LGT 5073 Risk Management in

Operations

Module 1 Basic Understanding

of Risk
 World Trade
Center
11 September
2001

Oklahoma City Bombing

19 April 1995

Chernobyl Fukushima Daiichi

Nuclear Plant Nuclear Plant
25-26 April 1986 14 March 2011

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 Wenzhou Train Collision
23 July 2011

Qingdao Train Crash

28 April 2008
Great
Hanshin (Kobe)
Earthquake
17 January
1995

Sendai
Earthquake
11 March
2011

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Indian Ocean Tsunami Hurricane Katrina
26 December 2004 25 August 2005

Disintegration of Challenger and Columbia

28 January 1986 and 1 February 2003

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Severe Acute Respiratory Syndrome (SARS),
Human Swine Influenza, Mad-Cow Disease

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 European Debt Crisis
2011 - 2012

Rain storm and

flooding – Beijing
July 21 2012

2012 Miss Hong Kong online

voting fiasco
August 26 2012

2012 Legislative
Council Election
September 9 2012

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 if risks are not managing properly and successfully:

risk

crisis

disaster
Financial Tsunami
European Debt Crisis
catastrophe 2007
2011 - 2012

new risk(s)

Fiscal Cliff 2013

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Module 1 Basic Understanding of Risk
This module intends to cover the following:-
 Introduction
 Origin of risk
 Definitions of risk
 Elements of risk
 Risk and uncertainty: basic concepts and
general principles
 Perceptions of risk
 Exposures of risk
 Responses to risk

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Module 1 Basic Understanding
of Risk

A Introduction
A. Introduction
 risk is part of every human endeavor
 from the moment we get up in the morning, take public
transportation to work and study, shopping in the
supermarket … until we get back into our beds, we are all
exposed to risk of different degrees and extents – believe it or
not, we are making millions of risk-related decisions per day
 we are trying to reduce the likelihood and impact of risk affecting
our everyday activities

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A. Introduction
 nothing in life is a "sure thing."
 while it is unlikely that it will snow in Hong Kong in February,
it is possible – who knows? In the same way, it is unlikely that
it will be 25°C in Beijing in December, but it is possible

 saying something is "unlikely" or that it "probably will happen"

is an indication of the probability that this particular thing will
and may occur. Everyday you weigh probabilities even without
realizing it

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A. Introduction
There is no future without risk
Swiss RE (2004:5), The Risk Landscape of the Future

He either fears his fate too much or his deserts are small,
Who dare not put it to the touch to win or lose it all
James Graham (1612-1650), Scottish General

One of the problems which has plagued those

attempting to predict the behavior of capital markets
is the absence of a body of positive microeconomic
theory dealing with conditions of risk

William F. Sharpe, recipient of the 1990

Nobel Prize in Economics

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A. Introduction
 in organizations, risk is not one concept, it a is a
mixture of the following three concepts (Coleman,
2009):
 what might occur: this is a hazard and can
range from insignificant incident to catastrophic
event and it is the nature and the number of a
possible unfavorable event
 the probability of occurrence: for example, for some
workplaces such as building sites, the chances of an accident
may be near 100%
 the extent to which we can control or manage a risk: eg.
a destruction of workplace can be avoided or becomes fatal if
practicable preventions and standards are or are not put in
place

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A. Introduction
• risk may not have a theoretical position in organizations‟
corporate strategy, it is often an intuition which influences on
firm performance and consider as an important factor in
organizations‟ decision making
• companies like Barings, Enron and Lehman Brothers are all
MNCs which were pushed towards bankruptcy due to strategic
errors and their failure in risk management

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A. Introduction
 Coleman (2009) comments that out of 500 S&P companies in
1997, 129 have dropped out of the list by end of 2003 which is
equivalent to an annual death rate of 4.3%

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Module 1 Basic Understanding
of Risk

B Origin of Risk
B. Origin of Risk
 Arabic word „risq‟ which signifies „anything that has been given to you
(by God) and from which you draw profit and has signified an
accidental and a favorable outcome‟
 Latin word „riscum‟ refers to the challenge that a barrier reef presents
to a sailor and clearly has signified an accidental (uncertain) and an
unfavorable (negative) outcome
 French word „risque‟ has negative but occasionally positive
signification, eg. in „qui de risque risen ná rień‟ or „nothing ventured
nothing gained‟

