The nature of risk management
Risk management is a scientific approach to the problem of dealing with pure risks faced by individuals and businesses. It is a function of management in the same style as marketing management, financial management, or personnel management.
Risk management is somewhat narrower than the term implies, because organisations face a wide range of risks, some of which are beyond the control of the risk management function as it is used here. For example, a business may face a host of speculative risks: investment risk, risk from changes in interest rates, risks from improperly pricing its products, risks that its customers will be able to pay their debts, and so on. The process for managing these speculative risks is increasingly referred to as risk management, since the concepts, principles, and many of the tools used in the management of risk have been adopted by those responsible for managing financial risks of a speculative nature. To preserve the distinction between risk management in its original sense and the techniques that address financial risk, we suggest the term financial risk management for the latter.
Many business firms have highly trained individuals who specialise in dealing with pure risk. In some cases, this is a full-time job for one person, or even for an entire department within the company. Those who are responsible for the entire program of pure risk management are risk managers. Risk management as a profession Is older than the title "risk manager", for the technique was utilised by businesses and individuals long before the term became fashionable. Because risk management is related to insurance management, we should also distinguish between these two functions.
Risk management is broader than insurance management in that it deals with both insurable and uninsurable risks and the choice of the appropriate techniques for dealing with them. Insurance management includes the use of technique other than insurance, but for the most part, it is restricted to the area of those risks that are considered to be insurable. Risk management, in contrast, is concerned with all pure risks, regardless of whether they are insurable.
Risk management also differs from insurance management in philosophy. Although insurance management involves techniques other than insurance - such as loss prevention or retention - they are considered primarily as alternatives to insurance. Insurance managers often view insurance as the "standard" approach to dealing with risk, and retention is viewed as an exception from this norm that requires justification. When considering deductibles or other forms of retention, the insurance managers ask "How much will I save, and does the saving justify the risk?" in viewing loss-prevention measures, the insurance manager asks, "How much will this measure reduce my insurance costs?" "How long will it take for a new sprinkler system to pay for itself in reduced fire insurance premiums?" "How long will it take for a new sprinkler system to pay for itself in reduced fire insurance premiums?"
Instead of the traditional focus of the corporate insurance buyer on getting the most insurance for the dollar spent, the emphasis in risk management is on reducing the cost of handling risk by whatever means are most appropriate. Under this scheme, insurance is viewed as simply one of several approaches for minimising the pure risks the firm faces.
The difference is obviously one of emphasis. Whereas the insurance manager asks, "Which risks should I retain? The risk manager asks, "Which risks must I insure?" in the risk management philosophy, it is insurance that must be justified. Since the cost of insurance must generally exceed the average losses of those who are insured, the risk manager views insurance as a last resort, and one that should be used only when necessary.
Risk management, then, is something more than insurance management in that it deals with both insurable and uninsurable risks, but it is something less than overall management in that it does not concern itself with business risk.
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