What Is Risk Management and Why Is It Important?

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Risk is probably one of the leading causes of uncertainty in any organization.

That is why, nowadays, more and more companies have a renewed focus: to identify and manage risks before they even affect the business.

To help us know more about the importance of risk management, we asked experts to share their insights.

Table of Contents

Dan Gallagher, MBA, CLU, ChFC, CBI

Dan Gallagher

Personal Finance Expert, ScoreSense |
Author, The Secrets of Successful Financial Planning: Inside Tips from an Expert

Risk Management is a general term applied to personal finances and to all businesses, from insurance to distributing shoes.

It refers to the mitigation of possible—over time, inevitable—loss from financial, physical and other costly threats to an enterprise and to a person

Risk Management involves two main types of actions taken to defend against the adverse effects of the threat:

Risk reduction

One can physically reduce risk, such as choosing to climb a synthetic sport cliff rather than a natural one; using safety lines rather than free climbing. Another example is to install monitoring equipment in a warehouse rather than to rely only on locks and a patrol; also dispersing inventory at multiple locations, rather than risking a fire destroying all inventory.

One can diversify to reduce one’s own risk: Another example is diversifying a portfolio into many asset classes so that changing economic conditions cannot devastate a large part of the portfolio concentrated in one or two asset classes. So, risk reduction can be physical or organizational, as with seeking many investors even if one could afford the outlay to be the only owner of a startup.

Risk transference

Insurance, guarantees, and warranties can be obtained to compensate one for the financial effects of a loss. A good example is Key person disability coverage in a business: If a crucial employee cannot function, the policy provides cash to engage an executive search firm to find a replacement.

Because there are numerous categories of risk associated with a vast range of endeavors, the specific techniques vary with the characteristics of the categories.

For example, a portfolio can have demographic risk (changes in demand associated with a change in the types of buyers in the population), credit risk (default potential that primarily affects bonds but can affect stocks too), supply risk (interruptions in labor or other inputs for the manufacture of a product) and many more.

So, each category of risk requires different actions to either actually reduce the likelihood of loss or to hedge the monetary effects of adverse events.

Matthew Iamelli, ACI

Matthew Iamelli

President, MRIA Group

While seemingly a simple question, the answer is far more convoluted than most may realize.

Risk management is anything and everything someone or something may do to minimize risk

Now, what exactly is a risk? Well, the risk is ultimately the chance of something, in industry terms a ‘peril’, causing some sort of financial loss. Losses, quantified in financial terms, can be the reason many business owners stay awake at night. Risk management is ultimately the plan to mitigate or entirely remove those risks altogether.

Managing risk is not a new concept. The small bakery in Vermont who sends an employee out a few times a day to shovel off its walkway and toss down a handful of sand is managing its risk just as much as our countries top defense contractors who form their own insurance companies simply to lay off most of their risks on the reinsurance market are both managing risks. The size, scale, and methods used are unique to each entity.

Decision-makers look at their business and determine which peril exists for them that could cause them a financial loss and then figure out the cost of minimizing or eliminating that risk.

Often times, attorneys, accountants, even actuaries are involved in this process. They isolate a risk, determine how wide the range of loss could be, from a few hundred dollars to a worst-case scenario, hundreds of millions, and apply confidence levels for those ranges occurring.

Let’s say a loss of “X” has a 90% chance of happening, think workers compensation losses or perhaps the auto physical damage losses on a fleet of trucks, vs a “Y” and its 10% of an earthquake swallowing your entire factory. All of these factors get boiled down and mulled over and the end result is the best estimate for a dollar figure on losses.

Care for a unique example? I had a client who formed their own insurance company to assume the risks of its multiple entities. One of those entities was a hospital that owned the attached parking garage.

Now, the entity looked at the cost it was paying for garage keepers insurance policy and thought it may be too expensive. So, they totaled up the number of spaces they had, found the average cost of the vehicles and amount that would be regularly parked there and decided that should some catastrophic event take place and all the cars are totaled, the top level’s car *could* be saved.