 Italian word „risco‟ or „rischio‟ has the meaning of hazard or danger

 in English, the word „risk‟ has a negative meaning associated with the
exposure to danger. In the late 18th century, the English form of
spelling of risk began to appear in the insurance transactions
(Flanagan and Norman, 1993)

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B. Origin of Risk
• in summary, „risk‟ might be used either as a measure of the
magnitude of the unintended outcome, based on which the Risk
Parameters Model illustrates the main parameters of risk:
 susceptibility to change
 severity of impact
 probability of occurrence
 degree of interdependency
with other factors of risks
• without any of the above
situation, the incident or event
cannot truly be considered as a
risk

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B. Origin of Risk
• Risk Parameters Model helps an individual or organization
identify, classify and analyze and then respond to a risk situation

• the model has two characteristics:

 it provides an answer to an individual or organization whether
they are in a risky situation
 it acts as a tool for
communication and brings
out factors which may not be
considered in the first place

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Module 1 Basic Understanding
of Risk

C Definitions of Risk
C. Definitions of Risk
• what is risk?
 an uncertain event or a set of events that, should it occur, will
have an effect on the achievement of the objectives
- where an outcome is certain, there is no risk
eg. a company car will depreciate in value due to wear and
tear, passage of time, obsolescence, etc. the outcome is
certain and there is no risk – the risk is only whether
the company car will be depreciated over the useful life
as estimated and expected
- however, when we are not certain if the car will be
involved in an accident or be stolen, risk is present
 risk is measured by the combination of the probability of a
perceived threat or opportunity occurring and the magnitude of
its impacts on objectives

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C. Definitions of Risk
• what is risk?
 all organizations will encounter uncertain events which may
arise inside and outside the organizations – each individual
uncertain event would impact one or more objectives is
known as a „risk‟
 „threat‟ is used to described an uncertain event that would
have a negative impact on objectives

 „opportunity‟ is used to describe an uncertain event that

would have a positive impact on objectives if it occurred

 the combined effect, negative or positive, of risks to the set

of objectives is known as „risk exposure‟

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C. Definitions of Risk
• there are diversities over the definition of „risk:
 in its broad and loose sense, the terms „risk‟ means exposure
to adversity – the dominant conception views risk as „the
chance of injury, damage, or loss‟ (Webster‟s New Twentieth
Century Dictionary, 1983)

 in the studies of risk, different definitions of risk have been

proposed
- most definitions include an estimate of
uncertainty (a likelihood, possibility or
judged subjective probability) for a
negative event to happen (a possible loss
or a negative consequence of an action)

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C. Definitions of Risk
• one of the most famous definitions of risk is
provided by Frank H. Knight (1885 – 1972)
Risk is present where future events occur
with measurable probability

Uncertainty must be taken in a sense radically distinct from the

familiar notion of risk, from which it has never been properly
separated …

The essential fact is that ‘risk’ means in some cases a quantity

susceptible of measurement, while at other times it is something
distinctly not of this character; and there are far-reaching and
crucial differences in the bearings of the phenomena depending
on which of the two is really present and operating… It will
appear that a measurable uncertainty, or ‘risk proper, as we
shall use the term, is so far different from an immeasurable one,
that is not in effect an uncertainty at all’

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C. Definitions of Risk
• other considerations of the definitions of „risk‟:
 „the chance, in quantitative terms, of a defined hazard
occurring‟- which introduces the concept of probability or
uncertainty, and also implies that it concerns „known unknowns‟

Royal Society (1992)

 „risk is a condition in which there is a possibility of an adverse

deviation from a desired outcome that is expected or hoped for‟
Vaughan (1997)

 „risk is defined as a subjectively-determined expectation of loss;

the greater the probability of this loss, the greater the risk
thought to exist’
Mitchell (1999)

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C. Definitions of Risk
• other considerations of the definitions of „risk‟:
 „the chance of something happening that will impact
objectives…’
Australia and New Zealand, AS/NZS 4360:2004
 „where action can be deemed to have consequences, then it is
the degree of uncertainty in those consequences that can be
considered as risk‟ Borodzicz (2005)

