Chapter 1: Introduction To Risk Management PDF

Chapter 1: Introduction To Risk Management WHAT IS RISK? HOW WILL YOU DEAL WITH RISK? Risk generally results from uncertainty. accidents, natural disasters etc. uncertainty in the market place (demand, supply and stock market) failure of projects There are different tools to...

Chapter 1: Introduction To Risk Management WHAT IS RISK? HOW WILL YOU DEAL WITH RISK? Risk generally results from uncertainty. accidents, natural disasters etc. uncertainty in the market place (demand, supply and stock market) failure of projects There are different tools to deal with these risks depending upon the kind of risk POTENTIAL DANGERS In a work environment, employers should know if there are potential dangers in the work place Hazards should be avoided to prevent accidents TYPES OF HAZARDS IN A WORK PLACE 1. Radiation – from x-rays, ultra-violet rays, microwaves 2. Psychological – stress, work shifts, problems dealing with difficult groups, harassment, lack of empowerment 3. Biological – viruses, bacteria, fungi coming from bites, cuts or contamination through contact from an infected person  4. Physical - lighting issues, objects obstructing walkways, unsafe machinery, spillages on floors. 5. Chemical - any form of liquid, vapor, dust, fumes or gases that could be spilt, leaked or misused. 6. Ergonomic – work stations that are not fit for healthy usage EXAMPLE: Occupational and health hazards of women working in the Export Processing Zone Ergonomic hazards Heat Overwork Poor ventilation Fatigue/ weakness OTHER EXAMPLES OF WORK HAZARD AND RISKS THAT MAY OCCUR Frayed electrical cords (could result in electrical shock) Boxes stacked precariously (they could fall on someone) Noisy machinery (could result in damage to hearing) HOW TO PREVENT HAZARDS 1. Before installing a new machinery, study its features and impact on the work place 2. Before work starts, check equipment, review work place for potential hazards 3. During work, staff should be aware of changes such as unusual sound, a new smell, or even an intuitive feeling 4. After an accident, management should be informed and documented so that risks can be minimized or removed UNETHICAL PRACTICES THAT MAY BE HAZARDOUS 1. Deceptive packaging 2. Misbranding or mislabeling 3. False or misleading advertising 4. Adulteration 5. Weight understatement  6. Short measurement 7. Quantity understatement DECEPTIVE PACKAGING MISLEADING ADVERTISING A food product is labeled as “all natural” but contains a synthetic preservative. A product label contains a typo or misspelling. A food product is labeled as "gluten-free" even though it contains gluten. A juice drink is marketed as “100% pure” while it contains added sugars and flavors. DEFINITION OF RISK Risk is the likelihood that a person may be harmed or suffers adverse health effects if exposed to a hazard.’ Risk is the probability that actual results will differ from expected results Risk is the potential for harm. It is a prediction of a probable outcome based on evidence from previous experience. RISK EXAMPLES 1. Typhoon Yolanda 2. Asian financial crisis 3. PAL: Covid 19 pandemic ASIAN FINANCIAL CRISIS: Two Economic Indicators  Value of the Peso 1997 P26/$1 1998 P46.50/$1 2001 P53/$1 STOCK MARKET INDEX PSE index went down The peso dropped from 26 pesos per dollar from 3,448 to 1,000 at the start of the crisis to 46.50 pesos in early 1998 to 53 pesos as in July 2001. PSE Composite Index, the main index of the Philippine Stock Exchange, to fall to 1,000 points from a high of 3,448 points in 1997. The peso's value declined Common Risk Categories in Enterprise Risk Management (ERM): Business Risks Strategic risks - These are risks that arise from an organization’s business strategy and objectives. For example, entering a new market or launching a new product may have strategic risks associated with them. EXAMPLES: Sources Of Risk Changes in senior management and leadership. The introduction of new products or services. Mergers and acquisitions which prove unsuccessful. Market or industry changes, such as a shift in the needs or expectations of customers. Operational risks - These are risks that arise from an organization’s day-to- day activities and processes. Examples include technology failures, employee errors or supply chain disruptions Examples:  Bank fraud Technology failures Execution, delivery, and process management Employee practices and workplace safety Natural disasters and damage to physical assets Inclement weather, fire, or harsh weather conditions Clients, products, and business BANK FRAUD 1. Automatic Withdrawal Scams 2. Phishing Scams 3. Charity Scams. 4. Overpayment Scam 5. Cheque-Cashing Scams Legal compliance risks - These are risks that arise from an organization’s failure to comply with laws, regulations or industry standards. Examples include contract disputes, intellectual property disputes, employment law violations, data privacy violations or noncompliance with environmental regulations. Reputational risks - These are risks that arise from damage to an organization’s reputation, image or brand. Examples include product recalls, lawsuits or negative media coverage. EXAMPLE: In 2010, the non-profit Greenpeace company launched a campaign against one of Nestlé‘s leading products, KitKat, concerning the use of palm oil and the direct destruction of forests and the death of orangutans. This has led to an invasion of users on the Facebook page of the company who were asking not to use this product and thus avoid the harmful consequences. Financial risks - These are risks that arise from an organization’s financial operations and management. Examples include credit risk, market risk and liquidity risk. UNSUCCESSFUL MERGERS One unsuccessful merger in the Philippines was the proposed acquisition of Central Azucarera Don Pedro Inc. (CADPI) and Roxas Holdings Inc. (RHI) by Universal Robina Corporation (URC). The Philippine Competition Commission (PCC) blocked this merger, which was the subject of PCC Case No. M-2018-006 AOL and Time Warner (three giants: communications, publishing and content provider) The consolidation of AOL Time Warner is perhaps the most prominent merger failure ever. Warner Communications merged with Time, Inc. in 1989. In 2001, America Online acquired Time Warner in a megamerger for $147 billion; the estimated $361 billion combined value was the largest business merger up until that time Bank of America and Countrywide (2008) Value: $4 billion Goals: To expand Bank of America’s presence in the mortgage lending market by acquiring Countrywide’s extensive mortgage business. Obsolete/In danger of Obsolescence The deal between Bank of America and Countrywide turned out to be one of the worst failed company mergers. This happened mainly because Countrywide ran into serious financial trouble during the 2007 crisis. The deal between Bank of America and Countrywide turned out to be one of the worst failed company mergers. This happened mainly because Countrywide ran into serious financial trouble during the mortgage crisis in 2008. Countrywide struggled to get money to fund its operations when the market for mortgage-backed securities declined drastically in 2008. Countrywide struggled to get money to fund its operations when the market for mortgage- backed securities eBay and Skype eBay overestimated the synergies and paid too much for Skype, which only generated $7 million in revenue. eBay was unable to integrate Skype into its business. Daimler-Benz and Chrysler The merger resulted in a loss and the company eBay overestimated the synergies and paid too much for Skype, which only generated $7 million in revenue. eBay was unable to integrate Skype into its business. PRODUCTS NEARING OBSOLESCENCE DUE TO MARKET CHANGES IN THE PHILIPPINES IN GENERAL 1. Bataan Matamis Cigarette · 5. Typewriter 2. Sison's Ice Drops 6. Pager, beeper 3. Royal Lem-O-Lime Soft 7. TV in cabinet Drink 8. Stereo 4. Bottled juice 9. DVD, cassette 10. Mail thru the post office 11. Newspaper 12. Phone book NEW PRODUCTS/SERVICES Only two of the six digital banks in the country are profitable, with losses likely to persist in the medium term as the nascent industry  continues to find the right business model for their target market with a largely untested credit profile. “There are two among the six banks that are profitable, but the expectation is that it would take about five to seven years before a digital bank becomes profitable,” Bangko Sentral ng Pilipinas (BSP) Director Melchor Plabasan said at a press conference. LESSON 2: RISK RESPONSE MARKET RISKS The risk that an investor faces due to the decrease in the market value of a financial product arising out of the factors that affect the whole market Not limited to a particular economic commodity Often called systematic risk Market risk arises because of uncertainties in the economy, political environment, natural or human-made disasters, or recession Risk that arises from movements in stock prices, interest rates, exchange rates, and commodity prices Is the risk arising from changes in the markets to which an organization has exposure RISK RESPONSE STRATEGIES 1. Exit Strategy: Avoiding the activities that lead to risk. 2. Reduction Strategy: taking certain actions that decrease the impact of the risk. 3. Accept Strategy: No step is taken to mitigate risk. This is taken due to cost/benefit considerations. 4. Share or Insure Strategy: Transferring a certain component of risk so that impact is reduced. TYPES OF RISK RESPONSE Avoiding Risk – Also Known as Risk Avoidance Identification of the risks  Review of previous project experiences and histories. An analysis is then made upon those that have a tendency to arise A course of action is arrived upon after assessing the relative impact of the risks Examples (simple, average, extreme) 1. Risk Failure to complete a project – Set your goal; Outline tasks and time table 2. Risk: Fear of failure to adjust in an overseas job – a local job 3. Risk: Avoid or lessen business loss – discontinue plan to open a dress shop, study possibility of putting up a pop up Christmas bazaar 4. “Sacrificing potential benefits in order to eliminate “danger altogether” Mitigating Risk - a control process that essentially stops a risk before it starts making an impact and bringing it to an acceptable level. A contingency plan is put in place to prevent the risk. Accepting Risk - There are certain risks that are unavoidable. This strategy is the best when the risk is low. But there has to be a due plan for the same such as determining when the project will be exposed to the risk and making small adjustments accordingly. Example: A resignation of a key officer, Corporate piracy; a bank managers Issue: compensation package; plan – identify one-downs with potential highly successful family business, usually owned by first movers or pioneers, aging, what to do? Transferring Risk - Risk transfer is one of the better means to dilute the impact of the risk. In project management as in finance a risk is often transferred to a third party. The most common form of risk transfer is by buying insurance Example – Health insurance, Educational insurance, Fire Insurance Insurance - is a contract whereby one party guarantees another party’s protection against losses resulting from specific accidents or other events. The main parties involved are the insurer providing the insurance cover and the insured or the policyholder who receives the coverage in exchange for the premium. Insurance business results in massive funds collected from different sources such as individuals and companies. They use the money collected as a premium to engage in investment activities when needed, provide the rightful compensation to the policyholders. TYPES OF INSURANCE Customers require protection plans for various purposes; hence, various policies exist. Life Insurance: It pays out a fixed amount of money upon the insured person’s death or after a specific period. Health Insurance: It covers fully or partially a person’s medical expenses caused due to illness. Life Insurance is one of