|/det|> Feedback: d. Although ERM standards typically include monitoring the results of the program, an insurer should conduct periodic self- assessments using an objective and consistent measurement tool with best practices elements and standards. The RIMS RMM provides a tool to conduct such assessments. This might be especially useful if the insurer is using multiple standards, such as COSO ERM for its strategic risk management and ISO 31000 for its operational risk management. <|ref|>sub_title<|/ref|><|det|>[[298, 303, 905, 332]]<|/det|> ## ISO 31000 RISK MANAGEMENT—GUIDELINES <|ref|>text<|/ref|><|det|>[[299, 335, 923, 476]]<|/det|> Part art, part science, an organization's risk management strategy doesn't exist in a vacuum. Instead, it is a complex, ever- evolving by- product of the organization's culture and the intersection of widely adopted practices and global economic forces. When an organization relies on internationally accepted standards such as the International Organization for Standardization's (ISO's) ISO 31000 to guide its approach to risk management, it is not only adopting techniques refined over time, but also strengthening its connections to organizations around the world that have joined in adopting them. <|ref|>text<|/ref|><|det|>[[298, 483, 923, 676]]<|/det|> ISO consists of the national standards institutes of 163 countries. ISO 31000 can be applied to all operations and most activities and to any type of risk, including hazard, operational, financial, and strategic risks. It also applies regardless of whether the risk has positive and/or negative consequences. Although the standard is universally applicable, it is not intended to produce uniformity. In fact, its process and framework are designed to be tailored to an individual organization's unique characteristics and requirements. For example, if an electronics manufacturer with factories and suppliers in Asia and the United States wanted to develop a risk management program for its supply- chain risks, ISO 31000, as a recognized international standard, could provide the framework and process for the organization's risk management program. <|ref|>sub_title<|/ref|><|det|>[[299, 699, 421, 722]]<|/det|> ## Principles <|ref|>text<|/ref|><|det|>[[299, 727, 915, 781]]<|/det|> ISO 31000 lists eight principles of risk management. In general, these principles are the elements that most significantly contribute to a risk management strategy's ability to create and protect an organization's value:² <|ref|>text<|/ref|><|det|>[[299, 788, 915, 959]]<|/det|> - Integration with all of an organization's activities- Adoption of a structured and comprehensive approach- Customization based on the organization's objectives- Inclusive of the perspectives of all stakeholders- Ability to dynamically react to changes in internal and external contexts- Based on accurate, comprehensive information sources- Mindful of human and cultural factors- Ability to be continuously improved
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<|ref|>sub_title<|/ref|><|det|>[[37, 113, 181, 136]]<|/det|> ## Framework <|ref|>text<|/ref|><|det|>[[36, 142, 667, 249]]<|/det|> ISO 31000 includes a generic risk management framework that organizations can use to integrate the risk management process into their management and operational systems. The framework can be adapted to an organization's specific operations and objectives. A strong mandate and commitment from managers must be in place to implement a successful, company- specific risk management framework. <|ref|>text<|/ref|><|det|>[[36, 256, 661, 363]]<|/det|> Designing a tailored framework begins with an evaluation of an organization's risk contexts, including all major factors both inside and outside the organization that affect its objectives and operations. For example, the ISO 31000 framework could help identify and address risks associated with an organization's supply chain, even if the individual suppliers are spread throughout the globe. <|ref|>text<|/ref|><|det|>[[36, 369, 661, 477]]<|/det|> Based on a thorough understanding of its contexts, an organization can establish its risk management policy. This policy should address how the organization will identify risks and how it will measure, review, and communicate its risk management efforts. The framework also must incorporate accountability procedures for meeting risk management goals and must integrate risk management throughout the entire organization. <|ref|>text<|/ref|><|det|>[[36, 483, 664, 608]]<|/det|> Appropriate resources should be available for designing and implementing the risk management framework. These resources should include staff with the necessary skills and any necessary equipment, such as that used for training or data management. Finally, the framework must establish internal communication and reporting methods and external communication with relevant stakeholders while ensuring that risk management accountability and oversight are incorporated in the organization's overarching governance.3 <|ref|>sub_title<|/ref|><|det|>[[36, 633, 137, 655]]<|/det|> ## Process <|ref|>text<|/ref|><|det|>[[36, 659, 656, 784]]<|/det|> The ISO 31000 risk management process consists of several activities besides establishing the scope and context of the organization and communicating: specifically, assessing risks, treating risks, and monitoring and reviewing the changes resulting from application of the process. Because the process is applied to different risks and functions of the organization, the specific context for each risk management process should be defined, in addition to the overall organizational context. <|ref|>text<|/ref|><|det|>[[35, 790, 666, 917]]<|/det|> For example, an electronics manufacturer will have financial, marketing, manufacturing, distribution, and information technology functions. The manufacturing operations may have multiple plants in different countries with different suppliers. Therefore, particular risk management processes, such as the one for managing supply- chain risks, will need to be established in detail within the context of each country in which the organization does business, as well as within the overall context of the organization.
