Risk management
Encyclopedia
Risk management is the identification, assessment, and prioritization of risk
Risk
Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...

s (defined in ISO 31000
ISO 31000
ISO 31000 is intended to be a family of standards relating to risk management codified by the International Organization for Standardization. The purpose of ISO 31000:2009 is to provide principles and generic guidelines on risk management...

 as the effect of uncertainty on objectives, whether positive or negative) followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities. Risks can come from uncertainty in financial markets, project failures (at any phase in design, development, production, or sustainment life-cycles), legal liabilities, credit risk, accidents, natural causes and disasters
Act of God
Act of God is a legal term for events outside of human control, such as sudden floods or other natural disasters, for which no one can be held responsible.- Contract law :...

 as well as deliberate attack from an adversary, or events of uncertain or unpredictable root-cause
Root cause
A root cause is rarely an initiating cause of a causal chain which leads to an outcome or effect of interest. Commonly, root cause is misused to describe the depth in the causal chain where an intervention could reasonably be implemented to change performance and prevent an undesirable outcome.In...

. Several risk management standards have been developed including the Project Management Institute
Project Management Institute
The Project Management Institute is a not-for-profit professional organization for the project management profession with the purpose of advancing project management.- Overview :...

, the National Institute of Science and Technology
National Institute of Science and Technology
The National Institute of Science and Technology is an engineering college in Palur Hills, Orissa, India. It was started in 1996 by a few NRIs, some of who belonged to Orissa. This institute was set up and is managed by the SM Charitable Educational Trust with the aim of promoting higher technical...

, actuarial societies, and ISO standards. Methods, definitions and goals vary widely according to whether the risk management method is in the context of project management, security, engineering
Risk analysis (engineering)
Risk analysis is the science of risks and their probability and evaluation.Probabilistic risk assessment is one analysis strategy usually employed in science and engineering.-Risk analysis and the risk workshop:...

, industrial processes, financial portfolios, actuarial assessments, or public health and safety.

The strategies to manage risk typically include transferring the risk to another party, avoiding the risk, reducing the negative effect or probability of the risk, or even accepting some or all of the potential or actual consequences of a particular risk.

Certain aspects of many of the risk management standards have come under criticism for having no measurable improvement on risk, whether the confidence in estimates and decisions seem to increase.

Introduction

This section provides an introduction to the principles of risk management. The vocabulary of risk management is defined in ISO Guide 73, "Risk management. Vocabulary."

In ideal risk management, a prioritization process is followed whereby the risks with the greatest loss (or impact) and the greatest probability
Probability
Probability is ordinarily used to describe an attitude of mind towards some proposition of whose truth we arenot certain. The proposition of interest is usually of the form "Will a specific event occur?" The attitude of mind is of the form "How certain are we that the event will occur?" The...

 of occurring are handled first, and risks with lower probability of occurrence and lower loss are handled in descending order. In practice the process of assessing overall risk can be difficult, and balancing resources used to mitigate between risks with a high probability of occurrence but lower loss versus a risk with high loss but lower probability of occurrence can often be mishandled.
Intangible risk management identifies a new type of a risk that has a 100% probability of occurring but is ignored by the organization due to a lack of identification ability. For example, when deficient knowledge is applied to a situation, a knowledge
Knowledge
Knowledge is a familiarity with someone or something unknown, which can include information, facts, descriptions, or skills acquired through experience or education. It can refer to the theoretical or practical understanding of a subject...

 risk materializes. Relationship risk appears when ineffective collaboration occurs. Process-engagement risk may be an issue when ineffective operational procedures are applied. These risks directly reduce the productivity of knowledge workers, decrease cost effectiveness, profitability, service, quality, reputation, brand value, and earnings quality. Intangible risk management allows risk management to create immediate value from the identification and reduction of risks that reduce productivity.


Risk management also faces difficulties in allocating resources. This is the idea of opportunity cost
Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...

. Resources spent on risk management could have been spent on more profitable activities. Again, ideal risk management minimizes spending (or manpower or other resources) and also minimizes the negative effects of risks.

Method

For the most part, these methods consist of the following elements, performed, more or less, in the following order.
  1. identify, characterize, and assess threats
    Threat
    Threat of force in public international law is a situation between states described by British lawyer Ian Brownlie as:The 1969 Vienna convention on the Law of Treaties notes in its preamble that both the threat and the use of force are prohibited...

  2. assess the vulnerability
    Vulnerability
    Vulnerability refer to the susceptibility of a person, group, society, sex or system to physical or emotional injury or attack. The term can also refer to a person who lets their guard down, leaving themselves open to censure or criticism...

     of critical assets to specific threats
  3. determine the risk
    Risk
    Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...

