CHAPTER 2

RISK MANAGEMENT
LEARNING OBJECTIVES
UPON COMPLETION OF THE CHAPTER, YOU SHOULD BE ABLE TO:

D E F I N E S O M E C O M M O N T E R M I N O L O G Y
E X P L A I N T H E I M P O R T A N C E O F R I S K M A N A G E M E N T T O I N D I V I D U A L S
AND ORGANIZATION
D E F I N E T H E R I S K M A N A G E M E N T F R O M I S L A M I C P E R S P E C T I V E
D E S C R I B E T H E O B J E C T I V E S O F R I S K M A N A G E M E N T
E X P L A I N T H E R I S K M A N A G E M E N T P R O C E S S
I D E N T I F Y T H E B E S T R I S K M A N A G E M E N T T E C H N I Q U E S T O B E U S E D F O R
DIFFERENT CATEGORY OF RISK
 Overview

 Definition & Evolution of Risk Management

 Risk Management from Islamic Perspectives
 Objectives of Risk Management
 Risk Management Process
 EVOLUTION OF RISK

Risk management is now considered crucial

for survival of the organization,

Climate changes, political

uncertainties, economic forces are
among external factors of emerging
needs of risk management in an
organization.
 Risk management is now
considered crucial for survival of
the organization, WHY?
 RISK MANAGEMENT

Process of thinking systematically about all possible risks, problems or

disasters before they happen and setting up procedures that will avoid the
risk or minimize its impact or cope with impact

Setting up process to identify the risk and setting up a strategy

to control or deal with it.

The purpose of risk management is to enable an organization

to progress toward its goal and objectives (mission) in the most
direct, efficient, and effective path
RISK MANAGEMENT IN ISLAMIC PERSPECTIVE
 RISK MANAGEMENT IN ISLAMIC PERSPECTIVE

Every human being who is the caliph (vicegerent) of Allah SWT must accept
all His great provisions and give way to His qada’ and qadar (actions and
reactions).
In fact, efforts and prayers should precede this kind of belief. Muslims are
asked to work hard in order to be able to change their conditions as God says:
"… Verily never will God change the condition of a people until they change it
themselves (with their own souls)…" (Qur'an 13:11).
 RISK MANAGEMENT IN ISLAMIC PERSPECTIVE

Risk management in Islamic

perspective should be aimed to
The ummah should expect the reduce the utilization of
risks that will hinder the The goals must be aligned with resources (financial and non-
ultimate goal of them which is the Shariah financial) and to minimize the
to attain success in the world negative effects of risks or
and hereafter. maximize the opportunities and
goals.
OBJECTIVES OF RISK MANAGEMENT
PROGRAMME

Objectives of
Risk
Management
Programme

Pre loss Post loss

objectives occurs
 Pre Loss Objectives of Risk Management

Reduce impact of loss : by installing smoke detector, fire

extinguisher

Reduce fear and worry: once everything in order and

functional, it can reduce fear and worry of a person to face risk

Required by law- eg: construction companies in Malaysia are

required to install safety devices to protect workers from harm
Post Loss Objectives of risk management

A well planned risk management program ensure the survival of organization –

organization still able to continue operations since they already have well planned
contingency plan

With proper risk management plan, business operations do not have to stop and
the organizations can concentrate on their business activities as usual, therefore
contribute to the stability of earnings

Reduce impact of losses to organization and society – when a loss occurs not only the
organization will suffer but the loss has to be burdened by society as well. Employees may
have to be retrenched and some departments may have to be closed down. However, proper
risk management program will help the company to survive and no retrenchment will occur.
 RISK MANAGEMENT PROCESS

Identifying existing and potential risks

Evaluating potential risks

Examining alternative risk management techniques

Selecting and Implementing risk management program

Evaluating, reviewing and controlling the program

1. IDENTIFYING EXISTING AND POTENTIAL LOSSES

Risk identification is the process by which an

organization is able to learn of the areas in which it is
exposed to risk.

Identification techniques are designed to develop

information on sources of risk, hazards, risk factors,
perils and exposures to loss.
 Risk Identification Tools

Risk Analysis Exposure Insurance

Orientation
Questionnaires checklists Policy checklist

Financial
Flowchart Inspections Interviews
Statements

Combination
approach
Risk Analysis Questionnaires
Exposure checklists
 Insurance
Policy checklist
 2. EVALUATING POTENTIAL LOSSES

Risk measurement evaluates the likelihood of loss and the value of loss in terms of
frequency and severity.

This step involves two important aspects of loss exposures

Frequency - Referring to the number of times the loss occurs
Severity - Referring to the maximum size of loss exposures

Rank into: Critical risk

Important risks
Unimportant risks
How can you determine and estimate the impact of losses

Frequency Severity
Referring to Referring to
the number of the maximum
times the loss size of loss
occurs exposures
Identifying and determining the loss exposures alone is not sufficient

Estimating the frequency and severity for each type of loss exposure and ranked it
according to their relative importance. High loss exposure will be given priority.

