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ABSTRACT
This research seeks to discover further theoretical base for the area of
Risk Management by incorporating aspects of Organization Behavior
Theory into the processes of risk identification and risk measurement.
This is done not only to help the individualrisk manager,but to a larger
degree to provide a base for the teaching of Risk Management in the
college classroom.A systems model by William G. Scott of a complex
organizationis adapted to the study of risk. The basic system and its
subparts are described and the goals of the system are related to the
general goals of the Risk Manager. Each subpart is then examined for
its contributionto the processes of risk identificationand measurement.
The interrelations between the subparts and the dynamic nature of
these interrelationsare noted.
Historically, the subject of risk management has been viewed as a threestep process consisting of recognition of risk, measurement of risk and
handling of risk. One description of the current process of risk management
is illustrated on the next page.'
Once these three steps of risk management were stated, the majority of
articles and texts on the subject then set about the task of finding the best
methods of carrying them out. In many works in the area of risk management, the first two steps are given only brief, cursory treatment.2 Risks
Darwin B. Close, Ph.D., CPCU is Associate Professor of Insurance and Finance in
The Ohio State University. He was Executive Director of the Griffith Foundation for
Insurance Education, 1965-69.
This paper was submitted in February, 1973.
1 Charles T. Bidek, unpublished research, The Ohio State University, January, 1972,
taken from an extensive survey of current literature in risk management.
2 For example in Risk Management and Insurance by Williams and Heins, one twenty
page chapter is devoted to risk recognition and measurement. Robert Mehr and Bob
Hedges devote three chapters in Risk Management and the Business Enterprise to these
subjects but cover many potential losses, leasehold interest, improvement and betterments, extra expenses, etc. almost completely from an insurance point of view.
Donald L. MacDonald, Corporate Risk Control, Ronald Press Company, 1966, has
nothing clearly identifiable as risk recognition and measurement. One minor section
titled "The Intelligence System" by implication is addressed to these areas.
The Growing Job of Risk Management, American Management Association, Inc.,
Times Square, New York, 1962, provides one case entitled "Alertness to Changing
Needs" and one article by A. J. Ingley on the "Problemsof Risk Analysis."
William M. Howard's casebook, Cases on Risk Management, McGraw-Hill, New
York, 1967, does not contain a single case on either subject.
( 435 )
436
The search
manageable
identified?
Yes
*
Can the risk be
measured?
No
Yes
Measuree
via least
criterion.
]tt
Handle
cost
..)Yes
aS
|
top
*No
Can the
risk
*
Can the
be
id
Stop
Sto
No
risk
economically
Yes
be
es
Yes
transferred?
nuac
Transfer
LT
No
Can combination
make handling
ble
No
0-4
ei
l~vauate ririoN
No
___
1ther
O
Yes
it feasible
desirable?
Yes
ombie
No
as reevaluation
a metho
provided
the
of handling
risk?
Yes
Source:
Charles T. Bidek
Unpublished Research
The Ohio State University
January 1972
are first classified, i.e., fundamental vs. particular, pure vs. speculative,
etc., and typically some schemes of risk recognition are described. The
insurance survey, insurance policy check list and risk-enumeration approaches are those most often described.
Risk measurement is often described in terms of probability distributions
and measures of variation, perhaps with some reference to utility functions
or indifference analysis accompanying the discussion.
H. Wayne Synder, ed., Risk Management, in the Huebner Foundation series, Richard
D. Irwin, Inc., Homewood, Illinois, 1964, has one page on analysis and one chapter
on evaluation.
Tom C. Allen and Richard M. Duval, A Theoretical and Practical Approach to Risk
Management, American Society of Risk Management, New York, 1971, devotes less
than one page to both topics.
Author Matthew Lenz, Jr., Risk Management Manual, Insurors Press, Santa Monica,
California, 1972, devotes one part of one small section, 19 pages, to identification and
another 14 pages to risk analysis out of almost 400 pages.
437
In any event, the brief treatment accorded risk recognition and measurement has been due to the rudimentary state of the art. There is, in fact,
little in the way of a theoretical base for risk management as a whole and
discussion, specifically of the topics of risk recognition and measurement,
has been entirely descriptive in the "how to do it," reporting sense of the
word. Teachers in the area have really had little to work with aside from
a simple "this is how it is done" approach.
One university recently dropped its course offerings in risk management
because of what was viewed as a lack of anything concrete to teach.3
This is why most texts pass quickly into the third step; that of handling
the risk. Here the authors are getting closer to firmer, more familiar ground
because it is only a short step to insurance. But even in this area, other
methods of handling risk: hedging, buy vs. lease, other contractual transfers
of risk, etc., are given short shrift. Once again there appears to be a distinct lack of much to say about these subjects, little in the way of theory
to be used either in the teaching of risk management or in its practice.