     (i.e. the expected consequences of specific types of attacks on specific assets)
  4. identify ways to reduce those risks
  5. prioritize
    Priority
    Priority may refer to:* Priority date, a concept of establishing waiting times in the immigration process by United States Department of State* Priority level, the priority of emergency communications...

     risk reduction measures based on a strategy

Principles of risk management

The International Organization for Standardization
International Organization for Standardization
The International Organization for Standardization , widely known as ISO, is an international standard-setting body composed of representatives from various national standards organizations. Founded on February 23, 1947, the organization promulgates worldwide proprietary, industrial and commercial...

 (ISO) identifies the following principles of risk management:

Risk management should:
  • create value
    Value
    Value or values may refer to:Concepts of worth:* Value theory – overview of approaches in various disciplines* Value ** Value * Value ** Theory of value ** Value investing...

     - resources expended to mitigate risk should generally exceed the consequence of inaction, or (as in value engineering
    Value engineering
    Value engineering is a systematic method to improve the "value" of goods or products and services by using an examination of function. Value, as defined, is the ratio of function to cost. Value can therefore be increased by either improving the function or reducing the cost...

    ), the gain should exceed the pain
  • be an integral part of organizational processes
  • be part of decision making
  • explicitly address uncertainty and assumptions
  • be systematic and structured
  • be based on the best available information
  • be tailorable
  • take into account human factors
  • be transparent and inclusive
  • be dynamic, iterative and responsive to change
  • be capable of continual improvement and enhancement
  • be continually or periodically re-assessed

Process

According to the standard ISO 31000
ISO 31000
ISO 31000 is intended to be a family of standards relating to risk management codified by the International Organization for Standardization. The purpose of ISO 31000:2009 is to provide principles and generic guidelines on risk management...

 "Risk management -- Principles and guidelines on implementation," the process of risk management consists of several steps as follows:

Establishing the context

Establishing the context involves:
  1. Identification of risk in a selected domain of interest
  2. Planning the remainder of the process.
  3. Mapping out the following:
    • the social scope of risk management
    • the identity and objectives of stakeholders
    • the basis upon which risks will be evaluated, constraints.
  4. Defining a framework for the activity and an agenda for identification.
  5. Developing an analysis of risks involved in the process.
  6. Mitigation or Solution of risks using available technological, human and organizational resources.

Identification

After establishing the context, the next step in the process of managing risk is to identify potential risks. Risks are about hazards/threats that, when triggered (or released), cause an event to occur, leading to problems. Hence, risk identification can start with the source of problems, or with the problem itself.
  • 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.
  • Problem 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 shareholders, customers and legislative bodies such as the government.

When 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. For example: stakeholders withdrawing during a project may endanger funding of the project; privacy information may be stolen by employees even within a closed network; lightning striking an aircraft during takeoff may make all people on board immediate casualties.

The 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:
  • Objectives-based risk identification Organizations and project teams have objectives. Any event that may endanger achieving an objective partly or completely is identified as risk.
  • Scenario-based risk identification In scenario analysis
    Scenario analysis
    Scenario analysis is a process of analyzing possible future events by considering alternative possible outcomes . Thus, the scenario analysis, which is a main method of projections, does not try to show one exact picture of the future. Instead, it presents consciously several alternative future...

     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 - see Futures Studies for methodology used by Futurists
    Futurists
    Futurists or futurologists are scientists and social scientists whose speciality is to attempt to systematically predict the future, whether that of human society in particular or of life on earth in general....

    .
  • Taxonomy-based 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.
  • Common-risk checking In several industries, lists with known risks are available. Each risk in the list can be checked for application to a particular situation.
  • Risk charting This method combines the above approaches by listing resources at risk, threats to those resources, modifying factors which may increase or decrease the risk and consequences it is wished to avoid. Creating a matrix
    Risk Matrix
    A Risk is the amount of harm that can be expected to occur during a given time period due to specific harm event . Statistically, the level of risk can be calculated as the product of the probability that harm occurs multiplied by the severity of that harm A Risk is the amount of harm that can be...

     under these headings enables a variety of approaches. One can begin with resources and consider the threats they are exposed to and the consequences of each. Alternatively one can start with the threats and examine which resources they would affect, or one can begin with the consequences and determine which combination of threats and resources would be involved to bring them about.

Assessment

Once risks have been identified, they must then be assessed as to their potential severity of impact (generally a negative impact, such as damage or 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. Therefore, in the assessment process it is critical to make the best educated decisions in order to properly prioritize the implementation of the risk management plan
Risk Management Plan
A Risk Management Plan is a document prepared by a project manager to foresee risks, to estimate the impacts, and to create response plans to mitigate them...

.

Even a short-term positive improvement can have long-term negative impacts. Take the "turnpike" example. A highway is widened to allow more traffic. More traffic capacity leads to greater development in the areas surrounding the improved traffic capacity. Over time, traffic thereby increases to fill available capacity. Turnpikes thereby need to be expanded in a seemingly endless cycles. There are many other engineering examples where expanded capacity (to do any function) is soon filled by increased demand. Since expansion comes at a cost, the resulting growth could become unsustainable without forecasting and management.