Estimating relative frequency and severity of each loss exposure as the selection of
appropriate technique will depend on this.
Risk MATRIX
3. EXAMINING ALTERNATIVE RISK MANAGEMENT
TECHNIQUES

 Two main ways to classify the risk management techniques

[Link] Control
Risk avoidance 2. Risk Financing
Loss control Retention/Assumption
•Loss prevention
Captive insurer
•Loss reduction
Separation Insurance
Contractual Transfer
 Risk Control

Methods seek to alter an organization’s

exposure to risk.

Risk control efforts help organization avoid

a risk, prevent loss, lessen the amount of
damage if a loss occurs or reduce
undesirable effects of risk on an
organization.
 RISK CONTROL

Risk Avoidance

Loss Control

Separation

Contractual Transfer
 Risk Avoidance

Risk is proactively avoided or abandoned after rational

consideration.

If someone is afraid of risks, the best way to deal with it is

to avoid it completely.

Example; a manufacturer may stop production of a

defective products to avoid a lawsuit.

However, some risks are unavoidable although risk

avoidance may be chosen as an option in handling certain
risks, the exposures of losses cannot be eliminated entirely.
 Loss Control

Loss control is designed to reduce both the frequency and severity of

losses by changing the characteristics of the exposure so that it is more
acceptable to the firm. Divided into:

Loss prevention

Loss reduction
 Loss Control

 Loss Prevention  Loss Reduction

• Seek to reduce the number of • Designed to reduce or lower the
losses (frequency) of losses severity of losses, should it occur.
• Is used when the benefits • Since some risks are unavoidable,
outweigh the costs involved. the other alternative is to reduce
• Either imposed by law or its impact.
imposed by companies • Can be used in two
• factories to fence dangerous circumstances:
machinery to reduce the • before a loss, e.g. installation of
chances of employees being fire alarm or
injured. • after a loss e.g. salvage efforts in
the restoration of a building burnt
down by fire.
 Separation

Involves the dispersal of the firm’s assets in several

locations instead of confining it to one major area.

This measure will reduce the impact of losses

should a major disaster occurs.

Example, separation of head quarters and

assembly plant in automobile industry.
 Contractual Transfer

Risk transfer mechanism.

Refers to the various methods OTHER THAN INSURANCE

by which a pure risk and its potential financial consequences
can be transferred to other party.
 Leasing contracts Hedging
An agreement to buy or
An agreement where the
sell a commodity at a
owner or landlord
certain price to avoid
transfers the risks to the
losses due to price
tenants
increase or decrease.

Hold-harmless
agreements
Incorporation
An agreement between a
The owner of the retailer and a manufacturer
company transfers the whereby the later agrees to
risks to corporation by bear losses due to the
registering the company. manufacturer of defective
Contractual products thus relieving the
retailer of any liability.
Transfer
 RISK FINANCING

Self
insurance
Retention Insurance
and captive
insurer
Retention

Retention – the company will bear the consequences of

the loss

Risk or loss exposed are normally assumed or retained

when their impact and consequences are not too great
or in cases when or other methods seem feasible.

In an organization, the ability to assume a risk depends

on one’s financial ability.
Self insurance & Captive Insurer

Self insurance implies that the organization sets up

a pool of fund to retain its loss exposures.

Adequate financial agreement has to be made in

advance of the occurrence of losses.

The number of loss exposures must be large

enough to ensure the mechanism of insurance to
be operative.
Self insurance & Captive Insurer

A captive insurance company is an entity to write

insurance arrangement for its parent company.

The captive’s parent may be one company, several

companies or an entire industry.

Example; The Lion Group is the parent company

([Link]
of Lion Insurance Company Limited (LICL)
Insurance

Risk financing method of transferring the financial consequences of potential

accidental losses from an insured firm or family to an insurer

Transferring the risks to another party involves a contractual agreement whereby

the other party assumes the risks and is liable for the loss in the event of loss.

In an insurance contract, the party exposed to the risks (the proposer/insured) pays
the premium to the insurance company.

In return, the insurance company agrees to pay a stated sum on the happening of
certain risks specified in the contract.
 4. SELECTION AND IMPLEMENTATION OF
THE RISK MANAGEMENT PROCESS

Non-
Financial
financial Whether it affects
criteria Whether it will
affect the
criteria the growth of the
organization,
organization's
humanitarian
profitability or rate
aspects and legal
of return.
requirements.
Risk Matrix Table
Low
High frequency
frequency

High
• flood
severity • tsunami

Low severity
• burglary
5. EVALUATION, REVIEW AND CONTROL

The risk management program must be monitored

and controlled systematically. It must be
periodically reviewed
The techniques that were appropriate last year
many not be the most advisable this year, and
constant attention is required

Evaluation and review of the risk management

program permits the manager to review decisions
and discover mistakes, it is hoped, before they
become costly.
THE END