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<|ref|>text<|/ref|><|det|>[[85, 136, 230, 199]]<|/det|> Risk criteria Information used as a basis for measuring the significance of a risk. <|ref|>text<|/ref|><|det|>[[298, 113, 920, 274]]<|/det|> As part of establishing the internal and external contexts, an organization should define risk criteria. Risk criteria are based on measures used to evaluate the significance of the organization's various risks in relation to the organization's values and objectives as well as the legal and regulatory requirements to which it is subject. In establishing risk criteria, an organization considers factors such as possible consequences resulting from each risk, their likelihood of occurring, how they will be measured, and the organization's tolerance of the risk. An organization could use multiple measures for a single risk, such as its effect on both net income and reputation. <|ref|>sub_title<|/ref|><|det|>[[299, 293, 484, 315]]<|/det|> ## Risk Assessment <|ref|>text<|/ref|><|det|>[[299, 318, 907, 354]]<|/det|> The ISO 31000 definition of risk assessment includes risk identification, risk analysis, and risk evaluation. <|ref|>text<|/ref|><|det|>[[298, 361, 914, 555]]<|/det|> An organization should develop a comprehensive list of risks that can have either a positive or negative effect on objectives. From a traditional risk management viewpoint, this assessment has focused on hazard risks, which can result only in negative consequences. However, the risk management process has evolved for most standards, regulators, and organizations to include risks that have the possibility of negative or positive consequences. For example, an organization that chooses a plant location or supplier in a catastrophe- prone region, where labor costs are lower than in other areas and where currency exchange rates are favorable, is accepting risk with an expected positive outcome resulting from lower costs as well as risk with an expected negative outcome associated with supply- chain interruptions. <|ref|>text<|/ref|><|det|>[[298, 561, 921, 651]]<|/det|> It is important to identify as many risks as possible, prioritizing key risks in terms of their effect on the organization's objectives. It is also essential that both line management and executive management are involved in identifying risks, as unidentified or missed risks will not be analyzed or addressed in the risk management process and therefore pose a greater threat of damage. <|ref|>text<|/ref|><|det|>[[298, 657, 918, 730]]<|/det|> After risks have been identified, the next step is analysis—quantitative, qualitative, or a combination of the two. This analysis includes determining the level of risk and its potential effects on the organization. Both the tangible and intangible effects of consequences should be considered. <|ref|>text<|/ref|><|det|>[[298, 736, 923, 808]]<|/det|> The third step in risk assessment is evaluating the organization's risks. This step involves applying the selected risk criteria to the levels of risk determined during the analysis. The subsequent evaluation will allow decisions to be made regarding risk treatment. <|ref|>sub_title<|/ref|><|det|>[[298, 826, 460, 848]]<|/det|> ## Risk Treatment <|ref|>text<|/ref|><|det|>[[297, 852, 912, 907]]<|/det|> Risk treatment is the ongoing process of deciding on an option for modifying risk, selecting a new risk treatment if the current one is not effective, and then repeating this assessment.
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<|ref|>text<|/ref|><|det|>[[35, 114, 647, 273]]<|/det|> In treating risks, an organization may choose to avoid, retain, or transfer all or part of a risk. Risks may also be treated by eliminating their sources, altering the likelihood that an event will result from a risk, or changing the consequences of events resulting from risk. For risks that present the possibility of positive outcomes, an organization may choose to assume a risk or even increase it. Selection of the risk treatment should include determining those within and outside the organization who are accountable, as well as performance measures that will be used in ongoing assessments of the risk treatment. <|ref|>text<|/ref|><|det|>[[36, 280, 633, 352]]<|/det|> Risk treatment options can be applied individually or in combination following a deliberate sequence. For example, an organization may find it economical to alter the likelihood of an event and its consequences before transferring the risk. <|ref|>sub_title<|/ref|><|det|>[[37, 370, 342, 394]]<|/det|> ## Risk Monitoring and Review <|ref|>text<|/ref|><|det|>[[37, 396, 658, 504]]<|/det|> Monitoring and reviewing both internal and external changes and how these changes affect risks and their treatment should be a planned part of the risk management process. Monitoring should also include recording the assessments and reporting them internally and externally, as needed; determining the frequency, distribution, and