The term “risk and reward” is an interesting dilemma. On one hand, something good can happen, but you also need to watch out for the bad side. How you manage the bad side is call “risk management.”

Successfully managing risk requires following a process. Business leaders need to protect their businesses from financial disasters. Years of hard work building a company can be wiped out by one event.

The reality for business leaders is that day-to-day operations take precedence. Deadlines, delays, hiring, firing, new opportunities, and surprises are challenges that all businesses face. Planning is a hard task to find the time to do. The phrase “some day I will do that” is a term we have all used when it comes to risk management.

When given the opportunity, Riviera Insurance Services helps businesses focus on risk management. We provide this guidance as part of our overall service that includes the placement of insurance. Insurance happens to be an excellent tool for managing critical risks. However, before insurance is purchased, business leaders should go through the risk management process.

The art of developing a risk management plan includes four distinct areas:

• Risk Identification
• Risk Quantification
• Risk Treatment
• Risk Monitoring

“Risk Identification” requires reviewing all aspects of the business and identifying what threats are lurking. Each business has risks associated with the operations, assets, employees, and vendors. The risk of an event should be broken into two parts. First, can the event cause a financial loss? For example, a fire can cause a financial loss if it destroys property. The second part is the consequence of the event. The consequences of a fire include damage or destruction of property, slow down or shut down of operations, failure to meet customer expectations, injury or worse for employees and other individuals. Putting it all together and using the example of a fire, the risk to a business can be summarized as follows, “A fire can destroy our building, all of our contents, shut down our operations, and cause bodily injury to employees and bodily injury and property damage to third parties for which we will/can be held accountable.”

“Risk Quantification” of each identified risk is the next step. The financial consequence of the risk needs to be assessed along with the event occurring. Below is a simple matrix for prioritization of risks:

Impact

Risks with significant financial consequence (3 or 4) and high probability (3 or 4) are “Critical” events to manage. The next priority “High” is for risks with significant financial consequence (3 or 4) and little probability (1 or 2). The next priority “Medium” is for risks with little financial impact (1 or 2) and high probability (3 or 4). Risks with “Low” rating are those with little financial impact (1 or 2) and little probability (1or 2).

Using an example, let’s explore this concept.

ABC Manufacturing Company is a publicly traded company with 100 employees and sales of $100 million. ABC manufactures high-end lighting fixtures for residential and commercial customers. ABC boasts a strong balance sheet, increasing gross revenue and a pretax profit of 15%. Future expansion plans include possible acquisition of competitors and expanding to the European market.

Applying the impact grid, the following financial consequences are assigned:

Impact 1 2 3 4

Financial consequence under $20,000 per event $20,001-$50,000 per event $50,001-$100,000 per event Over $100,000

After a brainstorming session and further refinement, the following risks are identified as Low, Medium, High, and Critical by the management team.

Risk Losing one supplier of key component Key employees leaving company Destruction of Facility Product Liability Claim Employee Related lawsuits Shareholder lawsuits One or more key customers leaving Competitor stealing intellectual property Bodily Injury caused by vehicles

Rating Low Medium High High High High High Critical Critical

Risk Treatment is the decision of what to do with the risk. The four optional actions are:

1. Avoidance
2. Transfer
3. Mitigate
4. Accept

Looking at three of the risks identified in the brainstorming session, below are some thoughts on using the risk treatment options.

Looking at the risk “one supplier of a key component” the potential consequence is that the supplier is unable to produce the key component, thus interrupting the production of the final product. Since the rating of this risk is “low,” management has decided to accept the risk. To mitigate the risk, management has identified two other potential suppliers and has increased the inventory of this component.

The “key employees leaving the company” risk is rated medium by management. The potential consequences include loss of leadership and uncertainty of future success. If the event is because of death, then the financial consequence can be transferred using life insurance. To mitigate, the board of directors will look for potential candidates, both within and outside the company to fill future leadership needs. When a key employee leaves the company, there is often a chance that one or more clients will follow the employee or move to another competitor. Management has decided the best approach to mitigate this risk is through semi-annual review of client relations with a focus on team relations. In addition, management will review its employee handbook and other communications related to ABC’s clients’ intellectual property to discourage exiting employees of wrongfully using information to solicit clients.

The “destruction of ABC’s facility” is rated high because it could cause the business to collapse. Causes leading up to this potential event include fire, earthquake, terrorism, and even an aircraft crashing into the building. Management has developed an extensive Disaster Recovery Plan with several mitigating processes and plans ABC purchased insurance to transfer the consequences caused by fire, terrorism, and aircraft; however, ABC is accepting the first $25,000 of any loss. Insurance is purchased to transfer 50% of the maximum possible loss due to earthquake.

Risk Monitoring is the ongoing process of identification, quantification, and treatment. Some businesses go through rapid changes while others remain more stable. Risk monitoring includes setting dates and times to review the current plan. Setting a schedule to review risks helps prevent the negative consequences of risk from catching everyone by surprise.

At Riviera Insurance Services, we enjoy working with businesses that want to manage their risks. Our job is rewarding when we are able to participate with the business owner and key decision makers who are the risk takers. Deciding where to allocate our clients’ precious dollars is one of the ways we successfully retain our clients for the long run.

This entry was posted on Monday, August 11th, 2008 at 12:19 pm and is filed under Insurance, Be prepared, Risk, Risk Management. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.