Now, to think that a multi-level garage could collapse and all the cars from the top level will survive unharmed while the middle and bottom layers would be crushed is a unique take. It is worth mentioning I never did hear how they would have safely removed that top layer of cars without damaging them but that’s neither here nor there.

The point is this, insurance can be cheap or expensive depending on how you look at something and how you value the potential for loss. Anything you don’t purchase insurance on you are effectively self-insuring. You can formalize that process by starting your own insurance company or you can simply not purchase insurance altogether, meaning that if you suffer a loss it comes directly out of pocket.

Risk management is largely the delicate balance between buying the insurance and ‘rolling the dice’ on your risks.

Risk management isn’t all about purchasing insurance. Often times, it involves looking over the companies internal controls, safety protocols, workflow, and making minor changes that don’t cost all that much.

It’s the overall management of the entire risk portfolio, both internal and external perils, that have given rise to companies paying huge salaries to their Chief Risk Officers (CRO’s) and rightfully so.

Saving company money by knowing which risks is can assume and which risks must be insured by a third party can quite literally make or break a company.

Rob Stephens

Rob Stephens

Founder, CFO Perspective

Risk management means balancing the impact of losses with the costs of preventing those losses and the opportunities of taking risks

The loss may be directly financial, like fraud or theft. It may be the loss of assets like having a building burn down. The most valuable assets to protect are your reputation and brand. You can replace financial assets with insurance. Other assets cannot be replaced, so you have to take strong action to protect them.

Risk can never be entirely eliminated.

You can take steps to reduce the impact or likelihood of a loss, but you can rarely eliminate risk. Risk management often involves incurring a small expense now (for example: buying insurance, using safety equipment, or implementing internal controls and audits) to reduce the potential for large losses.

Risk management is not just defensive. Opportunities often involve risk. You want to capture the opportunity while avoiding or mitigating the losses.

Joe Bailey

Joe Bailey

Business Development Consultant, My Trading Skills

Risk management is the identification, assessment, and control of factors that pose a risk to the growth and long-term stability of a company

Risk management is essential for any business because it helps the company set achievable objectives, and identify the influences that might jeopardize the achievement of these set goals. Once the risks are identified, the company can set up strategies of mitigating these risks, and this will help it gain a competitive advantage, and boost its long-term sustainability in the market.

Without risk management, the company will be unable to set the right objectives causing the company to lose direction, and eventually money.

Risk management is essential to minimizing current and future uncertainty in the running of a business allowing for proper setting of objectives, effective forecasting, and long-term sustainability as the potential risks would have been identified, assessed, and properly mitigated within a good time.

Jeff Smith

Jeff Smith

President, Castaline Insurance Agency

Risk Management is ultimately about peace of mind. We want to know that all the hard work we’ve put in over the years isn’t in vain. That our financial futures won’t be in jeopardy if something terrible were to happen.

But when most people hear the words “Risk Management”, they tend to instead think of “Risk Avoidance”. That can be a costly mistake. While avoiding risk altogether sounds great, it requires an unreasonable amount of upfront money.

Typical ways to avoid financial risk include purchasing insurance, warranties, retirement plans, etc. But in order to obtain zero financial risks, we would need to insure against every potential financial loss, big or small. We would purchase warranties on every device, have zero insurance deductibles, and select investments with guaranteed returns. That’s expensive, both in upfront cost and opportunity cost.

True risk management is important and means allowing for smaller amounts of risk while insuring against larger risks

Not having a warranty on your air fryer won’t ruin you financially. Not having insurance on your home will.

When managing your personal risk, you first need to understand your tolerance. How comfortable are you with risk? I’m not talking about emotional comfort, but financial comfort. Will having a $500 health insurance deductible break the bank if you were to get hurt? What about a $2,500 one? Do you have an emergency fund?

Once you understand your risk tolerance, go ahead and take risks up to that level of tolerance. You’ll begin saving money right away. Have a $50 car insurance deductible? Raise it to $500 if that makes sense. Cancel the warranty on your iPhone. Take a fresh look at your investments.

