Risk Management is the process of measuring, or assessing risk and
then developing strategies to manage the risk. In general, the
strategies employed 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.
risk management focuses on risks stemming from physical or legal
causes (eg fires, accidents and lawsuits). In ideal risk management,
a prioritization process is followed whereby the risks with the
greatest loss and the greatest probability of occurring are handled
first, and risks with lower probability of occurrence and lower loss
are handled later. In practice the process can be very difficult, and
balancing between risks with a high probability of occurrence but
lower loss vs a risk with high loss but lower probability of
occurrence can often be mishandled.
management also faces a difficulty in allocating resources properly.
This is the idea of opportunity cost. Resources spent on risk
management could be instead spent on more profitable activities.
Again, ideal risk management spends the least amount of resources in
the process while reducing the negative effects of risks as much as
STEPS IN THE RISK
definitive generic description of risk management that originated in
Australia and New Zealand, now being taken up in many other
countries, is set out in the Australian & New Zealand Standard
4360:2004. The core of the process is a series of five steps:
parallel with the core process, communication & consultation is
required to ensure adequate information is provided and conclusions
are disseminated. Monitoring and review is an intrinsic part of the
process required to ensure that the process is executed in a timely
fashion and the identification, analysis, evaluation and treatment
are kept up to date.
- Establish the
- Identify risks
- Analyse risks
- Evaluate risks
- Treat risks
standard can be found at www.standards.com.au and simple guidance on
its application can be found at
the context includes planning the remainder of the process and
mapping out the scope of the exercise, the identity and objectives of
stakeholders, the basis upon which risks will be evaluated and
defining a framework for the process, and agenda for identification
establishing the context, the next step in the process of managing
risk is to identify potential risks. Risks are about events that,
when triggered, will cause problems. Hence, risk identification can
start with the source of problems, or with the problem itself.
either source or problem is known, the events that a source may
trigger or the events that can lead to a problem can be investigated.
- Source analysis
Risk sources may be internal or external to the system that is the
target of risk management. Examples of risk sources are: stakeholders
of a project, employees of a company or the weather over an airport.
analysis Risks are related to identified threats. For example: the
threat of losing money, the threat of abuse of privacy information or
the threat of accidents and casualties. The threats may exist with
various entities, most important with shareholder, customers and
legislative bodies such as the government.
withdrawing during a building project may endanger funding of the
ideas may be stolen by employees and used to set up a competing
chosen method of identifying risks may depend on culture, industry
practice and compliance. The identification methods are formed by
templates or the development of templates for identifying source,
problem or event. Common risk identification methods are:
Risk Identification Organizations and project teams have
objectives. Any event that may endanger achieving an objective partly
or completely is identified as risk. Objective-based risk
identification is at the basis of COSO's Enterprise Risk Management -
Risk Identification In scenario analysis different scenarios are
created. The scenarios may be the alternative ways to achieve an
objective, or an analysis of the interaction of forces in, for example,
a market or battle. Any event that triggers an undesired scenario
alternative is identified as risk.
Risk Identification The taxonomy in taxonomy-based risk
identification is a breakdown of possible risk sources. Based on the
taxonomy and knowledge of best practices, a questionnaire is compiled.
The answers to the questions reveal risks.
Checking In several industries lists with known risks are available.
Each risk in the list can be checked for application to a particular
situation. An example of known risks in property.
risks have been identified, they must then be assessed as to their
potential severity of loss and to the probability of occurrence.
These quantities can be either simple to measure, in the case of the
value of a lost building, or impossible to know for sure in the case
of the probability of an unlikely event occurring eg a shopper suing
a shopping centre for an accident caused by a slippery floor.