the pillars of personal financial planning. For many families, it provides a crucial safety net in the unfortunate event of a breadwinner’s passing. A life insurance policy’s death benefit can help survivors continue to make mortgage, car, and other loan payments and ensure that children have the opportunity for higher education. A family with two breadwinners needs life insurance on both, and a non-employed adult who manages the household also should have significant coverage. TERM LIFE INSURANCE WHOLE LIFE INSURANCE Benefits Benefits 1. Cheaper option 1. Policy stays in force 2. Easier to understand throughout the 3. Premium does not vary policyholder’s lifetime 2. Premium does not vary 3. Cash value component makes whole life a potential investment/tax management tool Drawbacks Drawbacks 1. Policy expires after a set 1. Much more expensive, any term outstanding loans will be  2. No cash value component deducted from death benefit 2. Beneficiary usually does not receive the cash value 3. Typically more difficult to understand TERM INSURANCE Term Insurance policy covers a few years, so premiums are more affordable than the whole-life insurance. Term insurance is a good option for: Parents with young children Adults with dependents capable of earning income Business partners with new business ventures” Why Term Life Insurance? Term life Insurance is the best investment option for those who only need coverage for a specific amount of time. By the time their coverage ends, they believe that their beneficiaries would have become financially stable enough even after their passing. The best group whose needs match this type of insurance are parents with young children. Let’s say that you are in your late- twenties and the parent of a newborn child. Should you pass away before your child can become a working adult, your savings and the income of whoever becomes your child’s guardian may not be enough to pay for your child’s future until they become adults.” WHOLE LIFE INSURANCE Whole life Insurance is the traditional life insurance most people know: you’re covered permanently and your policy will not expire as long as you pay your insurance premiums. Aside from the death benefit, your beneficiary will also be entitled to cash set aside and accumulated over time.” Best for:  Parents of children with special needs Family breadwinners Adults with dependents incapable of earning income Married couples with outstanding debt Business partners ENDOWMENT INSURANCE Endowment Insurance products offer savings and life insurance all in one go. It’s the best plan suited to those who want to save money for a large expense in the future. It is common for parents who want to save up for their children’s college funds, but it’s also an option for people saving up for expenses like home renovation, retirement funds, and other large expenses”. Best for: Parents who want to save up for their children’s education People saving for retirement People who want to save up for long-term goals “Why Endowment Insurance? It’s not the most popular choice for savers since a portion of your premiums go to the cost of your insurance. But compared to other forms of savings, this provides all three: keeping your beneficiaries covered while still earning enough for the future. Variable Unit-Linked Life Insurance (VUL) Also known as VULs, this is a combination of variable life insurance—think whole life insurance, but instead of a growing savings account, you choose to take a gamble on the market by investing in different assets such as bonds, equities, etc. Best for: People interested in investing and buying life insurance Young adults who want to take advantage of their low insurance premiums Why VUL Insurance? The latest numbers per Statista show that as of 2018, the insurance penetration rate in the Philippines is at around 3% (world average as of 2019 is 7.23%), which can be attributed to a number of factors. Typically considered a liability, it’s not seen as a profitable investment compared to high-return investment vehicles like stocks, bonds, and mutual funds. But VULs can provide both coverage for their loved ones in case of a fatal event while also providing an opportunity to benefit from the market. Buy Term and Invest the Difference (BTID) Insurance More of a strategy than a specific type of insurance Term life insurance premiums are more affordable, so you can use the money you saved to invest into other vehicles like mutual funds, stocks, and other investments to add to your portfolio. Best for: 1. Young professionals who want life insurance and profitable investments 2. People who have dependents that can eventually find their own income NON-LIFE INSURANCE Insurance contracts that do not come under the ambit of life insurance are called general insurance. The different forms of general insurance are fire, marine, motor, accident and other miscellaneous non-life insurance. NON-LIFE INSURANCE/GENERAL INSURANCE 1. Tangible assets are susceptible to damages and a need to protect the economic value of the assets is needed. 2. General insurance products are bought as they provide protection against unforeseeable contingencies like damage and loss of the asset.  3. Like life insurance, general insurance products come at a price in the form of premium TYPES OF NON- LIFE INSURANCE Auto Insurance 1. It covers loss or damage to any vehicle. In other words 2. It protects from financial loss brought on by the damage of an insured motor vehicle. 