Now find other areas of your life that are exposed to large losses and make sure you’ve managed those risks, up to your tolerance level as well. Some areas that are overlooked are life insurance and disability.

When you’re done with your personal risk management plan, you’ll be able to feel peace of mind right away, knowing that your financial future is protected against large losses while not wasting money protecting against small ones.

Felix Bertram

Felix Bertram

Founder, Bertram Solutions, LLC

Most people make many decisions every single day. Each of these decisions is the conscious choice between multiple outcomes. Unfortunately, most often, we can’t be sure that these outcomes will materialize. Instead, failure is probable, and we need to consider the consequences of failure in our decision-making process.

In applying risk management in our decisions, we need to balance the expected benefits with the possible risks carefully

The techniques used are very similar across all aspects of life, investing is one of them.

Risk management has been around for a long time, but the mathematical concepts come from an unexpected field: gambling.

The field of Game Theory lays the mathematical foundation for optimizing a gambler’s return through risk management. In a casino world, the most critical aspect of risk management is simple: to continue playing, we need to avoid going bust under all circumstances. But this doesn’t mean that we should simply minimize our risk.

Instead, there is an optimal amount of risk to take, which is dependent on the expected returns and their variability. In mathematical terms, the Kelly Criterion defines the optimum amount of risk to take, calculated from the average returns, and their standard deviation.

In investing, the same rules apply. Even though we like to believe that markets are not random and that with smart choices, we can control our fate, there are good reasons to apply Game Theory nonetheless.

The Efficient Market Hypothesis suggests that we can’t predict markets and that therefore, random stock picking will, in the long term, lead to results identical to those of the most sophisticated financial professionals. Even though markets are far from perfectly efficient, showing anomalies that are exploited by quantitative analysis, these anomalies are quite small and easily drown in random noise.

While a gambler’s only goal is to continue playing, an investor’s objectives are more complicated. Young parents need to save enough money for their children’s education. Empty nesters need to pay off their mortgage and make sure their nest egg grows enough to support their retirement. Retirees worry about recession risk and outliving their savings.

Achieving these objectives requires not only a good understanding of investment returns but also sound risk management. The process of Financial Planning helps to balance returns and risks, tailored to an investor’s life plan.

But how can we plan for an uncertain future? As we cannot predict the future, the industry-wide accepted method of risk management involves a virtual casino.

The central element of software packages used by Financial Planners is to run Monte Carlo Simulations. These simulations use randomized returns, to create a large number of parallel universes, and estimate the likelihood of achieving the investor’s goals.

Concluding, there is a simple roadmap for risk management:

  • We determine the maximum amount of risk we can stomach.
  • We optimize our exposure to risk, such that the likelihood of success is maximized, without violating our risk limits.
  • To model an uncertain future, we use random processes.

Nance L. Schick, Esq.

Nance-Schick

Lawyer & Mediator

Risk management deals with losses, in terms of money, time, energy, relationships, opportunities, and more

I help defend claims against these corporate clients, and I bring matters to resolution. But we go beyond the individual cases. My clients understand that the best risk management strategies include education and training so that their employees and representatives minimize the chance of loss.

We work on having productive conversations regarding gender, race, religion, and disability. We learn about developments in safety, technology, and neuropsychology, so we can continuously create workplaces that evolve with the ever-changing needs of the marketplace and all the people that drive it, from customers to employees, manufacturers to marketers.

Monica Eaton-Cardone

Monica Eaton-Cardone

Co-Founder & CEO, Chargebacks911

Risk Management can refer to any strategy that businesses use to mitigate risk

As our digital world is everchanging, fraudsters are given new security vulnerabilities that their victims don’t even know about until after an attack. In order to avoid losing money and inventory, it is critical to stay on top of this ongoing issue.

The most important element of risk management is understanding where these threats are coming from.