The 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 intangible assets. Asset 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 organization 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 is:
Rate (or probability) of occurrence multiplied by the impact of the event equals risk magnitude

Composite Risk Index

The above formula can also be re-written in terms of a Composite Risk Index, as follows:

Composite Risk Index = Impact of Risk event x Probability of Occurrence

The impact of the risk event is commonly assessed on a scale of 1 to 5, where 1 and 5 represent the minimum and maximum possible impact of an occurrence of a risk (usually in terms of financial losses). However, the 1 to 5 scale can be arbitrary and need not be on a linear scale.

The probability of occurrence is likewise commonly assessed on a scale from 1 to 5, where 1 represents a very low probability of the risk event actually occurring while 5 represents a very high probability of occurrence. This axis may be expressed in either mathematical terms (event occurs once a year, once in ten years, once in 100 years etc.) or may be expressed in "plain english" - event has occurred here very often; event has been known to occur here; event has been known to occur in the industry etc.). Again, the 1 to 5 scale can be arbitrary or non-linear depending on decisions by subject-matter experts.

The Composite Index thus can take values ranging (typically) from 1 through 25, and this range is usually arbitrarily divided into three sub-ranges. The overall risk assessment is then Low, Medium or High, depending on the sub-range containing the calculated value of the Composite Index. For instance, the three sub-ranges could be defined as 1 to 8, 9 to 16 and 17 to 25.

Note that the probability of risk occurrence is difficult to estimate, since the past data on frequencies are not readily available, as mentioned above. After all, probability does not imply certainty.

Likewise, the impact of the risk is not easy to estimate since it is often difficult to estimate the potential loss in the event of risk occurrence.

Further, both the above factors can change in magnitude depending on the adequacy of risk avoidance and prevention measures taken and due to changes in the external business environment. Hence it is absolutely necessary to periodically re-assess risks and intensify/relax mitigation measures, or as necessary.
Changes in procedures, technology, schedules, budgets, market conditions, political environment, or other factors typically require re-assessment of risks.

Risk Options

Risk mitigation measures are usually formulated according to one or more of the following major risk options, which are:

1. Design a new business process with adequate built-in risk control and containment measures from the start.

2. Periodically re-assess risks that are accepted in ongoing processes as a normal feature of business operations and modify mitigation measures.

3. Transfer risks to an external agency (e.g. an insurance company)

4. Avoid risks altogether (e.g. by closing down a particular high-risk business area)

----

Later research has shown that the financial benefits of risk management are less dependent on the formula used but are more dependent on the frequency and how risk assessment is performed.

In business it is imperative to be able to present the findings of risk assessments in financial, market, or schedule terms. Robert Courtney Jr. (IBM, 1970) proposed a formula for presenting risks in financial terms. The Courtney formula was accepted as the official risk analysis method for the US governmental agencies. The formula proposes calculation of ALE (annualised loss expectancy) and compares the expected loss value to the security control implementation costs (cost-benefit analysis
Cost-benefit analysis
Cost–benefit analysis , sometimes called benefit–cost analysis , is a systematic process for calculating and comparing benefits and costs of a project for two purposes: to determine if it is a sound investment , to see how it compares with alternate projects...

).

Potential risk treatments

Once risks have been identified and assessed, all techniques to manage the risk fall into one or more of these four major categories:
  • Avoidance (eliminate, withdraw from or not become involved)
  • Reduction (optimize - mitigate)
  • Sharing (transfer - outsource or insure)
  • Retention (accept and budget)


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. Another source, from the US Department of Defense (see link), Defense Acquisition University
Defense Acquisition University
The Defense Acquisition University is a United States military training establishment that trains and enables the 147,705 military and civilian Department of Defense personnel in the fields of acquisition, technology, and logistics, including leadership, program management and bureaucratic...

, calls these categories ACAT, for Avoid, Control, Accept, or Transfer. This use of the ACAT acronym is reminiscent of another ACAT (for Acquisition Category
Acquisition Category
The United States Department of Defense divides future acquisition programs into four acquisition categories: ACAT I, ACAT II, ACAT III, or ACAT IA. The differences between these categories depend on their size and programatic differences....

) used in US Defense industry procurements, in which Risk Management figures prominently in decision making and planning.

Risk avoidance

This includes not performing an activity that could carry risk. An example would be not buying a property
Real property
In English Common Law, real property, real estate, realty, or immovable property is any subset of land that has been legally defined and the improvements to it made by human efforts: any buildings, machinery, wells, dams, ponds, mines, canals, roads, various property rights, and so forth...

 or business in order to not take on the legal liability
Legal liability
Legal liability is the legal bound obligation to pay debts.* In law a person is said to be legally liable when they are financially and legally responsible for something. Legal liability concerns both civil law and criminal law. See Strict liability. Under English law, with the passing of the Theft...

 that comes with it. Another would be not flying in order not to take the risk that the airplane
Fixed-wing aircraft
A fixed-wing aircraft is an aircraft capable of flight using wings that generate lift due to the vehicle's forward airspeed. Fixed-wing aircraft are distinct from rotary-wing aircraft in which wings rotate about a fixed mast and ornithopters in which lift is generated by flapping wings.A powered...

 were to be hijack
Aircraft hijacking
Aircraft hijacking is the unlawful seizure of an aircraft by an individual or a group. In most cases, the pilot is forced to fly according to the orders of the hijackers. Occasionally, however, the hijackers have flown the aircraft themselves, such as the September 11 attacks of 2001...

ed. 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 profits.