Therefore, in the assessment process it is critical to make the best
educated guesses possible in order to properly prioritize the
implementation of the risk management plan.
fundamental difficulty in risk assessment is determining the rate of
occurrence since statistical information is not available on all
kinds of past incidents. Furthermore, evaluating the severity of the
consequences (impact) is often quite difficult for immaterial assets.
valuation is another question that needs to be addressed. Thus, best
educated opinions and available statistics are the primary sources of
information. Nevertheless, risk assessment should produce such
information for the management of the organisation that the primary
risks are easy to understand and that the risk management decisions
may be prioritized. Thus, there have been several theories and
attempts to quantify risks. Numerous different risk formulae exist,
but perhaps the most widely accepted formula for risk quantification
of occurrence multiplied by the impact of the event equals risk
research has shown that the financial benefits of risk management are
not so much dependent on the formulae used. The most significant
factor in risk management seems to be:
- risk assessment
is performed frequently
- it is done
using as simple methods as possible.
business it is imperative to be able to present the findings of risk
assessments in financial terms.
risks have been identified and assessed, all techniques to manage the
risk fall into one or more of these four major categories:
- Reduction (aka
- Acceptance (aka
use of these strategies may not be possible. Some of them may involve
trade offs that are not acceptable to the organization or person
making the risk management decisions.
not performing an activity that could carry risk. An example would be
not buying a property so as not take on the liability that comes with
the investigation of the minutes of a strata title body corporate
administrating the plan of an investment unit it is discovered that
they have not insured the building as required under the act.
Therefore, to avoid the possibility of the loss of the value of the
investment asset by the body corporate being unable to rebuild after
say, fire and any fines or legal consequences of not abiding by the
act the investor has decide not to buy the unit.
may seem the answer to all risks, but avoiding risks also means
losing out on the potential gain that accepting (retaining) the risk
may have allowed.
buildings in the inner suburbs of Sydney inevitably have had some
“illegal” structures added over the years (such as a laundry
attached to the rear of the house). The investor may wish to avoid
the risk of buying a building with an illegal addition but in doing
so will miss out on a number of profitable opportunities in the inner
suburbs of Sydney.
entering an investment to avoid the risk of loss also avoids the
possibility of earning the profits.
reduction involves methods that reduce the severity of the loss.
Examples include sprinklers designed to put out a fire to reduce the
risk of loss by fire. This method may cause a greater loss by water
damage and therefore may not be suitable. Halon fire suppression
systems may mitigate that risk, but the cost may be prohibitive as a
accepting the loss when it occurs. True self insurance falls in this
category. Risk retention is a viable strategy for small risks where
the cost of insuring against the risk would be greater over time than
the total losses sustained. All risks that are not avoided or
transferred are retained by default. This includes risks that are so
large or catastrophic that they either cannot be insured against or
the premiums would be infeasible. War is an example since most
property and risks are not insured against war, so the loss
attributed by war is retained by the insured. Also any amounts of
potential loss (risk) over the amount insured is retained risk. This
may also be acceptable if the chance of a very large loss is small or
if the cost to insure for greater coverage amounts is so great it
would hinder the goals of the organization too much.
transfer causes another party to accept the risk. For an investment
property insurance is risk transfer that using contracts. Other times
it may involve contract language that transfers a risk to another
party without the payment of an insurance premium. For example a
tenant may accept the risk as part of the lease agreement. The rent
review clause of a typical lease manages the risk of the rent falling
below a market rent.
ways of managing risk fall into multiple categories. Risk retention
pools are technically retaining the risk for the group, but spreading
it over the whole group involves transfer among individual members of
the group. This is different from traditional insurance, in that no
premium is exchanged between members of the group up front, but
instead losses are assessed to all members of the group.
on the combination of methods to be used for each risk. Each risk
management decision should be recorded and approved by the investor.