3. A famous example is car insurance. Travel Insurance 1. It protects from any accidental financial losses incurred while traveling, whether abroad or domestically 2. Travel-related costs, losses, and other listed expenditures are all covered by it Property insurance helps you protect your residence in the event of natural and unexpected disaster such as fire, flood, earthquake, storms, and volcanic eruptions. Products offered. Regular fire and with allied TYPES OF NON-LIFE INSURANCE 1. Regular fire and with allied perils 2. Industrial all risk 3. Commercial all risk 4. Trust receipts 5. Fire and lightning 6. Typhoon and flood 7. Earthquake, fire and shock 8. Riot, strike and malicious damage 9. Smoke damage 10. Vehicle impact 11. Falling aircraft 12. Explosion LESSON 3: ORGANIZATIONAL STRENGTH Corporate governance is strong and maintains a well balanced outlook towards the interest of all stakeholders Business ethics is embedded in the organizational culture and reflected in management decisions, employee behavior and in the manufacture of its products or delivery of services Internal controls are in place Who are stakeholders? Shareholders, management, employees, government, community, customers, suppliers, financiers CORPORATE GOVERNANCE System of rules, practices and processes by which business corporations are directed and controlled and it is about what the board of directors does and how it sets the values of the firm Purpose: To facilitate effective entrepreneurial and prudent management that can deliver long term success of the company To enhance shareholder value and protect the interest of all stakeholders” BASIC OBJECTIVES OF CORPORATE GOVERNANCE 1. Fair and equitable treatment of shareholders 2. Self-assessment (even before the firm is scrutinized by regulatory agencies) 3. Increase shareholders wealth 4. Transparency and full disclosure BASIC PRINCIPLES AND SOME BEST PRACTICES OF CORPORATE GOVERNANCE A. Transparency, Full Disclosure and Independence Information is formalized and disclosed to the public it serves A board should have independent directors (not major shareholders) B. Ethical And Responsible Decision Making Code of conduct necessary to maintain confidence in the company’s integrity Disclose policy concerning trading in company’s securities by directors, officers and employees Integrity in financial reporting C. Corporate Control To ensure the integrity, transparency and proper governance in the conduct of its affairs, the company should have a strong and effective internal control system a Establish an audit committee Recognize and manage risk Encourage enhanced performance, remunerate fairly and responsibly and enterprise risk management framework LESSON 4: BUSINESS ETHICS INTRODUCTION TO ETHICS Ethics can be defined broadly as a set of moral principles or values that govern actions and decisions of an individual or group CHARACTERISTICS AND VALUES ASSOCIATED WITH ETHICAL BEHAVIOR Integrity – principled, honorable, Not two-faced, does not adopt upright, courageous, act on “end-justifies the means” conviction philosophy Honesty – truthful, sincere, Does not cheat, steal, lie, deceive, forthright, straightforward, frank, act deviously candid Trustworthiness and promise Does not interpret agreements in keeping – full commitments, abide unreasonable, technical, legalistic by the spirit and the letter of an manner agreement Loyalty, Fidelity, Confidentiality – Does not use or disclose faithful and loyal to family, friends, information learned in confidence, employers, client and county professionally, safeguards influence and conflict of interest Fairness and openness – Fair and Does not overreach, open-minded, willing to admit error, Does not take advantage of where appropriate, change another’s mistake or diversities positions and beliefs, demonstrates a commitment to justice, equal treatment Care for others – kind, Avoids harming others compassionate, giving, of service to others Respect for others – demonstrates Does not patronize, embarrass or respect for human dignity, privacy demean and the right to self determination of all people, courteous, prompt, decent, shares information VALUES Responsible citizenship Obey just laws If law is unjust, openly protest it Exercise all democratic rights, social consciousness, public service When in a position of authority, honor democratic processes of decision making Avoid unnecessary secrecy or concealment of information Pursuit of excellence Excellence in all matters, personal and professional responsibilities Diligent, reliable, industrious and committed  Performs all tasks with the best ability Maintains a high degree of competence Is not content with mediocrity BUSINESS ETHICS Refers to standards of moral conduct, behavior and judgment in business It is an area of corporate responsibility where businesses are legally bound and socially obligated to conduct business in an ethical manner It is based on the personal values and standards of each person engaged in the business Its purpose: to help business to determine what practices are right and what are wrong PURPOSES OF BUSINESS ETHICS To help business to determine what practices are right and what are wrong To make sure that businessmen realize that they cannot employ double standards to the actions of other people and to their own actions Common practices which businessmen have thought to be right because they see others doing it, are really wrong To serve as a standard or ideal upon which business conduct should be based SCOPE AND IMPACT OF BUSINESS ETHICS Business ethics has an - Economic Impact If employees’ compensation are fair living wages and benefits  It will have a positive effect on its suppliers if they are paid fairly and on time Social Impact If businesses resort to bribes, accounting fraud or breach of regulatory and legal limitations in their operations Corruption in the business may result to unwarranted increase in price of the goods, or a reduction in the quality of the product IMPACT OF BUSINESS ETHICS ON MANAGERS The manager is Is expected to act in the best interest of the business, and never in a manner that is contrary to law or his conscience Should serve the business enterprise and the community Should avoid use of executive power for personal gain or advantage or prestige Should reveal to his superior whenever his personal business or financial interest is in conflict with those of the company he works for Be actively concerned with difficulties and work-related problems of subordinates Should lead by example and assure them of reasonable access Should recognize that his subordinates have a right