 „the effect of uncertainty on objectives’ ISO 31000:2009

 „risk is an occurrence that may cause damage or loss through

preventing or hindering the achievement of a firm’s objectives’
Blunden and Thirlwell (2010)

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C. Definitions of Risk
• other considerations of the definitions of „risk‟:
 „the probability of undesired effects arising from exposure to a
hazard. It is often expressed as an equation:

Risk = Probability x Consequences’ Pamela (2010)

 „something that might happen and its effect(s) on the

achievement of objectives‟
British Standard on Risk Management
 there are definitions mentioned above, do not speak of threat,
they speak of impacts – though risk tends to stress the
negative side or downside by equating it with the chance of
injury, harm or loss, but risk and risk management can be
about opportunities as much as threats

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C. Definitions of Risk
• as a conclusion and from the definitions, when consider both the
negative and positive sides of risk, risk concerns about:
 uncertainty of loss
 possibility of loss
 risk is an event (peril) in which a possibility of loss exists
 combination of hazards (a condition that may create or
increase the chance of loss)
 unpredictability – the tendency that actual results may differ
from projected results
 probability of any outcome different from the one expected
the definitions of risk have been progressed from uncertainty to
probability, and from loss to an outcome which may not result in
loss (that is, it may be a neutral or a positive outcome)

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Module 1 Basic Understanding
of Risk

D Elements of Risk
D. Elements of Risk – two basic elements (Vaughan, 1997)
 indeterminacy outcome
 „indeterminacy outcome‟ means that the outcome must be
in question because of the existence of uncertainty
 for risk to exist, there must always be two possible outcomes:
- no outcome at all
- uncertain outcome (positive or negative)
 where an outcome is certain, there is no risk

 loss
 at least one of the possible outcomes is undesirable
 individual possesses is loss, or a gain smaller than the
possible gain, or loss (or cost) of next opportunity forgone

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D. Elements of Risk – three typical threads of risk

uncertainty

three typical
threads of risk

level of risk cause of

loss (peril
and hazard)

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D. Elements of Risk – three typical threads of risk

 uncertainty (thread 1)
• uncertainty can be defined as „the inability to predict the
outcome from an activity due to lack of information about the
required input/output relationships or about the environment
within the activity take places‟ (CIMA, 2005)
• risk and uncertainty are often seen as synonymous (Helliar et
al., 2001), but risk can also been seen as the consequences of
uncertainty (Lalwani et al., 2006)

• Walters (2007) – risk has some quantifiable measure for future

events, but uncertainty alone does not. This means that risks
can be defined as quantifiable uncertainties

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D. Elements of Risk – three typical threads of risk
 uncertainty (thread 1)
• uncertainty is about a psychological reaction and a state of
mind characterized by doubt to the absence of knowledge about
what will or will not happen in the future

• uncertainty varies with the knowledge, experience and attitudes

towards conditions (even under identical conditions):
 the organization thinks that there is a chance of loss but
where no chance of loss exists at all – the organization
incur needless expenditure on risk prevention measures
 an organization feels that no uncertainty regarding a
particular risk when the exposure to loss is not recognized
but actually incurred

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D. Elements of Risk – three typical threads of risk

 uncertainty (thread 1)
• management‟s perception of uncertainty will be increased by
two factors: complexity and dynamism

 a number of variables which can impact on the

organization and how difficult they are to predict or
understand

 if the relationships between the variables is complex, this

will also increase uncertainty

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D. Elements of Risk – three typical threads of risk
 uncertainty (thread 1)
• management‟s perception of uncertainty will be increased by
two factors: complexity and dynamism

 the rate of change of the business environment

 increased dynamism means that management‟s models of
„how things work‟ will become out of date much quicker

 competitors will be able to respond more quickly to an

organization‟s initiatives

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D. Elements of Risk – three typical threads of risk
 level or degree of risk (thread 2)
 we need to consider the following for the level or degree of risk:
 how often an event is likely to happen – „degree of risk‟ is
related to the likelihood of occurrence
- specifically the probability of it happening as measured
by the frequency with which the risk occurs
 risk is the possibility of an adverse deviation from a desire
outcome - the degree of risk is measured by the probability
of the adverse deviation

 possible size of the loss (severity) – „more risk‟ or „less risk –

say $1,000 possible loss is riskier than a possible loss of $ 1,
even though the probability of loss is the same in both cases