One text even defines the term risk management in a way that accommodates this state of the art. Mehr and Hedges define the term as "the
management of those risks for which the organization, principles, and techniques appropriate to insurance management are useful."4
As a result, the risk management works cited are about ten percent risk
identification and measurement and about 90 percent "here is how the
insurance mechanism works as the most effective way of handling risk."
Thus risk management becomes insurance oriented and emphasizes the
handling of risk.
One recent incident demonstrated this emphasis. The August, 1971
Annual Meeting of ARIA in Montreal presented a session termed "What's
New in Risk Management." This session was interesting and lively, but
it should have had a different title, more appropriately, "What Are the
Current Problems in Insurance Coverages for Larger Business Concerns?"
The topics discussed, "product recall" coverage for example, dealt almost
exclusively with the problem of securing appropriate insurance coverage
for unusual exposures. No new aspects in the areas of identification or
measurement were discusssed.
The major problem of risk management, then, appears to be related to
the lack of any underlying theory of risk management and so the historical
emphasis on insurance seems to be a nervous grasping for something concrete and explainable. The result has been many courses in principles of
insurance masquerading as courses in risk management, and many articles
about insurance topics which the authors have cloaked with a pseudo risk
management flair.
Perhaps the reason for this situation is the fact that the emphasis has
been upon "risk"rather than upon "management." Risks to the organization
3 University of Pennsylvania discussion with Dr. Dan M. McGill, Spring, 1972.
4Robert I. Mehr and Robert A. Hedges, Risk Management in the Business Enterprise (Richard D. Irwin, Inc., Homewood, Illinois, 1963), p. viii.
438
THE SYSTEM
439
THE GOAL OF
THE SYSTEM
0_ STABILITY
INPUT- IND|
8.1f
GROWTH
INTERACTION
C-The Physical Environmentof the Work Systems-the task environment where people, processes and equipment interface,
D -The Informal Organizations-the peculiar qualificationsand alterations of the formal organization so as to make it livable and
bearable,
E - The Structureof Status and Role-ExpectancySystems-literally the
effects of individuals on the formal organizationand how values
are built into the system.
Scott then described the goal of an organizationas being any one, or
combination of: (1) Growth, (2) Stability, and (3) Interaction.
These goals may be interrelatedor they may be completely independent.
Or they may be sequential, for example a short term goal may be growth,
then would come stability as a desired state. One of these goals, interaction,
refers to the end of providing a mechanism for association of members
from which they gain satisfaction. Scott interprets this as meaning that
any system which is dependent upon the properfunctioningof interrelated
parts must seek the interaction goal.6 This suggests that all organizations
have to be responsiveto the needs of their members.
The first two goals are perhaps of more direct interest to a risk manager.
First, he has a substantial interest in the stability of his organizationand
stability of his organizationcan be directly affected by his treatment of
B Ibid.,
p. 128.
440
la
T
ThRio
ZManager _
\Tmenfo
Oraniztio
INGROWNR
\eWr
ronment
STABEITV
441
Within the system he would view his job in relation to the various subparts. He would ask himself two questions:
1. How can my knowledge of this system and the individual sub-sets
help me perform my job more effectively?
2. How will the incidences of change in any one sub-part affect the
interrelations between the sub-parts?
In this paper the object will be to take the first steps toward utilizing
this systems approach for risk management. The intention is not to explore
exhaustively the aspects described above but rather to illustrate how each
of the steps subsequently described can be used in risk management.
But how can he use the system? The risk manager should begin by
attempting to identify and classify risks in relation to the sub-parts most
directly affected. This suggests that an internal classification of risks might
be more helpful than some more familiar dichotomy such as fundamental
vs. particular, pure vs. speculative, etc. It would seem logical to state that
if those risks affecting each part are identified, then the risk manager has
gone a long way toward identifying the risks acting upon the system.
Simply put, the risk manager tries to identify those risks which affect each
sub-part. The sum of the risks affecting each sub-part will become the
first total of risks impinging upon the total organization.
A-The
Individuals
442
443
444
job, the man, and the equipment would lead to job specialization, job
simplification, and logically, to greater efficiency. Taylor's emphasis upon
the physical environment of the job points out a natural area of interest
to a risk manager.
Two aspects are immediately evident; first, the industrial safety engineering considerations and secondly, the concepts of the flow chart as advanced
by Ingly.'5 Both of these ideas arise logically from the risk manager's
interest in the physical environment of the work.