to information on matters affecting them through proper communication, unless informing them shall undermine the security of the business Fully evaluate the likely effects on employees and the community of business plans before taking a final decision Cooperate with his colleagues and not attempt to secure personal advantage at their expense COMMON UNETHICAL PRACTICES OF BUSINESS ESTABLISHMENTS Direct misrepresentation 1. Deceptive packaging 2. Misbranding or mislabeling 3. False or misleading advertising  4. Adulteration 5. Weight understatement 6. Measurement understatement SOME UNETHICAL PRACTICES OF BOARD OF DIRECTORS 1. Graft 2. Interlocking directorship 3. Negligence of duty 4. Insider trading SOME UNETHICAL PRACTICES OF EXECUTIVE OFFICERS AND MANAGERS 1. Claiming a vacation trip as a business trip 2. Having an employee do work unrelated to business 3. Loose or ineffective controls 4. Making false claims about losses to free themselves from paying right compensation 5. Making employees sign documents that they are receiving fully what they are entitled to under the law, when in fact, they are not 6. Unfair labor practices UNFAIR LABOR PRACTICES 1. Prevent employees from exercising their right to self organization 2. To impose a condition of hiring only if an applicant shall not join a labor organization 3. To outsource services or functions being performed by union members 4. To assist, dominate or assist in the formation or administration of any labor organization 5. To discriminate via wages, hours or terms/conditions of employment in order to encourage or discourage membership in any labor organization 6. To dismiss, discharge or otherwise prejudice or discriminate, against an employee for giving or preparing to give testimony under the Labor Code  7. To violate the duty to bargain collectively as prescribed by the Labor Code 8. To pay negotiation or attorney’s fees to the union or its officers or agents as part of the settlement of any issue on collective bargaining agreement 9. To violate or refuse to comply with voluntary arbitrations awards or decisions pertaining to CBA 10. To violate any provision of the CBA SOME UNETHICAL PRACTICES OF EMPLOYEES Conflict of interest 1. An employee whose family owns a business competitor of the company he works for should not say, or do anything prejudicial to his employer 2. an employee should not receive any favor or gift from a customer, supplier or competitor 3. He should not disclose any confidential information for his personal gain 4. The employee engages in the same type of business as his employer. 5. The employee uses for his own benefit a business opportunity in which his employer might be expected to have an interest Dishonesty 1. Taking office supplies home for personal use 2. Padding an expense account through the use of fake receipts when claiming reimbursement 3. Taking credit for another employee’s idea LESSON 5: RISK MANAGEMENT THE GREAT DEPRESSION A worldwide economic downturn that began in 1929 and lasted until about 1939. It was the longest and most severe depression ever experienced by the industrialized Western world, sparking fundamental changes in economic institutions, macroeconomic policy, and economic theory. Although it originated in the United States, the Great Depression caused drastic declines in output, severe unemployment, and acute deflation in almost every country of the world. VALUE OF PESO 1997 P26/$1 1998 P46.50/$1 2001 P53/$1 STOCK MARKET INDEX PSE Index went down 2007-2009 GLOBAL FINANCIAL CRISIS from 3,448 to 1,000 It is widely referred to as “The Great Recession.” It began with the housing market bubble, created by an overwhelming load of mortgage-backed securities that bundled high-risk loans. Reckless lending led to unprecedented numbers of loans in default; bundled together, the losses led many financial institutions to fail and require a governmental bailout. Efforts to revive the economy were made through the American Recovering and Reinvestment Act of 2009 The crisis led to the collapse of several large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. The crisis led to a global recession, with millions of people losing their jobs and homes. The crisis also led to significant changes in the regulation of financial markets and institutions. ORIGIN OF RISK MANAGEMENT Early development emerged in the United States out of the insurance management function In the 1950’s insurance costs became prohibitive and the extent of coverage was limited Organizations realized that purchasing insurance was insufficient if there was inadequate attention to the protection of property and people. In the 1970’s the combined approach to risk financing and control was developed in Europe As this approach became established, It became obvious that there were many risks facing organizations that were not insurable THE IMPORTANCE OF RISK MANAGEMENT IN SPECIFIC AREAS OF BUSINESS Variable costs of raw materials Variable costs of raw materials can be a risk because price fluctuations can impact a manufacturer’s production costs and profitability. Cost of retirement and social As the average age of the work benefits force increases, retirement cost, health and other social benefits become costlier; succession, if not addressed can also present a risk Desire to deliver greater A desire to deliver increased shareholder value shareholder value can be risky because it can lead to short-term thinking, neglect of other  stakeholders, and overly risky financial engineering. Greater transparency required to Sharing too much information and required from organizations can slow down productivity, especially when teams are on tight schedules. Too much transparency can contribute to the dissemination of doubt and confusion Pace of changes in business ever Change Management risks refer to increases potential negative outcomes that could occur during the process of implementing a change. These include things like operational disruptions, financial losses, or security vulnerabilities. Impact of e-commerce on all Threats: cyber security, data privacy, aspects of business life logistics and competition Increased reliance on IT systems Increasing reliance on technology and the proliferation of digital devices in daily life will create increasing risks related to ‘Data privacy’, cyberattacks, and consequences of system failure. Increasing importance of Protecting trademarks, designs, intellectual property inventions, etc. can result to financial loss, damage to reputation, loss of competitive advantage Greater supply chain 1. Suppliers can go out of business, complexity/ dependency not deliver products on time, or not deliver the correct quantity. 