RISK

IDENTIFICATION
Module 2
 Business Risk Exposure
Business Risk Exposure (BRE) is a method of calculating (scoring) the nature and level
of exposure that an organization is likely to confront through a potential failure of a
specified asset or group of assets.
Business Risk Exposure is derived by assessing both likelihood of failure and the
consequence of failure attributable to an asset.
Expressed mathematically, BRE is the product of the Consequence and Likelihood of a
possible failure, adjusted for risk mitigation measures currently in place and those that
could be put in place. Risk mitigation measures are those practices applied to an asset on
a case by case basis to either reduce either the likelihood of failure or the consequence of
failure.
Figure 1 is a schematic representation of the key variables of business risk exposure.
Analysis and Evaluation of Risk Exposure -
Business Related Risk Exposures
Commercial general liability, commonly thought of as the "slip and fall"
coverage, insures a business against accidents and injury that might happen on
or away from its premises, as well as certain exposures relating to the carrying
out of its business operations.
It protects the business owner from payments for bodily injury or property
damage to a third party, for medical expenses accruing to the underlying
incident, for the cost of defending lawsuits including investigations and
settlements, and for any bonds or judgments required during an appeal
procedure.
.contd
Business risk exposures to consider:
1) General Liability
2) Errors and Omissions
3) Director & Officer protection
4) Business Overhead expenses
5) Employee Group Benefit plans
 Individual Exposures, Exposures of Financial
Assets -Exposures of Human Assets
Types of RisksRisk Exposures
Most risk professionals define risk in terms of an expected deviation of an occurrence
from what they expectalso known as anticipated variability.
In common English language, many people continue to use the word risk as a noun
to describe the enterprise, property, person, or activity that will be exposed to losses.
In contrast, most insurance industry contracts and education and training materials
use the term exposure to describe the enterprise, property, person, or activity facing a
potential loss.
So a house built on the coast near Galveston, Texas, is called an exposure unit for
the potentiality of loss due to a hurricane.
Pure versus Speculative Risk
Exposures
Professional people who study risk use several words to designate what others
intuitively and popularly know as risk.
Professionals note several different ideas for risk, depending on the particular
aspect of the consequences of uncertainty that they wish to consider.
Using different terminology to describe different aspects of risk allows risk
professionals to reduce any confusion that might arise as they discuss risks.
.contd
Risk professionals often differentiate between pure risk that features some
chance of loss and no chance of gain (e.g., fire risk, flood risk, etc.) and those
they refer to as speculative risk.

Speculative risks feature a chance to either gain or loss (including investment

risk, reputational risk, strategic risk, etc.).
 .contd
Within the class of pure risk exposures, it is common to further explore risks by use of the dichotomy
of personal property versus liability exposure risk.
Personal Loss ExposuresPersonal Pure Risk
Because the financial consequences of all risk exposures are ultimately borne by people (as
individuals, stakeholders in corporations, or as taxpayers), it could be said that all exposures are
personal.
Some risks, however, have a more direct impact on peoples individual lives. Exposure to premature
death, sickness, disability, unemployment, and dependent old age are examples of personal loss
exposures when considered at the individual/personal level.
An organization may also experience loss from these events when such events affect employees. For
example, social support programs and employer-sponsored health or pension plan costs can be
affected by natural or man-made changes. The categorization is often a matter of perspective. These
events may be catastrophic or accidental.
 .contd
Property Loss ExposuresProperty Pure Risk
Property owners face the possibility of both direct and indirect (consequential) losses.
If a car is damaged in a collision, the direct loss is the cost of repairs.
If a firm experiences a fire in the warehouse, the direct cost is the cost of rebuilding and replacing
inventory.
Consequential or indirect losses are nonphysical losses such as loss of business.
For example, a firm losing its clients because of street closure would be a consequential loss.
Such losses include the time and effort required to arrange for repairs, the loss of use of the car or
warehouse while repairs are being made, and the additional cost of replacement facilities or lost
productivity.
Property loss exposures are associated with both real property such as buildings and personal
property such as automobiles and the contents of a building. A property is exposed to losses because
of accidents or catastrophes such as floods or hurricanes.
 .contd
Liability Loss ExposuresLiability Pure Risk
The legal system is designed to mitigate risks and is not intended to create new risks.
However, it has the power of transferring the risk from your shoulders to mine.
Under most legal systems, a party can be held responsible for the financial consequences of causing
damage to others.
One is exposed to the possibility of liability loss (loss caused by a third party who is considered at fault) by
having to defend against a lawsuit when he or she has in some way hurt other people.
The responsible party may become legally obligated to pay for injury to persons or damage to property.
Liability risk may occur because of catastrophic loss exposure or because of accidental loss exposure.
Product liability is an illustrative example: a firm is responsible for compensating persons injured by
supplying a defective product, which causes damage to an individual or another firm.
Exposures to Legal Liability, Exposure to Work-
Related Injury, Basic concepts form
probability and Statistics
To be able to survive and sustain, organizations need to ensure continuity of their operations
and preservation of their assets.
They are exposed to various risks and therefore in order to sustain themselves to achieve
corporate goal the organization must have a Risk Management Policy.
As a result of social changes, rapid technological advancements and the prevailing political,
economic and legal environment, the organizations are faced with a new threat to their
existence.
The liability exposure along with other areas of loss exposure therefore should form Part of
the overall risk management policy of any organization.
.contd