Hazard Prevention

Hazard prevention refers to the prevention of risks in an emergency. The first and most effective stage of hazard prevention is the elimination of hazards. If this takes too long, is too costly, or is otherwise impractical, the second stage is mitigation.

Risk reduction

Risk reduction or "optimization" involves reducing the severity of the loss or the likelihood of the loss from occurring. For example, sprinkler
Fire sprinkler
A fire sprinkler system is an active fire protection measure, consisting of a water supply system, providing adequate pressure and flowrate to a water distribution piping system, onto which fire sprinklers are connected...

s are designed to put out a fire
Fire
Fire is the rapid oxidation of a material in the chemical process of combustion, releasing heat, light, and various reaction products. Slower oxidative processes like rusting or digestion are not included by this definition....

 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
Halon
Halon can refer to:* Haloalkane, or halogenoalkane, a group of chemical compounds consisting of alkanes with linked halogens. In particular, bromine-containing haloalkanes.* Halomethane fire extinguishing systems...

 fire suppression systems may mitigate that risk, but the cost may be prohibitive as a strategy
Strategy
Strategy, a word of military origin, refers to a plan of action designed to achieve a particular goal. In military usage strategy is distinct from tactics, which are concerned with the conduct of an engagement, while strategy is concerned with how different engagements are linked...

.

Acknowledging that risks can be positive or negative, optimizing risks means finding a balance between negative risk and the benefit of the operation or activity; and between risk reduction and effort applied. By an offshore drilling contractor effectively applying HSE Management in its organization, it can optimize risk to achieve levels of residual risk that are tolerable.

Modern software development methodologies reduce risk by developing and delivering software incrementally. Early methodologies suffered from the fact that they only delivered software in the final phase of development; any problems encountered in earlier phases meant costly rework and often jeopardized the whole project. By developing in iterations, software projects can limit effort wasted to a single iteration.

Outsourcing
Outsourcing
Outsourcing is the process of contracting a business function to someone else.-Overview:The term outsourcing is used inconsistently but usually involves the contracting out of a business function - commonly one previously performed in-house - to an external provider...

 could be an example of risk reduction if the outsourcer can demonstrate higher capability at managing or reducing risks. For example, a company may outsource only its software development, the manufacturing of hard goods, or customer support needs to another company, while handling the business management itself. This way, the company can concentrate more on business development without having to worry as much about the manufacturing process, managing the development team, or finding a physical location for a call center.

Risk sharing

Briefly defined as "sharing with another party the burden of loss or the benefit of gain, from a risk, and the measures to reduce a risk."

The term of 'risk transfer' is often used in place of risk sharing in the mistaken belief that you can transfer a risk to a third party through insurance or outsourcing. In practice if the insurance company or contractor go bankrupt or end up in court, the original risk is likely to still revert to the first party. As such in the terminology of practitioners and scholars alike, the purchase of an insurance contract is often described as a "transfer of risk." However, technically speaking, the buyer of the contract generally retains legal responsibility
Legal risk
Legal risk is risks that counterparty are not legally able to enter into a contract. Another legal risk relates to regulatory risk, i.e., that a transaction could conflict with a regulator's policy or, more generally, that legislation might change during the life of a financial contract.-The Risk...

 for the losses "transferred", meaning that insurance may be described more accurately as a post-event compensatory mechanism. For example, a personal injuries insurance policy does not transfer the risk of a car accident to the insurance company. The risk still lies with the policy holder namely the person who has been in the accident. The insurance policy simply provides that if an accident (the event) occurs involving the policy holder then some compensation may be payable to the policy holder that is commensurate to the suffering/damage.

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
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...

, in that no premium is exchanged between members of the group up front, but instead losses are assessed to all members of the group.

Risk retention

Involves accepting the loss, or benefit of gain, from a risk when it occurs. True self insurance
Self insurance
Self insurance is a risk management method in which a calculated amount of money is set aside to compensate for the potential future loss.If self insurance is approached as a serious risk management technique, money is set aside using actuarial and insurance information and the law of large numbers...

 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
War
War is a state of organized, armed, and often prolonged conflict carried on between states, nations, or other parties typified by extreme aggression, social disruption, and usually high mortality. War should be understood as an actual, intentional and widespread armed conflict between political...

 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.

Create a Risk Management Plan

Select appropriate controls or countermeasures to measure each risk. Risk mitigation needs to be approved by the appropriate level of management. For instance, a risk concerning the image of the organization should have top management decision behind it whereas IT management would have the authority to decide on computer virus risks.