method of reporting is an integral part of developing the risk management process. <|ref|>sub_title<|/ref|><|det|>[[38, 526, 251, 547]]<|/det|> ## Apply Your Knowledge <|ref|>text<|/ref|><|det|>[[37, 548, 648, 619]]<|/det|> An auto manufacturer relies on a far- reaching supply chain that includes distributors in politically volatile regions for crucial elements of product assembly. How could its adoption of ISO 31000 help mitigate the associated risks? <|ref|>text<|/ref|><|det|>[[37, 625, 655, 752]]<|/det|> Feedback: The manufacturer's adoption of ISO 31000 could help it mitigate such risks by encouraging an organization- wide examination of how sudden disruptions at strife- prone supply- chain locations could adversely affect its profitability, productivity, and reputation. ISO 31000 would also encourage the organization's corporate governance to account for the development of possible alternatives, such as examining the advantages and disadvantages of forming relationships with suppliers in other locations.
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<|ref|>sub_title<|/ref|><|det|>[[295, 112, 857, 204]]<|/det|> ## COSO ENTERPRISE RISK MANAGEMENT-INTEGRATING WITH STRATEGY AND PERFORMANCE <|ref|>text<|/ref|><|det|>[[297, 206, 923, 295]]<|/det|> Organizations are exposed to many risks they recognize and anticipate, and many they do not. Although organizations use risk management techniques to prepare for expected risks, they can also use, and even leverage, enterprise risk management (ERM) to stay ahead of unexpected risks throughout all areas of their organizations. <|ref|>text<|/ref|><|det|>[[297, 302, 920, 460]]<|/det|> As risks continue to evolve in terms of both type and complexity, organizations require new tools to successfully manage them. The Committee of Sponsoring Organizations of the Treadway Commission (COSO) report Enterprise Risk Management—Integrating With Strategy and Performance, detailing an already widely recognized and applied ERM framework, provides an updated framework to meet the challenges this changing risk environment presents. It describes enhanced uses of ERM that not only respond to but proactively plan for and take advantage of the vast array of emerging risks that confront organizations. <|ref|>text<|/ref|><|det|>[[297, 467, 920, 540]]<|/det|> In addition to providing a high- level view of COSO's report, this discussion focuses on how an organization can use the framework to further guide its ERM efforts to select strategies and business objectives, enhance performance, increase value, and remain competitive. <|ref|>sub_title<|/ref|><|det|>[[297, 562, 825, 589]]<|/det|> ## Integrating Risk, Strategy, and Performance <|ref|>text<|/ref|><|det|>[[297, 591, 919, 732]]<|/det|> Organizations face and manage many traditional and evolving risks, including newly emerging technology, employee engagement and retention in competitive markets, changing regulatory and legal requirements, cyber threats, the need to safeguard employee and customer information, artificial intelligence and big data, and supply chain interruption. Although they may find it easier and less costly to manage only identified and known risks, organizations are aware that identifying and preparing for unknown risks can facilitate their growth and performance and minimize interruptions. <|ref|>text<|/ref|><|det|>[[297, 738, 904, 880]]<|/det|> The changing risk landscape facing organizations requires them to be adaptive to change. Organizations have come to realize how their various risks are integrated and how these risks should be viewed in the context of making decisions, formulating strategy, and achieving business objectives. As risk management has evolved—from addressing only hazard risks in siloed departments to recognizing positive as well as negative risks and more comprehensively approaching risks to and from all departments through ERM—organizations have been further leveraging ERM. <|ref|>text<|/ref|><|det|>[[297, 887, 891, 924]]<|/det|> Enterprise Risk Management—Integrating With Strategy and Performance provides a framework for organizations—including their management, boards,
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<|ref|>text<|/ref|><|det|>[[38, 110, 666, 202]]<|/det|> and employees—to consider risks when selecting a business strategy. Implicit in the selected strategy is that, based on current and evolving risks, the strategy must adapt as conditions change, and it must align with the organization's mission, vision, and core values. This is a significant departure from identifying and evaluating risks based on a preselected strategy. <|ref|>text<|/ref|><|det|>[[38, 207, 664, 298]]<|/det|> Accordingly, organizations must continually assess their strategy to determine its strengths and weaknesses as new and changing risks emerge. Using an adaptive strategy allows organizations to contemplate and prepare for, as opposed to only react to, risk. In this way, rather than fuel a crisis, change can provide an opportunity. <|ref|>text<|/ref|><|det|>[[38, 303, 664, 429]]<|/det|> With an adaptive strategy in place, organizations can be confident that they will meet business objectives and achieve performance targets as they effectively address changing risks. This reinforces the organization's confidence and resonates with its stakeholders, who demand ever- greater transparency and scrutiny. Therefore, when appropriately handled, organizations can effectively use ERM to not only manage risks but gain and maintain a competitive advantage. <|ref|>text<|/ref|><|det|>[[38, 434, 664, 508]]<|/det|> In addition to