Before we discuss insurance part of it, lets examine risk management per se
from the point of view of an organization which typically consists of
i) Risk Analysis
ii) Risk Control
iii) Risk Financing
iv) Monitoring and review
 .contd
Risk Analysis basically involves identification and evaluation of risk.
We first identify the areas of risk exposure e.g. assets, earning capacity, human resource, legal liabilities,
etc. and then correlate them with possible sources of loss/ damage/ injury.
What is the probability of happening of such a loss and its likely severity is then evaluated.
Broadly speaking there may be high frequency and low severity and Low Frequency and high
severity losses.
The next step in the process is Risk Control measures, which is aimed at avoiding, eliminating or
reducing the chances of loss producing events. This also involves measures for diminishing the severity
of loss that has occurred.
These can be achieved by technical improvement, procedural changes, TQM approach and loss
prevention measures.
.contd
Since these involve substantial amount of money, a cost-benefit analysis is
carried out before the actual measures are initiated.
Inspite of the best efforts in preventing accidents losses, they do take place
and the organizations must have to find ways to finance them. The possible
options are insurance, finance by loan, creation of contingency fund, losses to
be charged to operating costs, etc.
We are living in a dynamic world and any policy / strategy needs to be
continuously reviewed and monitored to effect change if so warranted.
 .contd
Lets now examine the legal liability and its implication on an organization. Lets also
examine the evolution of liability legislation and the prevailing judicial attitude. This is
necessary because the liability insurance has to necessarily move along the path
determined by both the liability legislation and the court decision / judgment. Legal
liability may be defined as specific responsibilities and obligations which can be
enforced at law. We are here basically concerned with civil liability which may arise
under (i) Law of Tort (ii) Statutory Law (iii) Law of Contract.
It should be noted that for any civil wrong suits can be filed for damages / injury. It
should also be noted that there is no escape from liability under statutory and contract
law provision.
 .contd
Originally everybody abided by the principle you pay for your own losses. However with
the passage of time the notion of fault got incorporated in civil law, which meant that if you
are responsible for the damages / injures you have to pay the monetary compensation. But this
required the establishment of fault in the court law - a difficult task indeed. Therefore, in
order to help the victims and to safeguard his interest, the onus of proof was shifted to the
defendant who has to prove his innocence rather than the victim proving the negligence.
The principle that for every wrong there must be redress in the form of damage has now
changed to for every injury there must be redress in the form of damage. With this change
has come the concept of strict or absolute liability which means that mere existence /
operation of an activity constitute the cause triggering liability - the only requirement being a
causal link between the activity and the loss event. With growing awareness about the
environment, preservation of flora & fauna, the assets belonging to society as a whole
(ecosystem) are being brought in the liability net, the guiding principle being the polluter
pays.
 .contd
Retroactive application of these laws has their own implication.
In order to ensure that the victims get the compensation (where the liable party is not in a
position to pay) the concept of group common fate has been introduced.
Several parties are held jointly responsible in accordance with their ability to pay creating
deep pocket approach.
This means that persons / parties who have nothing to do with the original event may be
fastened with liability.
The net of liable parties is thus widening.
Of late there has been trend to award punitive damage as a deterrent to the perpetrators,
apart from soaring compensation payments. Sometimes the punitive damages exceed the
actual damage awarded.
 .contd
It will not be out of place here to mention a few relevant court cases, which are
indicative of the shape of things to come in future.
In the case of SriRam Foods & Fertilizer where oleum gas escaped from one of the units
resulting in injuries to many, the Supreme Court held that the liability to compensate is
absolute and that Chairman / MD/ Officers heading the plant are personally liable to pay
the compensation.
In Uphaar Cinema tragedy the court has held MCD, Delhi Police and (All public
agencies) jointly responsible for the payment of compensation.
The liability exposure arising out of cases like Bhopal Gas Tragedy can be well
imagined.
At this stage it will not be out of place to have a look at statutory laws governing civil
liability. Apart from tort they are
.contd