The risk management plan should propose applicable and effective security controls for managing the risks. For example, an observed high risk of computer viruses could be mitigated by acquiring and implementing antivirus software. A good risk management plan should contain a schedule for control implementation and responsible persons for those actions.

According to ISO/IEC 27001
ISO/IEC 27001
ISO/IEC 27001, part of the growing ISO/IEC 27000 family of standards, is an Information Security Management System standard published in October 2005 by the International Organization for Standardization and the International Electrotechnical Commission...

, the stage immediately after completion of the risk assessment
Risk assessment
Risk assessment is a step in a risk management procedure. Risk assessment is the determination of quantitative or qualitative value of risk related to a concrete situation and a recognized threat...

 phase consists of preparing a Risk Treatment Plan, which should document the decisions about how each of the identified risks should be handled. Mitigation of risks often means selection of security controls
Security controls
Security controls are safeguards or countermeasures to avoid, counteract or minimize security risks.To help review or design security controls, they can be classified by several criteria, for example according to the time that they act, relative to a security incident:*Before the event, preventive...

, which should be documented in a Statement of Applicability, which identifies which particular control objectives and controls from the
standard have been selected, and why.

Implementation

Implementation follows 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 avoided without sacrificing the entity's goals, reduce others, and retain the rest.

Review and evaluation of the plan

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.

Risk analysis
Risk analysis (Business)
Risk analysis is a technique to identify and assess factors that may jeopardize the success of a project or achieving a goal.This technique also helps to define preventive measures to reduce the probability of these factors from occurring and identify countermeasures to successfully deal with these...

 results and management plans should be updated periodically. There are two primary reasons for this:
  1. to evaluate whether the previously selected security controls are still applicable and effective, and
  2. to evaluate the possible risk level changes in the business environment. For example, information risks are a good example of rapidly changing business environment.

Limitations

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. Qualitative risk assessment is subjective and lacks consistency. The primary justification for a formal risk assessment process is legal and bureaucratic.

Prioritizing the risk management processes too highly could 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.

It is also important to keep in mind the distinction between risk and uncertainty
Uncertainty
Uncertainty is a term used in subtly different ways in a number of fields, including physics, philosophy, statistics, economics, finance, insurance, psychology, sociology, engineering, and information science...

. Risk can be measured by impacts x probability.

Areas of risk management

As applied to corporate finance
Corporate finance
Corporate finance is the area of finance dealing with monetary decisions that business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize shareholder value while managing the firm's financial risks...

, risk management is the technique for measuring, monitoring and controlling the financial or operational risk
Operational risk
An operational risk is, as the name suggests, a risk arising from execution of a company's business functions. It is a very broad concept which focuses on the risks arising from the people, systems and processes through which a company operates...

 on a firm's balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...

. See value at risk
Value at risk
In financial mathematics and financial risk management, Value at Risk is a widely used risk measure of the risk of loss on a specific portfolio of financial assets...

.

The Basel II
Basel II
Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision...

 framework breaks risks into market risk
Market risk
Market risk is the risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices...

 (price risk), credit risk
Credit risk
Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised. Such an event is called a default. Other terms for credit risk are default risk and counterparty risk....

 and operational risk and also specifies methods for calculating capital requirements for each of these components.

Enterprise risk management

In enterprise risk management, a risk is defined as a possible event or circumstance that can have negative influences on the enterprise in question. Its impact can be on the very existence, the resources (human and capital), the products and services, or the customers of the enterprise, as well as external impacts on society, markets, or the environment. In a financial institution, enterprise risk management is normally thought of as the combination of credit risk, interest rate risk
Interest rate risk
Interest rate risk is the risk borne by an interest-bearing asset, such as a loan or a bond, due to variability of interest rates. In general, as rates rise, the price of a fixed rate bond will fall, and vice versa...

 or asset liability management
Asset liability management
In banking, asset and liability management is the practice of managing risks that arise due to mismatches between the assets and liabilities of the bank. This can also be seen in insurance....

, market risk, and operational risk.

In the more general case, every probable risk can have a pre-formulated plan to deal with its 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
Cost accrual ratio
The Cost Accrual Ratio for a business may be defined as the total average cost per person per unit time, e.g. average cost per day per person. It is only useful for risk assessment in small projects where average wages are roughly equal....

, a project manager can estimate:
  • the cost associated with the risk if it arises, estimated by multiplying employee costs per unit time by the estimated time lost (cost impact, C where C = cost accrual ratio * S).
  • the probable increase in time associated with a risk (schedule variance due to risk, Rs where Rs = P * S):
    • Sorting on this value puts the highest risks to the schedule first. This is intended to cause the greatest risks to the project to be attempted first so that risk is minimized as quickly as possible.
    • This is slightly misleading as schedule variances with a large P and small S and vice versa are not equivalent. (The risk of the RMS Titanic sinking vs. the passengers' meals being served at slightly the wrong time).
  • the probable increase in cost associated with a risk (cost variance due to risk, Rc where Rc = P*C = P*CAR*S = P*S*CAR)
    • sorting on this value puts the highest risks to the budget first.
    • see concerns about schedule variance as this is a function of it, as illustrated in the equation above.