This is most likely to be carried out by the property manager. For
example, the extent of the extensions over and above the basic fire
policy should be the decision of the investor. For example, to
include meltdown (as opposed to fire), flood or plate glass
extensions. If the investment property is sited in a well behaved
society the investor my prefer to carry the plate glass insurance
risk management plan should propose applicable and effective security
controls for managing the risks. For example, a yearly update of the
building cover by having a replacement cost valuation carried out by
the valuer. A good risk management plan should contain a schedule for
control implementation and responsible persons for those actions. In
the case of updating the cost of replacement, the employment of the
valuer can be carried out done by the property manager at a certain
date each year. However, the property manager would need instructions
in writing to do this. The risk management concept is old but is
still not very effectively measured
is the following of all the above planned methods to mitigate or
eliminate the effect of the risks. For example, purchase insurance
policies for the risks that have been decided to be transferred to an
insurer, avoid all risks that can be avoided without sacrificing the
investment strategy, reduce others, and retain the rest.
REVIEW AND EVALUATION
OF THE PLAN
risk management plans will never be perfect. Practice, experience,
and actual loss results, will necessitate changes in the plan and
contribute information to allow possible different decisions to be
made in dealing with the risks being faced.
analysis results and management plans should be updated periodically.
There are two primary reasons for this:
- to evaluate
whether the previously selected security controls are still applicable
and effective, and
- to evaluate the
possible risk level changes in the investment environment. For example,
rapidly increasing building costs are a good example of rapidly
changing investment environment.
risks are improperly assessed and prioritized, time can be wasted in
dealing with risk of losses that are not likely to occur. For
example, insuring against war. Spending too much time assessing and
managing unlikely risks can divert resources that could be used more
profitably. Unlikely events do occur, but if the risk is unlikely
enough to occur, it may be better to simply retain the risk, and deal
with the result if the loss does in fact occur.
too highly the risk management processes itself could potentially
keep an organization from ever completing an investment project or
even getting started. Delay while assessing risk will cost the
investor through loss of interest and rising building costs.
is also important to keep in mind the distinction between risk and
investment project management, a risk is more narrowly defined as a
possible event or circumstance that can have negative influences on a
project. Its influence can be on the schedule, the resources, the
scope and/or the quality.
project management when a risk escalates, it becomes a liability. A
liability is a negative event or circumstance that is hindering the
of the processes for assessing risk include the following (the
parentheses contain some of the jargon used to refer to them).
addition, every probable risk can have a preformulated plan to deal
with it and to deal with its possible consequences (to ensure
contingency if the risk becomes a liability).
- Choosing unique
identifiers for referring to the same risk in company or project
- Describing the
risk and how it could become a liability (description).
- Assessing the
consequences of that (effect).
what precautions could be taken to prevent it (precaution).
- Drawing up
contingency plans or procedures for handling it (contingency).
the risk as new, ongoing or closed (risk status)
- Estimating the
probability of the risk becoming a liability (Risk escalation
- Estimating the
consequences in terms of time for the project (Schedule impact, S)
ACTIVITIES AS APPLIED TO PROJECT MANAGEMENT
project management, risk management includes the following
- Planning how
risk management will be held in the particular project. Plan should
include risk management tasks, responsibilities, activities and budget.
- Assigning a
risk officer. This should be a team member other than a project manager
who is responsible for foreseeing potential project problems. Typical
characteristic of the risk officer is a healthy scepticism.
live project risk database. Each risk should have the following
attributes: opening date, title, short description, probability and
importance. Optionally risk can have assigned person responsible for
its resolution and date till then risk still can be resolved.
anonymous risk reporting channel. Each team member should have
possibility to report risk that he foresees in the project.
mitigation plans for risks that are chosen to be mitigated. The purpose
of the mitigation plan is to describe how this particular risk will be
handled – what, when, by who and how will be done to avoid it or
minimize consequences if it becomes a liability.
planned and faced risks, effectiveness of mitigation activities and
effort spend for the risk management.