In relation to safety engineering, Brereton and Peterson describe specific
methods of searching out and identifying risks in the physical work setting
and state them in the form of guiding principles of safety management.'8
The first principle: "An unsafe act, an unsafe condition, an accident-all
are symptoms of something wrong in the system." 17 An accident suggests
that a risk was not identified and that the risk manager has had a failing,
large or small as it was. This is true because the function of job safety must
be performed by someone or some department and part of a risk manager's
responsibility must be to observe these results.
The function of safety engineering is to define and to locate these
operational errors, whether they occur because of poorly defined responsibilities, organizational deficiencies, inadequate planning, or imperfect
tool or process design. Brereton and Peterson believe that each accident
opens a window through which the system can be viewed; that different
accidents may indicate the same or similar factors responsible.
Certainly all risk managers in organizations where machinery is used
must consider employee safety as one of their major concerns. This is one
area in which reducing dangers reduces risks. The savings in human lives
and productivity make this job most important.
Equally rewarding are endeavors at risk identification which follow
Ingly's ideas of the flow chart method of risk management.'8 Ingly believed
that the risk manager should diagram the entire operations from initial
acquisition of raw materials, through the processing and marketing to the
final use of the product by the consumer. Such a diagram would indicate
bottlenecks and other possible risks. He defined the measurement of risk
as being the costs associated with elimination of these bottlenecks.
Ingly believed in physical inspections of the process flows as an important adjunct to flow charting. Visual inspections are always advantageous.
Such an approach, somewhat akin to current management concepts of
critical path analysis, is of great importance exactly because it focuses
attention on critical processes, critical points in processes, and critical
people performing them. The risk manager will find this area a fertile one
15 A. J. Ingly, Corporate Risk Management Insurance Series 112, New York American
Management Association, 1956, p. 3.
16 Philip R. Brereton and Daniel C. Peterson, "Safety Management for the Risk
Manager," Risk Management, February, 1971, p. 31.
7 Ibid., p. 31.
445
Informal Organization
446
and Role
447
448
449
by the subparts as each reacts to the new strain caused by its connection
to the affected part. For example, new safety regulations may cause
changes in part C, which alters the job's prestige which alters that worker's
place in the informal organization.
RIGID FRAMEEXTERIOR
WITHELASTIC.
FLEXIBLE
CONNECTIONS
BETWEEN
THE SUBPARTS.
STRAININTRODUCED
ON SUBPARTC.
li,
TENSION
INCREASED
One can expect that a new equilibrium will develop within the confines
of the system. Even the periphery itself may well bend a little; however,
if it is assumed that the organization survives the change as a viable force,
one must assume that the perimeter remains intact. The risk manager now
must look at a new set of relationships, new connections between the parts.
It is precisely at this point that the systems approach to risk management
becomes of such great importance. Previously used methods of risk identification have been relatively static in their operation. Searching for risk
was like viewing one frame of a motion picture, a snapshot of the organization at one particular point in time and space. Emphasis was upon the
risk and not necessarily upon its effects on all parts of the organization.
450
Emphasis on one part created by some change could be handled but there
was no way to analyze the changing relations between the various parts
of the organization. Each change was handled as though it affected the
organization only through its effect on one part, thus the perception of
interdependency was missing.
This systems approach, with its emphasis upon inter-relations, gives
the risk manager a framework within which he can begin to assess the
effects of change upon an organization. It is, after all, dynamism which
creates risk and the systems approach lets the risk manager handle change.
What are the effects of a change in A on parts B, C, D, and E? The systems
approach provides a theoretical framework within which such questions
can be approached.
Conclusion
The systems approach to risk management is of value because of several
attributes. It focuses attention upon risk identification, a function long
neglected in the literature. It provides an emphasis upon the organization
rather than upon some artificial, external classification of risk. This approach
tries to classify risks by means of identifying those risks impinging upon
each of the subparts of the system. Such a classification makes sense
because the very nature of the process customizes the classification to the
specific organization served by the risk manager.
It is believed that by identifying the risks acting upon each subpart that
the risk manager has gone a long way toward identifying the risks acting
upon the whole. This seems logical since the whole, barring substantial
synergistic properties, would appear to be the sum of the parts.
Finally, the systems approach emphasizes the inter-relations present
within the organization, providing the risk manager with a framework
with which to measure the incidence of risks effect on the total organization. Dynamic conditions can be handled.
It has not been the aim here to describe exhaustively the risks affecting
each part but only to illustrate some obvious ones. The goal rather was to
describe the system and indicate how it can be used by a risk manager.
By concentrating upon the system, a risk manager has a new tool, a framework wherein his identification and measurement process can be attacked
more systematically, more logically, and more completely.