Risk in a project
Project
A project in business and science is typically defined as a collaborative enterprise, frequently involving research or design, that is carefully planned to achieve a particular aim. Projects can be further defined as temporary rather than permanent social systems that are constituted by teams...

 or process
Business process
A business process or business method is a collection of related, structured activities or tasks that produce a specific service or product for a particular customer or customers...

 can be due either to Special Cause Variation or Common Cause Variation and requires appropriate treatment. That is to re-iterate the concern about extremal cases not being equivalent in the list immediately above.

Risk management activities as applied to project management

In project management
Project management
Project management is the discipline of planning, organizing, securing, and managing resources to achieve specific goals. A project is a temporary endeavor with a defined beginning and end , undertaken to meet unique goals and objectives, typically to bring about beneficial change or added value...

, risk management includes the following activities:
  • Planning how risk will be managed in the particular project. Plans should include risk management tasks, responsibilities, activities and budget.
  • Assigning a risk officer - a team member other than a project manager who is responsible for foreseeing potential project problems. Typical characteristic of risk officer is a healthy skepticism.
  • Maintaining live project risk database. Each risk should have the following attributes: opening date, title, short description, probability and importance. Optionally a risk may have an assigned person responsible for its resolution and a date by which the risk must be resolved.
  • Creating anonymous risk reporting channel. Each team member should have the possibility to report risks that he/she foresees in the project.
  • Preparing 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 it be done to avoid it or minimize consequences if it becomes a liability.
  • Summarizing planned and faced risks, effectiveness of mitigation activities, and effort spent for the risk management.

Risk management for megaprojects

Megaprojects (sometimes also called "major programs") are extremely large-scale investment projects, typically costing more than US$1 billion per project. Megaprojects include bridges, tunnels, highways, railways, airports, seaports, power plants, dams, wastewater projects, coastal flood protection schemes, oil and natural gas extraction projects, public buildings, information technology systems, aerospace projects, and defence systems. Megaprojects have been shown to be particularly risky in terms of finance, safety, and social and environmental impacts. Risk management is therefore particularly pertinent for megaprojects and special methods and special education have been developed for such risk management.

Risk management of Information Technology

Information technology
Information technology
Information technology is the acquisition, processing, storage and dissemination of vocal, pictorial, textual and numerical information by a microelectronics-based combination of computing and telecommunications...

 is increasingly pervasive in modern life in every sector.
IT risk
IT risk
Information technology risk, or IT risk, IT-related risk, is a risk related to information technology. This relatively new term due to an increasing awareness that information security is simply one facet of a multitude of risks that are relevant to IT and the real world processes it...

 is a risk related to information technology. This is a relatively new term due to an increasing awareness that information security
Information security
Information security means protecting information and information systems from unauthorized access, use, disclosure, disruption, modification, perusal, inspection, recording or destruction....

 is simply one facet of a multitude of risks that are relevant to IT and the real world processes it supports.

A number of methodologies have been developed to deal with this kind of risk.

ISACA's Risk IT
Risk IT
Risk IT provides an end-to-end, comprehensive view of all risks related to the use of IT and a similarly thorough treatment of risk management, from the tone and culture at the top, to operational issues.Risk IT was published in 2009 by ISACA...

 framework ties IT risk to Enterprise risk management
Enterprise Risk Management
Enterprise risk management in business includes the methods and processes used by organizations to manage risks and seize opportunities related to the achievement of their objectives...

.

Risk management techniques in petroleum and natural gas

For the offshore oil and gas industry, operational risk management is regulated by the safety case
Safety case
A safety case is a structured argument that presentsevidence that is intended to demonstrate that a system issafe. More specifically, a safety case aims to showthat specific safety claims are met....

 regime in many countries. Hazard identification and risk assessment tools and techniques are described in the international standard ISO 17776:2000, and organisations such as the IADC (International Association of Drilling Contractors) publish guidelines for HSE Case development which are based on the ISO standard. Further, diagrammatic representations of hazardous events are often expected by governmental regulators as part of risk management in safety case submissions; these are known as bow-tie diagrams. The technique is also used by organisations and regulators in mining, aviation, health, defence, industrial and finance.

Risk management and business continuity

Risk management is simply a practice of systematically selecting cost effective approaches for minimising the effect of threat realization to the organization. All risks can never be fully avoided or mitigated simply because of financial and practical limitations. Therefore all organizations have to accept some level of residual risks.

Whereas risk management tends to be preemptive, business continuity planning
Business continuity planning
Business continuity planning “identifies [an] organization's exposure to internal and external threats and synthesizes hard and soft assets to provide effective prevention and recovery for the organization, whilst maintaining competitive advantage and value system integrity”. It is also called...

