The Objective of Risk Management

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The Objective of Risk Management
According to asset pricing models in Finance, the risks specific to a firm are
diversifiable and therefore irrelevant except as it affects

 the firm's systematic
risk. However, corporations are majors purchasers of insurance and financial
futures and forward contracts, sign long-term purchase and sales contracts, and
engage in a variety of activities to avoid or reduce risks. One explanation of this
behavior is that asset pricing models are concerned only with the effect of risk
on market discount rates and for the most part ignore its effect on expected cashflows.
Property losses are often not the only losses that occur when property is
damaged or destroyed. Until that property is replaced or restored to its initial
condition, the business may suffer a reduction in its net income either because
revenues are decreased or because expenses are increased or both. Any action
taken by a firm that decreases risks, improves its prospects for survival and
provides greater assurance to potential customers that the company will be
around in the future to service and upgrade its products. 5
Obviously, the relative importance of risk management activities will vary
according to the corporation ownership. The existence of other claims, such as
those of employees and suppliers, creates incentive for risk management.6 In
the following discussion. the management is willing to take any action to reduce
the preloss fire hazard and the postloss consequences.

Professors Robert Mehr and Bob Hedges in their risk management text have

classified the objectives in risk management as postloss and preloss.
Survival is often considered as the most important objective of a firm. The other
possible objectives include (1) the continuity of operations, (2) the stability of
earnings and preservation of growth, and (3) a good public image. They also
explained how risk management activities inevitably reflect the anxiety level of
the managers and are directed toward specific goals and objectives, for example, a
"quiet night's sleep" may be one of the managerial objectives.
50 THEORY AND PRACTICE OF INSURANCE
Because the management of a firm is often directly concerned with
problems of injury or damage to employees and to the public in general, social
responsibility or "good citizenship" is important. Mehr and Hedges argued "If
results after a loss are a matter of indifference, no reason remains to consider the
loss before it happens. n 7 On the other hand, a firm may not be prepared to take
a chance of polluting a river even though it may be able to accept the risk and
its financial consequences. Similarly, any airline company places great
emph~ls on its safety record and prefer to avoid adverse pUblicity.
Risk management is a !>-pecialized aspect of the overall financial
management of an enterprise. The objectives must be consistent with the
financial objectives and as in other financial management problems, alternatives
are evaluated by considering their potential financial advantages and risks.
While the objective of management in general is the conservation of assets
and the maximization of the wealth of the shareholders, the objective of risk
management is to make sure that losses that arise because of existing risks do
not prevent management from meting its goal. Although risk management
principles and procedures are applicable to a wide variety of problems, they are
generally limited to the problems that arise from the existence of pure and static
risks.
Since risk management does not generate revenues, in the traditional sense
of the term, the evaluation of alternative programs will be made on comparative
costs. The objective of risk management has frequently been stated as the
"minimization of costs".
Methods of Handling Risks
It must be recognized that risk management is still in a development state.
Willett considered that the ways of meeting risk for "a man in isolation" or a
business firm, could be classified into avoidance, prevention and assumption.
Then, he explained that "a man living in society" had the same opportunities but
that he could also consider other courses of action such as distribution, transfer
and combination of risks.
Risk management like other areas of management, is concerned with
establishing or identifying objectives, gathering relevant information regarding
the nature of the problem and the environment, evaluating the costs and benefits
of alternatives using modern analytical techniques, and choosing the alternative
that is most consistent with the goals and objectives.
Doherty (1982) suggests that the risk management process can be
represented in terms of the responses to the following questions:
1. What is the problem? (identification)
2. What is the magnitude of the problem? (measurement)
3. What can be done about the problem? (decision)
As most currently defined, the elements of the risk management process can
be classified in Four steps as described in 

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