2. Natural disasters, economic downturn. political instability can disrupt the supply chain. Reputational damage – especially Loss of customers, business to worldwide brands partners. high employee turnover High profile losses and failures ruin Biggest ever accounting fraud case: reputations Lehman Brothers -the most notorious accounting fraud case in  the global financial crisis - firm hid over $50 billion in loans disguised as sales. Example: Increased Reliance on IT Systems RISK MANAGEMENT In General Is the process of measuring or assessing risk and developing strategies to manage it. Is a systematic approach in identifying and controlling areas or events with a potential for causing unwanted change In Business Is the identification, assessment and prioritization of risks, followed by coordinated and economical application of resources to minimize, monitor and control the probability or impact of unfortunate events and to maximize the realization of opportunities. The process of minimizing or mitigating the risk Starts with the identification and evaluation of risk followed by optimal use of resources to monitor and minimize the same A risk prioritization process is followed - those risks that pose the threat of great loss and have great probability of occurrence are dealt with first. ENTERPRISE RISK MANAGEMENT Is a process, effected by an entity’s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives. COMMONLY USED TERMS 1. Business risk – the possibility that the business may not be able to generate sufficient revenue, or an increase in production and operating costs may occur. 2. Credit risk – the risk that a counter-party will pay to fulfill his obligation 3. Default risk – related to the probability that some or all of the initial investment will not be returned 4. Counter-party – the other party such as the borrower or customer who has an agreement with the principal party 5. Risk appetite - Is the level of risk that the company can accept in pursuit of its objectives. (risk aversion vs. risk tolerance) 6. Pure risks – refers to the prospect of a loss such as the risk that a plant may be destroyed by a fire 7. Speculative risks – refers to the chance of a gain but might result in a loss, ex. Investment in a new project, or marketable securities 8. Demand risks – the probability that the demand for a product or services will change 9. Input risks – refers to production costs such as labor and materials that face the risk that they may increase and the company may not be able to pass such increases to their customers 10. Environmental risks – risks from forces of nature, ex. climate change 11. Financial risks – risks that interest rates and exchange rates may change and thus result to unexpected increase in costs BENEFITS OF RISK MANAGEMENT 1. Forecasts probable issues 2. Avoids catastrophe 3. Enables growth 4. Helps to stay competitive 5. Improves business process 6. Enables better budgeting Forecasts Probable Issues Remember the list of 11 risks in specific areas One of the benefits of risk management is that it changes the culture of a business organization. Companies that tend to focus more on risk management tend to be more proactive as compared to other companies which can be reactive. Risk management forces the companies to take a hard look at each of their business processes and decide what can possibly go wrong. This detailed what-if analysis helps companies become more proactive and forecast probable issues. Avoids catastrophe Risk management prepares the companies for ali kinds of shocks. Risk managers try to foresee the small shocks which affect the day-to- day business of any firm. However, they also try to focus on catastrophic events. Such events have a very low probability of occurring. However, if they do occur, then companies need to be prepared to deal with them without going bankrupt Enables growth When new products have to be launched or when new markets have to be entered, companies have a ready framework that can be deployed in order to avoid these risks.  Hence, in a way, risk management ends up enabling companies to take calculated risks and expedite their growth. Extensive risk management processes mean that the company has a lot of data. This data can be mined in order to gain meaningful insights which ultimately leads to better decisions. Helps to stay competitive Adverse events (recession) afloat lot of cash, continue to stay afloat During crisis some companies seem to have the extra cash than is required therefore, they can make acquisitions. Risk management processes force different departments, stakeholders to actively communicate with each other. This communication is helpful since it increases the competitiveness of the company. Improves business process Continuously monitor the working or various departments look for things that can go wrong Able to identify the parts of the process which are inefficient or where there is scope for improvement Business process reengineering) Result Companies that have risk management processes in place have better control of their finances as opposed to other companies. Risk management requires plenty of information The day-to-day processes of risk management force companies to collect more and more information about their processes and operations. As a result, companies are able to identify the parts of the process which are inefficient or where there is scope for