 (BCP) was invented to deal with the consequences of realised residual risks. The necessity to have BCP in place arises because even very unlikely events will occur if given enough time. 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 preemptive approach and assumes that the disaster will happen at some point.

Risk communication

Risk communication is a complex cross-disciplinary academic field. Problems for risk communicators involve how to reach the intended audience, to make the risk comprehensible and relatable to other risks, how to pay appropriate respect to the audience's values related to the risk, how to predict the audience's response to the communication, etc. A main goal of risk communication is to improve collective and individual decision making. Risk communication is somewhat related to crisis communication.

Seven cardinal rules for the practice of risk communication

(as first expressed by the U.S. Environmental Protection Agency and several of the field's founders)
  • Accept and involve the public/other consumers as legitimate partners (e.g. stakeholders).
  • Plan carefully and evaluate your efforts with a focus on your strengths, weaknesses, opportunities, and threats (SWOT).
  • Listen to the stakeholders specific concerns.
  • Be honest, frank, and open.
  • Coordinate and collaborate with other credible sources.
  • Meet the needs of the media.
  • Speak clearly and with compassion.

See also

  • Chief risk officer
    Chief risk officer
    The chief risk officer or chief risk management officer of a corporation is the executive accountable for enabling the efficient and effective governance of significant risks, and related opportunities, to a business and its various segments. Risks are commonly categorized as strategic,...

  • Environmental Risk Management Authority
    Environmental Risk Management Authority
    The Environmental Risk Management Authority is a New Zealand government agency which controls the introduction of hazardous substances and new organisms....

  • Event chain methodology
    Event chain methodology
    Event chain methodology is an uncertainty modeling and schedule network analysis technique that is focused on identifying and managing events and event chains that affect project schedules...

  • Financial risk management
    Financial risk management
    Financial risk management is the practice of creating economic value in a firm by using financial instruments to manage exposure to risk, particularly credit risk and market risk. Other types include Foreign exchange, Shape, Volatility, Sector, Liquidity, Inflation risks, etc...

  • Fuel price risk management
    Fuel price risk management
    A specialization of both financial risk management and oil price analysis – and similar to conventional risk management practice – fuel price risk management is a continual cyclic process that includes risk assessment, risk decision making, and the implementation of risk controls...

  • Hazard and operability study
  • International Risk Governance Council
    International Risk Governance Council
    Founded in June 2003 at the initiative of the Swiss government, the International Risk Governance Council is an independent and neutral organisation whose purpose is to help improve the understanding and management of potentially global risks that have impacts on human health and safety, the...

  • International Swaps and Derivatives Association
    International Swaps and Derivatives Association
    The International Swaps and Derivatives Association is a trade organization of participants in the market for over-the-counter derivatives....

  • ISO 31000
    ISO 31000
    ISO 31000 is intended to be a family of standards relating to risk management codified by the International Organization for Standardization. The purpose of ISO 31000:2009 is to provide principles and generic guidelines on risk management...

  • List of finance topics
  • List of project management topics
  • Managerial risk accounting
    Managerial risk accounting
    Managerial Risk Accounting is concerned with the generation, dissemination and use of risk related accounting information to managers within organisations to enable them to judge and shape the risk situation of the organisation according to the objectives of the organisation.- Subject :As a part of...

  • Operational risk management
    Operational risk management
    The term Operational Risk Management is defined as a continual cyclic process which includes risk assessment, risk decision making, and implementation of risk controls, which results in acceptance, mitigation, or avoidance of risk...

  • Optimism bias
    Optimism bias
    Optimism bias is the demonstrated systematic tendency for people to be overly optimistic about the outcome of planned actions. This includes over-estimating the likelihood of positive events and under-estimating the likelihood of negative events. Along with the illusion of control and illusory...

  • Precautionary principle
    Precautionary principle
    The precautionary principle or precautionary approach states that if an action or policy has a suspected risk of causing harm to the public or to the environment, in the absence of scientific consensus that the action or policy is harmful, the burden of proof that it is not harmful falls on those...

  • Process Safety Management
    Process Safety Management
    Process Safety Management is a regulation, promulgated by the U.S. Occupational Safety and Health Administration . A process is any activity or combination of activities including any use, storage, manufacturing, handling or the on-site movement of Highly Hazardous Chemicals as defined by OSHA...

  • Public Entity Risk Institute
    Public Entity Risk Institute
    The Public Entity Risk Institute is a nonprofit organization that serves as a resource to enhance the practice of risk management throughout organizations and communities.- About:...

  • Reference class forecasting
    Reference class forecasting
    Reference class forecasting is the method of predicting the future, through looking at similar past situations and their outcomes.Reference class forcasting predicts the outcome of a planned action based on actual outcomes in a reference class of similar actions to that being forecast. The theories...