understanding how risk influences strategy and performance, organizations must align their strategy with their mission, vision, and core values and realize the implications of the selected strategy—each decision about a particular strategy requires trade- offs from other strategies not chosen. <|ref|>sub_title<|/ref|><|det|>[[38, 530, 377, 556]]<|/det|> ## Using the COsO Framework <|ref|>text<|/ref|><|det|>[[38, 558, 664, 631]]<|/det|> By following the Enterprise Risk Management—Integrating With Strategy and Performance framework, an organization further leverages ERM by not only selecting and refining an adaptive strategy but also linking it across all organizational functions, levels, and departments through five components: <|ref|>text<|/ref|><|det|>[[38, 637, 430, 743]]<|/det|> - Governance and culture- Strategy and objective setting- Performance- Review and revision- Information, communication, and reporting <|ref|>text<|/ref|><|det|>[[38, 750, 666, 805]]<|/det|> ERM supports an organization's mission, vision, and core values by using these components to help develop strategy, formulate business objectives, and guide implementation and enhanced performance. <|ref|>text<|/ref|><|det|>[[38, 811, 653, 903]]<|/det|> These five components are, in turn, supported by twenty principles that further define each component's role in the framework. The principles describe ERM activities that can be applied to reach an organization's objectives and performance levels while remaining aligned with the organization's mission and core values.
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<|ref|>text<|/ref|><|det|>[[298, 113, 916, 343]]<|/det|> In the context of this framework and each of its components, an organization will discover existing and emerging risks that must be considered when setting its strategy and objectives, and it will realize the optimal characteristics of each component in terms of enhancing organizational value. For example, under the governance and culture component, one of the principles of effective ERM is that the organization "exercises board risk oversight," which, among other issues, describes organizational bias and the need to appropriately identify and manage such biases. An organization using the framework can identify its own bias of, for example, disregarding negative customer feedback. By recognizing this, the organization can then ask for feedback and comments and make changes to address the issue. In turn, the organization gains and retains customers, sells more products, and realizes increased revenue and profits. <|ref|>sub_title<|/ref|><|det|>[[299, 364, 835, 416]]<|/det|> ## Relationship With Governance, Strategy, and Performance <|ref|>text<|/ref|><|det|>[[299, 420, 916, 528]]<|/det|> These aspects of the first three of the five components—governance, strategy, and performance—are particularly integral to an organization's achievement of enhanced value. The framework links culture with governance in the third principle—defining the desired culture—and the organization sets objectives (with measurable performance targets) to provide quantifiable assurance that the selected strategy is attained. <|ref|>sub_title<|/ref|><|det|>[[300, 547, 556, 569]]<|/det|> ## Governance and Culture <|ref|>text<|/ref|><|det|>[[299, 572, 917, 713]]<|/det|> Governance can refer to a board of directors of a large corporation, general partners in a venture, or the owner of a small family business—the entity that governs the many facets of an organization, including risk oversight. Culture, meanwhile, is becoming more important and relevant to and through the use of ERM, which defines and encourages desired behaviors and promotes awareness of the expected and tolerable levels of risks. Culture, when fully embraced by all employees, is essential to adapting to change and achieving the organization's objectives. <|ref|>text<|/ref|><|det|>[[299, 720, 920, 877]]<|/det|> For example, a large manufacturing company that is governed by a long- standing board of directors is using the COSO framework to better anticipate risks and select its strategy. The company has some employees who were recently hired, but also many who have worked there for more than thirty years. The ERM framework can help this organization use its governance and culture (as it is assessed and evolves) to further its ERM efforts and continually move the organization forward. To do so, this organization may explore questions such as these, which are pertinent to its particular organization but do not provide an exhaustive list: <|ref|>text<|/ref|><|det|>[[300, 885, 910, 923]]<|/det|> - How relevant is the governing body of an organization? (Are the current members fully engaged in the manufacturing industry and its processes?)