improvement. BASIC PRINCIPLES OF RISK MANAGEMENT For Risk Management to be effective: 1. It should create value, meaning its benefits should exceed its costs 2. Management should first identify uncertainties and reasonable assumptions should be in place 3. It should be an integral part of the organization, its decision-making process and can only succeed under a supportive culture 4. It should be dynamic (responsive to change) transparent and well communicated 5. Its practice should allow flexibility in order to have room for enhancement if information and human factors so require 6. It should be systematic, structured and subject to periodic review LESSON 6: RISK MANAGEMENT PROCESS The process includes five specific elements: Strategy/Objective setting: Understand the strategies and associated risks of the business. Risk identification: Provide a clear profile of major risks that can negatively impact the company’s overall financials. Risk assessment: Identified risks are strictly analyzed to determine both their likelihood and potential. Risk response: Consider various risk response strategies and select appropriate actionable paths to align identified risks with management’s risk tolerances. (avoidance, reduction. Sharing, retention) Communication and monitoring: Relevant information and data need to be constantly monitored and communicated across all departmental levels. RISK MANAGEMENT FLOWCHART 1. Strategy/Objective Setting 2. Risk Identification 3. Risk Assessment 4. Risk Response 5. Communication & Monitoring EXAMPLES OF AN ENTERPRISE RISK MANAGEMENT PROCESS 1. Strategy/Objective setting: Consider Tesla, a publicly traded company operating in two primary segments – automotive and energy generation. In this example, ERM will begin by considering what drives the company’s value during the strategy/objective setting. For Tesla, this could include the company’s competitive advantage, new strategic initiatives, key product lines, or an acquisition 2. Risk identification: Once the key drivers are identified, the ERM process will begin the risk identification process by evaluating relevant risks that can potentially hinder the success of each key driver. 3. Risk assessment: The risks must then be carefully analyzed from cross-departmental views during the risk assessment step. 4. Risk response: Once the discussion and acknowledgment of the potential risks are finalized by upper management, executives will consider an optimal risk response strategy. 5. Communication and monitoring: Finally, upper management will measure, monitor, and communicate the effectiveness of the risk response strategies by utilizing any key risk indicators deemed effective by that organization. MANILA WATER Manila Water continues to implement its Enterprise Risk Management (ERM) Program based on a globally-accepted approach, the ISO 31000:2009.  The program helps Manila Water and its subsidiaries monitor and manage the strategic, regulatory, operational and financial risks. It is a proactive process that is well linked to corporate goals and objectives, embedded in the corporate culture and is well integrated into critical and strategic planning and operational processes of the company. The ERM Program has been cascaded to all the departments in Manila Water. he same has been implemented in its subsidiaries in Boracay, Cebu, Clark DETAILED STEPS IN IMPLEMENTING THE RISK MANAGEMENT PROCESS 1. Set up a RM committee chaired by a board member 2. A formal comprehensive RM system should be in place 3. The said system should have: a. Goals and objectives b. Risk language definition c. Organizational structures d. Documentation 4. RM process should follow these steps: a. Risk assessment: identification, determination of the source b. Develop and implement an action plan - reduce, avoid, retain, transfer or exploit c. Monitor and report RM performance d. Continuous improvement of RM capabilities 5. Perform a periodic evaluation of risks and corresponding RM strategies adopted by the enterprise 6. Observe and replicate best practices of other organizations RISK MANAGEMENT PROCESS – KFC Develop and implement an action plan - reduce, avoid, retain, transfer or exploit: Although KFC does not have 100% control all areas of supply chains, it does have the ability to influence the terms of its contracts with its suppliers. For example, it can use its 2018 experience to argue for increased supplier accountability in the event of interruption. The final agreement should specify that both parties assume financial responsibility. If the suppliers fail to furnish the required ingredients, they must compensate for the resulting financial losses. As long as this detail is addressed in the contract, the corporation will be able to manage such a risk. Monitor and report RM performance Continuous improvement of RM capabilities To continue operations, the corporation needed to immediately rearrange its logistics. RISK MANAGEMENT CYCLE Assess Evaluate Manage Measure RISK MANAGEMENT FRAMEWORK EIGHT R’S AND FOUR T’S 1. Recognition or identification of risks and identification of the nature of the risk and the circumstances in which it could materialize 2. Rating and evaluation of risks in terms of magnitude and likelihood to produce the ‘risk profile’ that is recorded in the risk register  3. Ranking or analyzing the level of risk against the established risk criteria 4. Responding to the significant risks and deciding on the appropriate action: (a) tolerate, (b) treat (c) transfer or (d) terminate 5. Resourcing controls to ensure adequate arrangements are made to institute controls 6. Reaction planning and event management, including disaster recovery in case of hazard risks, as well as business continuity planning 7. Monitoring of risk performance and communicating remaining risk issues 8. Reviewing the risk management system, internal audit procedures, review and updating of risk strategy and protocols PHILIPPINE CASES ON RISK MANAGEMENT 1. Risk Management in Disaster Response and Preparedness: Typhoon Haiyan (Yolanda) 2. Philippine