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D. Elements of Risk – three typical threads of risk

 level or degree of risk (thread 2)

 the two relationships tend to predominate by applying the
quadrants of (i) frequency/probability/likelihood and (ii)
severity/impact/effect
 high frequency, low severity
- this is where the majority of
losses tend to be of a relatively
small amount eg. property
damage of various kinds
 high frequency, high severity
- this is where the majority of the losses which occur are
serious, such as air crashes, satellite failures, terrorist
bombs

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D. Elements of Risk – three typical threads of risk
 level or degree of risk (thread 2)
• there is a further aspect to level or degree of risk – utility,
which relates very much to „economic theory of utility‟ in that
it refers to how important the risk is to the individual or
organization
 the disruption of a business premises will be highly
significant to an organization operating from a single
outlet than an organization has a large number of retail
outlets and the fire is only in one of the retail stores
 a loss of $500,000 is devastating to a small organization
with an annual turnover of $1 million than a
multinational organization with a turnover of $1 billion

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D. Elements of Risk – three typical threads of risk
 cause of loss (thread 3)

 „peril‟
 a prime cause of the loss (eg. fire, storm, theft,
etc.), each of these incident results in the
cause of loss
 „hazard‟
 a condition which creates or increases the chance and
impact of loss arising from a peril – even where the same
peril is likely to occur, the frequency and severity of the
losses may differ because various factors which influence
the final outcome
- a fire is likely to do much more damage to a timber
framed building than to a stone building

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D. Elements of Risk – three typical threads of risk
 cause of loss (thread 3)
• hazard can be classified into four broad categories:
 physical hazard: physical characteristics of the risk being
considered
 moral hazard: the attitude and conduct of people which
may affect the outcome
 morale hazard: results from insured person‟s careless
attitude toward the occurrence of losses
 legal hazard: the increase in the frequency and severity of
loss that arises from legal doctrines enacted by legislatures
and created by courts

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Module 1 Basic Understanding
of Risk

E Risk and Uncertainty:

Basic Concepts and
General Principles
E. Risk and Uncertainty: basic concepts and general principles

• there has been a lot of discussions and debates on the differences

and common characteristics of risk and certainty
 risk is used in a subjective phenomenon involving uncertainty
 risk arises whenever there is uncertainty
 many things are uncertain, not all of them are risks –
uncertainties only become risks when they could affect our
objectives – risk is uncertainty that matters businesses
• Bussey (1978), Merrett and Sykes (1983)
 “A decision is said to be subject to risk when there is a range of
possible outcomes and when known probabilities can be
attached to the outcome.”
 “Uncertainty exists when there is more than one possible
outcome to a course of action but the probability of each
outcome is not known.”
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E. Risk and Uncertainty: basic concepts and general principles

• uncertainty includes both upside and downside outcomes

• risk commonly has a negative meaning of hazard or exposure to
dangerous situation, however, risk may also means opportunity
eg. the concept of „Yin Yang‟ describes how polar opposites and
seemingly contrary forces are interconnected and
interdependent in the natural world. The Chinese character
„Wei Ji‟ (危機) is translated as „risk‟ and has two elements
that represent „danger‟ (危險) and „opportunity‟ (機會)

chance of
opportunity in
danger
possible danger
in opportunity

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E. Risk and Uncertainty: basic concepts and general principles

• if risk management is to help an organization tackle problems in

an uncertain world, then defining risk clearly and unambiguously
helps an organization focuses properly and effectively in the
implementation of risk management strategy(s)

thus, if an organization fails to define a risk clearly, it will not

be able to undertake risk management effectively

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E. Risk and Uncertainty: basic concepts and general principles

 Knight (1921) in his book „Risk,

Uncertainty and Profit‟ provides a clear
distinction between uncertainty and risk

 he addressed in the field of economics and

used basic mathematical theory which
address:
 risk arises from randomness with knowable probabilities
- risks can be defined as quantifiable uncertainties
- risks are uncertainties that matter
 uncertainty reflects randomness with knowable probabilities
- uncertainties become risks when they affect our objectives
- many things are uncertain, not all of them are risks

