Colegio de Dagupan
School of Business and Accountancy Risk Management
Module 4
Risk Management Techniques: Risk Avoidance and Loss Control
Learning Outcomes
1. Give examples of the use of risk avoidance and explain when it is an
appropriate risk management technique
2. Differentiate between frequency reduction and severity reduction and give
examples of each
3. Explain three different forms of loss control, differentiated on the basis of
timing issues, and provide examples of each
4. List several potential costs and benefits associated with loss control
measures
Lesson 1 : Risk Avoidance
Risk Avoidance - a conscious decision not to expose oneself or one’s firm to a
particular risk
Can be said to decrease one’s chance of loss to zero
A doctor may decide to leave the practice of medicine rather than contend
with the risk of malpractice liability losses
Risk avoidance is common particularly among those with a strong aversion to
risk
Risk avoidance is one way to manage risk. Risk avoidance deals with eliminating
any exposure of risk that poses a potential loss. Risk avoidance is not performing
any activity that may carry risk. For example, suppose an investor wants to buy
stock in an oil company, but oil prices have been falling significantly over the past
few months. There is political risk associated with the production of oil and credit
risk associated with the oil company. She assesses the risks associated with the oil
industry and decides to avoid taking a stake in the company. This is known as risk
avoidance. The investor who avoids the risk forfeits any potential gains the oil stock
may have. ([Link]
However, avoidance is not always feasible or may not even be desirable if it is
possible. When risk is avoided, the potential benefits, as well as costs, are given up.
Lesson 2: Loss Control
Loss Control
When particular risks cannot be avoided, actions may often be taken to
reduce the losses associated with them known as loss control.
The firm or individual is still engaging in operations that give rise to particular
risks.
Involves making conscious decisions regarding the manner in which those
activities will be conducted
Focus of Loss Control
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Colegio de Dagupan
School of Business and Accountancy Risk Management
Some loss control measures are designed primarily to reduce loss frequency called
frequency reduction.
Example: Some firms spend considerable funds in an effort to reduce the
frequency of injuries to its workers.
Domino Theory (originally stated by H. W. Heinrich)
Employee accidents can be viewed in light of the following steps
1. Heredity and social environment, which cause persons to act a
particular way
2. Personal fault, which is the failure of individuals to respond
appropriately in a given situation
3. An unsafe act or the existence of a physical hazard
4. Accident
5. Injury
Each step can be thought of as a domino that falls, which in turn causes the
next domino to fall.
If any of the dominos prior to the final one are removed the injury will not
occur
Often argued that the emphasis of loss control should be on the third domino
Types of Loss Control
1. Severity reduction
For example, an auto manufacturer having airbags installed in the company
fleet of automobiles, the air bags will not prevent accidents from occurring,
but they will reduce the probable injuries that employees will suffer if an
accident does happen
2. Separation
Involves the reduction of the maximum probable loss associated with some
kinds of risks
3. Duplication
Spare parts or supplies are maintained to replace immediately damaged
equipment and/or inventories
Timing of Loss Control
1. Pre-loss activities - Implemented before any losses occur
2. Concurrent loss control - Activities that take place concurrently with losses
3. Post-loss activities - Always have a severity-reduction focus. One example is
trying to salvage damaged property rather than discard it.
Decisions Regarding Loss Control
A major issue for risk managers is the decision about how much money to spend on
the various forms of loss control. In some cases it may be possible to significantly
reduce the exposure to some types of risk. But if the cost of doing so is very high
relative to the firm’s financial situation, the loss control investment may not be
money well spent.
The general rule is that to justify the expenditure, the expected gains
from an investment in loss control should be at least equal to the
expected costs.
Potential Benefits of Loss Control
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Colegio de Dagupan
School of Business and Accountancy Risk Management
Many of the benefits are either readily quantifiable or can be reasonably estimated.
These may include the reduction or elimination of expenses associated with the
following:
Repair or replacement of damaged property
Income losses due to destruction of property
Extra costs to maintain operations following a loss
Adverse liability judgments
Medical costs to treat injuries
Income losses due to death or disabilities
Another potential quantifiable benefit of loss control is a reduction in the cost of
other risk management techniques used in conjunction with the loss control . An
example is the decrease in insurance premiums that often accompanies a loss
control investment. There may be loss control benefits for which a dollar value
cannot be easily estimated. Examples include:
The reduction in subjective risk that may accompany lower expected
loss frequency and severity
Improved public and employee relations associated with fewer and less
severe losses
Potential Costs of Loss Control
It is usually easier to estimate the potential costs. Two obvious cost components are
installation and maintenance expenses. For example:
a sprinkler system will have an initial cost to install and also will have
ongoing expenses necessary to maintain it in proper working order
The challenge of cost estimation is often identifying all of the ongoing expenses.
Also, some of the ongoing cost may merely be increases in other expenses.
References:
Trieschmann, Hoyt, and Sommer. Risk Management and Insurance, 12 ed.
[Link]/money/insurance/[Link]
[Link]/ask/answers/040315
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