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Risk management is the process of measuring, or assessing risk and then developing strategies to manage the risk. 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.
Risk 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 effects of risks as much as possible.
A first step in the process of managing risk is to identify potential risks. The risks must then be assessed as to their potential severity of loss and to the probability of occurrence.
Once risks have been identified and assessed, all techniques to manage the risk fall into one or more of these four major categories:
Ideal 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.
Includes not performing an activity that could carry risk. An example would be not buying a property or business in order to not take on the liability that comes with it. Another would be not flying in order to not take the risk that the plane were to be hijacked. Avoidance 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. Not entering a business to avoid the risk of loss also avoids the possibility of earning the profits.
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 strategy.
Involves accepting the loss when it occurs. True self insurance falls in this category. All risks that are not avoided or transferred are retained by default.
Means causing another party to accept the risk, typically by contract. Insurance is one type of risk transfer. Other times it may involve contract language that transfers a risk to another party without the payment of an insurance premium. Liability among construction or other contractors is very often transferred this way.
Some 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.
Decide on the combination of methods to be used for each risk
Follow all of the planned methods for mitigating the effect of the risks. Purchase insurance policies for the risks that have been decided to be transferred to an insurer, avoid all risks that can be without sacrificing the entity's goals, reduce others, and retain the rest.
Initial 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.
If risks are improperly assessed and prioritized, time can be wasted in dealing with risk of losses that are not likely to occur. 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.
Prioritizing too highly the Risk management processes itself could potentially keep an organization from ever completing a project or even getting started. This is especially true if other work is suspended until the risk management process is considered complete.
As applied to corporate finance, risk management is a technique for measuring, monitoring and controlling the financial or operational risk on a firm's balance sheet. See value at risk.
In 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.
In project management parlance, when a risk escalates, it becomes a liability. A liability is a negative event or circumstance that is hindering the project.
Some of the processes for assessing risk include the following (the parentheses contain some of the jargon used to refer to them).
In addition, every probable risk can have a pre-formulated plan to deal with it to deal with it's possible consequences (to ensure contingency if the risk becomes a liability).
From the information above and the average cost per employee over time, or Cost Accrual Ratio, a project manager can estimate
Risk in a project or process can be due either to special causes of deviation or common causes of deviation and requires appropriate treatment. That is to re-iterate the concern about extremal cases not being equivalent in the list immediately above.
In project management, risk management includes the following activities:
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