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E. Risk and Uncertainty: basic concepts and general principles

 in today‟s world, nearly all decisions made in

business are made purely based on financial
outcomes
 management needs to well understand and analyze
the return of all business operations and decisions
justify to take risks, and the extent of these
outcomes (losses) if the risk do not carry out

 business investors also need indication of whether the returns of

their investments meet their minimum and expected returns of
their investment when their investment is fully exposed to risks

 by understanding the full extent of the business gains and losses,

business investors can decide whether they should approve or
reject a business decision or investment

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E. Risk and Uncertainty: basic concepts and general principles

• as a summary, this diagram

illustrates the concept of risk in
terms of uncertainty, probability,
effect and outcome

 once the probability and effect

of an occurrence can be
determined, then a probability
distribution can be identified

 from this probability distribution,

over a range of possibilities, the
chances of risk occurring can be
determined, and as a result uncertainty associated with the
event occurrence can reduced/mitigated

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Module 1 Basic Understanding
of Risk

F Perceptions of Risk
F. Perceptions of Risk – risk perception model

• the risk perception model theorizes that the public's perception

of risk comes from the strength of 15 different factors, each of
which can alter perceptions in varying degrees of magnitude
(Covello et al., 2001)
• these 15 factors determine the public's level of concern and
elevate or decrease worries, anger, fear, hostility and outrage

• understanding the strengths or

weaknesses of these levels affects the
ability to alter perception, change
behavior and modify attitudes and
factors based on the messages
delivered (Covello et al., 2001)

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F. Perceptions of Risk – risk perception model

 chain effect of culture

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F. Perceptions of Risk – risk perception model

 each situation has a unique combination of these 15 factors, which may

be strong or weak, or may have no relevance

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F. Perceptions of Risk – negative dominance model

• addresses how the public processes negative and positive

information in high-concern situations
• the model suggests that the relationship between the two
messages is asymmetrical, however the negative messages
receive substantially more weight than the positive ones
• the public places more value on their losses than on their gains

risk perception

negativity positive
dominance preferences

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F. Perceptions of Risk – changing perception of risk
• in addition to the risk perception model and negative
dominance model, Wagner and Bode (2009) claim that the
perception of risk is changing:
 while some executives are becoming more risk averse in the
face of a growing array of both traditional and new threats
(risk averter), others are taking advantage of the
opportunities presented to exploit fresh arenas, while, at the
same time, mitigating the associated risks (risk seeker)
• Wagner and Bode (2009) further state that one can identify two
major perceptions of risk:
 risk as both danger and opportunity
 risk as purely danger (Mitchell, 1995)

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F. Perceptions of Risk – changing perception of risk

 risk as both danger and opportunity

• risk can be conceived as the µ=mean
fluctuation (variability) around
the expected value (mean) of a
measure (Arrow, 1965), which -δ = negative +δ = positive
means risk has both a downside value value
(loss) and an upside (gain) potential

• this is connected to the general economic problem that one

has to assume more of this risk, if one wants to achieve
higher rates of return

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F. Perceptions of Risk – changing perception of risk
 risk as a purely danger
• most dictionaries define risk as the threat of danger, injury,
damage, or loss (McKechnie, 1983)
• risk has primarily negative consequences seems more
consistent with the human perception (also negative
dominance model) than with the mean-variance approach
• March and Shapira (1987) examine the ways in which managers
perceive and react to risk, and conclude that the majority of the
managers tend to exaggerate the downside potential of risk

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F. Perceptions of Risk – changing perception of risk
 risk as a purely danger
• MacCrimmon and Wehrung (1986) find empirical support
that managers do not consider variance to be risk but that the
managers are rather concerned about the chances of losses
• in the same asymmetric vein, most business people see risk in
a behavioral rather than mathematical sense. They, like most
of us, fear losses more than we value gains

one would claim that risk as purely

danger is somehow a traditional
perception about risk
nowadays, the real challenge is how best
to capitalize on the upside of risk