Risk factors will vary from one business to another based on location, vertical, and countless other factors. With credit card fraud, for instance, card scheme chargeback reason codes can help to a certain extent, as they identify the reason behind a transactional dispute and can give you a better understanding of your customers. However, they’re not very reliable, as many disputes are actually cases of friendly fraud.

Thus, you need to dive deeper to identify risks at their source. This may call for specialized professional assistance, given that the average merchant has limited insight on industry data.

Once you pinpoint key threat sources, you should then outline general risks, their characteristics and how they affect your organization.

Once you define the primary source of the problem and deploy necessary solutions to address it, you should routinely monitor important data by giving members from your team certain tasks to complete.

You can assign them to audit business processes for errors, contact customers regarding service performance, provide risk training and perform safety checks. Your team must continue to track and prioritize risks that greatly impact your objectives.

Gus Cicala

Gus Cicala

CEO, Project Assistants

Risk management is a framework that allows you to identify risks, evaluate priorities, and plan a way to mitigate those them

The main way to evaluate risks is to compare their impact and probability. Organizations with a risk management process generally know to focus on high-impact, high-probability risks. The most overlooked risks, then, are ones with disastrous impact but low probability, particularly when the cost to mitigate this risk would be very low.

People who offer simple measures to patch up high-impact, low-probability risks generally get looked down on as fear-mongers, or worse: insurance salesmen. Just like a healthy parent with young kids can ensure their family’s future with an expensive life insurance premium, there’s a lot of low-hanging measures businesses could take to prevent disaster-level improbabilities.

Nina LaRosa

Nina LaRosa

Marketing Director, Moxie Media

Risk management is a process where companies predict, assess, and plan to address risks that could threaten their business

These risks could include everything from internal threats and issues to legal liabilities, natural disasters, financial instability, worker accidents, and more.

Risk management is important for businesses because it helps to establish goals and processes for the future.

If you make goals without considering possible risks, you may face serious issues without a plan in place to address them.

A JSA, or a Job Safety Analysis, is a great way to conduct risk management for on-the-job safety.

A JSA allows you to anticipate possible safety concerns, minimize or eliminate hazards, and be prepared to respond to incidents. Just follow these 3 steps:

  • Outline the steps of a job.
  • Review each step for safety issues.
  • Make a plan to minimize those risks.

Performing a JSA can lower your company’s risk of experiencing incidents that could injure workers, customers, or visitors. With the right training, you can make sure JSAs and other forms of risk management become the norm at your organization. To start, train supervisors and employees on how to perform JSAs, and make these a periodic part of their workflow.

Kevin Kleinman

Kevin Kleinman

Financial Advisor, Blue Haven Capital

Risk management is the practice of a pre-determined plan that controls for loss of principal on investments

It is a very important component of any investment strategy because it is your buffer against extreme losses. There are a number of different risk management systems investors can use. Here are two of my favorites:

Small size investing

The best way to limit potential losses on a risky investment is to limit the amount of money you put into that investment in the first place. For example, take bitcoin, which has become an extremely popular investment vehicle. Bitcoin has gone up more than 1000% over the last few years, but it has also seen multiple declines of 50% or more in that same span.

If someone wants to invest a portion of their assets to bitcoin to try and capture the upside potential, they should do so with no more than 1-2% of their portfolio. That way if they end up on the wrong side of a 50% drop in Bitcoin’s price, the impact is only 0.50-1.0% on their total portfolio value.

Non-correlated investing

Another effective form of risk management is to own various investments that are not correlated. Such as pairing technology stocks with utility stocks. Technology companies are generally regarded as the riskiest type of stock in the market, while utilities are regarded as the safest. The two tend to benefit from different cycles in the economy.

Tech stocks do best in a growing economy, while utility stocks will hold up better in a contracting economy. Investors often make the mistake of owning different stocks within the same sector and thinking they are managing risk. For example, someone who buys Apple, Microsoft, and Google should expect all three of those investments to perform very similarly and have a high correlation.

Sean Clancy

Sean Clancy

SEO Director, Edge Online

In other industries, such as venture capitalism, the focal point of risk management is about optimizing your success to failure ratio. It’s mainly a matter of strategic decision-making and smart resource allocation to reduce the harm created by shock events.

