From an insurance perspective, risk is the possibility of loss or injury, and the uncertainty of outcomes. To understand risk, you must understand the difference between possibility and probability.
- Risktech – Risktech is the technology used in the risk management environment to help mitigate risk faced by people and organizations.
- Insurtech – Insurtech, similar to risktech, is the technology used in the insurance environment to mitigate risk and improve the facilitation of insurance transactions.
Risk management is the process of avoiding and reducing the negative possibility of risk. The risk-management process uses probability to determine if a risk is acceptable. For example, there is a 10% chance that a driver will cause an automobile accident. The driver may decide this risk is too high and will choose to use public transportation rather than driving.
There are two types of risk management:
- Enterprise-Wide Risk Management (ERM)
- Traditional risk management
Enterprise-Wide Risk Management (ERM)
Enterprise-wide risk management, abbreviated as ERM, is an approach to managing a business’s risks and opportunities. The purpose of ERM is to maximize shareholder value by managing and exploiting risks and opportunities.
- Under an ERM structure, all levels within an organization are responsible for risk management. ERM encompasses all stakeholders within the organization, as opposed to traditional risk management, in which the risk-management department is responsible for managing risk. Stakeholders include employees, management, directors, and shareholders.
- This is often referred to as “holistic” risk management because it accounts for all aspects of risk, both the downside and upside of risk. Whereas traditional risk management only focuses on hazard risk.
- This is typically used to manage regulations in the United States and Europe, especially after the financial crisis of 2008.
Traditional risk management
Traditional risk management is an alternative to ERM. Traditional risk management was the preferred risk management-technique before ERM; traditional risk management is now considered outdated.
- Traditional risk management only focuses on managing pure risk loss exposures, with the primary focus being hazard risk. Traditional risk management is primarily focused on a historical view of risk, using root cause analysis to determine the underlying cause of a loss.
- In contrast, Enterprise-wide Risk Management is designed to encompass both pure and speculative risk in order to manage all risks faced by an organization including hazard, operational, financial, and strategic risk. ERM is the preferred risk-management technique.