Financial Institutions: The Case of the Asian Financial Crisis (1997 – 1998) 3. Philippine Airlines: Crisis Management During the COVID-19 Pandemic 4. San Miguel Corporation: Risk Management in Business Diversification 5. PhilHealth (Philippine Health Insurance Corporation): Managing Fraud Risk and Financial Sustainability 6. Risk Management in the Philippine Agriculture Sector: Typhoon- Related Losses: Risk and Financial Sustainability PRACTICAL GUIDELINES IN REDUCING AND MANAGING RISKS 1. Understand the nature of the risk 2. Identify and prioritize the risks 3. Consider the acceptable level of risk 4. Understand why risks become reality TYPICAL AREAS OF ORGANIZATIONAL RISK Financial inefficient cash management  Commercial market changes Strategic marketing entry, marketing decisions Technical equipment failure Operational failure to maintain supply TYPICAL RISK CATALYSTS 1. Technology - new system, new hardware 2. Organizational change – new management, new agreements 3. Processes – new products, new markets 4. People – losing key people, lack of succession planning 5. External factors – changes in regulation, political, economic or social disruptions WHAT COMES NEXT? 1. So far, the previous topics identify the factors that may trigger risk 2. The next step is to quantify them Pointers: a. Risks that lead to frequent losses can often be solved using past experience b. Unusual or infrequent losses may be harder to quantify 3. Once Identified, Control the Risks a. Share information b. Prepare and communicate guidelines c. Establish control procedures and risk management systems CONTROL THE RISK 1. Install accident prevention and emergency equipment 2. Train people to use them 3. Take security measures to prevent crime, sabotage, espionage, etc. 4. Share risks through: a. Joint ventures b. Licensing agreements  5. More collaborative and flexible way to enter a new market a. Can combine your strengths, resources, and capabilities with a partner. b. Can also benefit from the local knowledge, contacts, and credibility of a partner c. Share the costs and risks of the venture Quality assurance programs This system involves standardizing processes, training employees, and monitoring operations to ensure products meet quality standards. ISO 9000 is an internationally recognized QMS that encourages the production of high- quality goods and services. Environmental and control Regulating and managing processes environmental factors to maintain desirable conditions such as temperature, humidity, airflow, air quality, noise, and vibration Health and safety regulations Personal protective equipment, laws on hazardous substances PRACTICAL TECHNIQUES TO IMPROVE PROFITABILITY Focus decision making on most profitable areas Decide how to treat least profitable products Make sure new products enhance overall profitability Manage development and production decisions Set the buying policy Consider how to create greater value from existing customers Develop people through training, motivation, support and good leadership CONTROL COSTS Focus on big item expenditures  Be cost conscious Maintain a balance between cost and quality Use budgets for better financial management Develop a positive attitude to budgeting Eliminate waste Understand the impact of cash flow MANAGE COSTS TO AVOID PITFALLS Understand the impact of cash flow Financial expertise must be widely available Consider the impact of financial decisions Avoid weak budgetary control Know where the risks lie TAKE ACTION, REVIEW STRATEGY Improve profitability Avoid pitfalls in making financial decisions Reduce financial risks Note: Profitability and cost control will be illustrated during the discussion on financial control INTERNAL CONTROL (INTRODUCTION) Management 101 – planning, organizing, leading/motivating and controlling What does controlling entail? – evaluating how well an organization is achieving goals, putting processes and taking action in case of variance between objectives and actual performance COSO Definition – a process effected by an entity’s board of directors, management and other personnel designed to provide reasonable assurance of the achievement of objectives in the following categories: 1. Operational effectiveness and efficiency 2. Financial Reporting Reliability 3. Applicable laws and regulations compliance *Committee of Sponsoring Organizations (read COSO framework) FIVE INTERRELATED COMPONENTS OF INTERNAL CONTROL 1. Control Environment is the responsibility of the BOD, To set the philosophy and operating style of an organization To assign authority and responsibility to the officers who comprise the management To organize and develops its people To establish a management control system that includes: a. Internal audit function b. Personnel policies and procedures c. Delineation and segregation of duties 2. Risk Assessment process refers to management’s Ability to initiate, record, process and report financial data Identify, analyze and manage risks pertaining to the preparation of the financial statements Once identified, assess he risks as to significance, likelihood of occurrence and how they should be managed Establish action plans and programs to address specific risks 3. Information system and business processes relevant to financial reporting and communication Journal entries, general ledgers, financial reports (balance sheet, income statement, statement of cash flows, changes in capital) Consists of procedures and records designed and established to a. Initiate b. Record, process report transactions of the company c. Maintain accountability for each particular asset, liability or equity that is being recorded and reported Transfer information from transaction processing to general ledger Capture information relevant to financial reporting for events and conditions, such as depreciation and amortization Resolve incorrect processing  Process and account for system overrides Ensure information required to be disclosed is accumulated, recorded, processed, summarized and appropriately reported in the FS