RISK MANAGEMENT AND
management is simply a practice of systematically selecting cost
effective approaches for minimising the effect of threat realisation
to the investor. All risks can never be fully avoided or mitigated
simply because of financial and practical limitations of the real
world. Therefore all investors have to accept some level of residual
risks which still may realise despite their efforts.
risk management tends to be preemptive, Business Continuity Planning
(BCP) was invented to deal with the consequences of realised residual
necessity to have BCP in place is because even very unlikely events
will occur if a necessarily long time is available. Risk management
and BCP are often mistakenly seen as rivals or overlapping practices.
In fact these processes are so tightly tied together that such
separation seems artificial. For example, the risk management process
creates important inputs for the BCP (assets, impact assessments,
cost estimates etc). Risk management also proposes applicable
controls for the observed risks. Therefore, risk management covers
several areas that are vital for the BCP process. However, the BCP
process goes beyond risk management's pre-emptive approach and moves
on from the assumption that the disaster will realise at some point.
- Dorfman, Mark
S. (1997). Introduction to Risk Management and Insurance (6th ed.),
Prentice Hall. ISBN 0137521065.
- Stulz, René M.
(2003). Risk Management & Derivatives (1st ed.), Mason, Ohio:
Thomson South-Western. ISBN 0-538-86101-0.
Antonius (2004). Focused Enterprise Risk Management (1st ed.), PT Ray
Indonesia, Jakarta. ISBN 979-9891818-1-7.
- U.S. EPA's
General Risk Management Program Guidance (April 2004)
- Risk Management
Carol and Sheedy, Elizabeth (2004). The Professional Risk Managers'
Handbook: A Comprehensive Guide to Current Theory and Best Practices
(1st ed.), Wilmington, DE: PRMIA Publications. ISBN 0-9766097-0-3.Learn
risk premium (article)
AND INVESTMENT PROPERTY
The property investors is investing
for one clear reason: To make a profit. Poorly managed risks will
have tangible and sometimes dramatic effects on that profit. For
example, if the building is not adequately insured and burns down.
Therefore, sound risk management is important to ensure that your
investment strategy can overcome any problems and the investment to
continue to grow.
Threats to a small investors or project can
come from a variety of sources. Typically risk is categorized risks
into four areas:
These risks hinge on the financial performance of the
investment. This can be affected by for example, the rate of inflation
and the cost of money.
Risks that affect how the investor operates internally. For example,
the introduction of the GST resulted in new and costly accounting
Risks emerging from competitors or markets of the investor. An investor
in a preschool has found that the opening of a more modern preschool
nearby has affected their investment.
These risks can be the most damaging. Events like natural disasters,
manmade disasters, and crime can permanently disable a company.
EFFECTIVE RISK MANAGEMENT STRATEGY
effective risk management strategy must be systematic and robust. It
also must be straight-forward, and simple to implement. There are
During this stage, the investor needs to thoroughly examine the
investment from a number of different perspectives. All risks facing
all areas of a company need to be identified. This should be done with
as many people involved as realistically possible to give a complete
risks are minimized by clear check and balance procedures and
management oversight within the company. Strategic risks can be
minimized by better documentation, such as a good lease with modern
plain english clauses.
Each risk is given a probability of occurrence and a severity of
occurrence ranking. This can be done with a simple 1 to 5 scale; 1
being rarely occurring and minimal damage. This allows the investor to
more clearly understand the extent of potential damage.
The resulting risks are controlled through a variety of methods. For
example, traditional insurance is one way to remove hazard risk.
Financial risks can also be managed through insurance eg landlords
insurance against loss of rent.
RISK MANAGEMENT CASE STUDY
and Jill two retirees have been looking around for a suitable
investment for their retirement nest egg about $800 000. Nearby is an
old service station that has been disused for 3 years. They make
enquiries with the local council and find out that the site is
suitable for the construction of 8* 2 bedroom strata units. The
council is only too pleased to have the site developed as it is an
eye sore next to the local hopping centre.
and Jill make enquiries with the oil company that owns the service
station and find that they are only to glad to get rid of it as there
are too many service stations in the area. They are so pleased to
sell that it is on the market for only $600 000.
have been employed to advise them on their proposed investment.