WC Act 1923 (as amended)

Factories Act 1948
Consumer Protection Act 1986
The Environment Protection Act 1986
National Environment Tribunal Act 1995
Public Liability Insurance Act 1991
Law of Contract
 .contd
Those falling within the purview of WC Act 1923 & PLI Act, 1991, have to necessarily
taken Insurance cover as provided in the Act. As for the liability under other statutes and
the liability under tort the companies have to plan for them in their Risk Management
Programme.
Lets now examine the position from the point of view of Insurers. Lets first start with
the pricing part of it. It is an accepted principle of insurance pricing that there should be
proper matching between the rate of premium and degree of exposure in terms of
probability of loss.
 .contd
Liability claims being long-tail, open-ended, and intangible, pose problem in working out the premium rate.
It is difficult to objectively measure the probability because of lack of adequate data- base and also because
the liability fixed is very subjective based upon the prevailing judicial attitude. The Risk / premium balance
is disturbed because the liability standard as prevailing in a future date will decide the outcome of the events
that has already taken place is the past and which incidentally was underwritten in the past based on the then
prevailing condition.
Besides it is very difficult to quantify objectively the loss on account of pain / suffering / mental agony,
damage to eco-system, environment, etc. Keeping the above factors in view and the requirements of the
market, Indian Insurance Company have many liability products to offer.
However, in order to keep their financial commitments within their limit of retention, the insurance
companies sets out two limits called AOA (Any one accident limit) and AoY (Any one year limit) in all
liability insurance policies. In liability claims, at times, the insured event do not occur suddenly and
accidentally but manifests itself only gradually and hence it becomes difficult to ascertain whether cover
exists from a time related point of view.
These are called gradual loss event.
 .contd
Therefore the following three concepts typical to liability insurance need to be
understood:
Retroactive date - It is the date when the first policy issued commences and will
continue to be the retroactive date for subsequent policies if renewed without break.
Policy period. It is the one year policy period as depicted on the face of the policy.
Period of insurance - It means the period commencing from the retroactive date and
continues, if the policies are renewed without break, till the expiry date in the last policy.
 .contd
In relation to the claims, to find out whether insurance coverage in a particular case
applies or not, there are three types of policy wordings.
1) Occurrence basis: The damage / injury must occur during policy period. Claim may
occur after expiry also.
2) Claims made basis: the claim is made during the policy period irrespective of when the
negligence occurred.
3) Acts committed basis: The negligent act must occur during the policy period. The
courts, however, have interpreted the wordings in their own way and there are conflicting
judgments specially in USA. In India, the indemnity clause generally provide the cover for
Claims arising out of accidents, during the period of insurance
First made during the policy period.
 .contd
This means that the event must occur during the period of insurance and the policy is
continuously in force without break till the time the claims is reported.
The following liability insurance products are available in Indian market.
Public liability for industrial and non-industrial risk.
Product liability
Professional indemnity for Doctors / Solicitors, etc.
Employers liability
Directors and Officers liability
Act policy under PLI Act (hazardous goods) 1991.
Motor, marine hull and aviation policies also cover liability.
 .contd
Depending upon the specific needs of a client, tailor made policy can also be made.
Some of the private insurance companies have come out with products like commercial
general liability insurance cover.
It should be noted that liability insurance by its very nature has the potential to result is
heavy losses of catastrophic nature. Hence the reinsurance support is required. However,
in view of limited insurance capacity, higher premium, increased deductibles a need is
felt about alternative risk transfer mechanism (ART). This is being attempted by transfer
of risk through capital market instruments e.g. CAT Bonds. Therefore, optimized risk
transfer at optimal price may involve combination of insurance & ART. In this regard a
new concept is gaining currency in
European market to avoid complications from liability laws and unpredictable nature of
court judgments. The concept of First party cover takes the place of liability insurance
specially for covering environmental liability.
 .contd
Instead of the tort-fearer taking the policy, the would be aggrieved party takes the First
party covers. In the event of any damage, instead of locating the tort fearer, the
aggrieved party without going through the court mechanism claims compensation from
the insurance company.
The ever-increasing entitlement - mentality of society, the widening net of liability
legislation, and the trend of court judgments may well have a very negative effect on the
economy and more so on small entrepreneurship. We have to think of innovative ways to
come out with solutions, which takes care of the need of not only big organizations but
also SSIs and SMEs who are the most vulnerable.
The solutions must be cost effective and innovative in nature.