  • RiskAoA
    RiskAoA
    RiskAoA is a United States Department of Defense project Risk Management tool, allowing the instantaneous review of portfolio , proposal or alternatives Risk. It was designed by Air Force Research Laboratory Headquarters to perform predictive risk analysis for the Analysis of Alternatives ...

  • Risk assessment
    Risk assessment
    Risk assessment is a step in a risk management procedure. Risk assessment is the determination of quantitative or qualitative value of risk related to a concrete situation and a recognized threat...

  • Risk governance
    Risk governance
    Risk governance is a systemic approach to decision making processes associated to natural and technological risks, based on the principles of cooperation, participation, mitigation and sustainability, adopted to achieve more effective risk management, that is convergent with other public and...

  • Risk homeostasis
    Risk homeostasis
    Risk homeostasis is a hypothesis about risk, developed by Gerald J.S. Wilde, a professor emeritus of psychology at Queen's University, Kingston, Ontario, Canada. This hypothesis is elucidated in Wilde's book. The idea of risk homeostasis has garnered criticism. The hypothesis of risk homeostasis...

  • Risk Management Agency
    Risk Management Agency
    The Risk Management Agency of the U.S. Department of Agriculture helps producers manage their business risks through effective, market-based risk management solutions. RMA's mission is to promote, support, and regulate sound risk management solutions to preserve and strengthen the economic...

  • Risk Management Authority
    Risk Management Authority
    The Risk Management Authority is a Scottish public body, established by the Criminal Justice Act 2003. Its functions relate to the risk assessment of offenders whose liberty presents a risk to the public at large and minimising risk in respect of a small number of serious violent and sexual...

  • Risk Management Information Systems
  • Risk Management Programme
    Risk Management Programme
    Risk Management is a research programme set up by the Geneva Association, also known as the International Association for the Study of Insurance Economics...

  • Risk management tools
    Risk management tools
    Risk Management is a non-intuitive field of study, where the most simple of models consist of a probability multiplied by an impact. Even understanding individual risks is difficult as multiple probabilities can contribute to Risk total probability, and impacts can be "units" of cost, time, events...

  • Risk register
    Risk register
    A Risk Register is a Risk Management tool commonly used in Project Management and organisational risk assessments. It acts as a central repository for all risks identified by the project or organisation and, for each risk, includes information such as risk probability, impact, counter-measures,...

  • Roy's safety-first criterion
    Roy's safety-first criterion
    Roy's safety-first criterion is a risk management technique that allows an investor to select one portfolio rather than another based on the criterion that the probability of the portfolio's return falling below a minimum desired threshold is minimized....

  • Society for Risk Analysis
    Society for Risk Analysis
    The Society for Risk Analysis is a multidisciplinary and international organization providing an open forum for anyone interested in risk analysis. The concepts of risk have challenged the minds of many of history's greatest mathematicians and scientists. Covello and Mumpower traced the roots of...

  • RiskLab
    RiskLab
    RiskLab is a laboratory that conducts research in financial risk management. The first was created in 1994 at Eidgenössische Technische Hochschule Zürich in Zurich, Switzerland. In 1996, another one was created independently at the University of Toronto, this time sponsored by the private company...

  • Social risk management
    Social risk management
    Social risk management is a new conceptual framework assigned and designed by the World Bank. The objective of SRM is to extend the traditional framework of social policy to the non-market based social protection of which its three primary strategies include prevention, mitigation, and coping. ...

  • Social vulnerability
    Social vulnerability
    In its broadest sense, social vulnerability is one dimension of vulnerability to multiple stressors and shocks, including abuse, social exclusion and natural hazards. Social vulnerability refers to the inability of people, organizations, and societies to withstand adverse impacts from multiple...

  • Substantial equivalence
    Substantial equivalence
    Substantial equivalence is a concept, developed by OECD in 1991, that maintains that a novel food should be considered the same as and as safe as a conventional food if it demonstrates the same characteristics and composition as the conventional food. Substantial equivalence is important from a...

  • Supply Chain Risk Management
    Supply Chain Risk Management
    Supply chain risk management is a discipline of risk management which attempts to identify potential disruptions to continued manufacturing production and thereby commercial financial exposure.- Supply chain exposures :...

  • Vulnerability assessment
    Vulnerability assessment
    A vulnerability assessment is the process of identifying, quantifying, and prioritizing the vulnerabilities in a system. Examples of systems for which vulnerability assessments are performed include, but are not limited to, information technology systems, energy supply systems, water supply...

  • Global Risk Forum GRF Davos


Further reading

  • Airmic / Alarm / IRM (2010) "A structured approach to Enterprise Risk Management (ERM) and the requirements of ISO 31000" http://www.theirm.org/documents/SARM_FINAL.pdf
  • Hopkin, Paul "Fundamentals of Risk Management" Kogan-Page (2010) ISBN 978 0 7494 5942 0
The source of this article is wikipedia, the free encyclopedia.  The text of this article is licensed under the GFDL.
 
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