Application of risk managementBy Tauqir Haider

Basics of risk management: Risk management is the process of measuring, or assessing, risk and developing strategies to manage it. Strategies include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, and accepting some or all of the consequences of a particular risk. (Source Wikipedia website)

The business world has its own sets of risks. How a company deals with these risks impacts directly on all the people dealing with this company, its clients, employees, creditors, owners, suppliers and those living in the vicinity of its operations.

Because of this multiplier effect it is of utmost importance that companies and governments have proper risk management strategies in place. Failure to do so amounts to denial of their social responsibilities. One unfortunate circumstance in Pakistan is that the implementation of this discipline has been restricted to only the banking industry and its cash assets. In the rest of the world this discipline encompasses all possible risks, theft, destruction, political risk, cash, environment, employee health, product liabilities, professional liabilities, weather, etc. etc. Very sophisticated financial and electronic tools have been developed to evaluate and manage risks both nationally and internationally. The impact on the balance sheet of companies using these tools is dramatic.

Emergence of risk management

Risk Management is the discipline of looking ahead to discover which events may prevent a chosen course of action to achieve its objective and how these events can either be eliminated or controlled in their impact.

Mankind has been obsessed with this discipline for as long as we walked the earth and have designed many techniques to deal with it. These techniques range from carrying a talisman or a lucky dollar to fortunetellers and star readers and ultimately to the multinational financial behemoths of insurance companies.

Most businesses in the past centuries have transferred some of their risks to insurance companies in exchange for a premium payment. Insurance companies in their search for more business and more profits have hired agents and brokers to sell more of their products to more clients in exchange for a sizeable commission.

It is only when business owners realised that the costs of this distribution system and its inherent conflict of interest did not work to their advantage that the discipline of Risk Management came into its own right.

The conflict of interest comes from the fact that agents and brokers are paid by the insurance companies to produce sales. Consequently, they only solve risk problems through more insurance sales and then only solve those problems that fit the available products of the insurance companies they represent.

Risk Management as a discipline is an objective look at all the risks a business faces, evaluating them, prioritising them and solving them. This process often does not involve insurance or transfer of risk, but requires practical solutions. For example: providing protective footwear to your employees may be a much more practical and cost effective manner to solve your problem than buying insurance for such risk.

With this realisation and the ever-increasing demands from better-educated consumers and employees the business world brought the management of their risk "in house". They hired and trained professionals who were on the payroll of the company rather than commission driven marketing people, to handle all aspects of their risks.

When the broker industry saw their business disappear, they reacted by consolidating ferociously and repositioning themselves very often as risk consultants. This however did not solve the fundamental problem of their inherent conflict of interest.

A professional Risk Manager should be completely independent from the insurance industry in order to be able to provide advice and solutions, which are in the best interest of those they serve. This can be obtained by either bringing the service "in house" or hiring consultants on a fee for service basis. Any Risk Manager worth their "cup of tea" should be able to earn this fee back for their employer/client in a short time by improved protection and lower insurance costs.

In comparison with Pakistan the Risk and Insurance Management Society (RIMS) based in New York is one of the most prestigious international organisations in this field advocating the above principles. It celebrated its 50th anniversary this year. Their annual convention gathers some 15,000 people, active in the international Risk Management business. But in Pakistan we are still on the confusion of having a start for it whereas, internationally this has emerged as a major department in many organisations. The right steps in this field can lead to a competitive business environment.

Risk management in Pakistan

It has unfortunately never fully developed as elsewhere in the world. There are several reasons for this phenomenon.

(a) The government's overly protective attitude towards the insurance business: By forcing all insurance through local companies and severely limiting the operations of foreign insurance companies the government has provided handsome profits to the local players, but also substantially limited the knowledge, development, competition and products needed in these local companies for a modern economy.

(b) The monopoly of only a few large insurance broker firms in the country: With only a few brokers sharing the substantial Pakistani insurance market a virtual monopoly was created, which had everything to gain from preventing modern business practices, such as Risk Management, to take hold in their market.

(c) The very adaptive attitude of buyers and sellers to the business practices of the New Regime in the last decades: Collusive practices between insurer and insured, as well as wide spread pay off practices to the people involved in the actual buying process are major incentives for not installing more modern and transparent business systems in dealing with risks.

Collectively these practices have shielded the insurance/broker business from developments taking place elsewhere in the world. They have kept the Pakistani business world from staying in tune with international developments in this area.

Risk management and cultural values

The cultural and religious realities in Pakistan place a very strong emphasis on "accepting one's fate". Everything is in the hand of God, who arranges everything for the betterment of mankind. Interfering in this process is very often felt as an act of disobedience, disrespect and sometimes as rebellious.

Risk Management deals with the daily lives of a lot of people and those involved in the discipline should have a great deal of respect and understanding of what is important in the lives of those whom they are trying to protect.

One more important argument why it should be entrusted to independent professionals, rather than commercially driven marketing people.

The process of risk management

A properly functioning Risk Management program should encompass the following elements: (1) Make an inventory of all possible risks facing a company, covering areas such as finance, assets, liabilities, markets, products, environment, employees, politics, suppliers, etc.; Prioritise these risks; (2) Determine with the company people involved what the best ways are of dealing with these risks in a practical manner; (3) Select which risks will be retained by the company and which risks or parts thereof should be transferred to an insurance company; (4) Determine which particular clauses should be built into this insurance contract in order to provide optimum value and protection to the company; (5) Based on the above elements, prepare the specifications for submission to selected reputable insurance companies, based in their financial strength and expertise. This process may involve pooling several subsidiaries within the Client Company and risk sharing with the insurance company; and (6) Select the best offer and install the contract.

The process will provide the company with a transparent, comprehensive and very cost-effective plan to deal with unforeseen liabilities. One can never eliminate risk, since being in business means: taking risks. However, with proper planning and protection risks can be contained and prevented from becoming a calamity, which may destroy the whole company. That is the discipline of Risk Management.

Pakistan's changing business climate

One of the consequences of the monetary crisis to Pakistani business is the opening up to more international ownership and influence. With that comes the requirement for companies to adjust to international business practices, including proper Risk Management. Joint venture companies may find such requirements imposed by foreign partners and have to find the necessary expertise for its implementation. Local companies will find the competitive pressure to live up to the standards hard to resist.

The time has come for Pakistani business to make up for the lost ground in Risk Management and expand its practice from the current limited bank / cash territory to the full range of its discipline. The substantial cost savings involved and improvement of risk protection should be enough incentive for the Pakistani business to take the initiative and make the necessary steps to its full implementation. No business serious about survival can afford to continue paying for risk protection which leaves some of the most damaging risks exposed, while affording too expensive a protection for the less important risks. Modern technology is rapidly changing the business landscape and forging one international market place, including Pakistan. In order to remain competitive in this market place everyone has to make the best use of available business systems and practices.

Conclusion

Risk Management is an international discipline, which allows businesses to properly assess the many risks they face and design appropriate solutions to either wholly prevent them or prevent them from becoming disasters. This discipline allows companies to move decidedly from Crisis Management to Risk Management. In the process they improve their balance sheets and the lives of all the people involved in the company, directly or indirectly