ECONOMICS of RISKS
Post 240 ⇒ by Gautam Shah →
Risks result into losses, delays, setbacks and death (diffusion or termination of the system). Ideally, the expenditure on risk management must be minimized, and also maximize the risk-safe zones and periods (MTF =meantime between failures). Yet, sometimes risks are indulged into or ignored in view of the benefits (often called a gamble or calculated risks).
In the commercial world risks are of two types: Inherent risks are part of any business operation, and affect the profits or opportunities negatively. Incidental risks are natural, and not always part of, or due to the business activity.
Projects are work entities with a set start, end and process of run or operation to accomplish certain goals. Any condition that does not allow these objectives being achieved, is a risk. The risk could be intrinsic or extrinsic. The intrinsic risks could be handled through good design, management, and modalities of accommodation. The origins of extrinsic risks, are beyond the organization, so their nature, schedule, frequency of occurrence and scale of affectation must be identified.
Risks in projects are identified by enacting various scenarios (combination of various possibilities occurring together). The scenario, if risky is further probed to assess its potential severity and extent of loss. These two quantities are simple to measure when set as the value of the damaged component. However, the probability of occurrence is difficult or impossible to assess as an event mainly due to lack of its history.
The fundamental difficulty in risk assessment is determining the rate of occurrence, since in many instances the statistical information is unavailable. Furthermore, evaluating the severity of the consequences (impact) is often quite difficult for immaterial assets (with emotional value). Asset valuation is another question that needs to be addressed. Thus, best educated opinions and available statistics are the primary sources of consideration.
Risks are of several types:
- The Determinable risks are the ones which are predictable and suitable risk avoidance measures can take care of it.
- The Probable risks are predictable but within limits of probability. Suitable margin or safety factors can take care of such risks.
Some systems biologically or otherwise intelligent, and are capable of self regulating, or self organizing to accommodate the changed circumstances. But such systems are inherently limitative or finite in nature. The accommodative risk systems must remain capable of feeling the change and should have energy to deal with the circumstances.
Provisions for various risks tend to have a cumulative effect. For example a building foundation is designed to carry the load of the building, with additional provisions for an earth quake, hurricanes, temporary loadings, etc., but not all of these are likely to occur simultaneously. Similarly we provide extra for individual considerations: loads calculations, strength of cement concrete and steel bars. These, if not properly attuned, these can add up to substantial over spending. All provisions for risks need a careful working for the individual, as well as cumulative effect.
Interior Design Projects fail to satisfy a client, or are commercial losers for a variety of reasons like, shift in taste, changes in market demands, arrival of new technologies, prices, etc. Many of these factors begin to be affective when projects’ execution is long drawn or delayed. Finishing projects on schedule, eases many such problems. Projects become risky due to poor definition of the project requirements, and lack of complete understanding and acceptance of the project profile report by the client. Interior Design projects often fail due to ironclad specifications, which may not allow correction or improvisation during execution. The risks on this count can be taken care of, for example by keeping ‘open certain windows’ for later formulation or decision. These are often done by hiring other agencies for work that is likely to occur in different time and space.
A Designer must be extremely careful of individual warrantee and guarantee that when read as a combination often cancels out each other. Complex Interior Design projects formed of several systems (offered by equally varied vendors), have conflicting provisions.
Insurance is a risk management investment. By paying a small sum, the premium, risks are conditionally insured. The compensation is invariably for providing an equivalent product or commercial value (at the time of loss or more commonly the depreciated value of the original cost of purchase) in monetary terms. Emotional and such other associated considerations (nose of an actress) are often insured, but by determining a fixed value for it, before a contract is made. Value for the loss of life, is an example of similar nature. Loss of opportunity such as earning, business, etc. due to sickness, injury, strikes, riots, war, etc. can also be insured. Loss due to certain happenings like flood, riot, calamity, malicious damage by any person, devaluation of currency, sudden drop or rise in prices, defaulted business services, blames, lawsuit expenses, fines, compensation payments, etc. can be provisioned through insurance.
Insurance is an indemnity against loss. It is a way of contracting out of a risk. A person, company, an organization, or government, pay a small amount -premium, to protect own self from a potential large loss. In case of risk insurance, however, only risks that are stated distinctly in the contract are included for premium compensation, all other risks (including unknown and indeterminable ones) are presumed to be bourn by the party (insurer).
DISTRIBUTION OF RISKS AND REINSURANCE
A typical insurance company working on life insurance has a large clientèle consisting of people of various age, vocation, etc. Of these only few will die, in a year, for which compensation is paid. The premium rates are based on historical data, such life expectancy, rate of natural deaths and caused by accident, etc. An actuary is an expert who compiles and analyses statistics in order to calculate insurance risks and premiums.
An insurance company can be in a problem zone, if in one locality many people were to die simultaneously. In such an eventuality, the sudden demand for compensation can be very difficult to meet. To provide for such an eventuality, the insurance company re-insures itself with another company that perhaps has no such liability in the same geographic region. This reinsurance strategy spreads the risks, over time and space.
The insurance company operates on the premise that not all risks happen simultaneously and to all the insurers. Insurance companies plan their business in such a way that in comparison to their premium income the amount to be paid out for compensation is less, resulting in meeting the administrative expenses of business and a reasonable profit.
Often for a very large risk like insurance for nuclear power plant or a space craft, the insurance company or some other commercial entity acts as an underwriter. It may not on its own insure any risk personally, but as a professional body with very strict rules of conduct, manages everything about insurance and takes the first liability. It than, divides and transfers the risk, to several insurance companies by sharing the earned premium.
CLASSES AND KINDS OF INSURANCE
Basic classes of Insurance are Fire, Accident, Life, Marine. Other ways of defining the Insurance:
- Imperative: These are risks, which would imperil the organization’s existence, such as the destruction of assets (fire, flood, etc.), or circumstances that would seriously impair its ability to operate effectively (such as a machinery breakdown, loss of vehicles and the like).
- Statutory: These consist of insurance covers that are required by law, such as employers’ liability for its employees, and third-party accident in connection with motor vehicles, etc.
- Contractual: Construction and similar contracts require the contractors to take out insurance to cover such risks as public liability and fire.
- Advisable: These include risks that could be costly or embarrassing: examples are burglary, export credit and accident to key personnel.
- Other: There are many minor risks that organizations consider it worthwhile to insure against, plate glass insurance for retail stores being an example.