WHAT ENQUIRIES DO YOU MAKE
old service stations are mentioned immediately the “alarm bells
ring”. Old service stations will be subject to severe oil
contamination and this will have to be completely remedied before the
units can be built.
enquiries with council show that yes indeed the site is contaminated
and they will need an environmental engineer' report that the site
has been decontaminated before approval will be given for a
residential use. Jack and Jills' investment is looking much riskier
now than when they first made enquiries.
CAN YOU HELP REDUCE THEIR EXPOSURE TO RISK?
mentioned the oil company is keen to sell the disused site so you
begin negotiations with the company. You discover that it will take
12-18 months for the site to be decontaminated. Under these
circumstances you successfully negotiate with the company that they
carry out the decontamination process and obtain clearance to develop
from the council. This way the risk of decontamination has been
passed from Jack and Jill to the oil company. It also happens that
they are experts in decontamination and can carry out the process
more thoroughly and quicker than local contractors.
HOW CAN THE INVESTORS' INCREASED RISK CAUSED BY THE DELAY BE
risk can be mitigated by advising Jack and Jill to take up an option
to purchase rather than buying outright. This will require the
payment only of an option fee with the balance payable on the
completion which is subject to council's approval to build. Their
interests can be further reduced by having time limit on the option
or the oil company will pay penalties or compensation for every month
the decontamination process is behind schedule. A period of indemnity
against any claim caused by the contamination has also been
negotiated with the oil company.
can also negotiate with the oil company for a discount in the
purchase price as compensation for the extra costs incurred by the
SEEKING COUNCIL APPROVAL FOR THE DEVELOPMENT
oil company has decontaminated the site and during the 18month delay
the investors have employed an architect to design the new 8*2
bedroom strata units. To reduce risk they have employed Council's pre
planning enquiry and negotiation process. This is a free service and
reduces the risk of the proposed development being rejected
particularly on technical grounds. The architect is also there so
that they know exactly what sort of development the council favours
to mitigate risk of delay.
is further reduced by a having a fixed process contract with the
architect to obtain all council's approvals and supervise the
building. Risk is further reduced by entering into a fixed price
contract with the builder with penalties for any time overruns. The
contract should have as long an indemnity period as possible (ie the
period during which the builder will fix any faults). Further, it is
checked with the builder that they are licensed, qualified and have
made all insurance payments to the Board so that the investors can
claim compensation if the builder does not complete for example,
- You advise the
investors that immediately upon completion (with council's and the
architects certificates completion) take control of the building and
insure it against loss through fire, storm and tempest. Since there is
no plant and equipment, plate glass or the likelihood of water damage
these extensions are not taken up and the investors take the risks
- LETTING UP AND
have advised the investors that the highest and best use of the site
is keep ownership and lease the units out. This is because of the
property's location near a viable and popular shopping centre. Risk
is reduced by the fallback or exit position which is selling the
units off to owner occupiers. This safety option has been achieved by
having the units strataed even though the investors' intentions were
to lease the properties. Further, the fallback position has been
strengthened by the fact that council would look favorably on a
change of use of the lower units from residential to home office.
is reduced by employing a reputable and experienced property manager.
A professional property manager will have access to a database of
“bad tenants” and expertise in vetting prospective tenant. This
will reduce the risk of the tenants' not paying or causing damage. To
further reduce risk the valuer/agent advises the investors to take
out landlord's insurance which will indemnify the investors against
loss of rent and damage caused by the tenants.
a professional and thorough property manager has been employed then
there should be little risk to income arising from the building
during the investment period. The property manager has agreed to
notify the investors not only their monthly statements but
immediately any major problems arises during the investment period.
the investment matures the property will be subject to appreciation
in an expanding economy. This means that the investors' equity will
increase over time. This will allowing the investors to negotiate for
a new loan at a lower interest rate.