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<|ref|>text<|/ref|><|det|>[[66, 111, 642, 150]]<|/det|> How long has each board member been in that position? (Can some be rotated out to refresh decision making?) <|ref|>text<|/ref|><|det|>[[39, 151, 666, 260]]<|/det|> - Can the board be independent and objective? (Are any members aligned with competitors or substantially financially invested in the organization?) How can the organization attract qualified talent when manufacturers shift their business model away from manual processes? What training is available for current employees, and what opportunities can be realized by moving to more automated and robotic activities? <|ref|>sub_title<|/ref|><|det|>[[36, 277, 366, 302]]<|/det|> ## Strategy and Objective Setting <|ref|>text<|/ref|><|det|>[[35, 303, 655, 444]]<|/det|> The next component, strategy and objective setting, includes defining the organization's risk appetite, which should, similar to existing and emerging risks, be aligned with strategy. Determining a risk appetite and selecting a strategy are dynamic decisions that are considered together as various strategies and financial considerations are explored. The selected strategy is then realized through business objectives using measurable performance targets. An appropriate strategy, therefore, is essential to enhancing business value; a poorly developed strategy results in a tremendous loss of shareholder value. <|ref|>text<|/ref|><|det|>[[35, 450, 662, 609]]<|/det|> For example, a local taxi company wants to expand into nearby communities that do not currently have reliable access to transportation, a proposition that presents both new risks and new opportunities. This small company wishes to grow, but at a cautious speed; the three brothers who own it have been highly risk averse. This stance has not allowed the owners to reap great financial rewards, but they have consistently earned steady income and been able to offer competitive wages and benefits for their drivers for the past twenty years. The company might wish to ask these questions to better define its selected strategy and to set objectives: <|ref|>text<|/ref|><|det|>[[35, 616, 644, 925]]<|/det|> - What are the current and future customer expectations? Do any new political, economic, environmental, social, or legal risks or regulatory requirements apply in the areas into which the company wishes to expand?- What assets will be at risk if the company goes forward with this venture (owners' capital, loans, employee buy-ins)? What trade-offs will be necessary until the new service is in place (postponing wage increases, interrupted salaries for owners)?- What is the maximum amount of risk the company is willing to undertake? (Can the owners take on the amount necessary for expansion?) What are the risks (hiring too many or too few new drivers, finding qualified drivers, unfamiliar local traffic laws and speed limits)? And what are the opportunities (gaining greater revenue, achieving higher market share, helping underserved markets) for this expansion? Are the business objectives (for example, increase customers served in new areas by 25 percent, fully staff and train new drivers in four months) measureable and attainable with performance targets?
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<|ref|>sub_title<|/ref|><|det|>[[297, 114, 436, 135]]<|/det|> ## Performance <|ref|>text<|/ref|><|det|>[[297, 138, 923, 280]]<|/det|> The next component of the framework, performance, refers to the practices that allow the organization to continually identify, assess, and respond to risk on an ongoing basis—through and across all areas and departments. By doing this, the organization ensures that ERM is commensurably applied to its current and future risks. The principles that support this component—identifying and prioritizing risks, assessing their severity, and implementing responses—show how performance plays a vital role in an organization's decision- making process. <|ref|>text<|/ref|><|det|>[[297, 287, 923, 393]]<|/det|> For example, a global shipping company operates in and among North America, South America, and Europe with a fleet of cargo aircraft, trucks, and vans in many locations and with outsourced local land transport in remote destinations. The company wants to better anticipate and manage its existing and emerging risks. In the context of the performance component, the company can ask these questions: <|ref|>text<|/ref|><|det|>[[297, 400, 923, 781]]<|/det|> - Have there been any changes in the business context (new customer expectations for earlier deliveries or regulatory changes in destination countries)? What new risks can be identified (missing delivery time frames or not understanding or responding to regulations)?- Can risks be categorized as current, new, and emerging? Can identified risks be grouped together to categorize them based on whether they affect a single business objective or multiple ones (such as per continent, per country, or per type of cargo shipped)? Are risks framed without a bias toward being exclusively upside or downside?- What determines risk severity, the likelihood of risk—qualitative (high or low), quantitative (less than 30 percent), or frequency (three times in any calendar year)—or the impact of the risk (the result from its occurring)? How do these measurements affect the possible assessment of or responses to risk?- Can the organization's risk appetite be used to prioritize risks? For example, will continuing operations in the country with the new regulations result in risks greater than the organization is willing to take on?- What are the appropriate responses to the identified risks? Should the organization accept, avoid, pursue, reduce the severity of, or transfer the risks? Should the strategy or business objectives be reviewed further for possible modification? <|ref|>text<|/ref|><|det|>[[297, 790, 899, 843]]<|/det|> The answers to these questions and the subsequent actions the organization will take again show how performance practices support the organization in making decisions. <|ref|>text<|/ref|><|det|>[[297, 851, 897, 905]]<|/det|> The final components of the framework—review and revision and information, communication, and reporting—can be applied to an organization's ERM efforts in ways similar to those just discussed.
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End of preview. Expand in Data Studio