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F. Perceptions of Risk – changing perception of risk
 risk as a purely danger
• a good example of the two positions can be seen in the actions of
Nokia and Ericsson – following a fire at the Philips semi-
conductors plan in Albuquerque (US) in 2000

delayed remedial action

US$400 mil lost

alternative suppliers within days

• Ericsson was forced to exit the phone manufacturing and was

bought by Sony, and became Sony-Ericsson, soon afterwards
(Cleary and Malleret, 2007)

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F. Perceptions of Risk – changing perception of risk
• you can see that one company was able to take advantage of the
dangers presented through a correct assessment of the risks
(Nokia) while the other was too slow to capitalize on the
consequences (Ericsson) – realizing the upside of risk can
confer confidence, strength and resilience to a business (Trim
and Caravelli, 2009)

if handled appropriately, risk is an

enabler that can release
opportunities that were previously
hidden and hindered

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F. Perceptions of Risk – triple strand of influences on the
perceptions of risks

• factors which affect the perceptions of risk:

 conscious factors
 subconscious factors
 affective factors

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F. Perceptions of Risk – triple strand of influences on the
perceptions of risks

 conscious factors
 based on situation where decision can be made in a form of
measurable and visible matter
 based on the visible and measurable characteristics of the
situation within which the decision is being made

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F. Perceptions of Risk – triple strand of influences on the
perceptions of risks

 subconscious factors
 include mental short-cuts made to facilitate decision-making
(heuristics) and other sources of cognitive bias
 operate at individual, group or organizational levels which
provide mechanisms for making clear of the complexity or
uncertain situations

 allow rapid filtering of data to determine the most important

elements, easing the decision-making task

 have positive influence on decision making while cognitive

biases do not

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F. Perceptions of Risk – triple strand of influences on the
perceptions of risks

 subconscious factors

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F. Perceptions of Risk – triple strand of influences on the
perceptions of risks

 affective factors
• affective factors are instinctive gut-level responses are based
on instinctive emotion or deep underlying feelings rather
than rational assessments

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F. Perceptions of Risk – triple strand of influences on the
perceptions of risks

• as a summary, the triple strand

of influences interact together
to affect the risk perception in
two important ways:
 how people distinguish a
particular risky situation
 what people distinguish as the
right way to respond to a risk
event

risk averter  risk neutral  risk seeker

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F. Perceptions of Risk – perception of risk is purely human
attributes
• perception of risk is a highly intuitive behavior or recognition
where the mind senses and decides on the responsive action, the
intuitive responses are shaped and affected by many subjective
factors which include the degrees to which the risk is:
 known (certain) or unknown (uncertain)
 acceptable or preventable
 controllable or uncontrollable
 threatening (danger) or attractive (opportunity)

risk averter  risk neutral  risk seeker

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F. Perceptions of Risk – perception of risk is purely human
attributes
• in order for an individual, group or organization to determine
their risk, one thing we can do is to understand:
 where we have come from in the past (eg. background,
character, education, training, experience etc.)
 where we are and measure how well we are doing at the
present moment (eg. performance, status quo, willing to
change, willing to take risk against opportunity etc.)

 foresee where we might lead to, and

where we will and want to be in the
future (eg. goals, targets, achievements
etc.)

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F. Perceptions of Risk – perception of risk is purely human
attributes – the “Human Bathtub”
• “Human Bathtub” (Duffey and Saull, 2008) help us perceive risk
clearer to describe and understand
• risk perception are divided into three broad categories which
explain what is the nature or type of risk that we perceive as we
learn, and why
 risky
 improving
 inevitable

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F. Perceptions of Risk – perception of risk is purely human
attributes – the “Human Bathtub”
 risky
• when we start out as a beginner
(novice), we are at the highest
risk (the beginning of the curve
is labeled „RISKY‟)
• observe both outcomes and
non-outcomes, and learn
quickly from the initially
unknown mistakes and
errors, whatever they are, as
and if they occur
• we fear these unknown consequences, we do not want to
accept these unknown outcomes and try to avoid them from
happening

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F. Perceptions of Risk – perception of risk is purely human
attributes – the “Human Bathtub”
 improving
• if we survive the earlier mistake
and have learned the outcomes
from the first stage, we are
seeking for „IMPROVING‟
• the chance of success or not
failing is increasing, or not
having an unknown outcome
becomes less, both from the
experience and knowledge we
have gain from the past
• this experience inevitably provides us some knowledge and
results with some greater comfort level or familiarity about the
risk