Things are a bit different in our industry. The remit of risk management focuses on multiple, specific areas spanning several departments, not just the business operations team.

The content team tackles reputation and brand risk — helping to secure a brand narrative that is profitable and ethical

The developers protect us from malware and work with the ad team to minimize ad fraud. In the area of SEO, part of my role, in particular, is to protect our google results from spammers and trolls by ranking high-quality content or brand positivity.

The cost of poor risk management in digital marketing is catastrophic. If clients become a victim of brand attacks and then they view our own brand negatively, the reliability and trust value of our company would plummet.

Schimri Yoyo

Schimri Yoyo

Financial Advisor | Insurance Agent, Auto Insurance Companies

As defined by the BusinessDictionary.com, risk management is “the identification, analysis, assessment, control, and avoidance, minimization, or elimination of unacceptable risks.”

Risk management is the development of strategies that will minimize your exposure to financial loss and ruin when unforeseen events occur

In other words, it is proactive damage control with your wealth. For an individual, risk management begins with a solid financial plan. The planning process will help prioritize your goals and evaluate your assets as well as identify the greatest threats to them in the case of an unexpected crisis.

Once your planning needs have been adequately assessed, products such as a succession plan, a last will and testament, and disability insurance and life insurance policies may be utilized as a part of your risk management strategy.

Though none of us can predict the future, all of us can prepare for it by implementing sound risk management principles. Having such preparations in place will protect your goals, dreams, and financial well-being when the inevitable calamities of life happen.

Chelsea Brown

Chelsea Brown

Certified Cyber Security Consultant | CEO & Founder, Digital Mom Talk

Risk Management is the process in which a business determines the cost of a certain problem, issue, product or threat to the company, what it will cost the company and what it will cost the company to prevent it from happening.

An example of risk management would be a company estimating the cost of a data breach resulting in the loss of sensitive client information like names, phone numbers, email addresses, etc. and the cost of a lawsuit or settlement as a result.

Risk management is important in cases like the example given above because it can potentially save a company hundreds of thousands of dollars. It also can help the company protect itself from potential issues that are not perceived as a threat right away.

Gareth Davies

Managing Director, DSM Stainless Steel Products

Risk management is a great way to keep everything on track and safe for your employees

Often it’s a legal requirement and so it must be done, other times it simply acts as best practice and creates an ethical bond. In our manufacturing facilities, there are a number of risks that we have to take into consideration. One of which is the heavy machinery moving or falling because if this were to happen, our team could be trapped under it or hurt themselves.

From a business perspective, if you haven’t performed a risk assessment you might be liable for injuries and damages which means that you could have to pay out a lot of money. From an ethical point of view, you need to be doing a rick assessment whether you think it’s necessary or not. Putting your members of staff in danger isn’t acceptable.

Carsten Schaefer

Carsten Schaefer

Founder & CEO, Crowdy

Risk management is the process of identifying potential risks to your business

These risks can be in terms of finances, security, data, poor management, legal issues and more. Risk management should be incorporated into your business plan, no matter the size of your business or the niche you operate in.

Risk management is important if you want to predict issues before they happen. Unfortunately, you can’t prepare in advance for things you don’t know will happen, so my advice is to always have a business mentor. They will be able to tell you what you should pay attention to and what the biggest risks are in advance.

Adam Hempenstall

Adam Hempenstall

CEO, Better Proposals

Risk management is the process of identifying, documenting and preparing for risks in a certain organization

For our company, this process is vital because it lets us prepare for the troubles ahead, whether it’s about funding, competitors, our website getting broken, servers getting hacked or something completely unpredictable.

The good thing is, I’ve been running this company for 10 years now, so I know what can happen and how things can go bad. I’ve been documenting all of the issues we’ve had so far and preparing for them diligently. If you don’t have this kind of experience yourself, it’s a good idea to join mentorship groups and learn from others in your industry.