Page 54 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Unit 3: Managing Investment Risks

Of course, not all risks can be avoided. Notable in this category is the risk of death. But even Notes
where it can be avoided, it is often not desirable. By avoiding risk, you may be avoiding many
pleasures of life, or the potential profits that result from taking risks. Those who minimize risks
by avoiding activities are usually bored with their life and don’t make much money. Virtually
any activity involves some risk. Where avoidance is not possible or desirable, loss control is the
next best thing.

3.5.2 Loss Control

Loss control works by either loss prevention, which involves reducing the probability of risk,
or loss reduction, which minimizes the loss.
Losses can be prevented by identifying the factors that increase the likelihood of a loss, then
either eliminating the factor or minimizing its effect. For instance, speed and driving drunk
greatly increase auto accidents. Not driving after drinking alcohol is a method of loss prevention
that reduces the probability of an accident. Driving slower is an example of both loss prevention
and loss reduction, since it both reduces the probability of an accident and, if an accident does
occur, it reduces the magnitude of the losses, since slower speeds yield less damage.

Most businesses actively control losses because it is a cost-effective way to prevent losses from
accidents and damage to property, and generally becomes more effective the longer the business
has been operating.

3.5.3 Retention

Risk retention, as active retention or risk assumption, is handling the unavoidable or unavoided
risk internally, either because insurance cannot be purchased for the risk, because it costs too
much, or because it is much more cost-effective.
Usually, retained risks occur with greater frequency, but have a low severity.

Example: An insurance deductible is a common example of risk retention to save money,
since a deductible is a limited risk that can save money on insurance premiums for larger risks.

Businesses actively retain many risks—self-insurance—because of the cost or unavailability of
commercial insurance.
Passive risk retention is retaining risk because the risk is unknown or because the risk taker
either does not know the risk or considers it a lesser risk than it actually is.

Example: Smoking cigarettes can be considered a form of passive risk retention, since
many people smoke without knowing the many risks of disease, and, of the risks they do know,
they don’t think it will happen to them. Another example is speeding. Many people think they
can handle speed, and that, therefore, there is no risk.
However, there is always greater risk to speeding, since it always takes longer to stop, and, in a
collision, higher speeds will always result in more damage or risk of serious injury or death,
because higher speeds have greater kinetic energy that will be transferred in a collision as
damage or injury. Since no driver can possibly foresee every possible event, there will be events
that will happen that will be much easier to handle at slower speeds than at higher speeds. For
instance, if someone fails to stop at an intersection just as you are driving through, then, at
slower speeds, there is obviously a greater chance of avoiding a collision, or, if there is a
collision, there will be less damage or injury than would result from a higher speed collision.

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