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F. Perceptions of Risk – perception of risk is purely human
attributes – the “Human Bathtub”
 inevitable
• at the „INEVITABLE‟ stage, we
become experts who have gained
sufficient knowledge, comfort
and accepting of the known
• even if outcomes happen or
have occurred, we will not be
surprised by them or are afraid
of the risk anymore due to the
accumulation of our knowledge
and experience
• the outcome probability is rising at this inevitable stage,
unusually and paradoxically it seems we are actually at greater
risk but we in fact have much less concern and accept it

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F. Perceptions of Risk – perception of risk is purely human
attributes
• as a conclusion, risk may be different from the perception and it
will vary from person to person, culture to culture, and society to
society
• our knowledge to differing degrees about different risks will
depend on our experience and the path we each have followed in
the past
• both quantitatively and qualitatively, the perceived perception
of risk curve provides us a consistent and useful outline of our
learning experience and our feeling about risk

• “Human Bathtub” curve can act as a guide, keeping it in our

mind as we journey forward even further into the dark world of
quantifying risk perception

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Module 1 Basic Understanding
of Risk

G Exposures of Risk
G. Exposures of Risk

• Cendrowski and Mair (2009) offer the definitions and

relationships of risk, exposure and events as follows:

„exposures‟ is closely related to „risk‟ and „risk management‟

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G. Exposures of Risk

• Young and Tippins (2001) state that understanding the nature of

risk exposure is important. In a broad sense, an entire
organization is an exposure, but this notion provides little
technical insight into the nature of particular exposure to risk

• a much more meaningful approach relies upon a categorization of

exposures into asset groupings. These main categories are:
 physical asset exposures
 financial asset exposures
 human asset exposures
 intangible asset exposures (brand or reputation risk)

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G. Exposures of Risk

 physical asset exposures

• there are numerous ways that one may categorize the wide
range of physical assets an organization could possess or for
which it would have responsibility. The more salient of these
approaches are:
 property asset type
 cause-of-loss (cause-of-gain) type
 loss (gain) type
 interest

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G. Exposures of Risk

 physical asset exposures – property asset type

• real assets – fixed and immovable, a fixed asset‟s exposure to
risk is more constant and knowable
• personal assets – somehow movable in nature and physical
location changes which command a relatively higher risk
exposure
 physical asset exposures – cause-of-loss (cause-of-gain) type
• is based upon the nature of the peril or opportunity which
affects or may affect a physical asset
• natural hazard-based (eg. earthquakes, hurricanes, etc.)
• behavioral hazard-based (eg. riots, vandalism etc.)
• social, political, and economic phenomenon from collective
behavioral influences (eg. changes in consumer preferences)

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G. Exposures of Risk

 physical asset exposures – loss (gain) type

• physical assets can be typed by the nature of the impact of
peril and opportunity on the asset:
 direct impacts – direct impacts is an actual physical
result (eg. fire on the factory building)
 indirect impacts – influence the value of an asset without
directly or physically affect those asset (eg. earthquake of
the neighbor leads to a reduction of the property price)
 consequential impacts – (net
income or time element impacts):
effects that occur as result of a
direct or indirect impact (eg. rent a
new factory building or move to
another city)

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G. Exposures of Risk

 physical asset exposures – interest

• the best perspective of physical assets is not obtained by
considering their tangible characteristic alone, but by
understanding the enforceable interests (in associated with
their contracts, obligations, commitments, and
arrangements) that attach to physical assets
eg. the loss of an expensive piece of construction equipment
is defined as much by whether an organization owned,
rented, or was borrowing it as by the physical nature of
that asset or the manner in which it was lost

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G. Exposures of Risk

 financial asset exposures

• financial assets are a subset of physical assets, which means
stock certificate or a dollar bill is exposed to many of the
same perils and opportunities as are land and buildings,
automobiles, computers etc.
• financial assets and physical assets are distinguished as:
 the value of the financial assets is derived from some
other asset (the other asset may or may not be possessed
by the holder of the financial asset)
 financial assets are both the sources of risk and the risk
management tools
• financial assets are further exposed to a set of risks being
characterized as financial risks (eg. price, credit, interest rate,
currency exchange, default etc.)