Document OCR using DeepSeek-OCR

This dataset contains markdown-formatted OCR results from images in andesco/risk-management-3rd-images using DeepSeek-OCR.

Processing Details

Configuration

  • Image Column: image
  • Output Column: markdown
  • Dataset Split: train
  • Batch Size: 8
  • Max Model Length: 8,192 tokens
  • Max Output Tokens: 8,192
  • GPU Memory Utilization: 80.0%

Model Information

DeepSeek-OCR is a state-of-the-art document OCR model that excels at:

  • LaTeX equations - Mathematical formulas preserved in LaTeX format
  • Tables - Extracted and formatted as HTML/markdown
  • Document structure - Headers, lists, and formatting maintained
  • Image grounding - Spatial layout and bounding box information
  • Complex layouts - Multi-column and hierarchical structures
  • Multilingual - Supports multiple languages

Dataset Structure

The dataset contains all original columns plus:

  • markdown: The extracted text in markdown format with preserved structure
  • inference_info: JSON list tracking all OCR models applied to this dataset

Usage 

from datasets import load_dataset
import json

# Load the dataset
dataset = load_dataset("{{output_dataset_id}}", split="train")

# Access the markdown text
for example in dataset:
    print(example["markdown"])
    break

# View all OCR models applied to this dataset
inference_info = json.loads(dataset[0]["inference_info"])
for info in inference_info:
    print(f"Column: {{info['column_name']}} - Model: {{info['model_id']}}")

Reproduction

This dataset was generated using the uv-scripts/ocr DeepSeek OCR vLLM script:

uv run https://huggingface.co/datasets/uv-scripts/ocr/raw/main/deepseek-ocr-vllm.py \\
    andesco/risk-management-3rd-images \\
    <output-dataset> \\
    --image-column image

Performance

  • Processing Speed: ~0.5 images/second
  • Processing Method: Batch processing with vLLM (2-3x speedup over sequential)

Generated with UV Scripts
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Size of downloaded dataset files:
246 MB
Size of the auto-converted Parquet files:
246 MB
Number of rows:
340