Risk management involves identifying, analyzing, and taking steps to reduce or eliminate the exposures to loss faced by an organization or individual. The practice of risk management utilizes many tools and techniques, including insurance, to manage a wide variety of risks. Every business encounters risks, some of which are predictable and under management’s control, and others which are unpredictable and uncontrollable. Risk management is particularly vital for small businesses, since some common types of losses – such as theft, fire, flood, legal liability, injury, or disability – can destroy in a few minutes what may have taken entrepreneur years to build. Such losses and liabilities can affect day-to-day operations, reduce profits, and cause financial hardship severe enough to cripple or bankrupt a small business.  But while many large companies employ a full-time risk manager to identify risks and take the necessary steps to protect the firm against them, small companies rarely have that luxury. Instead the responsibility for risk management is likely to fall on the small business owner.

The term risk management is a relatively recent (within the last 30 years) evolution of the term “insurance management.”  The concept of risk management encompasses a broader scope of activities and responsibilities than does insurance management.  Risk management is a now widely accepted description of a discipline within most large organizations. But risks such as fire, windstorm, employee injuries, and automobile accidents, as well as more sophisticated exposures such as product liability, environmental impairment, and employee practices, are the province of the risk management department in a typical corporation. 

Although risk management has usually pertained to property and casualty exposures to loss, it has recently been expanded to include financial risk management – such as interest rates, foreign exchange rates, and derivatives – as well as the unique threats to businesses engaged in E-commerce. As the role of risk management has increased, some large companies have begun implementing large-scale or organization-wide programs known as enterprise risk management.

Risk Management Process

The risk management typically includes six steps. These steps are 1) determining the objectives of the organization, 2) identifying exposures to loss, 3) measuring those me exposures, 4) selecting alternatives, 5) implementing a solution, and 6) monitoring the results.  The primary objective of an organization – growth, for example – will determine its strategy for managing various risks. Identification and measurement of risks are relatively straightforward concepts. Earthquake may be identified as a potential exposure to loss, for example, but if the exposed facility is in Lagos, Nigeria, the probability of earthquake is slight and nit will have a low priority as a risk to be managed.

Businesses have several alternatives for the management of risks, including avoiding, assuming, reducing, or transferring of risks.. Avoiding risks, or loss prevention, involves taking steps to prevent a loss from occurring, via such methods as employee safety training. As another example, a pharmaceutical company may decide not to market a drug because of the potential liability. Assuming risks simply means accepting the possibility that a loss may occur and being prepared to pay the consequences. Reducing risks, or loss reduction, involves taking steps to reduce the probability or the severity of a loss, for example, by installing fire sprinklers.

Transferring risks refers to the practice of placing responsibility for a loss on another party via a contract. The most common example of risk transference is insurance, which allows a company to pay a small monthly premium in exchange for protection against automobile accidents, theft or destruction of property, employee disability, or a variety of other risks. Because of all its costs, the insurance option is usually chosen when the other options for managing risks do not provide sufficient protection.  Awareness of, and familiarity with, various types of insurance policies is a necessary part of the risk management process. A final risk management tool is self-retention of risks – sometimes referred to as “self-insurance.”  Companies that choose this option set up a special account or fund to be used in the event of a loss.

Any combination of these risk management tools may be applied in the fifth step of the process, implementation. The final step, monitoring, involves regular review of the company’s risk management tools to determine if they have obtained the desired result, or if they require modification. Some easy risk management tools for small businesses are: maintain a high quality of work; train employees well and maintain equipment well; install strong locks, smoke detectors, and fire extinguishers; keep the office clean and free of hazards; back up computer data often; and store records securely off-site.

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