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G. Exposures of Risk

 human asset exposures

• key characteristics of human asset risks include:
 premature death
 disability and poor health
 old age and retirement
 unemployment
 poverty
 productivity

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G. Exposures of Risk

 human asset exposures – premature death

 death of a leader or senior executive within an organization
affect the morale of the surviving members or the continuity
of the organization, even when economic impacts are not visible

 human asset exposures – disability and poor health

 risks of disability and poor health is partly due to society‟s
improved ability to prevent premature death
 disability and poor health
reveals a number of
dimensions which contribute
to the complexity in managing
risk

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G. Exposures of Risk

 human asset exposures – old age and retirement

 represents the economic challenge of retirement
 supporting retirees has given rise to various social insurance
and security programs that are intended to supplement private
saving and support efforts

 human asset exposures – unemployment

 dismissal or lay-off of employees have significant effects on
organizational performance and effectiveness

 human asset exposures – poverty

 government mandate interest in poverty in taxes support and
numerous public assistance programs

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G. Exposures of Risk

 human asset exposures – productivity

 construed as the „investment risk‟ associated with human
assets either run by government or the organization itself
 training and personal/professional development are investments
in employees with the expectations that employees will become
more effective, efficient and useful
 training and education are tools that may be explained as
„upside-risk management techniques‟

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G. Exposures of Risk

 intangible asset exposures (brand or reputation risk exposures)

• intangible asset exposure of an organization is associated with
reputation risk
• reputation risk is the risk that the reputation of an organization
is damaged due to (risk) events
• reputation risk is costly to an organization and is also seen as
a key threat to success
• it requires a considerable amount of resource and effort to resort
the reputation of the organization
• loss of reputation can lead to a complete
destruction of the organization and to be
completely out of the commercial platform

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G. Exposures of Risk

 intangible asset exposures (brand or reputation risk exposures)

• „some of the problems which arise if reputational issues are
poorly handled‟ – Blunden and Thirlwell (2010):

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Module 1 Basic Understanding
of Risk

H Responses to Risk
H. Responses to Risk

• if an organization is able to develop and implement a good

response(s) to tackle the identified and assessed risks, the
organization is able to:
 minimize the threats and maximize the opportunities
 optimize the likelihood of achieving business objectives

• the „Seven As‟ criteria (Hillson, 2010)

can be used to test whether the
planned risk responses are likely to
work

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H. Responses to Risk

 appropriate
 determine the level of risk before
choosing the correct level of response
 “do nothing” response can be used to
deal with some minor risks
 in some risks, it may be appropriate to
stop until a particular risk has been
dealt with and other risks can be
completely ignored

 affordable
 for each risk response, a planned budget and the actual
amount spent should be kept within the organization‟s overall
budget

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H. Responses to Risk

 actionable
• determine whether a risk response is
possible at a given timeframe which
allows risk to be tackled effectively
• some risks, immediate actions are
needed, while others can be safely left
until later
• needs to identify the action window
within which responses need to be
completed in order to address the risk

 achievable
• for each risk response, it must be realistically achievable or
feasible, otherwise, there is no point in describing and
determining response

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H. Responses to Risk

 assessed
• assure all proposed response will work
and be risk-effective
• make predictive „post-response risk
assessment‟ assuming effective
implementation of the response, and
compare it with „pre-response position

 allocated
 for each risk response, a single point of responsibility and
accountability for implementing the response is necessary

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H. Responses to Risk

 agreed
 must attain consensus and general
agreement of all stakeholders before
committing on risk response

 it is vital to buy-in response owners

who are expected to implement planned
actions, so that responses are not
imposed on people who are unwilling
or uncommitted

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H. Responses to Risk

• each proposed response should be

examined against the „Seven As‟ criteria
before it is accepted for implementation,
to ensure that it is likely to be effective
and achieve the intended result
• risk management will never deliver the
promised benefits unless effective risk
responses are both planned and
implemented

• if we can test our proposed risk responses against the „Seven As‟
criteria, it can maximize their effectiveness and ensure that we
can properly tackle the inevitable risk exposure on business
operations

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LGT 5073 Risk Management in
Operations

 End of Module 1 

Module 2 Major Issues of Risk